Thailand - Telecommunications Project

FLL~ COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT RNATIONAL DEVELOPMENT ASSOCIATION RETURN TO Not For Pub%c Use REPORTS DESK WITHIN ONE WEEK N PU-99a APPRAISAL OF A TELECOMMUNICATIONS PROJECT OF THE TELEPHONE ORGANIZATION OF THAILAND THAILAND October 27, 1972 Asia Projects Department This report was prepared for official use only by the Bank Group. It may not be published, quoted | or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CUM= UQUALNTS Bl - 100 Satag US$1 - B20.8 Bl - US04,8 Bt million - US$48,o77 MEABI IV 1 kilometer - 0.622 mile PRINCIPAL AEVUTIONS AID ACRONDLS USD B - Baht (umit of currency) BTM - Bel Telephone Yknufacturing CGaw (BDelgiu) DEL - Direct Exchange Line UGAT - Electricity Oenerating Authority of Thailand GNP - Gross National Produet EF - HLgh Freqizency ITT - International Telephone and Telegraph Company NAC - National Audit Council NBC - Nippon Electric Companr IIEB - National Economic Development Board P&T - Posts and Telegraphs Department STD - Subscriber Trunk Dialling TOT - Telophone organsation of Thailand TV - Television UNDP - United Nations Development Program YEA - Electricity Authority FISCAL YEAR October 1 - September 30  THAILAND TELEPHONE ORGANIZATION OF THAILAND APPRAISAL OF A TELECONMUNICATIONS PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS .....................******** - ii 1. INTRODUCTION ....*99*****. *****..................* ....... 1 2. THE SECTOR .......................... 2 Economic Setting ................... 2 Sector Organization . ........... . ......... ...... 2 Existing Facilities ........... ........ ... 3 Service Standards ..................... ................... 4 3. THE PROGRAM AND THE PROJECT .................. ..eo. e900 6 The Program .............. ......... 6 The Project ............................ .......*........... 6 C'ost Estimates .............................. ............. 7 Contingencies .............................................. 9 Items for Bank Financing . ............................... . 9 Procurement ..................**.... ............................. 10 Disbursements .......................................... 10 Execution ................................................ 10 4. PROGRAM AND PROJECT JUSTIFICATION ........................ 12 Market Demand .......... .................................. 12 Least-Cost Solution ....... 13 Rate of Return ........................................... 14 5. THE BORROWER .......................... 15 Legal Status and Authority ............ 15 Organization and Management .. .......... *................. 15 Staff and Training ........ ......... 16 Accounting and Audit ................ . 16 Insurance ....................... * 17..... ..... . 17 This report is based on the findings of a mission composed of Messrs. I. A. Newstead, J. M. Vance, N. R. Holcer and R. Schkolnick, which visited Thailand in March 1972.  Page No. 6.FINANC ES 1.....@,, 18 Tariffs tOetn...................................... 18 Past Operations ........ 19 Collections *...*....*.*...*.**.*..* 19 Payments to Government 19 Bonuses . ........... 20 Present Financial Pbsition ........................ . 20 Financing Plan .............* 21 Future Finances ...........23 Ibbt Limitation Covenant ........... ........... 24 7. RECOMMENDATIONS ....................................... 25  LIST OF ANNEXES AND CHARTS 1. Comparative Telephone Statistics 2. Types and Capacities of EKchange Equipment 3. TOT's Investment Program Chart No. 6865 4. Telephone Development Targets 5. Phase I Project, Yearly Investment 6. Estimated Schedule of Disbursements 7. Demand Forecasts Chart No. 6750 (2R) (Bangkok) Chart No. 6749 (2R) (Provinces) 8. Rate of Return 9. Epilogue to the 1970 Annual Report 10. TOT Organization Chart No. 6771 (R) 11. Consultants' E&isting Terms of Reference 12. Skunmal7 of Tariffs 13. Actual and Forecast Income Statements, 1968-1978 14. Actual and Forecast Balance Sheets, 1968-1978 15. Forecast Sources and Applications of Funds, 1972-1978 Map Thailand - Long Distance Network   THAIIBND TELEPHONE ORGANIZATION OF THAILAND APPRAISAL OF A TELECOMMUNICATIONS PROJECT SUMMARY AND CONCLUSIONS i. The project appraised in this report is the first phase of the 1572-76 development plan of the Telephone Organization of Thailand (TOT), the State enterprise responsible for the national telephone services. A Bank loan of US$37 million equivalent is proposed. This would be the first Bank operation in support of the telecommunications sector in Thailand. ii. As part of Thailand's Third National Development Plan (1972-76), TOT's development plan aims at improving and approximately doubling the domestic telephone system by installing about 166,000 more exchange lines, replacing obsolete equipment and adding long-distance facilities, at a total cost estimated at US$146.1 million equivalent. Together with the completion of ongoing works, this will increase the capacity of the telephone system from approximately 200,000 exchange lines at present to 416,000 in 1977. The vast majority of new connections will be for business purposes and will meet about 65% of the estimated total demand. iii. The plan divides conveniently into two overlapping phases, which are defined largely by lead times for procurement and by service priorities. The first phase is a suitable unit for Bank financing and constitutes the project. iv. The project consists of installing 88,100 exchange lines in Greater Bangkok and 42,700 in provincial networks; enlarging the long- distance network by adding about 1,300 circuits and associated trunk switching equipment; and progressively introducing subscriber trunk dialing (STD), commencing in 1974. v. The estimated cost of the project is US$102.8 million equiva- lent, including a foreign exchange cost of US$56.6 million equivalent. The amount proposed for the Bank loan would finance 65% of the foreign cost, with the remaining 35% to be financed by bilateral loans. The Thai Government wishes to reserve the right to reduce the amount of the Bank loan if subsequently it is able to obtain additional bilateral credit on terms more favorable than those of the Bank loan. vi. All equipment financed by the Bank would be procured by inter- national competitive bidding, except selected extensions to exchanges where direct compatibility is essential for efficient operation. These extensions, estimated to cost US$3.1 million equivalent, would be bought from suppliers of the original equipment at prices based on earlier  - ii- contracts awarded after widespread international bidding. A preference of 15% or the customs duty, whichever is lower, would be applied to local manufacturers' cables. The principal items financed by the Bank would be telephone cables (US$15.1 million), switching equipment (US$5.9 million), telephone sets (US$6.4 million), and transmission equipment (US$6.3 million). Training, consultants and miscellaneous items would account for US$3.3 million of the Bank loan. vii. TOT has adequate autonomy and, overall, its organization and management are adequate but need strengthening in certain operational and financial areas. Consultants have given TOT assistance in the past, and would continue to do so during the project period. viii. TOT's past operating results have been satisfactory and its present financial position is sound; but with the high rate of capital expansion, forecasts show a financing gap of about US$30 million equiva- lent during the years 1973-1975. It was recommended and agreed with Government that this