Document of The World Bank Report No. 13298-PAK STAFF APPRAISAL REPORT PAKISTAN TELECOMMUNICATIONS REGULATION AND PRIVATIZATION SUPPORT PROJECT OCTOBER 18, 1995 Energy and Project Finance Division Country Department I South Asia Region CURRENCY EQUIVALENTS (As of June 1995) Currency Unit = Pakistan Rupee (Rs) US$I = Rs 31.0 Rs I = US$0.0323 Rs I = 100 paisas Fiscal Year (Government of Pakistan) Juli I - June 30 WEIGHTS AND MEASURES I meter = 3.28 feet I kilometer = 0.63 miles ABBREVIATIONS AND ACRONYMS BLT - Build Lease Transfer ECNEC - Economic Committee of the National Economic Council FAB - Frequency Allocation Board FTN - Federal Telecommunications Network GITT - Government Inspector for Telegraph & Telephone GOP - Government of Pakistan HF - High Frequency (3-30 MHz) ITU - International Telecommunication Union MOC - Ministry of Communications MOF - Ministry of Finance NTC - National Telecommunications Corporation PC - Privatization Commission PCO - Public Call Office PCS - Personal Communications Services PTA - Pakistan Telecommunications Authority PTC - Pakistan Telecommunications Corporation PTCL - Pakistan Telecommunications Company Ltd. PWB - Pakistan Wireless Board T&T - Telegraph & Telephone (Department) UHF - Ultra High Frequency (300-3000 MHz) VHF - Very High Frequency (30-300 MHz) VSAT - Very Small Aperture Terminal PAKISTAN TELECOMMUNICATIONS REGULATION AND PRIVATIZATION SUPPORT PROJECT Loan and Project Summary Borrower: Islamic Republic of Pakistan Beneficiaries: Ministry of Communications (MOC), along with Pakistan Telecommunications Authority (PTA) and Frequency Allocation Board (FAB) Poverty Categorv: Not applicable Amount: US$35.0 million equivalent Terms: 20 years, including 5 years of grace, at the Bank's standard variable interest rate. Commitment fee: 0.75% on undisbursed loan balances beginning 60 days after signing, less any waiver. Project The project components are as follows: (i) technical assistance, through a Description: technical cooperation arrangement to support PTA and FAB during their first year of operation; (ii) consultancy services to assist in the establishment of suitable long-term strategies regarding tariffs, demand management, quality of service and others to support the privatization of PTC; (iii) training of PTA's and FAB's staff; and (iv) hardware and software for an integrated radio spectrum management and monitoring system. Upon completion, Pakistan will have a complete regulatory system for the telecommunications sector, including an adequate licensing regime and radio frequency management. Project Benefits: The project is an attractive investment in basic economic management, leading to a more efficient telecommunications sector. The establishment of a transparent regulatory framework and competent regulators with adequate authority and known mandate is essential for the reform of the sector and GOP's privatization efforts. Private operators of telecommunications services would benefit from knowing the rules for tariff adjustments, interconnection, competitive behavior, licensing, etc., and this should encourage them to invest and expand services. The consumers would benefit from increased choice and competition in the provision of services, the establishment of quality of service standards, the consumer protection aspects of new legislation and the possibility to take their complaints to the regulator, PTA, in case an operator does not take adequate corrective action. The expansion and improvement of telecommunications services will contribute to economic growth and poverty alleviation. Proiect Risks: A delay in project implementation may reduce the project's usefulness to GOP in its privatization efforts. Further, GOP's maintenance of capable regulators and adequate funding arrangements for PTA and FAB are critical to ensure the efficient regulation and longer term benefits of the project. Estimated Project Costs ,, ,.,,,,, ,'',.'','.l' 00- B : ........ ........ ....... .... . 0 MOC Support to Sector Reform Program 0.2 0.2 0.4 51.3 Project Implementation Support 0.3 0.0 0.3 0.0 Subtotal: 0.5 0.2 0.7 27.8 PTA Type Acceptance Laboratory 0.5 1.3 1.8 71.4 Frequency Managment Equipment 1.3 3.3 4.6 71.4 Computers, Office Equipment and Vehiclcs 0.4 0.5 0.9 57.8 Land, Buildings, Air Cond. and Power Supply 1.7 0.2 1.9 9.0 Training 0.3 0.7 1.0 71.4 Technical Assistance 0.2 0.6 0.8 71.4 Subtotal: 4.4 6.6 11.0 59.6 FAB Frequency Management System 8.3 20.6 28.9 71.4 Computers, Office Equipment and Vehicles 0.7 1.0 1.8 58.2 Land, Buildings, Air Cond. and Power Supply 2.3 0.3 2.7 12.4 Training 0.5 1.2 1.7 71.4 Technical Assistance 0.7 1.8 2.5 71.4 Subtotal: 12.5 25.0 37.5 66.6 TOTAL BASE COST 17.5 31.8 49.3 64.5 Physical Contingencies 0.9 1.6 2.5 64.5 Price Contingencies 0.6 1.2 1.9 66.1 .........; i -0- - 0i: . - . .- . .......gi6 j: -0 TOTA ESIMTD RJETCOST .............4. Note: Totals may not be exact due to rounding. Local costs include about USS 14.3 million equivalent for taxes and duties. Project Financing Plan (USS Million Equivalent) t~~~~~~~~~~~~. . . .. .. ... .. .. .. . .. . -...i.;....-...-;. '' -i -0 i GOP 18.6 0.0 18.6 34.7 IBRD 0.4 34.6 35.0 65.3 TOTAL 19.0 34.6 53.6 100.0 Disbursement of Bank Loan (US$ Million Equivalent) ; R - R R B |~996 ;99 199 B 1999 Annual 0.X 9.5 20.5 4.2 Cumulative 0.8 10.3 30.8 35.0 Economic Rate of Return: Not applicable - jjj - PAKISTAN TELECOMMUNICATIONS REGULATION AND PRIVATIZATION SUPPORT PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. Loan and Project Summary i I. The Telecommunications Sector 1 A. Background 1 B. The Legal and Regulatory Framework 3 C. Telecommunications Service Providers 5 D. Supply and Demand of Telecommunications Services 7 II. Sector Issues 8 A. Regulatory Arrangements 8 B. PTC Tariffs 8 C. Satisfaction of Demand 10 D. Interconnection and Revenue Sharing Arrangements 11 E. Quality of Service 11 F. Licensing Regime 12 G. Management of the Radio Frequency Spectrum 13 III. Sector Reform 14 A. Sector Objectives and Strategy 14 B. PTC's Privatization 14 C. Proposed Regulation 16 D. The Regulatory Agencies 19 E. The Operators 21 F. The Bank's Role 22 This report is based on the findings of an appraisal mission that visited Pakistan in May 1994. The project team consisted of Mihkel Sergo (Task Manager, SA1EF), David Delgado (Telecommunications Engineer, IENTI), Syed Sathar (Consultant, SAIEF) and Ritin Singh (Consultant, SAlEF). Local and foreign consultants also assisted in the preparation of the project. Mr. Paul Isenman was the Director, Country Department 1, South Asia Region, and Mr. Per Ljung is Chief, Energy and Project Finance Division. The peer reviewers were Bjom Wellenius, Peter Smith (IENTI), Pierre Guislain (PSD), Khalid Siraj (ASTTP) and Mohsen Khalil (CIND3). - iv - Paee No. IV. The Project 23 A. Project Objectives 23 B. Status of Project Preparation 23 C. Project Components 23 D. Project Cost and Financing 24 E. Project Administration and Implementation 26 V. Project Justification 30 A. Project Benefits 30 B. Fiscal Impact 30 C. Project Sustainability 32 D. Project Risks 33 E. Performance Indicators 33 VI. Agreements Reached and Recommendation 34 Annexes 1 Telecommunications Laws and Regulations 35 2 PTC's Local Exchange Network 36 3 PTC's 1993-1998 Development Plan 37 4 Selected PTC Telephone Tariffs 38 5 PTC Revenue Analysis 39 6 Quality of Service Survey 42 7 Work Performed by Consultant's Consortium 44 8 Highlights of the 1995 Telecommunications Ordinance 46 9 Telecommunications Sector Policy Letter 48 10 Sector Reform Program Study 52 11 Organization Chart of Pakistan Telecommunications Authority 54 12 : Organization Chart of Frequency Allocation Board 55 13 : Project Description 56 14 : Terms of Reference for Technical Assistance through Technical Cooperation Arrangement 59 15 Training Program 64 16 Project Cost 68 17 : Project Implementation Plan 70 18: Procurement Schedule - Target Dates 71 19 : Estimated Schedule of Disbursement 72 20 : Disbursement Categories 73 21 : Project Performance Indicators 74 22 : Reporting Requirements 75 23 : Supervision Plan 76 24 : Documents in Project File 77 v - Paee No. Tables and Boxes in the Text 1.1 Chronology of Sector Reforms 4 1.2 PTC's Telephone Network Development 1990-1995 5 1.3 Private Sector Service Providers 6 2.1 Telephone Tariffs of Selected Asian Countries 9 2.2 Distribution of Bills and Revenues 10 2.3 Service Quality Performance Indicators 12 3.1 Rate Rebalancing in Canada 16 3.2 Commercial Value of Radio Spectrum 18 3.3 Institutions and Regulatory Responsibilities 19 4.1 Estimated Project Costs 25 4.2 Project Financing Plan 26 4.3 Summary of Procurement Arrangements 27 4.4 Disbursement of Bank Loan 28 5.1 Regulatory Systems and Private Sector Performance 31 5.2 New Zealand's Experiment in Radio Frequency Management 32 Map: IBRD No. 27286 PAKISTAN TELECOMMUNICATIONS REGULATION AND PRIVATIZATION SUPPORT PROJECT STAFF APPRAISAL REPORT 1. THE TELECOMMUNICATIONS SECTOR A. BACKGROUND 1. 1. Over the last ten years, Pakistan's economic growth has averaged about 5.5% per annum. However, the September 1992 floods were a major setback for Pakistan's economy. The real GDP growth rate dropped from an average 6.1% in fiscal 1978-92 to only 3.6% in fiscal 1992-95 with several key sectors (agriculture, mining, manufacturing and commerce) experiencing a significant slow down in their growth rates. The management of the fiscal policy has been difficult and, as a result, overall public sector borrowing, which had declined in fiscal 1991-92 to 7.4% of GDP, increased to over 9% in fiscal 1992-93. 1.2 The process of structural reforms initiated in the late 1980s was subsequently expanded into a comprehensive Bank-and-IMF-supported adjustment program in 1993. Under it Pakistan has made significant advances in reducing trade and regulatory barriers to private sector-led growth, although further deepening of reforms is required to improve competitiveness and diversify the economy's productive base. The Government's reform program emphasizes a redefinition of public and private sector roles, by limiting public sector activities to areas of substantial externalities and appropriate regulation of a more competitive environment for the private sector. This policy is reflected in GOP's privatization program for state-owned enterprises and the opening up of areas previously reserved for the public sector. For this purpose, GOP established a Privatization Commission (PC) to manage the privatization of state-owned enterprises. The Bank supports the PC's activities through consultants and other assistance financed by an Institutional Development Fund grant for these purposes and through advice provided by staff. 1.3 The 1980s was a period of rapid technological development and innovation in the telecommunications sector with the introduction of new products and services, such as cellular communications, telefax and high speed data communications. To keep pace with these changes, and meet the dramatically increased demand for service, a growing number of developing countries have restructured their telecommunications sectors. The objectives of these reforms have been to mobilize additional capital for investment. improve the performance of operating enterprises, and respond to rapidly growing pressures for better and more varied telecommunications services. The pace and scope of reforms has varied considerably. Chile, Argentina, Venezuela and Mexico have privatized their telephone companies. In the earlv 1990's, there was a partial privatization in Malaysia, liberalization of non-basic services in Indonesia, reorganization of telecommunications departments to state enterprises in Sri Lanka and Fiji, and decentralization of operations in India and China. The results have by and large been beneficial. However, the regulatory framework often fell short of what was needed for efficient competition, privatization and market liberalization. 1.4 The restructuring of Pakistan's telecommunications sector has followed similar trends. The Pakistan Telegraph and Telephone Department (T&T) was formed in 1979 separating the telecommunications and postal services. However, T&T's status as a government department under the Ministry of Communications (MOC) did not provide it with adequate financial and operational autonomy or incentives to efficiently operate and expand the telecommunications network. Realizing the importance of good quality telecommunications services as an essential business tool, GOP decided to further - 2 - restructure the telecommunications sector. A new state owned corporation, the Pakistan Telecommunications Corporation (PTC), was created out of T&T by the PTC Act of 1991 (XVIII of 1991) and PTC was licensed to provide basic telecommunications services. Improvements in the availability and quality of service have been made since PTC became operational, but it still has to become more consumer and commercially oriented and achieve acceptable service and efficiency standards. 1.5 GOP's main sector objectives are to improve service quality and operational efficiency, expand service and satisfy pending demand. Considering the unsatisfied demand for basic services, projected growth in demand, sector investment needs, and PTC's project implementing capabilities, the public sector alone is unlikely to achieve these objectives. The PTC Act of 1991 opened the telecommunications market for non-basic services to private service providers and MOC has granted operating licenses to mobile cellular, paging, card phone, data communication, and subscriber equipment companies. This trend is being continued by also getting the private sector involved in the provision of basic telephone services. 1.6 GOP's current strategy includes the restructuring of the telecommunications sector to improve its performance, thereby relieving a key constraint on the development of the economy; privatizing PTC to help inject private sector capital and skills into the main service provider; and redefining GOP's role from operator to, primarily, sector policy maker and regulator. For this purpose, GOP retained a consortium of consultants in 1991 to advise on the restructuring of the telecommunications sector. Based on the consortium's recommendations, GOP decided to pass the necessary enabling legislation to separate the sector's commercial operations from its regulation and to initiate the privatization process for PTC (Telecommunications Ordinance of 1994). With Bank's assistance, GOP has developed a strategy which aims at setting up the necessary regulatory framework for the sector and facilitating PTC's privatization. Two regulatory agencies, the Pakistan Telecommunications Authority (PTA) and the Frequency Allocation Board (FAB) have been established to regulate the sector and manage the radio frequency spectrum. 