Colombia - Fourth Telecommunications Project

Report No. 1464a-CO FILE COPY Colombia Empresa Nacional de Telecomunicaciones (TELECOM) Appraisal of the Fourth Telecom-munications Project May 25, 1977 Latin America and the Caribbean Regional Office Energy, Water and Telecommunications Department FOR OFFICIAL USE ONLY U Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1 = Col$36.38 (January 1977) Col$1 = US$0.0275 Col$1 ,000, 000 = US$27,500 FISCAL YEAR January 1 to December 31 LIST OF ABBREVIATIONS AND ACRONYMS USED IN THE REPORT CARRIER - a system of providing a number of circuits over one radio link, coaxial cable, or a pair of wires CHANNEL - one circuit of a carrier system carrying speech or tele- graph signals FILL - percentage of installed capacity of a telephone exchange actually in service HF/UHF/VHF - high frequency radio up to 30 MHz; ultra high frequency radio beyond 300 MHz; very high frequency radio between 30 - 300 MHz MHz - Megahertz MICROWAVE - radio system working at frequencies above 300 MHz but normally applied to systems working at frequencies above 1 ,000 MHz MULTIPLEX - part of the equipment in a carrier system - see above TELECOM - Empresa Nacional de Telecomunicaciones - an entity solely responsible for operating national telegraph, telex and long distance services and international services; and with 47 other entities responsible for local telephone services TELEX - telegraph exchange service for subscribers TOLL TICKETING - method of charging long distance calls by recording par- ticulars of each call made applying the relevant tariff  FOR OFFICIAL USE ONLY COLOMBIA EMPRESA NACIONAL DE TEECOMUNICACIONES (TELECOM) APPRAISAL OF THE FOURTH TELECOMMUNICATIONS PROJECT Table of Contents Page No. SUMMARY AND CONCLUSIONS ............... ...................... i-ii 1. INTRODUCTION .................... so* ... e..o ................ so 1 2. THE TELECOMMUNICATIONS SECTOR ....... ........................ 2 Role of Telecommunications in the Economy .... ............. 2 Sector Organization ........ ...................................... 2 Sector Constraints .............................................. 2 Access to Service ....................... 0 ....................... 3 Sector Objectives ....................................... . 4 Sector Organization ...................................... 5 Audit Report Findings ... ...................... .............. 5 3. THE PROGRAM AND PROJECT ..................................... 6 The Program ................. 0................................ 6 The Project .............................................. 6 Project Cost ................................................. 7 Contingencies ............... 0 ................................. 9 Items for Bank Financing ................................. . 9 Procurement ............................................... 10 Project Implementation ...... . . 10 Disbursement .. ................................. ... ........ 10 4. JUSTIFICATION . ................................................ 11 Sector Reorganization . ......... ........................... 11 Rural and Urban Development ............................... 11 Urban Efficiency .......................................... 11 Demand Forecast ........................................... 12 Least-Cost Solution ........................................ 12 Return on Investment ...................................... 12 This report is based on information obtained from TELECOM and on the find- ings of a mission composed of Messrs. M. DeLima and R. Mitchell who visited Colombia in October 1976. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Table of Contents (Continued) Page N~ 5. THE BORROWER ............................................... 13 Organization and Management ............................... 13 Management of Acquired Systems ......... ................... 14 Staff and Training ....................... ......*... * ..... 14 Accounting and Audit ..................................... 15 Billing and Collection ..................................... 15 Tariffs .... ......................................... 17 Insurance ..... ........................................ 18 6. FINANCES .......... 18 Background ........................................ 18 Present Financial Position ................................ 18 Past Financial Performances .... ........................... 19 Financing Plan ..... .................................. 20 Future Operating Results .................................. 22 Acquisition of Other Entities .... 23 7. AGREEMENTS REACHED AND RECOMMENDATIONS ..... ................. 