deficit would be covered by Government subscribing 50% of the amount as equity and providing or arranging loans (including possible bond issues by TOT) for the remaining 50%. On this basis, forecasts show that TOT should be able to carry out the expansion progran and continue to maintain a satisfactory financial position. The present overall level of tariffs is reasonable, pexmitting TOT sufficient revenue to cover its financial requirements, including financing an adequate portion of its capital expansion from internal sources. However, some changes in the tariff structure are necessary. ix. Government is tardy in paying its bills and the method used for settling its local telephone service accounts is not satisfactory to TOT. TOT will be required to correct these deficiencies, and satisfactory arrange- ments were agreed during negotiations. x. The project will provide for an annual increase in telephone subscribers of about 12% up to 1977. The economic rate of return on the project is estimated to be at least 14%. xi. With the assurances indicated in Chapter 7, the project forms a suitable basis for a Bank loan of US$37 million equivalent over a term of 20 years, including four years of grace.  THAILAND TELEPHONE ORGANIZATION OF THAILAND APPRAISAL OF A TELECOMMNICATIONS PROJECT 1. INTRODUCTION 1.01 The Government of Thailand has requested Bank assistance in financing a major phase of telecommunications expansion under Thailand's Third National Development Plan (1972-76). The project is estimated to cost US$102.8 million equivalent, with a foreign exchange component of US$56.6 million equivalent. 1.02 A Bank loan of US$37 million is proposed, covering some two- thirds of the project's foreign cost, and would be made to the Telephone Organization of Thailand (TOT), the State enterprise which operates the country's domestic telephone services. This would be the Bank's first loan for telecommunications in Thailand. 1.03 The project would expand the national telephone network through installation of 88,100 exchange lines and tandem exchanges in Bangkok and 42,700 lines in the provincial networks, 1,300 long-distance circuits, and trunk switching equipment. Service would be substantially improved and would be extended to rural areas presently without telephones. 1.04 This report is basedl on information provided by TOT and on the findings of an appraisal mission composed of Messrs. I. A. Newstead, J. M. Vance, N. R. Holcer and R. Schkolnick, which visited Thailand in March 1972.  -2- 2. ITE SECTOR Economic Setting 2.01 Thailand occupies an irregular area of 514,000 km2 that narrows as it extends down the Malay Peninsula. The population, estimated at 38.3 million, is growing at an annual rate of 3.1% and the GNP per capita is around Us$180. 2.02 During 1966-69, the Thai economy experienced a high GDP growth rate, averaging 9% per year, but subsequently went through a period of slowdown. With a large increase in exports in 1971, economic growth started to regain its momentum in the second half of that year. The Government's objective during the Third Plan period, 1972-76, is to achieve an annual GDP growth rate of 7%. While agriculture still makes the largest contribution to GDP (30%) and provides employment to nearly 80% of Thailand's labor force, manufacturing is expanding at about double the rate of agricul- ture, keeping its share of GDP at about 15%; tourism is growing in importance as a foreign exchange earner. Rice is produced throughout the country as the staple food of the Thai people and is also the main export. Other major exports include rubber, produced in the southern region and along the Cambodian border; maize, in the northeastern plateau; and tin, in the southern region. Industrial development has so far been heavily concen- trated in the Greater Bangkok area, chiefly because of its superior commer- cial, public utility and port facilities. Now an important objective of the Third Plan is to reduce the regional disparities; this calls for special efforts to develop the outlying regions, particularly the Northeast, which is the poorest. 2.03 The telecommunications system is undergoing rapid development to handle the increasing flow of b-asiness and administrative information re- quired to support Thailand's continued growth. The processing and trans- port of raw materials, manufactured goods and agricultural produce between Bangkok and the provincial centers and the efficient marketing, dispatching, warehousing and shipping of the country's products require good telecommuni- cations service, as does the growing tourism industry. The present low telephone density of 0.54 per 100 population is in line with that of other countries of comparable per capita income level (see Annex 1). Sector Organization 2.04 Telecommunication services in Thailand were initially operated by the Government's Posts and Telegraphs Department (P&T). The Telephone Organization of Thailand (TOT) was established in 1954 as a State enter- prise by Act of Parliament, for the purpose of organizing and improving telecommunication services in the Bangkok-Thonburi area. The Act is administered by the Minister of Communications, whose portfolio includes P&T. In 1961, provincial telephone services and long-distance facilities were also transferred to TOT; hence TOT now operates all the national tele- phone services, while P&T operates all the international services and the domestic telegraph and telex services, and is responsible for radio frequency allocation and control.  2.05 Although the separation of telephone and telegraph/telex facil- ities has some disadvantages, the arrangement is working reasonably well in Thailand. P&T leases local cable pairs and high-grade trunk circuits from TOT when required and owns the older, open-wire telegraph circuits. The form of a possible merger has many variations and within Government the whole question is controversial. The present sector organization is acceptable to the Bank for the current program and project; assurances were obtained during negotiations that the Bank will be consulted before any changes affecting TOT's overall organization or responsibilities are made. Meanwhile, technical coordination between TOT and P&T needs strengthening and it was agreed that joint engineering committees would be set up to deal with planning and operational matters. It was confirmed during negotiations that this action has been taken. 2.06 The telecommunication industry in Thailand consists mainly of two privately owned cable factories, which produce mainly power cables but also small-sized plastic-insulated telephone cables. The establishment of a factory for partial manufacture and assembly of selected trans- mission equipment, and local manufacture of switching equipment are also being considered. Existing Facilities 2.07 TOT's existing (September 1971) facilities are summarized as follows: Bangkok Metropolitan Network Number of exchanges Local 23 Metropolitan tandems 4 Main trunk 1 Number of local lines installed 162,300 Number of lines connected (DEL's) 105,550 Number of telephones 161,192 Provincial Networks Number of exchanges Local 79 Trunk switching 22 Number of local lines installed 37,060 Number of lines connected (DEL's) 31,198 Number of telephones 36,680 Long-Distance Network Number of circuits 856  2.08 Work has now been virtually completed on two earlier expansion plans: Bangkok 1967-72, which has added 102,000 exchange lines, and Long Distance 1967-72, which has provided 18 spur routes. The national network is currently being expanded by two other major plans: (i) Bangkok 1970-74 - installation of a further 38,000 exchange lines with associated subscribers' and junction plant. This plan supplements the above Bangkok 1967-72 Plan and caters for increased demand. (ii) Provincial 1967-74 - installation of 37,600 exchange lines in 59 locations with associated subscriber plant, and 19 trunk switching installations. 