1.7 The consultants consortium also recommended that PTC be made into a company, Pakistan Telecommunications Company Limited (PTCL) under the Companies Act and that 26% of it's equity, including its management and operation, be sold to a suitable strategic investor, with additional equity sales from time to time as market conditions permitted. However, GOP initiated PTC's privatization before it was converted into a company by selling "PTC Vouchers", which will be convertible into PTCL shares once the necessary legal steps have been completed. The first voucher issue was made in August 1994 for about 2% of PTC's equity and brought in the equivalent of about US$100 million. Due to the success of this offer, another voucher issue of about 10% of PTC's equity was made in September 1994 and this provided GOP with an amount of about US$ 900 million. 1.8 This staff appraisal report provides the background and current status of the telecommunications sector, including regulations, service providers, demand and supply. It then addresses demand and tariff issues, service quality, interconnection and revenue sharing arrangements, licensing regime, and management of the frequency spectrum. The main elements of sectoral reform in response to these problems, the proposed project to set up the regulatory agencies, and how it addresses the sectoral issues are also described. ' In the staff appraisal report "PTC" refers to the existing state owned corporation and "PTCL" to the new company to be incorporated under the Companies Act which will enable the sale of equity to private investors. - 3 - B. THE LEGAL AND REGULATORY FRAMEWORK 1.9 The MOC is the main telecommunications policy maker, and until recently, the Govemment Inspector for Telegraph and Telephone (GITT), within MOC, was partially responsible for sector regulation. However, a number of other institutions also influenced the telecommunications policy and regulation, such as the Ministry of Finance (MOF), the Planning Commission, the PC, PTC, and the Pakistan Wireless Board (PWB). A description of their respective roles is given below. Regulatory Role of Institutions 1.10 The Telecommunications Ordinance, originally issued in July 1994 and repromulgated in July 1995, created two authorities, PTA and FAB, for the regulation of the sector. Howvever, until the new institutions are fully operational, the existing ones will still play a role in sector regulation: (a) MOC, as the relevant GOP ministry, sets policies, oversees and regulates the telecommunications sector, has the power to grant and revoke licenses, and currently represents GOP's interests in PTC. MOC is involved with PTC's annual development plans within the five year plan cycle along with the Planning Commission. In addition, MOC also approves tariffs. A representative of the MOC sits on the PTC board. (b) GITT, located within the MOC, is responsible for inspecting new and installed public or private network equipment, and to ensure that it complies with prescribed technical standards. In 1991, MOC further entrusted GITT with regulatory duties related to mobile cellular and payphone licenses, including service quality and tariffs. The GITT reports to the MOC. (c) PTC's regulatory role includes licensing of some services, type approval of equipment, establishment of standards through its Central Telecommunications Research Laboratories and representing Pakistan at intemational organizations such as ITU and INTELSAT. According to the PTC Act, PTC has the power to introduce regulations to carry out the provisions of the 1885 Telegraph Act. In practice, this has meant that in new service areas where there is no clear govermment policy, PTC has been allowed to license and regulate on an ad hoc basis. This is illustrated by the value added service markets in which PTC provides only fragmented services, yet allows no competition. (d) PWB manages the frequency spectrum: frequency assignment and licensing, monitoring and interference complaint handling, advising GOP on policy, and coordinating with intemational bodies on standards. The Board is headed by a PTC official who reports to the MOC. The management board of the PWB is composed of ministerial and user representatives, including the PTC, Civil Aviation, Railways, Defense Services, and the Pakistan Television Corporation. (e) MOF primarily reviews financial plans, tariff increases and PTC's five year development plans with the Planning Commission. MOF is also responsible for cash transfers from PTC to Government. A representative of the MOF sits on the PTC board. (f) Vigilance Committees were recently constituted at the divisional, regional, and national level by MOC to handle consumer complaints on PTC billing and delays in providing telecommunications services. These committees report to the MOC and their findings may also be submitted to the Ombudsman. -4 - (g) The Office of the Ombudsman, operating under the Wafaqi Mohtasib (Ombudsman) Act, investigates and rectifies acts of maladministration committed by government agencies and institutions. PTC currently falls under its purview. The Ombudsman has also been involved in telecommunications sector licensing policy. In 1990, after MOC issued two mobile licenses, the Ombudsman was asked by the third short-listed applicant to investigate the evaluation process. The Ombudsman found evidence of maladministration and recommended that MOC take remedial measures and as a result a third license was issued. 1.11 The telecommunications laws and regulations consist of: the Pakistan Telecommunications Act (PTC Act) of 1991, the Wireless Telegraphy Act of 1933 and by-laws issued thereunder, and the Telegraph Act of 1885 (as anended in 1975). The Telecommunications Ordinance of 1994, repromulgated in July 1995, amends previous acts. Annex I gives a summary of these telecommunication laws and regulations. A chronology of the sector development and its legal fratnework is given below: - .................. .. . . . .. ... . y. . - . . . ....n . . . ...,,., .,..,. , ;X,,:.,.,f.,.tX, : fif.,. 0. ;i.:..... . ., ........ ..... ..... .... 1885 Telegraph Act of 1885 is the primary statute of the Government of India and continues to be applied for govemn telecommunications in Pakistan. Grants the Federal Government with exclusive powers to establish and maintain all manner of services and products. 1933 Wireless Telegraphy Act applied to regulate the possession of wireless apparatus. 1947 Post and Telegraph Department established. 1951 Pakistan Wireless Board (PWB) established to perform frequency management functions. 1962 The Telephone and Telegraph Division separated from the postal service, creating the Pakistan Telegraph and Telephone Department (T&T) under the control of MOC. 1975 Telegraphy Act of 1885 amended. The post of Government Inspector of Telegraph and Telephones (GITT) created. 1979 Pakistan Telegraph and Telephone Department Order reaffirmns T&T as a department under MOC. 1983 The Office of the Ombudsman created to investigate and rectify injustices done to consumers by maladministration. 1990 T&T department reorganized as a statutory corporation, the Pakistan Telecommunications Corporation, (PTC) 100% GOP owned. 1991 Enactment of the Pakcistan Telecommiunication Corporation Act. 1991 Private sector allowed to develop cellular, paging, and other non-basic services. 1991 Government pledges to satisfy all pending demand for PTC services and improve service quality. "BLT-style" contract for the installation of 500,000 telephone lines signed and PTC investments increased. 1992 Consultants appointed for the planning and implementation of sector reform, including the privatization of PTC. 1994 Government passed a Telecommunications Ordinance (no. LI of 1994) to create the regulatory agencies, the Pakistan Telecommunications Authority and the Frequency Allocation Board, and for PTC's privatization. 1995 Governmnent repromulgated the Telecommunications Ordinance with some changes. - 5 - C. TELECOMMUNICATIONS SERVICE PROVIDERS 1.12 PTC was incorporated in January 1991 out of the former T&T Department. PTC has the monopoly to provide basic local and long distance telephone services and has a nationwide network and international facilities for voice, telex, telegraph and facsimile services. In addition to manufacturing activities through its participation in local joint ventures, Telephone Industries of Pakistan, Carrier Telephone Industries and Alcatel Pakistan Ltd., PTC has established a subsidiary, the Telecommunication Foundation, to compete in new markets with the private sector. This subsidiary can apply for licenses to operate services under similar terms and conditions as any private service provider. PTC's operating revenues in 1994 were about Rs. 26.4 billion and its operating income about Rs. 15.2 billion. 1.13 PTC's telephone network and switching capacity consisted of approximately 2,105 manual, analog and digital telephone exchanges with about 2,800,000 exchange lines by end-June 1995 and about 2,200,000 main lines in service, i.e. a capacity utilization of about 80%. Over 70% of the exchanges have been installed in the last eight years (Annex 2). In 1994, about 60% of the working connections were digital. The table below summarizes the network development since 1990. The accelerated development since PTC's incorporation in 1991 is notable. ::::~~~~~~~~~~~~~~~~ . . ....... .- ::.:.. .::: Table L2~RTC TleVhen." ""Na'" wket i~pet Q94 1990 1991 1992 1993 1994 1995 Exch. Line capacity ('00) 919 1,156 1,464 2,027 2,430 2,801 Lines in Service('000) 814 1,044 1,243 1,547 1,830 2,205 Populat.ion (millions) 1 09 112 117 1 20 1 22 1 29 Telephone Density (%)(a) 0.83 0.92 1.17 1.28 1.5 1.71 Pending Demand ('000) 730 720 670 344 293 209 Digitalization (%) 10 21 36 48 60 70 Number of Employees 49,717 54,084 49,522 51,589 47,766 52,116 Staff/1000 Lines in service 53 52.4 40 33 26 24 Public Call Offices 3,393 3,850 4,676 5,618 6,400 10,000 Source. PTC (data as of June of each year). (a) Lines in service per 100o population. 1.14 PTC's domestic long distance service is based on an analog network of about 6,500 km of high capacity microwave systems covering the major cities in the country. The network also includes over 2,500 km of analog coaxial cable, and 140/560 megabits/sec digital fibre optic links of approximately 3,000 km. Access to remote areas in the north and southwest is provided by a satellite-based domestic system and circuits leased from INTELSAT and INMARSAT. Telex services have declined significantly during the past decade as new technologies, such as facsimile, have been introduced. 1.15 PTC's international services are based on four INTELSAT Standard "A" earth stations providing direct access to about 40 overseas destinations. There are three international gateway exchanges (two in Karachi and one in Islamabad) with about 4,000 operating international circuits. International outlets to - 6 - neighboring India, Iran, and Turkey are via coaxial cable and microwave links. PTC also has access to a submarine cable network. 1.16 In 1989, the first operating license for paging services was issued to a private company. Following the 1990 restructuring of the sector, operating licenses to cellular, paging, data transmission and card phone companies were granted. The cellular licenses granted to PakTel (Cable & Wireless, UK), and Instaphone (Millicom, Comvik and Arfeen) have a fifteen year exclusivity period. Despite this exclusivity period, a third license was granted to Pakistan Mobile Cellular Ltd., which recently started operations. Paging licenses have been issued to fifteen companies but only one, Digital Communications Ltd., is in operation with a ten year exclusivity period. Its network suffers from poor coverage, with service offered only in the Karachi and Islamabad/Rawalpindi areas. In July 1992, MOC issued 20 licenses for the provision of card phone services. Three companies are currently in operation nationally with a total of about 8,300 card payphones competing with PTC's about 10,000 public call offices in 1995. 1.17 There is no central record of leased circuit subscribers. PTC is currently the major authorized public packet switched telecommunication network operator, with 200 nodes, of which about 100 are occupied. Several other organizations, including the Water & Power Development Authority, Oil & Gas Development Corporation, Pakistan Petroleum Ltd., and Pakistan Railways operate extensive private networks using their own plant and equipment, which are not interconnected. In addition, there are a number of private licensed systems, using mainly radio communications and operated by companies such as Sui Gas, Pak Arab Refinery, etc., which are not connected to the public switched network. Currently, only one private data communication operator (Telecommunication Foundation) offers data communications services. Many companies have applied for licenses and await Government approval. There are currently no value added services in Pakistan (the mobile operators offer voice messaging in their service packages). Fourteen companies have applied for licenses to provide Voice Mail services. Applications have also been invited for audiotex information and trunked radio services. Proposals for a domestic satellite for communication and broadcasting is under consideration. The status of private sector service providers is summarized in below: Service Company No. of Subscribers Year of License Operation Paging 1. Digital Comm. 9,500 1989 1990 Cellular 1. PakTel 20,000 1990 1990 2. InstaPhone 10,000 1990 1990 3. Pakistan Mobile 4,000 1992 1993 Cellular (PMCL) Card Payphones 1. Telecom Foundation 7000 phones 1992 1993 2. Telecard 800 phones 1992 1993 3. Telefon International 500 phones 1992 1993 Data Transmission 1. Telecom Foundation 30 1992 1994 Voice Mail Service 15 companies have applied for license 1.18 Significant progress has been made towards liberalization of the market for customer premises equipment in Pakistan. Customers can purchase PBXs, modems, and handsets from a variety of suppliers and, provided they have been type-approved, connect them to the publicly switched network. The supply of the first telephone currently remains a PTC monopoly. Moreover, the responsibility for setting technical standards and granting type approval of equipment also resided within PTC. D. SUPPLY AND DEMAND OF TELECOMMUNICATIONS SERVICES 1.19 After the 1990 corporatization, and on GOP's directive, PTC embarked on an ambitious expansion program. Annex 3 describes PTC's development program prepared for GOP's Eighth Five Year Plan 1993-1998. In FY92-93, PTC undertook an 800,000 line (400,000 under supplier credit of a 'BLT" type) investment program and an additional program for 500,000 lines (100,000 "BLT") in FY93-94. This increased PTC's exchange capacity from about 1,460,000 lines in 1991 to about 2,800,000 by mid-1995. The connection of new subscribers has, however, lagged the installation of new lines. In mid-1995, PTC had about 2,200,000 subscribers, a 1.71 % telephone density. While this penetration is relatively low, it is a marked increase from the 0.8% density of 1990. 