24  List of Annexes 1. Summary of Existing Facilities as of December 31, 1976 2. Telephone Entities Operating in Colombia as of December 31, 1975 3. International Telephone Statistics 4. Basic Data as of December 31, 1976, 1978 and 1982 5. Exchange Capacity and Connected Lines - Actual (1970-76) and Forecast (1977-82) 6. Investment Program (1977-82) 7. Summary of Project Costs (1977-82) 8. Physical Program (1977-82) 9. Schedule of ConstructToi - Chart No. WB 16632 10. Schedule of Disbursements 11. Return on Investment 12. Organization Chart - Chart No. WB 16631 13. Staff Details 14. Summary of Principal Tariffs 15. Income Statement 16. Statement of Financial Position 17. Statement of Sources and Applications of Funds 18. Income Statement - Notes and Assumptions for Projections 19. Statement of Financial Position - Notes and Assumptions for Projection 20. Performance Indicators MAPS IBRD 10891R (February 1977) - Local Automatic Telephone Exchange Network IBRD 11272R (February 1977) - Long Distance Network   COLOMBIA EMPRESA NACIONAL DE TELECOMUNICACIONES (TELECOM) APPRAISAL OF THE FOURTH TELECOMMUNICATIONS PROJECT SUMMARY AND CONCLUSIONS i. This report appraises a project comprising part of the works of the Empresa Nacional de Telecomunicaciones (TELECOM) 1977-82 development program scheduled to be started and completed during the six-year period 1977-82. ii. TELECOM operates national telegraph, telex and long distance serv- ices, and all international telecommunication services. Local services are fragmented among TELECOM and 47 other poorly coordinated entities, many of them very small in size and lacking in managerial and technical skills. The institutional consolidation of the fragmented local entities is essential if efficient planning, financing and project implementation are to be achieved. iii. The project would: (a) help consolidate into TELECOM a significant proportion of the small municipal and state government-operated local telephone entities, and rationalize and improve service in the small towns and rural communities they now serve; (b) greatly expand access to telephone service in rural areas by providing long distance call offices to 2,200, out of about 4,000 rural communities now without telephone facilities; (c) upgrade service in 150 rural areas currently using call offices, by installing manual exchanges; (d) upgrade and expand the long distance network to cater to the additional traffic generated over the network (including rural call offices); and (e) significantly develop local networks in small towns to meet part of the demand for local connections. At the end of the project, TELECOM will have absorbed 32 of the 47 other entities currently responsible for telephone services in Colombia, paving the way to better services particularly in small towns and rural areas. iv. The project will largely meet the objectives set by Government who consider the extension of telephone services to all rural communities essen- tial in the provision of health-and agricultural extension services, effi- cient regional transport and proper marketing of rural agricultural output.  - ii - v. The project is estimated to cost Col$ 7,937 (US$167.7) million, with a foreign exchange component of US$101.3 million equivalent. The pro- posed Bank loan of US$60 million would partially cover the foreign costs; the balance of US$41.3 million would be covered by an Inter-American Devel- opment Bank loan of US$16 million (plus an additional US$13 million in Colombian pesos for financing local currency expenditures), and by TELECOM's own resources. TELECOM would also provide the balance (US$53.4 million equiva- lent) of local costs. vi. TELECOM has the managerial and technical capabilities -- achieved with Bank assistance during the past decade -- and will be able to effectively undertake the new responsibilities. In addition, the internal organization of TELECOM is being strengthened during the proposed project. vii. All Bank-financed equipment would be procured through international competitive bidding in accordance with the Bank's Guidelines. viii. TELECOM plans to make annual tariff revisions during the project period. With these tariff increases, the project would be financially sound. The internal rate of return is estimated at 19%. Internally generated funds during the project period would provide 62% of the financing requirements after servicing all debt. ix. The project is suitable for a Bank loan of US$60 million equivalent for a term of 17 years, including a grace period of three and one-half years. The Republic of Colombia would be guarantor of the loan.  1. INTRODUCTION 1.01 The Government of Colombia has requested Bank assistance in fi- nancing the 1977-82 development program of Empresa Nacional de Telecomu- nicaciones (TELECOM). The proposed borrower and beneficiary of the loan would be TELECOM. 1.02 TELECOM's development program is estimated to cost Col$ 16,177 (US$345.9) million including a foreign exchange cost of about US$222.4 mil- lion equivalent. The project, which would comprise part of TELECOM's develop- ment program, is expected to be started and completed during 1977-82. The project provides for: the installation of additional local exchange lines mainly in provincial and rural communities; provision of rural telephone call offices; and the extension of long distance facilities to handle traffic from those lines, from the rural call offices and from existing connections. The cost of the project is estimated at Col$ 7,937 (US$167.7) million, includ- ing a foreign exchange component of US$101.3 million equivalent. The proposed Bank loan would provide US$60 million equivalent, and the Inter-American Development Bank (IDB) would provide US$16 million (plus an additional US$13 million equivalent in Colombian pesos to cover local costs). The balance of foreign costs (US$25.3 million) and of local costs (US$53.4 million equivalent) would be provided by TELECOM. 