2.09 The types and capacities of exchange equipment are shown in Annex 2. Since 1967, TOT has adopted register-controlled crossbar switch- ing equipment as its network standard. In the Bangkok network, 13,000 exchange lines of obsolete step-by-step equipment are being replaced by crossbar equipment in the Bangkok 1970-74 Plan; the remaining 19,000 will be replaced in the 1972-76 Development Plan (described in Chapter 3). Provincial equipment is being converted progressively from manual to automatic (crossbar) operation, with the remaining manual exchanges scheduled for replacement during the 1972-76 period. 2.10 Local-line plant consists mainly of underground cables for primary distribution and junctions, with overhead cables in the secondary distribution networks. 2.11 The long-distance toll facilities consist of microwave broad- band systems installed in 1967 on backbone routes serving the main regional centers, and low-capacity (less than 300 channels) radio systems with some carrier cables for spur routes. 2.12 International facilities, operated by P&T, consist of circuits through two earth stations working with the Pacific and Indian Ocean satellites, supplemented by HF radio circuits. Service Standards 2.13 Local service has improved considerably in the last few years but there is still much to be done to attain acceptable standards by reducing faults and eliminating traffic bottlenecks. The cost of provid- ing good service is only 5-10% of the basic network expenditures, whereas poor service standards result in a virtual breakdown of the whole system when even minor overloading occurs. 2.14 Although the long-distance semiautomatic service is operating reasonably well, traffic through the main Bangkok trunk exchange now exceeds the capacity of manual operator positions and there are frequently delays of up to an hour in completing calls during busy periods. These delays will increase as trunk traffic grows until relief is given by the progressive introduction of STD commencing in 1974.  2.15 Action is in hand with the assistance of Swedish consultants (Swedtel) to improve maintenance standards (see paragraph 5.05). The following measures were also recommended to upgrade the overall quality of service: (a) Traffic measurement procedures should be reinforced and traffic forecasting methods reviewed, with the assistance of Swedtel. (b) Independent assessments of the quality of service should be introduced, with periodic reports to TOT's management on the quality of local and long distance service. TOT agreed with these recommendations, and confirmation that appropriate action has been taken was obtained during negotiations.  - 6 - 3. THE PROGRAM AND THE PROJECT The Program 3.01 Rapid growth of telephone demand in Thailand in recent years has necessitated overlapping stages of development to meet the changing needs of the national telephone system. 3.U2 TOT's total investmen- program for the five fiscal years 1972-1976 is given in Annex 3 and is also summarized graphically in the chart follow- ing that armex. The program consists essentially of completion of ongoing works in the Bangkok 1970-74 and Provincial 1967-74 Plans, and execution of a major new expansion plan -- the 1972-76 Development Plan, covering the Bangkok, provincial and long-distance networks. Total investment for the 1972-76 period is estimated at US$168 million i/ with a foreign exchange component of US$87 million. The program will approximately double the capacity of the national network from the present figure of around 200,000 exchange lines to 416,000 by September 1977; the long-distance network will increase from 856 channels at present to 2,345; and subscriber trunk dialing (STD) will be introduced progressively from 1974. Annex 4 gives details of the year-by-year development targets. 3-03 The 1972-76 Development Plan -- the major undertaking in the program -- is scheduled in two overlapping phases in which 166,360 exchange lines and 26,240 replacement lines will be installed and long-distance facilities added. The Plan will greatly3 improve telephone service where it is now provided and will extend such service to rural communities at present without telephones. Its total cost is US$146.1 million 2/ (including a foreign exchange component of US$78.5 million), which repre- sents a continuation of the rate of increase of investment needed to sustain an annual network growth of 12-14%. The timing and composition of the two phases are dictated largely by procurement lead times and service priorities. Phase I concentrates on expanding the existing ex- changes, addiig local and tandim oxrl1iages in ontral Baugkolc, replaoing small irianual exchalnges in provincial networks with automatic exchanges (of higher capacity) and providing new trunk routes to serve the regional centers. Phase II concentrates on providing new exchanges in suburban Bangkok and the provinces, with associated trunk provision. The Project 3.04 The project proposed for initial Bank assistance is Phase I of the 1972-76 Development Plan; a future loan could be considered for Phase II. The project consists of the following main items: 1/ Excludes US$9.4 million to be spent in 1977. 2/ Includes US$6.8 million to be spent in 1977.  - 7 - (i) Installation of 88,100 lines of automatic switching equipment in the Bangkok metropolitan network (including replacement of 19,000 lines of obsolete equipment); three additional tandem exchanges to serve Greater Bangkok; associated subscribers' and junction line plant. (ii) Installation of 142,700 lines of automatic exchange equipment in provincial networks (including 7 new exchanges and replace- ment of 31 obsolete manual exchanges); associated subscribers' line plant. (iii) Provision of about 500 circuits on 23 new trunk routes with TV bearers on selected routes; expansion of existing routes by about 800 circuits; trunk switching equipment at 32 loca- tions; progressive introduction of STD from 1974. (iv) Training and consultancy services, to include technical and management training, organization studies and project supervision. Exchange works proposed for Phase I are listed in Annex 2, together with works scheduled for Phase II. The proposed development of the long- distance network is shown on the telecommunications map. Cost Estimates 3.05 The project is estimated to cost US$102.8 million, with a foreign exchange component of US$56.6 million. Details are summarized in the following table and the yearly expenditures are shown in Annex 5.  -8- Bank- Financed Local Foreign Total Local Foreim Total Items ---(Baht milionT----- million)--- 1. Land & Buildings 190.0 4.8 194.8 9.13 0.23 9.36 2. Bangkok Network a. xcchange equipment 90.0 257.7 347.7 4.32 12.39 16.71 0.82 b. Subscriber & junction networks 282.8 405.2 688.o 13.61 19.48 33.09 16.53 3. Provincial Networks a. Ecchange equipment 45.1 90.0 135.1 2.17 4.32 6.49 4.32 b. Subscriber network 33.4 86.6 120.0 1.60 4.16 5.76 4.19 4. Long-Distance Network a. Trunk switching equipment 4.1 15.8 19.9 0.20 0.76 o.96 0.76 b. Transmission equipment 96.3 233.2 329.5 4.63 11.21 15.84 6.32 c. Cables and accessories 12.5 16.8 29.3 o.60 0.80 1.40 0.80 5. Miscellaneous a. Training & consultants 3.7 36.9 40.6 0.18 1.77 1.95 1.77 b. Vehicles 30.3 7.0 37.3 1.46 0.34 1.80 0.34 c. Other (overhead, etc.) 127.1 - 127.1 6.11 - 6.11 - Sub-Total 915.3 1,i54.0 2,069.3 44.01 55.46 99.47 35.85 b. Contingencies a. Physical - 24.0 24.0 - 1.15 1.15 1.15 b. Price 44.3 - 44.3 2.14 - 2.14 - Total 959.6 1,178.0 2,137.6 46.15 56.61 102.76 37.00 3.06 These estimated costs give a figure of around US$650 per DEL for local network service. This is reasonable for the scope of work, which includes estab- lishment of three new tandem (traffic routing) exchanges with associated cable routes, to service the growing areas of Greater Bangkok.  -9- Contingencies 3.07 Telecommunications development is a continuous process that occurs through the installation and augmentation of plant at thousands of locations in any program year. While some works will cost more due, for example, to striking rock beds or to adverse weather when laying a cable, there will be others where conditions will result in less than average costs. Because of this wide spread in costs, plus the variety of telecommunication works, the overall risk of a cost overrun due to physical contingencies is small; in any case, it would result in only a slight rephasing and retiming of target objectives. For these reasons, the only physical contingency provision is US$1.15 million equivalent for possible increases in quantities of provin- cial cable plant which may be needed when the network requirements are more precisely known, and for additional long-distance switching equipment to cope with unforeseen growth of trunk traffic with the introduction of STD; this represents a contingency of about 20% on the items concerned. 3.08 Any overall increase in the cost of the project due to price increases would likewise result in a corresponding rephasing of target objectives. No price contingency is required for the foreign exchange costs of either switching equipment or cables (which represent over 80% of the cost of imported items) since cost estimates are based on recent bids and these prices should also apply during the procurement phase. 3.09 Local costs include an in-built provision for wage increases at around 4% per annum; this has been the trend over recent years and is expected to continue. A local cost contingency of US$2.14 million equiva- lent is included mainly for possible increases in land and building costs which are sensitive to upswings in the economy; this represents a contingency of about 20% on these costs. Items for Bank Financing 3.10 Items for Bank financing are: US$ million Telephone cables, associated plant and accessories 15.11 Exchange switching equipment 5.90 Subscriber apparatus and associated plant and public telephones 6. 41 Transmission equipment 6.32 Training and consultants 1.77 Motor vehicles 0.34 Unallocated 1.15 37.00  - 10 - 3.11 The Thai Government wishes to reserve the right to utilize, wherever practicable, bilateral sources of financing which are available on favorable terms; this could reduce effective utilization of the Bank loan below US$37 million, depending on the countries in which future procure- ment awards are made following international bidding according to normal Bank procedures. Procurement 3.12 All goods financed by the Bank loan would be purchased through international competitive bidding, with the exception of extensions to certain trunk and local exchanges where direct compatibility is essential for efficient use of existing common-control equipment. These extensions would be purchased from the original suppliers, ITT (Pentaconta equipment) and L.M. Ericsson, at prices based on contracts awarded in 1969 and 1971, respectively, after international competitive bidding. The cost of such direct procurement (included under Items 3(a) and 4(a) of the table of costs) should not exceed US$3.1 million -- about 8% of the loan amount. A preference of up to 15% or the applicable customs duty, whichever is lower, would be applied to bids from local manufacturers. Thailand has no agree- ments giving preferential tariffs to any foreign country. Disbursements 3.13 The Bank loan would be disbursed against the CIF costs of imported equipment, the foreign exchange cost of consulting services and the ex-factory cost less local taxes of any locally awarded contracts for goods specified under the loan. This would be mainly for smaller size cables for which the local currency component would be unlikely to exceed US$2 million equivalent. The estimated schedule of disbursements is in Annex 6. As the project forms part of a continuing investment program, any unused balance of the loan could, after consultation with the Bank, be used for the purchase of addi- tional plant of similar types -- unless it should be cancelled for reasons mentioned in paragraph 3.11. Ececution 3.1i TOT intends to install equipment for expansion of existing installations with its own personnel, under the supervision of the suppliers; new installations would be carried out under suppliers' contracts. Cable installations, with the exception of new major works in Bangkok for which international tenders would be called, would be executed by TOT; buildings and access roads would be built by contractors after local bidding. This is a reasonable division for installation and civil works, in light of TOT's workforce. 3.15 As with TOT's previous and current expansion plans, consultants will be employed to assist in the preparation of specifications, super- vision of the project and acceptance testing. Their costs would be financed by the loan (see also paragraphs 5.05 and 5.09).  - 11 - 3.16 For the progressive introduction of STD commencing in 1974, there is need to prepare a coordinated plan covering: (a) Tariff structure -- trunk rates and method of charging; grouping of exchanges; (b) Bquipment and additional trunk circuit requirements and cost estimates; (c) Implementation timetable; and (d) Coordination and public education program. This studr is being made with the assistance of consultants (Swedtel) and copies of preliminary reports covering tariff proposals and circuit require- ments have been supplied to the Bank. Daring negotiations it was confirmed that the STD implementation plan will be completed early in 1973. 3.17 Augmented by the training programs referred to in paragraphs 5.06 and 5.07 and with the outside assistance indicated in paragraph 3.14, the personnel of TOT should be adequate to implement the project successfully and subsequently maintain the new installations.  - 12 - 4. PROGRAM AND PROJECT JUSTIFICATION 4.01 The basic justification for th.e program, and thus the project, is to support Thailand's development objectives by providing an essential service for Thai industry and agriculture. Efficient organization of the flow of inputs for the production, distribution and marketing of manufac- tured goods depends on access to rapid and reliable comunnications. Agriculture, with its wide dispersion of production (see paragraph 2.02), has similar requirements. Development of the provinces, which is a partic- ular objective of the Government, will be supported by improving the exist- ing long distance service and extending service to rural areas which now have no telephones. Considerable expansion of the national telecommunica- tions network is necessary to meet even the presently extensive unsatisfied demand. In Bangkok, TOT discontinued waiting lists a few years ago when there was little prospect of giving service to the large number of appli- cants. Business men have been prepared to pay many times the official installation cost whenever this could help them get connected to the network. Market Demand 4.02 Historical and forecast telephone demand for Greater Bangkok and the provinces is shown in the two graphs following Annex 7. By 1977 there will be some 263,000 DEL's connected in Greater Bangkok and 68,ooo in the provinces, equivalent in total to about 65% of the demand forecast for that time. The vast majority of new connections will be for business and agricultural purposes (see also paragraph 6.o4). The average annual increase in DEL's for the period 1972-77 is 12.2%. 