1.20 Telephone service is concentrated in major cities. It is estimated that 90% of PTC's telephone lines are installed in urban areas. The metropolitan areas (Karachi, Lahore, Islamabad, and Faisalabad) constitute 33% of Pakistan's total population and yet they have 63% of the lines in service. There are approximately 29,300 villages with a population in excess of 500 people according to the 1981 census. These areas are served by about 1,250 manual exchanges with a capacity of about 110,000 lines, and about 10,000 Public Call Offices (PCOs). The telephone density in these areas is only about 0.13 %. 1.21 The accelerated expansion in recent years has allowed PTC to connect most of the subscribers waiting for service. With the installation of new lines, pending demand fell from about 670,000 in 1991 to about 210,000 lines in June 1995. The total unmet demand may be higher than indicated by PTC's waiting lists as such lists are maintained only in areas in which PTC currently provides service. Further, potential subscribers may not bother to register without a realistic expectation of being connected within a reasonable period of time. On the other hand, PTC's local tariffs and monthly subscription are low, which may have promoted uneconomic demand, especially from the residential sector. It is proposed that a study be undertaken under the project to evaluate the likely impact of tariff changes on demand (para. 2.10). While there is no doubt that future demand will support sector expansion, such a study would facilitate adequate longer-term investment planning in the sector. - 8 - II. SECTOR ISSUES A. REGULATORY ARRANGEMENTS 2.1 In 1989, selected markets were opened to private sector investment, yet weaknesses in the institutional environment and sector regulation persisted even after the 1991 PTC Act. For example: - the regulatory functions were divided between too many parties to be effective (para. 1.9); - the provision of telecommunications services was dominated by PTC, with statutory monopoly privileges for basic services; - the relationship between PTC and the Government was essentially administrative in nature, with PTC acting as an extension of the executive arm of the Government; - a range of regulatory tasks were delegated to the main operator, PTC, leading to a conflict of interest; and - no clear distinction was drawn between GOP's roles as policy maker, regulator, and operator as the sole owner of PTC. 2.2 Presently, neither MOC nor PTC are equipped to monitor compliance with license conditions on a regular basis, detect license violations, take corrective action against the violators, investigate unlicensed users of radio frequencies, or monitor radio frequencies. Except as provided in the Posts, Telegraphs & Telephones Initial Account Code (1971) for radio fees and royalties, there are no guidelines to determine the amount of fees and royalties to be charged for the licenses nor the manner of recovery. 2.3 These regulatory arrangements have raised a number of issues. First, there is a potential conflict of interest between PTC's commercial interests as a service provider and its role as a regulator. Second, there are no clearly defined responsibilities nor a regulatory body to monitor tariffs, promote fair competition, enforce access and interconnections, manage conflicts, promote uniform technical standards, type approval of equipment, or to monitor performance of operators. Third, the allocation, management, and monitoring of radio frequencies is inadequate. Finally, the existing regulatory arrangements are hindering several applicants and/or licensees to provide services. The need for strengthening the sector regulation has become more urgent as the complexity of the sector increases in a multi-operator environment. B. PTC TARIFFS 2.4 The 1991 PTC Act established the following criteria for tariff setting purposes: (a) cost of providing services; (b) need to mobilize funds for network development; and (c) a reasonable return on investments. On the whole, PTC's operations have produced a positive cash flow for investment purposes as well as a reasonable rate of return. However, the total revenue numbers hide a substantial imbalance between low monthly subscription fees and local call charges and high long distance charges (Annex 4). The excise duty, currently 35%, charged on domestic long-distance calls, has contributed to making such calls very costly. It costs about the same to make a call from Islamabad to Karachi as to London. The subscription fee and local call charges, on the other hand, are among the cheapest in Asia. Table 2.1 summarizes the telephone tariff structure of selected Asian countries. -9 - ...T b .l.... ..... . .. .A. . ... Connection Fee Monthly Subscription Residential Business Residential Business Local Call Pakistan 80.0 same 1.7 same 0.04 Indonesia 147.8 same 3.7 same 0.05 India 57.1 na 4.7 na 0.05 Malaysia 19.6 same 7.8 13.7 0.05 Philippines 11.5 13.9 9.0 19.9 0.08 Sri Lanka 280.0 same 1.8 same 0.03 Thailand 145.7 same 3.9 same 0.04 All Low Income 99.6 126.6 3.8 4.9 0.06 Source: World Telecomnmunication Development Report. ITU. 1994. Data for Pakistan as of May 1994. Note: Malaysia and Philippines are the only two countries in the above table with differentiated tariffs for business and residential subscribers. na: Not available. 2.5 The imbalance in PTC's tariff structure has promoted some uneconomic demand for new connections, especially from the residential sector which does not generate large numbers of profitable long-distance calls. It is estimated that about 70% of subscribers do not make NWD (Nation-Wide Dialing) calls while as many as 90% do not make overseas calls. A mid-1994 study (summarized in Annex 5) indicated that 68% of PTC's bills averaged only Rs. 2400/year (about US$80), which does not cover PTC's annual estimated operating and maintenance cost of US$40 per working connection, fixed costs and overheads of US$150, and a return on the necessary net investment of over US$1,000 for exchange equipment and local network. In addition, the low monthly rental for a telephone may have reduced the demand for alternative services, e.g., paging, cellular, and public card phones, which currently are being supplied by the private sector. 2.6 The Telecommunications Ordinance of 1995 gives the privatized PTC (PTCL) a seven year exclusivity period on basic voice telephone services. After this period, PTCL's monopoly would cease and competition in the provision of all telecommunications services would be allowed. If the current tariff structure is maintained, PTCL's competitors are likely to concentrate on the profitable business segments, leaving PTCL with the residential subscribers, who may not even produce sufficient call charges to cover the cost to maintain and operate the lines. The chart below (Box 2.2) illustrates the case. - 10 - Box 2.2: Distribution of Bills & Revenues 60 50. 40 E 30 20 10 0 0-300 300- 1000- 3000- >10000 1000 3000 10,000 Billed Monthly Amotmt (PRs) | %bills %revenue Souse: SHM Associates. August 1994. 2.7 PTCL would be required to satisfy all demand within a reasonable timeframe. This would be very costly, as most new demand currently is for residential connections (over 70%), which at current tariffs are unprofitable. This is likely to be reflected in the price a private investor is willing to pay for PTCL. PTCs tariffs would, therefore, have to be studied and a plan to rebalancing of tariffs established. C. SATISFACTION OF DEMAND 2.8 Since its incorporation in December 1990, PTC embarked on an ambitious expansion program which has more than doubled the size of the network and telephone density (see Table 1.2). The waiting lists for telephone service have been dramatically reduced and the bottleneck in many locations is now the connection procedures and documentation rather than network capacity. In some major cities, where the BLT and other schemes led to rapid network expansion, PTC has experienced problems in filling the exchanges with new subscribers. About a third of the service applicants on old waiting lists in many urban regions had already obtained telephone service or, for other reasons, were not applicants any longer. As of June 1995, PTC's idle exchange capacity averaged about 20% (see Annex 5). 2.9 PTC's exchange fill problems are likely to be temporary as new applicants for service are coming in. Unlimited demand is not guaranteed, however, even at current low prices. Further, if the tariff structure is rebalanced and monthly rental increased from the current $1.70 equivalent to about $7.00, some demand, especially residential, is likely to disappear. The impact of higher tariffs on demand could be significant given the increasing proportion of residential demand. 2.10 Waiting lists are currently maintained only in places which already have some telephone service. These waiting lists are unreliable and recent experience indicates that they tend to overstate actual demand (para. 2.8). The demand in areas currently without service is also difficult to estimate with any accuracy. To ensure coordinated and efficient network expansion, a new demand study should urgently be undertaken - 11 - (the most recent one is from 1990). This study should also look into the impact of changes in the tariff structure and level on demand and the cost/benefit effects of alternative tariff structures (Annex 10). D. INTERCONNECTION AND REVENUE SHARING ARRANGEMENTS 2.11 In accordance with their operating licenses, the cellular, card phone and other private service providers interconnected with PTC largely pay the same charges to PTC for calls originated within their networks as do PTC's normal subscribers. The cellular companies charge their subscribers per "air minute" at double PTC rates for outgoing calls and credit PTC half of that amount. The cellular companies also charge their subscribers for incoming calls from the PTC network at the PTC rate for a local call; PTC charges its subscribers for all outgoing calls. If PTC equipment does not allow for interconnection with the cellular network, the cellular operator pays for the additional equipment on PTC's behalf and recovers this expenditure over time out of the call charges accruing to PTC. All traffic monitoring and billing equipment needed for settlement of the accounts between PTC and the cellular operator are paid for by the latter. 2.12 The above arrangements are biased in favor of PTC. If tariffs and revenue sharing arrangements were cost based, PTC would charge the cellular operators less for calls generated within their networks. For such calls. PTC's costs are substantially lower for local network, subscriber equipment, maintenance. billing and collection. Further, the current arrangements may raise questions regarding the "level playing field," especially after PTC's privatization. 2.13 The current interconnection and revenue sharing arrangements are spelled out in adequate detail in the licenses for the private operators. However, the licensees are required to provide a nationwide network only "as practically possible." So far, the cellular operators have limited their services to the main urban centers, as it may not be in their best financial interest to take steps towards GOP's objective to provide nationwide service. It would be desirable to review the interconnection and revenue sharing arrangements between PTC and the private operators as well as other license conditions, with a view to negotiate more efficient and equitable conditions; this should ideally be done prior to PTC's privatization. E. QUALITY OF SERVICE 2.14 An assessment of service quality was carried out in 1991 through a survey of 42 large customers of the former T&T Department in Karachi, Lahore and Islamabad. In parallel, a small residential survey was undertaken in the same cities. Both business and residential survey respondents expressed overall dissatisfaction with the service provided by T&T. The results of the survey are detailed in Annex 6. As for the question: should T&T focus on network expansion or improving existing services, 58% of the respondents believed that PTC should split its efforts equally. The survey also indicated that good quality telecommunications services were of primary importance to both business and residential customers. Although this survey was based on a small sample, it is indicative of PTC's service quality problems. Further, the 1992 Annual Report of the Ombudsman contains about 7,250 complaints against PTC, which constituted 30% of the total complaints received for all public services. Most of the complaints were for excessive billing, delays in installation, and defective instruments. 2.15 Since its incorporation in 1991, PTC's service quality has improved, but is still poor compared to international standards. As in most developing countries, over 90% of the faults experienced by PTC are - 12 - attributed to the local network. Many faults are reported directly to local linesmen and may not be included in the statistics below. ... .700t 0 0 40 t $(04;tii(.... ....... ....., .. . . . ....... Pakistan Sri Lanka Philippines Indonesia India Int'l Standard Faults per 100 lines/month 16 22 N.A. 6 18 10 Faults repaired next working day 80% 75% 78% 73% 84% 5 hr ave. or I _________ ~~~~~~~~~~~working day Call Completion Rates Local 70%.. 40% N .A. N.A. 92% 95% Long distance 60% 30% N.A. 60% 83% 70% International 50%. 28% N.A. 39% N.A. 50% Note: A busy destination is counted as an incomplete call. The completion rate is, therefore, lower in systems with high traffic load per line. Source: IBRD. 2.16 A number of service targets, such as call completion rates and fault clearance, have been set for PTC, but have not been properly monitored. There is also a lack of country-wide coordination to ensure that consistent methods are applied and that the data collected is accurate. Since the capability to measure and monitor the actual service quality is weak, the reported data is open to abuse and mis-interpretation. Without a monitoring system and a deftned set of measurement methods, targets to be set for PTCL are unlikely to be meaningful. It is important that regulatory processes and procedures be put in place to properly monitor PTCL's performance against a range of service quality measures. F. LICENSING REGIME 2.17 The first license for a private company to provide telecomnmunications services in Pakistan was granted in 1989 for the provision of paging services. Since then, 13 additional paging licenses have been granted. However, the first licensee obtained a court stay order against the other licensees, and is still the only paging operator in Pakistan. 2.18 In 1990 and 1991, two licenses were granted for the provision of cellular mobile services with shared exclusivity to provide this service for 15 years. Even so, in 1992 a third cellular license was granted after an applicant posted a complaint with the Ombudsman and obtained a court order (para. 1.10). 2.19 Stipulated royalty paymnents, registration, and other fees, as well as the tariffs paid to PTC for the use of its network vary depending on the type of service and when the license was issued. In some cases, different license conditions are stipulated for the provision of the same kind of service, which may impede fair competition. Further, the licenses mention GOP, MOC, GITT, T&T, PTC, and/or PWB as the sector regulators for various aspects of the licensed services. - 13 - 2.20 Given the above, the telecommunications sector licensing regime needs to be overhauled. Existing licenses should be renegotiated with the licensees, updated to reflect GOP's recent regulatory reforms (as set out in the Telecommunications Ordinance of 1995) and sector policies, and rewritten in suitable legal language to avoid future conflicts regarding exclusivity rights, etc. Existing private service providers should have an interest in license review, as it may lead to lower interconnection costs with PTCL than provided for in the current licenses. 2.21 With the proposed creation of PTCL a license has to be granted to this entity for the provision of public telecommunications services. PTCL is expected to be the dominant carrier and PTA should ensure that the license conditions are consistent with GOP's policy of liberalization and competition in the sector. G. MANAGEMENT OF THE RADIO FREQUENCY SPECTRUM 2.22 The radio frequency spectrum is utilized by a variety of communications services, such as cellular, private corporate networks, maritime, aeronautical, AM and FM sound broadcasting, television, and satellite communications. The spectrum is a limited resource and demand is increasing from existing users, which includes GOP, common carriers, and the private sector. The allocation of frequency bands and specific assignments of radio frequencies have become a very complex task involving a number of technical, regulatory and economic issues. GOP is signatory to international radio regulations of the International Telecommunication Union (ITU) and is obliged to provide orderly registration, coordination and monitoring of the radio frequencies and their usage. 2.23 The system for allocation and monitoring of the use of radio frequencies by the national carrier, PTC, cellular service providers, paging companies, broadcasting and other GOP and private users is inadequate. PWB is not properly equipped nor does it have the organization, resources or infrastructure to manage this valuable and limited resource in an efficient manner. The procedures for assignment of frequencies is outmoded and there are no stations to monitor the frequency usage. 2.24 There are already three operators in the expanding radio cellular service market. Moreover, with the introduction of new radio based technologies and services the radio frequency spectrum is increasingly becoming crowded and equitable distribution difficult. Advances in digital technology will open the door to new low-cost wireless services like Personal Communication Services (PCS) which provide for access to an individual anywhere irrespective of location and require additional spectrum space. It is, therefore, necessary to prepare for the introduction of these new technologies and services which will have to share spectrum space with the existing ones and may require reallocation of current usage. This will need careful planning and management. Apart from overcoming the present inadequacies in the management of existing allocations and in the monitoring of the radio frequency spectrum, which is the immediate concern, Pakistan will also have to equip itself to meet the future challenges of equitable distribution and value maximization of this limited resource. 2.25 Despite the above problems, radio frequency usage in Pakistan has been controlled in a reasonable way. Currently, the total number of outstanding licenses and permits is about 20,000 and illegal use has been contained within "acceptable" limits. This should be compared to the Philippines, which has about 200,000 licensed transmitters and an estimated 800,000 illegal ones. Nevertheless, taking into account the expansion in radio services, the time is appropriate for Pakistan to immediately take steps for the establishment of an adequate structure and organization for the management of the radio frequency spectrum. - 14 - HI. SECTOR REFORM A. SECTOR OBJECTIVES AND STRATEGIES 3. 1 The Government's broad objectives in the telecommunications sector are to: (i) promote the rapid development, modernization, and diversification of telecommunications services; (ii) facilitate new investment and competition in the sector by adopting an enabling legal and regulatory framework; (iii) encourage increased private sector participation in telecommunications development, including the privatization of PTC; and (iv) reduce GOP's role as an operator in the sector. 3.2 In July 1991, a consortium of consultants was retained to assist GOP in the restructuring of the telecommunications sector and privatization of PTC (Annex 7). The principal recommendations of the consultants wvere to enact a new Telecommunications Act for the privatization of PTC and the creation of PTA for the regulation of the sector, and FAB for the management of the radio frequency spectrum. The Bank reviewed the consultants' studies and is in general agreement with these recommendations since these sector reforms are designed to: - separate and insulate regulatory activities from political interventions and commercial operations; - create a climate of "regulatory certainty" which encourages private investment in the development of the sector and increases the potential proceeds from the privatization of PTC; - provide adequate consumer protection; and - increase operating efficiency and development of the sector. 3.3 The Cabinet agreed to the above telecommunications sector reform strategy in February, 1994, including the draft Telecommunications Act and the privatization of PTC, in line with the recommendations of the Privatization Commission (PC) and the consultant's consortium. The draft Telecommunications Act was submitted by MOC to the Ministry of Justice for review in March 1994 and a Telecommunications Ordinance was issued in July, 1994. In July 1995, the Ordinance was repromulgated with some amendments. Annex 8 outlines the highlights of the Ordinance. The new Telecommunications Act is expected to be presented to Parliament later in 1995. In October 1994, GOP provided the Bank with a Sector Policy Letter and Implementation Plan which was reviewed at negotiations (Annex 9). 3.4 While the Telecommunications Ordinance is a major step and provides for an adequate legal basis to proceed with the establishment of PTA and FAB and continue with the privatization process, it is a temporary arrangement until the Parliament approves the Telecommunications Act. In May 1994, MOC appointed the chairman and members of PTA. The chairrnan of the FAB is the Secretary Communications and an executive vice chairman has been appointed. The functions and responsibilities of the regulatory agencies are given in paras. 3.22 to 3.32 below. B. PTC's PRIVATIZATION 3.5 The initial work to transform PTC into an autonomous company with private equity and operations was made by the consultants consortium led by Bear Stearns and Coopers & Lybrand (see - 15 - Annex 7). The consultants were funded by PTC and MOC supervised their work, which included the drafting of a new Telecommunications Act and an operating license for a privatized PTC (PTCL). 3.6 In early 1994, GOP decided that the Privatization Commission (PC) would manage the privatization of all state owned enterprises, including PTC. A group of Bank staff and consultants was established under the Privatization and Technical Assistance Project on GOP's request to advise and support the PC. The PC, with Bank support, drafted new terms of reference for the financial and investment banking aspects of PTC's privatization. In February 1995, the PC invited proposals for a Financial Advisor to assist the GOP in the sale of 26% of PTC's shares and the transfer of management control to a strategic investor. As a result of the evaluation of the proposals received, GOP has selected a consortium led by Morgan Grenfell of U.K. for this assignment. The Consultants are expected to commence the preparatory work for PTC's privatization shortly. Financing for a study of critical sector issues (Annex 10) is included in the proposed project to provide support for the Telecommunication Sector Reform Program and advise GOP on relevant conditions for PTCL's operating license (para. 3.1 1 to 3.21). 3.7 GOP's plans (Annex 8) to incorporate a new entity, PTCL, under the 1984 Companies Ordinance (XLVII of 1984), to which most PTC assets and liabilities will be transferred together with PTC's existing telephone operations (except for NTC operations, see para. 3.34). Separate classes of shares will be created with different voting rights to effectively transfer PTCL's management and corporate governance to a strategic investor. All employees of the PTC will be transferred to PTCL. By end 1995, GOP intends to start negotiating with suitable, prequalified private operators for equity participation in the PTCL. By early 1996, a substantial portion of PTCL's equity is expected to have been sold to a strategic investor, who would take over PTCL's operations and administration. Additional sales will be undertaken from time to time as market conditions permit. 3.8 PTCL will be licensed to provide basic telephone service for a period of twenty five years with an exclusivity period of seven years. Notwithstanding PTCL's exclusive rights, cellular radio telephones, paging and personal communications services will be provided on a competitive basis. GOP will retain some telecommunications operations within a new public sector entity, the National Telecommunications Corporation (NTC), for the provision of telecommunication services to the Federal Government, Provincial Government, Local Authorities, Armed Forces and other official agencies and institutions. A more detailed description of NTC is provided in para. 3.34. 3.9 In July 1994 GOP offered, with the assistance of Merrill Lynch, about 2% of PTC's equity in the domestic market in the form of a "PTC Voucher" convertible into PTCL shares, upon the conversion of PTC into a company. The objective of this offer was to achieve a broad based shareholding in PTCL (including a portion to its staff) in accordance with GOP's privatization policy. The vouchers were listed and traded on all the three stock exchanges in Pakistan. The Central Board of Revenue and the Corporate Law Authority recommended that the PTC vouchers be exempted from capital gains tax. After the incorporation and listing on the stock exchanges, each PTC voucher can be exchanged into 100 ordinary shares in PTCL of Rs. 10 each. This offer of PTC vouchers was heavily oversubscribed and GOP decided on a second issue in early September 1994, with the assistance of Jardine Fleming, Hong Kong, for about 10% of PTCL's equity. This issue was primarily aimed at international institutional investors and was twice oversubscribed. The second tranche vouchers were available in the form of dollar-denominated Global Depository Receipts. GOP plans to establish PTCL and exchange the PTC vouchers for the new company's shares in about a year. In the event that PTCL shares are not listed on the stock exchanges by September 1996, GOP will repurchase the vouchers at Rs. 3800 per voucher. - 16 - 3.10 The PTC voucher issues were not a part of the original privatization strategy as outlined by the Bear Steams and Coopers & Lybrand led consultants consortium, which recommended an initial sale of 26% of PTCL's equity, together with its operation and administration, to a suitable strategic investor/operator. On the other hand, the voucher issues brought in about US$1 billion equivalent and, thus, accelerated the fiscal benefits of PTC's privatization. There is a risk, howvever, that the success of the voucher issues may have increased GOP's expectations to unrealistic levels as regards the price a strategic investor would be willing to pay for a substantial equity stake in PTCL. In this context, PTCL's tariffs (para 3.12 below), and other issues related to PTCL's operating license, would have to be addressed to make the company more attractive to private investors. C. PROPOSED REGULATION 3.11 The proposed regulation of tariffs, demand satisfaction, interconnection, service quality, licensing regime and frequency management is set out in the Telecommunications Ordinance and in the operating licenses of the operators. Some important aspects of the proposed regulation are discussed below: 3.12 According to the proposed draft license, PTCL's tariffs, will be adjusted in line with inflation in accordance with a price-cap formula: inflation minus 0%. This formula is quite generous compared to other countries, e.g., U.K. and Sri Lanka, where tariff increases are capped at inflation minus 2-3%, taking into account potential economies of scale and efficiency gains. In Pakistan, however, the formula would be applied to a skewed tariff structure (para. 2.4-2.5) with a relatively low average revenue per subscriber (only about US$ 400 per line in 1994). A tariff study will, therefore, be undertaken prior to applying the price-cap formula, with a view to adjust PTCL's tariffs closer to the cost of providing a specific service. In addition to reducing distortions of demand for service, tariff rebalancing would make PTCL more attractive to private investors (see Box 3.1). ..0-:- .....' .. 'f-.. iS -C: .... . . ... . -- -, fi . . ..