4.03 Because waiting lists for Bangkok are not kept, both the 1970 and future demand (1980, 1990) were estimated on the basis of field surveys which assessed directly the telephone potential of each building block; thus the forecast estimates connected subscribers as well as the hidden demand. Annex 7 (pages 1 - 5) describes how the estimates were made. There is little danger of over-investment; the planned increase in capacity is well below the deinand forecast. 4.04 The starting point in estimating provincial demand was the number of subscribers connected plus the waiting list; estimated growth rates of 15% and 10% per year were applied as being reasonable upper and lower limits of growth. These forecasts are conservative since they take no account of present hidden demand. The sizes of the exchanges to be built are the most economic of the alternatives, and an exchange fill 1/ of 80% will be achieved by 1979. 1/ The percentage of the exchange line capacity which is connected to working services.  - 13 - 4.05 The additional trunk network facilities are essential to relieve congestion, give trunk-line service to places without trunk access, and provide the circuit capacity necessary to meet forecast demand with the introdaction of STD in 1974. Least-Cost Solution 4.06 The least-cost method of meeting the demand forecast depends on (i) having made the correct technological/economic decisions initially when planning the networks, and (ii) following an optimum path in the design, dimensioning and timing of the thousands of installations compris- ing the continuous development process. 4.07 Fundamental decisions establishing Thailand's basic network over the next decade were made some few years ago. They included the national numbering, switching and transmission plans; the choice of crossbar switch- ing equipment as the national standard; and the choice and disposition of microwave and cable systems Afor the long-distance network. These deci- sions were s. lmdly based and provide a satisfactory framework for future development. A national charging plan is being prepared, defining the grouping of exchanges and number analysis required for STD (see paragraph 3.16). 4.08 Optimum engineering design of large works in the project has been achieved by making present-value studies of alternatives over a typical 20-year period. For the small projects, generalized solutions were obtained for the various classes of plant from which particular types and sizes of plant are selected. Reintroduction of waiting lists for the Greater Bangkok area, however, is essential to ascertain priori- ties in providing distribution cables. Compilation of waiting lists for each exchange was recommended, and during negotiations TOT confirmed that this is being done, and should be completed by June 1973. 4.09 TOT agreed during appraisal that STD should be introduced progressively, commencing in 197L. The introduction of STD is a logical step in the most economic development of the trunk network. It requires only small additions of equipment to existing plant and obviates large investment in additional manual trunk switchboards as well as the anrmal costs of operating them, thereby giving better service at lower cost. Because of the high rate of growth of trunk traffic there will be no reduction in telephone operators, who will be still required for manual assistance. 4.10 The proposed replacement of the remaining 19,000 lines of step-by-step equipment in the Bangkok metropolitan network (see paragraph 3.04(i)) will avoid continuing probleme of interworking with the growing crossbar sector of the network, which call for complex and costly signalling conversion equipment and severely limit flexibility in assigning numbers as the networks expand. However, because of the  - 14 - large unsatisfied demand, postponing this replacement until Phase II of the program would have enabled TOT to use the new equipment to connect ore subscribers earlier in the fire-year period. But since the supply and installation of switching equipment must be committed well in advance, and network planning and equipment specifications have already progressed to the stage where any major change would cause extensive delays, with even greater disadvantages, the present replacement plans merit inclusion in the project. Rate of Return 4.11 The financial rate of return was calculated on the basis of actual charges; it was determined by equalizing the present values of expenditures and related increases in revenues at 1971 prices and is estimated to be 14% (see Annex 8). The least favorable combination of circumstances, when construction costs increased by 10%, operating costs increased by 10%, and the rate of growth was 10% less than current projections, lowered the financial rate of return to 11%.  - 15 - 5. THE BORROMER Legal Status and Authority 5.01 The Borrower would be the Telephone Organization of Thailand (TOT). TOT is a State enterprise and operates along commercial lines with a reasonable degree of autonomy. However, its investment plans and annual capital budgets, like those of all State enterprises, have to be approved by the Government; this has in the past imposed lengthy delay. This problem, which was candidly summarized in an "epilogue" to TOT's 1970 annual report (see Annex 9), has since diminished with improved working of the governmental machinery. Organization and Management 5.02 An organization chart for TOT is in Annex 10. Its Board of Directors consists of the Minister of Communications (Chairman), the Managing Director and five members, together with an Adviser and a Secretary. Two of the present members and the Adviser are military generals, and three members are senior civil servants. Commerce and industry are not represented on the Board; the advantages of such repre- sentation are felt to be outweighed by the risks of commercial interests lobbying through the Board. 5.03 The Board lays down policy and, under the Act, has the respon- sibility "to supervise, in general, the affairs of the Telephone Organi- zation". In practice, the Managing Director properly assumes fall responsibility for TOT's operations, for which he has adequate authority. 5.04 TOT is fortunate in having an exceptionally able Managing Director and a cadre of senior engineers and a financial manager who are well-qualified (many have obtained graduate degrees abroad), dedicated and competent. However, there is a need for closer integration of engineering and financial planning -- for example, in assessing the full implications of alternative courses of network development (see also paragraph 4.10). Management at the lower levels is understandably less impressive and there is a shortage of experienced first-line supervisors that will require time as well as training (see paragraph 5.07) to overcome. 