} .......... . ......Box J.: RaMeg Rba'lti~g~Cn The Canadian Radio Television & Telecommunications Commission (CRTC) took a major decision in mid- September 1994 which will fundamentally change tariff regulation (Telecom Decision CRTC 94-19). Key elements of this decision are: (i) Rate rebalancing: Monthly local telephone rates will rise by C$2 in each of the next three years. The current average is about C$ 15 per month. The scheduled increases in local rates will be accompanied by offsetting reductions in long distance rates. (ii) Regulation: Monopoly rates will be regulated on a rate of return basis till 1998, at which point it will be replaced by price-cap regulation. Depending upon the extent of competition, competitive services will either be deregulated or subject to a process designed to ensure non-predatory rates and guard against increases in certain basic toll rates. Different rate bases will be used for the monopoly and competitive segments of the sector and profits or losses in competitive markets will be borne by the service provider. Competitive services are likely to be deregulated within the next three years. (iii) Competition: The operators will allow full unbundled access to their networks for long distance traffic (which is already permitted) and local service competition. Operators will develop new information services and broadcast services on a common carrier basis Source: Angus Oliver Associates. September 1994. - 17 - 3.13 According to the Ordinance, PTCL will have an exclusivity period of seven years in the provision of basic voice service, and the private paging company up to 1999 (para. 1.16). Tariff regulation is, therefore, necessary to avoid monopoly abuse. For market segments in which adequate competition has been established, e.g., cellular services with three licensed operators, tariff regulation may not be necessary and the service providers should be free to set the tariffs they charge to their customers. As the telecommunications market becomes more competitive, including the provision of basic services once PTCL's exclusivity period expires, tariffs need not be regulated allowing market forces to establish tariff levels. 3.14 To reduce unsatisfied demand, the draft license for PTCL includes specific targets of additional exchange lines to be installed within a certain timeframe. These targets were established prior to PTCL's accelerated expansion program (including the BLT schemes) and have become outdated. The draft license also requires the operator of PTCL to provide service in all centers with population over 500. 3.15 Expansion targets expressed in number of exchange lines may be appropriate when the demand is well known. which is not the case in Pakistan. Further, as demand is a function of price, the growth of demand for services is likely to slow down if tariffs are increased or rebalanced (para. 2.7). A more suitable license condition would be to require PTCL, after the rebalancing of tariffs, to eliminate the waiting lists of service applicants and, thereafter, guarantee connection to new applicants within a reasonable time. 3.16 PTCL will be given the freedom to decide how to provide cost efficient service to centers with over 500 inhabitants: connection of subscribers or provision of PCOs, by radio and/or wireline. After all, convenient access to service for the many may be of greater economic and social value than personal telephones for the few. The cellular, paging, and other private service providers will also be encouraged to expand service outside the larger cities. This will be done by enforcing license conditions and by giving more favorable interconnection and revenue sharing arrangements with PTCL to companies that expand their services into rural and less profitable areas. 3.17 The interconnection and revenue sharing arrangements between PTC/PTCL and other operators should encourage expansion of service, when economically justified, and provide the operators with suitable financial incentives. All interconnected operators will gain as the telephone system as a whole expands, since the number of calling combinations will increase at an exponential rate, e.g., outgoing as well as incoming traffic for the network of one operator will increase as another operator expands his system. If incoming and outgoing traffic between the networks of interconnected operators is reasonably balanced, each operator could keep what they bill and no special accounting for the calls would be necessary. Against this background, PTC's current interconnection and revenue sharing arrangements with other operators will be reviewed. Any changes to these arrangements will, as far as possible, be implemented before PTCL's privatization. 3.18 The operating licenses to the operators include certain service quality standards. Suitable monitoring of these standards will be undertaken by PTA and FAB and corrective actions will be prescribed in the case of non-compliance. To provide an additional incentive for the operators to maintain adequate service quality, tariff adjustments may be made conditional on the compliance of agreed service quality targets. Improved service quality may also make tariff increases and/or rebalancing more acceptable to subscribers. - 18 - 3.19 PTA will be the licensing authority, replacing MOC, GITT, PTC and PWB. PTA will be provided with adequate procedures and the necessary legal expertise to ensure the validity of the licenses and minimize court challenges (para. 2.18). For a suitable longer term licensing policy, GOP/MOC will assess the future needs of the telecommunications market and establish an appropriate number of operators to be given licenses in each market segment. The objective would be to maximize competition within the constraints of the exclusivity periods already granted in existing licenses, availability of radio frequencies, security and other national concerns. 3.20 GOP/MOC will also establish a longer term policy for the use of the radio frequency spectrum. The current demand for the frequency spectrum would have to be balanced against the future needs for new radio based services and technologies. The demand for frequencies from radio based local networks is likely to increase. It may be desirable to require new operators to use digital technology, which would provide more flexibility to the frequency allocation planning. GOP should also take steps to realize the commercial value of the radio spectrum (see box below). 6'.,^'.',''r'"''.l,k''"-,',k'r¢^''''.''-'-'-t'E'''''''v'' ... . .....z'' .........~~~~~~. ... .... ......... .. . . . .. .. ... .. . ... ... .. . . .. . .. . .. . .. . . . ........ ..... .... ... ............... ............. .......... .. ....... ..... . ....... ... ...... ... ..--. The growing commercial value of the radio spectrum has prompted several countries to reconsider their current regime for spectrum management. Further, because the number of radio licenses sought by telecommunications service providers has risen sharply in recent years, failure to accord priority to an effective spectrum management policy can lead to large revenue losses for the government. For example, in Argentina, once the Commission Nacional de Telecomunicaciones (CNT) adopted an effective plan for monitoring the use of the radio spectrum, spectrum fees increased dramatically. From 1990 to 1991, CNT reportedly collected the equivalent of only $2 mnillion in fees following the enforcement of its new policy and in 1992 fee revenue increased to more than $10 million. Effective planning and regulation need not require a large organization. The key requirement is to get the legislative authority, organization structure, core staffing, and priorities right. source: A. Hill and M.A. Abdala, "RVegulation. Institutionls and Commitment: Privatization and Regulation in the Argentine Telecommunications Sector, ";World Bank Informal Discussion Paper, Draft, Policy Research Department, April 8, 1993. Radio Communications Spectrum Management Reform, Department of Transport and communications, Canberra, Australia, September 1992. 3.21 In August 1995, GOP retained a financial advisor to assist in PTC's privatization. This financial advisor will also study such regulatory issues that need to be resolved urgently to properly draft the operating license for a privatized PTC. To ensure adequate coordination between concerned parties, a working group was formed consisting of high level representatives from MOC, PTA, FAB, PTC, PC and the financial advisor. To assist GOP/MOC in its longer term policy formnulation and sector reform efforts and facilitate the regulation of a privatized PTC, a study of tariffs, taxation, demand, service quality, etc., will be carried out (Annex 10). This study will be initiated in January 1996 and coordinated with the activities of the financial advisor retained by GOP for PTC's privatization. An interim report will be available by June 1996 and the final report by December 1996 at the expected time of PTC's privatization. During negotiations, it was agreed to undertake a study of regulatory issues as outlined in Annex 10, discuss the results with the Bank and identify suitable strategies for implementation. - 19 - D. THE REGULATORY AGENCIES 3.22 The Telecommunications Ordinance of July 1995 establishes the Pakistan Telecommunications Authority and the Frequency Allocation Board to regulate the telecommunications sector in Pakistan. The ordinance provides for a division of the various regulatory functions which are summarized below: Regulatory Authority Regulatory Responsibilities Ministry of Communications - overall sector policy-making (MOC) - licensing policy (criteria for amendment) - representation on international bodies (with assistance from PTA and/or FAB) Pakistan Telecommunications Authority - policy advice to MOC (PTA) - sector monitoring - licensing - tariff regulation - arbitration of interconnection disputes - complaints handling - technical regulation (standards and type approval) Frequency Allocation Board - policy advice to MOC (FAB) - allocation of radio frequencies - monitoring of use and interference 3.23 GOP, through MOC, will retain the responsibility for overall telecommunications policy. It is znvisaged that key decisions would be made by MOC, such as policies for the licensing of additional operators, amendment of licenses and the radio frequency allocations. MOC will continue to represent the interests of GOP domestically and in international bodies such as ITU and INTELSAT with support and advice of PTA and FAB. PTA and FAB will monitor national and international developments in the telecommunications sector and provide advice to MOC on these matters as part of their policy advisory functions. 3.24 PTA will assume the responsibility over the regulatory functions currently entrusted to GITs, Vigilance Commission, PTC and MOC. PTA will be responsible for licensing of operators in accordance with policies laid down by MOC, collect license fees and maintain registers of all accredited service providers. A key role for PTA will be the establishment and enforcement of license conditions and other regulatory requirements. For this purpose, PTA will be empowered to require operators to supply the operational and financial data necessary to ensure that license provisions relating to service quality, network expansion, demand satisfaction, etc., are adhered to. It will be given the power to issue legally enforceable orders to service providers, and to impose penalties in the event of non-compliance. PTA will recommend license assumeents and revocations to MOC. License amendments would also be possible through mutual agreement between PTA and the licensee. PTA will also ensure reasonable interconnection between operators, arbitrate complaints and impose fines on service providers in case license and/or other regulatory provisions are not complied with. - 20 - 3.25 PTA will be responsible for the regulation of service quality standards. It will have the powver to impose mandatory technical guidelines designed to ensure safety and network inter-operability. It will set standards for all equipment which is to be connected to the public telecommunications network, and be responsible for type approval of such equipment. In summary, PTA will be given substantial financial and administrative autonomy to efficiently implement GOP's policies for the sector. 3.26 PTA will be governed by a three person board, one of whom will be a economic/commercial expert and an other will be a professional telecommunications engineer. One member of the board will serve as chairman. Each member will be appointed for a term of four years and will be eligible for re-appointment for a similar or shorter term. 3.27 The organizational structure of PTA (Annex 11) has been developed based on its principal responsibilities and functions. The key functions of the Divisions/Departments will be: (i) Corporate Management: financial and human resources, Management Information System, library, public relations, consumer protection and resolution of user complaints; (ii) Policy, Research and Law: policy advice (such as criteria for new licenses), research on current and future telecommunications issues and trends, and legal counsel; (iii) Licensing: issuing and monitoring of operator licenses and liaison with FAB; (iv) Finances and Tariffs: financial policies of licensed operators, audit to verify license compliance reports, tariff applications, interconnection agreements and issues, (v) Engineering: advice on all engineering matters including service quality, standards, type acceptance tests, and network and technical analysis and (vi) Standards and Specifications: development and evaluation of equipment standards. PTA will have permanent professional staff and fully operational PTA is expected to require about fifty professional staff plus support staff. 3.28 The Telecommunications Ordinance provides PTA funding from GOP grants (including a Rs. 50 million initial grant); loans raised by PTA; license fees from applications; and annual fees payable by the licensees. Once PTA has become operational, it would be fully funded by fees on the operators and no direct GOP support would be required. 3.29 Under the Ordinance, FAB took over PWB's current functions and responsibilities for allocating the radio frequency spectrum. Upon the application by PTA, FAB assigns specific frequencies for the operation of services; the operating licenses, however, is given by PTA. FAB will maintain computerized records of all frequency allocations, monitor radio spectrum use, and investigate complaints about interference. It has the power to inspect radio installations and issue orders requiring the cessation of activities found illegal or to have caused interference. 3.30 FAB is located in MOC and consists of six members, including the Secretary of Communications, Chairman of PTA, a nominee of each of the Ministries of Defense, Information & Broadcasting, and Interior. The sixth member appointed by GOP serves as full time Executive Vice Chairman and CEO and the Secretarv of Communications serves as Chairman of the FAB. 3.31 The organizational structure of FAB has been developed based on its principal responsibilities (Annex 12). The principal functions of the various Divisions/Departments will be: (i) Policv and Regulation regarding radio spectrum utilization; (ii) International and Domestic Coordination: responsible for bilateral and multilateral agreements, ITU relations, international monitoring and direction finding, and internal inter-agency coordination; (iii) Spectrum Planning: frequency allocation, plans and tables, and channeling plans; (iv) Spectrum Engineering: intermodulation, interference and propagation and area coverage analysis; (v) Inspection and Monitoring: enforcement programs such as inspections. FAB will - 21 - have permanent professional staff and may retain from time to time temporary staff and consultants as necessary. Fully operational, FAB will be a technically oriented organization in charge of 20 monitoring stations in addition to its radio frequency allocation functions. During negotiations, it was agreed that PTA and FAB would have an organization structure and conduct themselves in a manner satisfactory to the Bank To that end, the organization charts for PTA and FAB, as set out in Annexes 11 and 12, and staffing requirements were discussed and agreed These organizational structures are intended for the final organization and some major functions may be combined during the initial stages of operations. 3.32 The PTA and FAB powers and duties are in line with similar structures for telecommunications sector regulation outside Pakistan. PTA and FAB will have to closely work together and coordinate the licensing and assignment of the radio frequencies in Pakistan. To enable PTA/FAB to retain suitably qualified staff, they should be allowed to pay salaries comparable with those of the private sector. This will be especially important after the privatization of PTC. However, being part of the Government, exemption of PTA/FAB staff from civil service regulations as regards payscales may not be feasible. To attract and retain suitably qualified staff, PTA/FAB will, therefore, offer other suitable incentives to the extent possible. For staff outside Government service, e.g. long term consultants, contracts will be given with adequate conditions to attract experts from within and outside the country. E. THE OPERATORS 3.33 PTCL will provide basic telecommunication services during an exclusivity period of seven years. Thereafter, the telecommunications market in basic services will be opened to competition. If PTCL's tariff structure is not rebalanced before its exclusivity period expires, competitors would attract the profitable business subscribers by offering lower long-distance rates, while PTCL would be left with the less profitable residential subscribers. To ensure efficient competition, PTCL's tariffs should be close to the cost of providing a service before its monopoly expires. 3.34 Before PTCL's privatization, GOP intends, to create NTC for a separate network serving the northern areas, Government and the armed forces (para. 3.8). NTC would operate an independent network to be formed out of some of PTC's existing local and long distance facilities and by suitable rearrangements of official subscribers between exchanges. GOP has prepared a plan indicating the specific telephone exchanges and the microwave and coaxial networks needed to make NTC operationally independent. About 4% of PTCL's exchange capacity, or about 100,000 lines, would be transferred to NTC. Most of those lines are reliable but of a relatively obsolete EMD technology and are located in Islamabad, Lahore and Karachi (one exchange each) and about 50 minor exchanges mainly in the northeast. Domestic call charges would remain with the company where the call is originated (PTCL or NTC), which is a normal practice when incoming and outgoing calls are fairly balanced. PTCL would operate the international facilities and would bill NTC for its outgoing intemational calls. NTC will be operated as a Government statutory corporation on a commercial basis, whereas the new PTCL will be operated under the Companies Ordinance as a private company. 3.35 Similar govenmment networks exist in countries like the United States, namely the Federal Telecommunications Network (FTN) connecting all the Federal offices in the USA and operating independently of the private/public telecommunications networks. FTN leases facilities as needed from the private operating companies. Although a separate network may not be a least-cost solution, it provides direct advantages to a private operator in insulating it from Government pressures to invest and operate facilities that may not be financially viable. It also reduces the risk of Government interference in the - 22 - operations of a private system during crisis situations. Furthermore, Government is often slow in paying its telephone bills and collection is difficult as Government subscribers cannot be easily disconnected. For these reasons, a separate Government network may actually increase the attractiveness of PTCL to private investors. 3.36 Outside of PTCL and NTC's monopolies, there are a number of independent operators who will continue to provide services: three cellular, one card phone, one paging and one data communications service providers. There are also a number of licensees which have not yet started operations. With the establishment of PTA, the resulting "regulatory certainty," and an expanding market, it is expected that new operators will start providing more services. 3.37 To facilitate the establishment of new service providers and to encourage efficient competition, existing licenses may have to be renegotiated, e.g., with the paging operator to cease his monopoly up to 1999 over paging services. Financial and other incentives, through tariff adjustments and revenue sharing arrangements, should be identified by the regulator to encourage the operators to expand their services out of the urban centers into rural and other less profitable areas. If a licensee refuses to renegotiate his license, PTA would have to wait until the license (or exclusivity period) expires and then make suitable changes. As explained earlier (para. 3.17), all operators will gain from the expansion of the telecommunications system as a whole. F. THE BANK'S ROLE 3.38 The Bank has been involved in five telecommunications projects in Pakistan. The first four projects have generally been successful in developing programs for the expansion and modernization of the telecommunications network and some modest institutional building in the administrative and accounting areas. The fifth telecommunications project was approved in July 1986 and was closed in December 1993. In addition to network expansion, sector reform, such as PTC's incorporation, was initiated under this project and some progress was made in the commercialization of PTC with the passage of the 1991 PTC Act. The Project Completion Report, dated December 22, 1994, concludes that this was a highly successful project in expanding and improving the telecommunications network, as well as initiating sector reforms. The proposed project is a logical continuation of the sector reforms initiated under the fifth telecommunications project. The Bank will continue to play a critical role in the sector reform process, including the privatization of PTC, by supporting GOP's efforts to implement an adequate sector regulation. 3.39 The Bank's prior involvement in Pakistan's telecommunications sector and its experience with similar projects in Mexico, Philippines, and Venezuela, makes it well suited to assist GOP in its sector reform efforts and in the establishment of regulatory systems and institutions. GOP could also gain from the Bank's experience in other countries regarding increasing the flow of private capital, management, and technology for the telecommunications sector. 3.40 The Bank is also supporting GOP's privatization efforts through a group of Bank staff and consultants providing technical assistance to the Privatization Commission, including technical assistance for PTC's privatization. The proposed project aims at implementing the legal and regulatory framework, as suggested by the consultant's consortium (Annex 7) and accepted by GOP and the Bank. It will also assist GOP in its long term policy formulation, sector reform efforts, and privatization of PTC through a study of tariffs, demand, service quality, etc. (Annex 10). The project will be coordinated with the Bank support provided to the Privatization Commission. - 23 - IV. THE PROJECT A. PROJECT OBJECTIVES 4.1 The primary project objective is to support the reform and efficient development of the Pakistan telecommunications sector by implementing a suitable regulatory framework for both public and private telecommunications operators and the efficient allocation and use of the radio spectrum. More specifically, the project will assist in establishing the PTA and FAB. Through its regulatory activities, PTA will promote competition in the provision of telecommunication services and increase private sector participation. The FAB will provide for the efficient management and allocation of the radio frequency spectrum for private and public use. While fully supporting PTC's privatization process, the Bank does not provide any direct assistance to PTC in this project in view of its expected privatization. 4.2 The proposed project is consistent with the Bank's Country Assistance Strategy, which, inter-alia, emphasizes support for redefining public/private sector roles, including privatization of public services and increasing the public sector's ability to regulate a more competitive environment for the expansion of the private sector. The project is also consistent with the Bank's strategy in the telecommunications sector, which calls for shifting the Government's role from ownership and operations to policy making and regulation, promoting efficiency and service quality, and increased private sector participation in investments and provision of services. B. STATUS OF PROJECT PREPARATION 4.3 Consultants, under terms of reference agreed during the February 1994 pre-appraisal rmission and funded by a Japanese Grant Facility, prepared the detailed design of the regulatory system, including the radio spectrum management, in line with the reform strategy prepared by the GOP retained consultant's consortium. These proposals were discussed with MOC and concerned PTC staff upon which site inspections and technical specifications for the project equipment were completed and terms of reference for technical assistance prepared. Other GOP parties were also consulted through MOC's assistance. The proposed project, as described below, is based on the results of these discussions and consultations. As a condition of Board Presentation, MOC has obtained anticipatory approval of the project and its main components from Economic Committee of the National Economic Council (ECNEC). As a condition of Loan Effectiveness, MOC will obtain approval of the project and its main components by ECNEC. (6.2) C. PROJECT COMPONENTS 4.4 The proposed project addresses GOP's objectives and priorities for the sector through the following components: (a) technical assistance through a "technical cooperation arrangement"2 with a reputable regulatory agency (Annex 14). Under this arrangement, PTA's and FAB's priority tasks 2 These arrangements will be similar to "twinning." The term "technical cooperation" has been preferred, however, as the managerial authority will always remain with PTA/FAB officials. - 24 - will be to adopt appropriate organizational structures for their entire range of regulatory activities. Technical assistance to the extent of 48 expert-months will be provided to PTA and FAB for project implementation. An additional 24 expert-months will be provided to FAB during the first year of its operation to build operational and maintenance capabilities;3 (b) staff training for PTA and FAB will be incorporated in the provision of technical assistance through the arrangement of relevant courses and seminars in Pakistan, study trips abroad, and training by the equipment suppliers. In addition to training provided by suppliers on the operation and maintenance of the equipment for spectrum management and monitoring and PTA/FAB's technical cooperation partner (see (a) above), the project would provide for: (i) seminars and courses offered by private firms, universities and associations, dealing with specialized regulatory issues and general regulatory methods; (ii) research fellowships at universities for the study of regulatory and telecommunications issues; and (iii) a tour of regulatory agencies in other countries. Regular employee training in non-specialized functions (e.g., computer literacy) will be included in PTA's and FAB's operating budgets (Annex 15); (c) procurement and installation of an integrated radio spectrum management and monitoring system consisting of central administrative facilities at Islamabad, regional licensing offices, a satellite monitoring facility at Islamabad, a network of fixed and mobile radio frequency monitoring stations to cover the regions of the country where most of the radio systems are operating, and equipment for a type acceptance laboratory. The system has been designed as an integrated network that will provide both administrative (mostly licensing) and technical facilities (frequency planning, radio spectrum monitoring, etc.) and can be easily expanded in the future as the use of the spectrum increases; and (d) support to GOP's sector reform program through studies of sector issues to facilitate the privatization process, e.g., tariffs, demand management, quality of service standards, etc. Details of the project components are given in Annex 13. D. PROJECT COST AND FINANCING 4.5 The total project cost is estimated at US$53.6 million (including estimated customs duties and local taxes), with a foreign cost component of US$34.6 million. Relevant land and buildings will be transferred from PTC to PTA and, especially, to FAB. Detailed project cost estimates and yearly expenditures are presented in Annex 16 and summarized below in Table 4.1 3 US$0.3 million of the loan have been allocated to MOC for project implementation support (preparation of specifications, evaluation of bids, project execution). - 25 - Table 4.1: Estimated Project Costs ,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ . , . . . . . . . . . . . . . . ._ .x -6 ' ' I'-'Foregn''T-ta % of TI ota MOC Support to Sector Reforn Program 0.2 0.2 0.4 51.3 Project Implementation Support 0.3 0.0 0.3 0.0 Subtotal: 0.5 0.2 0.7 27.8 PTA Type Acceptance Laboratory 0.5 1.3 1.8 71.4 Frequency Managment Equipment 1.3 3.3 4.6 71.4 Computers, Office Equipment and Vehicles 0.4 0.5 0.9 57.8 Land, Buildings, Air Cond. and Power Supply 1.7 0.2 1.9 9.0 Training 0.3 0.7 1.0 71.4 Technical Assistance 0.2 0.6 0.8 71.4 Subtotal: 4.4 6.6 11.0 59.6 FAB Frequency Management System 8.3 20.6 28.9 71.4 Computers, Office Equipment and Vehicles 0.7 1.0 1.8 58.2 Land, Buildings, Air Cond. and Power Supply 2.3 0.3 2.7 12.4 Training 0.5 1.2 1.7 71.4 Technical Assistance 0.7 1.8 2.5 71.4 Subtotal: 12.5 25.0 37.5 66.6 TOTAL BASE COST 17.5 31.8 49.3 64.5 Physical Contingencies 0.9 1.6 2.5 64.5 Price Contingencies 0.6 1.2 1.9 66.1 ..... ..; ;;A,....; . .... ....... .. .. ..... ...... .; . i .... ,ii.... .iii-. i ;i.