5.05 With the continued emphasis on expansion, too much of the avail- able talent has been concentrated in the Planning and Project Department, leaving the Operations Department relatively weak. Also, maintenance is highly centralized to the extent of undermining the responsibilities of the field supervisors. These problems are now recognized by TOT and action is in hand to rectify the situation, with assistance from Swedtel, which has carried out extensive studies of TOT's organization and opera- tions. Since 1969 Swedtel has had a team of consultants, presently five, working with TOT; the terms of reference for the current activities are given in Annex 11. Swedtel assistance will continue during the project  - 16 - period under a proposed new contract which is expected to be finalized by December 31, 1972. During negotIiations it was confirmed that TOT will submit, for Bank agreenent, the draft terms of reference and contract. Subsequently, TOT will send the Bank time schedules, and progress reports on the work every six months, beginning with the first month after the loan is signed. (See also paragraph 5.09.) Staff and Training 5.06 TOT has a total staff of approximately 6,600, corresponding to 27 staff per 1,000 telephones as compared with 31 in 1966. While this is a satisfactory overall ratio (see Annex 1), there is a shortage of tech- nical personnel that is masked by the high number of clerical and other non-technical staff (3,300); no detailed breakdown by classification was available during appraisal. TOT agreed to review the present staffing structure and prepare a recruiting and training plan covering the project period. During negotiations a copy of the plan was supplied to the Bank. It provides for an overall staff increase of 53% (to 10,200), with a further decrease in the number of staff per 1,000 telephones from 27 at present, to 24 in 1976. No increase in non-technical staff is proposed during this period. 5.07 Existing training facilities are adequate. Near Bangkok there is a large,well-equipped telecommunications training center, constructed as a -UNDP project during the past five years. It has a staff of 46 instruc- tors, and provides comprehensive telecommunications training for technicians and engineers, as well as selective training in finance and management. The current annual output is 144 graduates, which can be readily expanded to meet TOT's additional requirements under the project. Training both in Thailand and overseas has also been provided under contract by equipment suppliers, and it is proposed to continue this practice under the project. Accounting and Audit 5.08 TOT's accounting system does not have an appropriate schedule of accounts for a telephone utility. The expense classifications do not conform to the major functions of the entity, thus making it difficult for management to assess in any depth the information now received. This also inhibits the forecasting of operating results for a given net- work expansion. There are not enough qualified senior financial staff and, in general, the accounting system is not oriented to provide manage- ment with timely information. 5.09 The Managing Director is keenly aware of these deficiencies and is taking steps that will begin to correct them. He has brought in a financial director who appears to have the background, temperament and drive to improve TOT's financial operations. Also, other trained finan- cial staff are being added, some of whom have had financial training  - 17 - abroad. Swedtel will review TOT's overall financial operations (includ- ing the accounting and budgeting systems, management reporting, stores stock control, and billing and collections), make recommendations and assist TOT's staff in implementing them. (See also paragraphs 3.15 and 5.05.) 5.10 The Act stipulates that the National Audit Council will perform an annual audit and examination of TOT's accounts and financlal position, and submit the results to the Council of Ministers within 120 days of the end of TOT's fiscal year. The Act also stipulates that TOT will publish an annual report, including certified balance sheet and profit-and-loss account, within 150 days of the end of the fiscal year. The present audit is weak. There are lengthy delays (up to 10 months) befcre the final accounts become available and the audit appears to be rat'aer superficial, dealing with matters of detail rather than substance. 5.11 Agreement was reached during negotiations that ir, order to assist the National Audit Council (NAC) in meeting Bank aud_ requirements, the Bank would provide a description of the type and scopw of audit which should be covered in NAC's annual audit report on the Bo-rower. It was further agreed that after two years, with the compl-tion of the audit for fiscal year ending September 30, 1974, if the audit requires strengthen- ing in order to meet Bank requirements, the Guarantor and -Borrower will take all measures necessary to improve the audit, inc.3-dirg if necessary, the engagement of a commercial audit firm to assist the NK. in performing the audit and/or training MAC personnel. Insurance 5.12 The Goverment and TOT have not in the past seen f_2t to purchase insurance against major losses on TOT's fixed assets from .yphoons or other catastrophes, because insurance rates for this type of coverage are con- sidered uneconomically high. TOT's management feels that the wide geographical spread of its assets provides reasonable dispersion of risk of the more normal risks such as fire and theft, and thus does not carry this type of insurance either. This is a reasonable policy for TOT and in line with the approach adopted by most telecommunications entities.  - 18 - 6. FINANCES 6.01 TOT's past earnings have been satisfactory. The main feature bearing on future financial operations is the greater use of debt financ- ing to support the construction program. Borrowings would finance 54% of total requirements (US$177 million equivalent) over the next five years, compared with about 20% of US$82 million equivalent during the previous five years, and the debt/equity ratio would rise from 24/76 to 48/52. There are two reasons for this change in the financing pattern: (i) abolish- ment in 1970 of a high connection fee which in the past provided funds for expansion, and (ii) TOT's increased capital investment. TOT should never- theless be able to carry out its expansion program under this new financing pattern and still maintain a satisfactory financial position. Tariffs 6.02 The tariff policy set forth in TOT's Act provides that income shall be adequate to meet expenses, including maintenance and depreciation, and provide surpluses for debt service and capital expansion; the amount to be provided for investment is not defined. 6.03 Procedurally, changes in telecommunications tariffs are proposed by TOT's Board of Directors and are subject to review by the Budget Bureau and the National Economic Development Board (NEDB) and approval by the Minister of Communications. A summary of present tariffs is in Annex 12. Tariff charges for Government are discus 3ed in paragraph 6.09. 