--j- -TOTAL ESTIMATE FROJEa COST ax..-- .O19r0 34 . 5.. --.. Note: Totals may not be exact due to rounding. Local costs include about US$14.3 million equivalent for taxes and duties. 4.6 Project costs have been estimated by consultants based on mid 1994 contracts and budgetary information provided by various potential suppliers (no changes were introduced following negotiations in July 1995 since prices remained stable between 1994 and 1995). Physical contingencies have been estimated at 5% for both foreign and local costs of equipment-related items. Local costs include about 40% custom duties and taxes on imported goods and services. The international price increases in US$ terms are assumed to be 2.0% in 1996, 1.6% in 1997, 2.1% in 1998, and 2.4% in 1999. 4.7 The financing plan for the project is presented in Table 4.2. The proposed Bank loan of US$35.0 million would finance about 65% of the total project cost and 100% of the foreign exchange costs. The remaining cost of US$16.3 million (32%) would be covered by GOP. GOP will transfer the necessary land and buildings for PTA/FAB's head offices and licensing and monitoring stations (about 20 sites) from PTC - 26 - to PTA/FAB at nominal cost. The market value of these properties is much higher than their book value and GOP's contribution to the project is, therefore, larger than the project cost and financing plan indicate. Table 4.2: Project Financing Plan (US$ Million Equivalent) ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. . . ... .. ; ............ . ... .. ;.. --..... -.... ... .. ....... ... .... ... ...... .. ........... .. . . . . . . . GOP 18.6 0.0 18.6 34.7 IBRD 0.4 34.6 35.0 65.3 TOTAL 19.0 34.6 53.6 100.0 4.8 The proposed Bank loan would be lent to the Governmnent of Pakistan for 20 years, to be repaid over 15 years after 5 years of grace, at the standard variable interest rate, with GOP assuming the foreign exchange risk. E. PROJECT ADMINISTRATION AND IMPLEMENTATION 4.9 Organization and Management. PTA and FAB will be responsible for the implementation of their own project components under the general supervision of the MOC. During negotiations, it was agreed that a unit will be formed within MOC by December 31, 1995 with a project manager to coordinate the project works, including procurement of goods and services, implementation monitoring, accounts, project audits and reporting. These arrangements were discussed and agreed during negotiations. 4.10 Implementation Timetable. GOP established PTA and FAB in August 1994 and key staff were appointed as a condition of loan negotiations. Contracts for equipment supply and TA/technical cooperation arrangements for PTA/FAB would be finalized by mid 1996. Both agencies would be fully operational in early 1996. A project implementation plan is shown in Annex 17. The project is expected to be completed by December 31, 1998. 4.11 Procurement. To encourage supplier/bidder interest and to provide a single responsibility for the proper functioning of the system as a whole, the main equipment for radio frequency management will be one package and will be procured under 1GB procedures in accordance with the Bank's procurement guidelines issued in January 1995. The same procedures will be used for laboratory equipment and vehicles. The consultants for the project will be hired in accordance with the Bank's guidelines for the use of consultants. Desktop computers and printers, costing under US$200,000 for each lot for a total not exceeding US$700,000, will be procured over the life of the project under national competitive bidding procedures. Project TA and training will be procured in accordance with procedures acceptable to the Bank. During negotiations, it was agreed that GOP will establish a special Tender Board by December 3], 1995, under the supervision of the MOC, for PTA's and FAB's procurement under the project. Table 4.3 indicates the proposed bid packages, procurement methods and estimated amounts. Annex 18 contains a procurement timetable. All procurement costing over US$200,000 will require the Bank's prior review. Other contracts will be subject to random post reviews in the field by visiting missions. Contracts for hiring - 27 - of consulting firms costing US$100,000 equivalent or more and contracts for hiring individuals costing US$50,000 equivalent or more would be subject to prior review by the Bank. Approximately 90% of the value of the Bank loan would require prior review. The bidding documents for the spectrum management system were submitted to the Bank for review as a condition of negotiations. Table 4.3: Summary of Procurement Arrangements (US$ Million Equivalent. Contingencies are included) ;~~~~~~~~~~ o .-X Equipment Spectrum Management System (PTA/FAB) 26.1 0.0 26.1 (26.1) (0.0) (26.1) Type Acceptance Laboratory 1.4 0.0 1.4 (1.4) (0.0) (1.4) Computers, Vehicles and Office Equipment 0.0 2.1 2.1 (0.0) (1.7) (1.7) Air Conditioning & Power Supply 0.5 0.0 0.5 (0.5) (0.0) (0.5) Civil Works 0.0 3.8 3.8 (0.0) (0.0) (0.0) TA (Institutional Development) Training 0.0 2.1 2.1 (0.0) (2.1) (2.1) Consultancy 0.0 3.3 3.3 (0.0) (3.3) (3.3) ................................ ......................... ......................................................... ................................................................................................................................................ Total Procurement 28.0 11.2 39.3 of which Bank financed ... .. ..... Taxes and Duties 14.3 Total Project Cost 53.6 Note: Figures in parentheses are amounts financed by the Bank. Totals may not be exact due to rounding. (*) Other: Includes limited international bidding, national competitive bidding, and Bank procedures for selection of consultants. 4.12 Disbursement. The Bank loan would be disbursed against: (a) 100% of foreign expenditures, and 100% of local expenditures (ex-factory cost) for equipment, (b) 100% of foreign and local expenditures (ex-factory cost) and 75% of local expenditures for other items procured locally for computers, vehicles and office equipment, and (c) 100% of expenditures for consultants' services and training. The estimated disbursement schedule and the standard disbursement profile for Bank-assisted - 28 - telecommunications project in Pakistan is given in Annex 19 and disbursement categories in Annex 20. A summary of projected disbursement is shown in Table 4.4. The loan will be closed on June 30, 1999. The projected disbursement period is about three years shorter than the Bank's standard disbursement profile (issued August, 1995) for telecommunications projects in the South Asia Region. Since the advance preparation of procurement documents under the project will facilitate early procurement and implementation, most disbursements have been projected during the first two years after loan effectiveness. Full documentation would be required for all equipment contracts above $200,000, consultant firm contracts above $100,000 and individual consultant contracts above $50,000. Disbursements for contracts below this amount and all training expenditures would be made on the basis of Statement of Expenditures (SOEs). The supporting documentation for SOE expenditures would be retained by PTA and FAB and made available for review by Bank supervision missions. Table 4.4: Disbursement of Bank Loan (US$ Million Equivalent) ....~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~...... Annual 0.8 9.5 20.5 4.2 Cumulative 0.8 10.3 30.8 35.0 4.13 Special Account. To facilitate disbursement, a Special Account will be established at a bank under terms and conditions satisfactory to IBRD. This Account will be maintained in US Dollars with an authorized allocation of US$1,000,000 and would be used for all eligible expenditures, both local and foreign, of less than US$500,000 equivalent. Replenishment applications will be submitted on a monthly basis or when amounts withdrawn are equal to one-third of the authorized allocation, whichever occurs first. During negotiations, the procedures for the operation and audit of the Special Account were explained to GOP. The Special Account will be opened and operated in accordance with Bank procedures. 4.14 Accounts and Audits. MOC will have the overall responsibility for the project audit. The actual audit work will be conducted by independent auditors acceptable to the Bank. PTA and FAB will establish and maintain their accounting systems in accordance with sound and internationally recognized principles and practices acceptable to the Bank. Each entity will provide interim and annual financial statements to reflect its financial performance and position. Audited financial statements for PTA/FAB will be provided to the Bank within nine months of the close of the fiscal year. The audit report will include a statement of the adequacy of the accounting system and internal controls, and compliance with financial covenants. The accounting, financial reporting, and audit arrangements should provide adequate and timely information to the Bank for supervision of the project. During negotiations, it was agreed that audit reports will be submitted to the Bank within nine months after the end of the financial year on: (a) the project accounts, including a separate opinion on the Special Account and any statements of expenditures (SOE); and (b) the annual financial statements for PTA and FAB. Unaudited financial statements for PTA and FAB will be submitted to the Bank within six months of the end of the financial year. 4.15 Monitoring, Reporting and Supervision. GOB and the Bank will monitor the overall performance of PTA and FAB during project implementation aided by performance indicators (Annex 21). In addition, the Bank will monitor procurement and project implementation. This monitoring will assist - 29 - GOP in taking timely corrective action as necessary. During negotiations, it was agreed to monitor PTA/FAB 's performance and project implementation progress using indicators set out in Annex 21. 4.16 During negotiations, it was agreed that MOC will supervise the preparation by PTA and FAB of quarterly project progress reports, in a format acceptable to the Bank, and will submit such reports to the Bank within one month of the end of the quarter. Project accounts will be maintained by MOC's project unit, so that the cost of each project component and loan disbursement can be clearly established. Reporting requirements are summarized in Annex 22. 4.17 Supervision of the project will focus on the following key aspects: (a) setting up and further development of PTA and FAB in accordance with the agreed timetable, organizational structure and staffing; (b) timely and effective procurement of goods and services; and (c) implementation coordination of the various project components. The final mission in 1999 will provide instructions for preparation of the Implementation Completion Report (ICR) and agree on a suitable plan for the future operations of the project. The total estimated Bank staff inputs are: telecommunications engineers and finance specialists for a total of about 10 staff-weeks a year. Specialized consultants will be used, as necessary, for a total of about 3 expert-weeks a year. A supervision plan is given in Annex 23. 4.18 Environment and Health Aspects. The project has been given a "C" environment rating. Since the project is mainly intended to assist GOP in the restructuring of the regulatory and institutional framework for the development of telecommunications in Pakistan, it is not expected to have any adverse impact on the environment or cause any health problems. HF monitoring stations will be installed away from urban centers to avoid harmful interference to or from other radio systems. VHF and UHF stations will use small rooms in mostly existing buildings, whose renovation or construction will be subject to standard construction practices in urban areas to avoid noise, dust and damage to neighboring property. No disruption of virgin land is expected. - 30 - V. PROJECT JUSTIFICATION 5.1 The proposed project supports an essential component of GOP's telecommunications sector reform program, namely the implementation of a regulatory framework which is essential for increased private sector participation. The sector regulation is becoming increasingly important with the growth in the number of service providers, rapid technological change, and private ownership of operations. The project is consistent with the Bank's policies regarding the telecommunications sector. A. PROJECT BENEFITS 5.2 Teleconununications services are increasingly based on radio technologies and it is being realized that the radio frequency spectrum is a valuable resource that should be protected. In India, the recent auctioning of licenses to provide mobile cellular services bought in winning bids equivalent to US$ 6.0 billion and in the USA the auctioning of frequency assignments for personal communications services (PCS) brought in about US$ 8.0 billion. In Pakistan, as in most other countries, the licenses for existing mobile cellular and other radio based services were granted without auctions or high up-front charges. It is, therefore, difficult to quantify the economic value of the radio frequency spectrum. For the future, however, the project will provide GOP with the licensing and monitoring tools to mobilize resources and protect against unlicensed use of the frequency spectrum, which, judging from international experience, has a substantial value. 5.3 The establishment of a transparent regulatory framework and competent regulators with adequate authority and a known mandate is a basic role of Government and would enhance GOP's privatization efforts and increase the interest of potential investors; this would be reflected in the bids for the initial sale of PTCL's equity. The operators of telecommunications services would also benefit from knowing the rules for tariff adjustments, interconnection, competitive environment, licensing, etc., and this will encourage the private sector to invest and expand services. The consumers will benefit from more efficient and better service quality, the consumer protection aspects of the Telecommunications Bill, and the possibility of presenting their complaints to the regulator, PTA, when the operators do not take adequate corrective action. Finally, the expansion and improvement of telecommunications services will contribute to economic growth and poverty alleviation. As the experience from other countries suggests, private sector performance improves with the establishment of an adequate regulatory system (Box 5.1). B. FISCAL IMPACT 5.4 The overall fiscal impact of the project will be positive. The initial set-up costs will, in addition to the Bank loan, be covered by the GOP budget and the operating costs will be met through license and other fees on operators. The initial GOP budget allocation is Rs.50.0 million. License and other fees charged to the operators, as indicated in the Telecommunications Ordinance, would exceed Rs. 200.0 million a year according to project PCI estimates. These arrangements would be more than adequate for PTA/FAB's salaries and other operating expenditures estimated at about Rs. 60.0 million a year (at full operation), provided GOP funds the initial capital costs to establish these regulatory authorities. As the telecommunications networks and traffic grows over time, GOP will through PTA collect substantially higher amounts in taxes, royalties, licenses and other fees charged to the various operators in the - 31 - telecommunication sector. According to the current licenses, the cellular operators pay a 4% royalty on their billing, less PTC's call charges, as well as 4% of their net after tax income. The second license for data communications prescribes largely the same royalties as for the cellular operators. Other licenses (e.g. card phones, paging, voice mail and store and forward facsimile, etc.) contain a variety of license, registration and renewal fees, per subscriber fees and deposits. The operating license for a privatized PTC will also provide for license fees and/or royalty payments and the eventual auctioning of frequencies for new services may produce substantial additional revenues (para 5.2). ..................... ..... .... ... .... .. ....... , ,., . ,,, . ,,, , , . ,,.,.g ............. E |.g E~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. . . . . . Country Regulatory System Private Sector Performance ARGENTINA Repeated changes in regulation 1989-1992. Highly profitable, but too soon to tell impact privatized in 1990 on service quality and national welfare. CHILE Highly detailed benchmark regulation Unprecedented high rates of investment and privatized in 1988-89 supervised by regulatory agency with network expansion subsequent to privatization; explicit arbitration process. substantial increase in national welfare. JAMAICA Rate of return specified in license Major investment in domestic network and privatized in 1988-1989 agreement. No independent regulator. increased national welfare, high profitability. PHILIPPINES Long-standing regulation by commission Alternation between stagnation and periods of private since inception with vague mandate and modest power. moderate investment. Very high unmet demand. Profitability unknown. UNITED KINGDOM Price-cap regulation and complex Take-off of investment in 1983, with large privatized in 1984 mechanisms of conflict resolutions gains in national welfare. ___________________ specified in the license. Source: Regulation, Institutions and Commitment in Telecommunications - A Comparative Analysis of Five Country Studies. B. Levy and P. Spiller, April 1993. 5.5 Once in full operation, the above taxes, royalties, license fees and other levies charged to the sector operators will more than cover the operating costs of PTA and FAB. Any funds surplus to PTA/FAB's requirements would be transferred to the Treasury. A renegotiation of existing licenses to standardize the fees paid by the various operators is likely to increase this fiscal surplus. During negotiations, assurances were obtained from GOP that it will provide in a timely fashion all the necessary funds for the implementation of the project and start-up of PTA/FAB operations. 5.6 The introduction of more market based fees for the assignment and use of the radio frequency spectrum would add to GOP's fiscal benefits from the sector. The radio frequency spectrum is a valuable scarce resource and it has become more common to charge for the assignment of frequencies, e.g., through frequency auctions (as in New Zealand, see below, and more recently in the United States), competitive hearings, etc. Further, recurrent fees can be charged to avoid hoarding of frequencies in the hope of later selling them at a higher price. - 32 - ..........5...N..... .mV .. ... i R~F~qe~yMiagmn In 1989, New Zealand reshaped its spectrum-management regime, privatizing large parts of the radio spectrum, and started to auction off spectrum rights giving permnanent private-property rights to the spectrum, permnitting the market to allocate frequencies efficiently. New Zealand's 1989 law mnade two key changes in the traditional spectrum management regime: the use of auctions rather than hearings as the method of assigning radio licenses and the privatization of spectrum rights through the distribution of long-term, tradable property rights of radio bands. Auctioning was an expeditious way of resolving competition for allocations. In a year and a half, New Zealand's Ministry of Commerce received a total of 2,915 bids for 264 contested licenses in 5 different bands, an average of 11 bids per license. Two conclusions can be drawn from this experience: private property rights to the spectrum are technically feasible and spectrum privatization can be achieved more easily by distributing nationwide rights to a broad spectrum of frequencies rather than privatizing individual channels. Source: Adapted from Reform of Spectrum Management: Lessonsfrom New Zealand. Reason Foundation, 1991. 5.7 PTC's privatization would provide GOP with a substantial one-time fiscal benefit,4 while the potential for recurrent future dividends from PTCL's operations would be reduced. This project supports PTC's privatization as well as other private investments in the telecommunications sector. Over the longer run, this should lead to substantial fiscal benefits. 5.8 A reduction of the 35% excise duty on domestic call charges to avoid distortions in calling patterns would reduce GOP's fiscal revenues. However, some revenues would be recaptured by higher income taxes from PTCL due to more long-distance traffic and profits. GOP may also replace the current excise duty on P.TCL's domestic calls with a lower flat tax on all telecommnunications revenue, which would preserve GOP's fiscal benefits while being less distorting for the telecommunications market. C. PROJECT SUSTAINABILITY 5.9 The institutional and legal features of the the project have been examined and are appropriate. The legal basis for PTA and FAB, their staffing and funding and GOP's commritment to sector reform are key factors in the sustainability of the project. The Telecommunications Ordinance of 1994 legally established the regulatory institutions PTA and FAB. However, this Ordinance, which was repromulgated in July 1995, is of temporary nature and GOP intends having the Telecommunications Bill enacted to provide PTA and FAB with a permanent legal basis. During negotiations it was explained that the Bank may take remedial action if the legal basis for PTA and FAD lapses or if GOP 's telecommunications sector reform program is not implemented A Sector Policy Letter and Action Plan outlining GOP's commitment to the sector reformn program is in Annex 9. GOP made key staff appointments for PTA and FAB prior to negotiations and a budget of Rs. 50.0 million has been provided for their start-up operations. PTA and The sale of PTCL vouchers (para. 3.10), equivalent to about 12% of PTCL's equity, brought in about US$1.0 billion. - 33 - FAB's staffing and funding arrangements were discussed during negotiations (paras. 3.31 and 5.4) and suitable agreements reached. PTA will collect license and other fees from the service providers, which will ensure adequate funding outside GOP's budget. Over the longer run, PTA/FAB's license and other revenues are likely to increase substantially, as existing service providers expand their operations and new operators are licensed. The importance of the regulatory institutions will increase in a complex, multi operator environment. It will, therefore, be in GOP's, the private operators' and the public's best interest to maintain strong regulatory institutions to ensure adequate interconnection and revenue sharing arrangements between mostly private operators as well as protection of consumer interests. D. PROJECT RISKS 5.10 There are specific project risks related to the timing of PTC's privatization. An early privatization of PTC would complicate the transfer of relevant staff, equipment, sites and buildings from PTC to PTA and FAB, renegotiations of interconnection and revenue sharing arrangements between PTCL and other operators, and reform of GOP's taxation policy towards the sector. The transfer of relevant staff, equipment, sites and buildings from PTC to PTA/FAB has been initiated and should be completed well in time before PTC is privatized. GOP, with assistance of the financial advisor and studies to be made under the project (para. 3.21), will review interconnection, revenue sharing and other regulatory issues with the objective of establishing adequate policies in time for PTC's privatization. 5.11 A delay in the passing of permanent legislation for the telecommunications sector (para. 5.9) is likely to delay the privatization of PTC. However, the project would still be justified, as the regulatory framework and frequency management infrastructure that it provides are needed with or without the privatization of PTC. A lapse in the legal basis for PTA/FAB or failure to implement the sector reform program would trigger remedial actions by the Bank. 5.12 GOP's maintenance of capable regulators and adequate funding arrangements for PTA and FAB are critical to ensure efficient regulation of the sector and the longer term benefits of the project. There is a risk that PTA/FAB staff is appointed on political grounds rather than merit. However, this risk is mitigated by the Telecommunications Ordinance, which provides PTA with substantial financial and administrative autonomy. During negotiations, GOP agreed to make available in a timely fashion all the necessary funds for the efficient operations of PTA and FAB. Similarly, GOP will finalize the staffing arrangements and the organizational structure of PTA and FAB by early 1996 to make them fully operational. After initial delays, GOP is now progressing satisfactorily in these matters. The above risks are managable. E. PERFORMANCE INDICATORS 5.13 The performance indicators for this project have been classified into three groups: (i) project implementation; (ii) efficiency of sector regulation; and (iii) project's contribution to longer-term sector objectives. Project implementation will be monitored through quarterly progress reports (see para. 4.16). The efficiency of sector regulation will be evaluated when the regulatory agencies, PTA and FAB, commence their operations and as the various regulatory functions are implemented. The project's contribution to the longer-term sector objectives will be evaluated towards the end of the project and would form part of the project implementation completion reporting. A list of proposed project performance indicators is given in Annex 21. - 34 - VI. AGREEMENTS REACHED AND RECOMMENDATION Agreements Reached 6.1 During Negotiations agreements were reached on: (a) study to support the sector reform program (3.21). (b) organizational structure and staffing of PTA and FAB (3.31); (c) establishment of a project unit and appointment of a project manager for the project implementation (4.9); (d) establishment of a special Tender Board, under the supervision of MOC, for PTA's and FAB's procurement (4.11); (e) annual audit reports for the project, special account and PTA and FAB (4.14); (f) performance indicators for PTA and FAB (4.15); (g) progress reports and project accounts for PTA and FAB (4.16); and (h) PTA/FAB's funding arrangements (5.4); 6.2 By Effectiveness: ECNEC approval of the project and the relevant PC 1 (4.3) 6.3 Remedies: The Bank may take remedial action if: (a) the Telecommunications Sector Reform Program is not carried out; and, (b) the legal foundation for PTA and FAB lapses or is changed so as to adversely affect their ability to implement the project (5.8) Recommendation 6.4 On the basis of the above, the proposed project is suitable for a Bank loan of US$35.0 million equivalent to the Islamic Republic of Pakistan for a term of 20 years at the standard variable interest rate, including a five year grace period. - 35 - Annex I Page I of ) PAKISTAN TELECOMMUNICATIONS REGULATION AND PRIVATIZATION SUPPORT PROJECT Telecommunications Laws and Regulations The Telecommunications Ordinance of 1995, maintains the Telegraph Act of 1885 and some Sections of the PTC Act of 1991, and overrides the provisions of the Wireless Telegraphy Act of 1933 (see Annex 8). The scope of the laws issued prior to the 1995 Ordinance is explained below. The Pakistan Telecommunications Corporation Act, 1991. is the statute pursuant to which the original Pakistan Telephone and Telegraph Administration was replaced with the Pakistan Telecommunications Corporation (PTC). Under the PTC Act, the PTC was constituted as a statutory corporation with a board of directors and chairman. The PTC Act specified that the purposes and functions of the corporation are to establish, maintain, and operate telecommunications throughout Pakistan; participate in the manufacture of telecommunications equipment, and to engage in research and development; as well as advise the Govenmment on telecommunications issues and maintain liaison with foreign telecommunications administrations and intemational organizations. The Wireless Telegraphy Act, 1933, applied primarily to one-way or broadcast services, specifically radio and television. Other one-way telecommunications services, such as paging, are authorized under the Telegraph Act. The Wireless Telegraphy Act govems the granting of licenses to manufacturers and retailers involved in the sale of radio equipment, as well as the licensing of radio and television receivers. Magisterial powers are granted to certain officials in the Telegraph and Telephone Department as well as to the licensing authority (the Pakistan Television Corporation) to issue summons. Finally, the Government is authorized to issue regulations to implement the provisions of the Act. The Telegraph Act of