6.04 Rental and call charges have not changed since 1962. With the current large expansion program, TOT has undertaken a tariff review which considers (i) establishing a common rental for all services, since most service is for business purposes even though it may be located in a resi- dence; (ii) replacing the free call allowance with a lower, fixed charge per call; and (iii) introducing a new scale of long-distance charges suit- able for subscriber trunk dialing (STD). During negotiations agreement was reached on a timetable for TOT submitting its tariff recommendations to the Bank for agreement and subsequently to Government for approval and on the recommendatiorsbeing implemented proimptly as needed to coordinate with the introduction of STD. 6.o5 The present level of tariffs has permitted TOT sufficient revenue to cover its operating costs, debt service, payments to Government (see paragraph 6.10), which are analogous to an income tax, and about 40% of its expansion costs. To ensure that TOT maintains satisfactory earnings, agreement was reached during negotiations that the overall net effect of changes in the present tariffs resulting from the review will not reduce total revenues from the amount which would be produced under the existing tariffs during the project period, and that thereafter tariffs will be maintained at a level to produce revenues, after deducting payments to Government, sufficient to earn a rate of return on average net fixed assets in operation of no less than 10% (see paragraph 6.19).  - 19 - Past Operations 6.06 Income statements for 1968-71 and related notes are shown in Annex 13. TOT's operating results over the past four years have been satisfactory. Operating ratios varied between 66% and 72%. Net operat- ing income has been equal to returns on average net plant in service ranging from 8.8% in 1968 to 11.4% in 1970. Oparating ratios and net operating income, as well as internal cash generation, throughout the report are stated on a basis which includes as operating expense the provisions for bonus payments (see paragraph 6.11) and payments to Government equivalent to income taxes. 6.07 During the past four years TOT has financed about 67% of its requirements from internal sources: 42% from net internal cash generation after debt service; 7% from subscriber deposits; 18% from draw-down of cash balances and from a large subscriber connection fee, which has since been abolished on order of Government; and the remaining 33% from borrow- ings (22%) and from Government taking up equity (11%). Collections 6.08 While collections from private subscribers have been reasonably satisfactory, Government collections have been slow. Government settles its telephone accounts in two ways, depending upon the type of service rendered. For other than rental and local call charges, TOT bills Government according to the tariff, allowing a 15% discount on long dis- tance on the basis of bulk usage, and Government pays these bills in full, though with some delay. The amount of these receivables is high, compris- ing about one-third of TOT's total receivables, which were equivalent to 90 days' billings at the end of fiscal year 1971. 6.09 Government pays erratically for rental and local call charges, electing from year to year an arbitrary amount for full payment equivalent to only about 60% of the concessional tariff currently applicable to Government. Actual payments, however, have fallen short of even this amount and B32.7 million (Us$1.6 million) of arrears has been written off over the years as an operating expense, amounting to about 3% of the last four years' total revenues. If Government had been billed according to the rate as quoted in the tariff, an additional B45 million (US$2.2 million) would be owed TOT. This problem will become more acute with the introduction of STD, when long-distance charges will appear on the local bill. Agreement was reached during negotiations that new tariffs, applicable to and payable by the Government, will be introduced according to an agreed timetable. The Government has further agreed to a timetable for settling its arrears to TOT within four years. Payments to Government 6.10 TOT makes annual payments to Government in accordance with a Cabinet Resolution passed in 1965 that requires State enterprises to return to Government an amount equal to the amount of taxes a private concern pays under the Revenue Code, which was 25% of net income until 1971, when it was raised to 30%.  - 20 - Bonuses 6.1i In accordance with another Cabinet Resolution pertaining to State enterprises, TOT pays an annual bonus to its staff and the members of the Board. The staff's bonus is equal to 5% of net income and the Board's bonus is equal to 2%, with the latter not to exceed B300,000 ($14,423). TOT's management feels that the overall incentive provided by this scheme is beneficial, giving most staff members a personal interest in the entity's well-being. The bonus payments are treated as an operating expense in the accounts. Present Financial Position 6.12 Balance sheets for 19658-1971 are presented in Annex 14. The book value of assets is realistic, since there has been a high degree of price stability in Thailand for many years; also a high proportion of the assets has been recently built and reflects current costs. Between 1954 and 1962, assets valued at B50.5 million were transferred from the Posts and Telegraphs Department. In 1966 and 1970, Government transferred to TOT microwave routes valued at B351.9 million, serving the country's northern and southern regionls; the value of these transfers totals about 25% of the value of plant in service at the end of fiscal year 1971. All other plant additions have been added under TOT's expansion programs. 6.13 Depreciation has been computed on a straight-line basis, based on the life of the various categories of plant in service. Rates vary from about 2% for buildings to 20% for vehicles, resulting in a composite rate of about 5-1/2%; this is realistic. Forecasts assume the same composite rate.  - 21 - 6.1L TOT's capitalization as of September 30, 1971, is summarized below: US$ Million B Million Equivalent % Equity Govemnment investment 513.4 24.7 28.9 Subscriber contribution 4.6 .2 .2 Retained earnings (less deficit on debt revaluation) 1/ 839.7 40.4 47.3 Total Eqaiity 1, 357.7 65.3 76.4 Long-Term Debt Long-term debt (less current maturities) 417.9 20.1 23.6 Total Capitalization 1,775.6 85.4 100.0 6.15 Two main factors contribute to TOT's conservative capital struc- ture wherein debt equals 24% of capitalization as of September 30, 1971: Government has provided substantial investment as equity; and TOT has been able to invest a large part of its eanmings in plant expansion. Government equity investment over the past three years increased by 43% and retained earnings by 42%. Financing Plan 6.16 The forecast of Sources and Applications of Funds for the period 1972-1978 (Annex 15) is based on TOT's total development program given in Annex 3, assumed future works beyond the program, forecast earmings given in Annex 13, borrowings given in Annex 14, and estimated increases in working capital. Shown below is a summary of the financing plan for the five-year project period 1972-1976. 1/ Debt repayable in Japanese yen and Belgian francs at the close of fiscal year 1971 was revalued upward by 20% and 15%, respectively, or by a total of B58.3 million equivalent (equivalent to 15% of long-term debt and 3% of total capitalization), and retained earnings were correspondingly reduced. While another method of accounting for the revaluation of debt would have been to increase the value of plant in service, TOT has indicated that it would be charging retained earnings. With the relatively small amount involved, either method is acceptable.  - 22 - B Million US$ Million % Requirements 1/ Development Plan 1972-76 (Phase I) 2,094.5 100.7 57 Development Plan 1972-76 (Phase II) 807.5 38.8 22 Ongoing development plans 602.7 29.0 16 Working capital increase 172.4 8.3 5 Total Requirements 3,677.1 176.8 100 - _ Sources Internal cash generation 1,818.5 87.4 49 Less: Debt Service 631.2 30.3 17 Net Internal Cash Generation 1,187.3 57.1 32 Government investment 310.0 14.9 9 Subscriber deposit 190.8 9.2 5 Borrowings Japan EXIM Bank loans 75.4 3.6 2 Proposed IBRD loan 1/ 743.6 35.8 20 TOT Bonds 100.0 4.8 3 Government loan 210.0 10.1 6 Future borrowings (Dev. Plan - Phase II) 450.0 21.6 12 Bilateral loans/Supplier credits 410.0 19.7 11 Tota1 Borrowings 1,989.0 95.6 54 Total Sources 3,677.1 176.8 100 6.17 Included as sources of funds are borrowings arranged by Government of B310 million (US$14.9 million) and Government investment as equity of B310 million. The borrowings would consist of Government loans and possibly bonds issued by TOT in the open market. The latter would be a new source of funds for TOT. EGAT successfully raised B50 million through a bond issue recently, which was the first time that a State enterprise offered bonds for public subscription. Government loans of B210 million are assumed at 1/ B195.9 million of the total 1972-1976 development program, including the residual US$1.2 million Bank loan, is estimated to be spent in 1977 and is mainly retention payments.  - 23 - 8% interest, with terms of 12 years including two year grace periods; bonds totaling B100 million are assumed to carry a 9% interest rate over five years, similar to the EGAT bond issue. About 50% of the total funds to be made available by Government. to TOT has been assumed to be equity investments in order to enable the entity to maintain a strong capital structure so that it will not find itself with too great a debt burden in the future. TOT will be incurring other debt to the extent that its debt/equity ratio is forecast to rise from 24/76 in fiscal year 1971 to 51/49 in 1978 -- a debt position which, although fairly conservative, preferably should not be exceeded at this time to permit TOT to incur the substantial debt required for expansion from 1978. It is assumed that TOT will continue to pay 30% of its annual net income to Government equivalent to normal corporate income tax, and would pay Government a dividend on its investment beginning about two years after completion of the program. During negotiations these financial arrangements with Government were confirmed, including dividends not being paid before completion of the 1972-76 Development Program. 6.18 Details of the other borrowings are given in Annex 14, paragraph 11. The Japan EUIM Bank loans totaling US$3.6 million have already been arranged. The sources of bilateral loans/supplier credits amounting to US$19.7 million are not presently known, but it is reason- able to expect that, as in the past, they would be available at favorable terms; about US$7 million is in the process of being firmed up. With these borrowings the financing plan for Phase I would be assured. Never- theless, assurances were obtained during negotiations that Goverment would be prepared to cover any financing gap in the project. Future borrowings of US$21.6 million equivalent are assuned to be available from 1975 from international financing agencies to help finance Phase II of the 1972-76 Developnent Plan. 6.19 During the five-year period, 1972-76, net internal sources of funds after providing for debt service would be equivalent to 37% of the construction costs and worldng capital increase; Government's equity investment would amount to 9% and borrowings 54%, of which 20% would be the proposed Bank loan. The financing of 37% of total requirements from internal sources is satisfactory, considering that TOT's value of plant in service is expected to increase by B2.6 billion (US$125 million) -- an increase of 1 .7 times. Future Finances 6.20 Forecast income statements and balance sheets for 1972-78 are shown in Annexes 13 and 14. Existing tariffs, summarized in Annex 12, are assumed for the forecasts. Based on the new facilities to be provided by the expansion program, operating revenues over the next seven years are estimated to increase at an average annual rate of 16%; operating expenses, which are estimated to increase at 17%, provide for additional staff as well as other expenses arising from the larger network. These increases are of the same order as in the past. The rate of return is expected to  - 24 - reach about 14% in 1972 and then decline to 10% during the seven-year period. Considering that TOT pays 30% of net income to Government as the equivalent of the income tax normally paid by a private concern, the 10% rate of return after this payment is very satisfactory; before deduct- ing the payment to Government, the corresponding rates of return would range from 19% to 12%. The higher rate of return in some years of this forecast is due to excessive occupancy of plant dae to backlog of demand before new works are commissioned. Operating ratios would be satisfactory at about 66%; this compares with past ratios of 66% to 72%. 6.21 The forecast financial position is satisfactory. The ratio of current assets to current liabilities would range between 2.5/1 and 1.9/1. Coverage of interest and amortization by internal cash generation would be satisfactory at between 4.7 and 2.1 times. Debt Limitation Covenant 6.22 In the past, TOT has had relatively little debt but with the proposed program a substantial amount of debt will be incurred, as is also expected for future programs. With this new financing pattern, it is essential that TOT in its long-term financial planning not over- extend itself with borrowings. During negotiations agreement was reached on a debt service coverage of at least 1.5 times, based on the Bank's usual debt limitation covenant.  - 25 - 7. REOMEDATIONS 7.01 During loan negotiations# agreement was reached on the following principal points: (a) Government will undertake to consult with the Bank before any changes affecting TOT's overa]4L organization or responsibilities are made (paragraph 2.05); (b) The Bank's standard audit covenant will be adopted; and the audited accounts will be sent to the Bank within four months after the end of the fiscal year (paragraph 5.11); (c) A tariff review will be male and the Bank willI be consulted on its terms of reference and on any changes recommended; total revenues will not be lowered during the project period and thereafter tariffCs will be sufficient to earn a ninimum rate of return of 10% after deducting payments to tGovernment equivalent to incoms taxes (paragraphs 6.O0 and 6,05); (d) Arrangements satisfactory to the Bank will be made for a tariff which will be applicable to and payable by Government and for Government to pay its current bills and settle its arrears (paragraph 6.09); (e) Government will arrange financing as needed by TOT, totaling about US$30 million equivalent, divided approximately equally between equity and debt (paragraph 6.17); (f) Dividend payments will not be paid before completion of the 1972-76 Development Plan (paragraph 6.17); (g) Government will cover any financing gap in the project (paragraph 6.18); (h) There will be a limitation to the incurrence of long-term debt (paragraph 6.22); (i) Consultants will be employed to assist with project super- vision and management studies, under terms and conditions acceptable to the Bank (paragraph 3015); and (j) A number of measures on technical matters. agreed with the Bank, are being taken isee paragraphs 2.05, 2.15, 3.16, 4.o8 and 5.o6).  - 26 - 7.02 With the indicated assurances and confirmations, the project is suitable for a Bank loan of US$37 million equivalent, for a term of 20 years including a four-year grace period. October 27, 1972  L.. rT