1.03 The Bank has been continuously associated with the telecommunica- tions sector in Colombia since 1967. In June 1967 the Bank approved a US$16 million loan (499-CO) to TELECOM to help finance a project to establish a modern long distance network and to expand and improve the national and international services. The project has been completed. In May 1971, a second loan (740-CO) for US$15 million was approved to help finance a proj- ect for the installation of new local networks and for the extension of long distance telecommunications facilities. This project is expected to be completed by June 1977, about 30 months behind schedule. A third Bank loan (1073-CO) for US$15 million approved in January 1975, is financing a further extension of local and long distance services within the country, an increase in telex services, and an extension of telephone services to about 200 rural towns. This third project is progressing satisfactorily and is expected to be completed on schedule in December 1978. 1.04 In May 1975 the Bank undertook a telecommunications sector study at the request of the Government of Colombia. This study (Report No. 663-CO) recommended that the sector be integrated by progressively consolidating all the various entities into a single entity. The Government has agreed to the need for such consolidation. The study also recommended that, as a first step, TELECOM takes over the smaller entities to remove the existing con- straints to planning and financing the required improvement and expansion of their facilities. One of the proposed project's aims is to assist TELECOM in this initial step toward consolidation. 1.05 This report is based on information obtained from TELECOM and on the findings of a mission composed of Messrs. M. DeLima and R. Mitchell which visited Colombia in October 1976.  - 2 - 2. THE TELECOMMUNICATIONS SECTOR Role of Telecommunications in the Economy 2.01 Colombia has a population of about 24 million people distributed over a number of distinct regions divided principally by mountain ridges. High mountain chains isolate the densely populated districts from each other and the coast; the sparsely populated districts over a large part of the country and extend into the Amazon forests. About half the population is urban; more than a quarter live in the four main cities of Bogota, Medellin, Cali and Barranquilla, all of which are important administrative and manu- facturing centers. Annual population growth has averaged 2.8%; GDP growth at 6.7%. In 1975 the value of exports of agricultural products (including coffee) comprised over 70% of the country's total value of export; industrial products about 24%. 2.02 Agricultural production for export requires adequate and reliable telecommunications to coordinate transport, sales, fertilizer and pest con- trol supplies, and to facilitate timely deliveries of the products. 1Manu- facturing requires coordination of a series of operations which are dependent on adequate communications. The provision of reliable telecommunications services is an obvious requirement for an expanding economy which needs such services to operate effectively. Additionally, Government considers the extension of telephone services to all rural communities essential in the provision of health and agricultural extension services. Sector Organization 2.03 TELECOM, the proposed Borrower, operates all long distance, inter- national telephone, telex and telegraph services. Local services are frag- mented among TELECOM and 47 other poorly coordinated entities. 2.04 TELECOM has been required by Government to provide local telephone services in rural areas and communities where the other entities are not willing or able to provide these services due to the small size of the com- munities and to the remoteness of the locations. On this basis, TELECOM provides local services at six large towns, several small towns and in rural areas; TELECOM thus functions in all areas of the country. The existing facilities provided by TELECOM are set out in Annex I and in the maps. 2.05 Currently, about 95% of the total local telephone services are operated by 47 other telephone entities. Many of the entities are small -- 24 of these local companies each operate from 200 to 1,400 lines. Only eight local companies operate more than 10,000 lines. Annex 2 sets out the list of operating companies. Sector Constraints 2.06 While TELECOM and the two largest entities at Bogota and Medellin are able to prepare their plans, they do so independently of each other.  -3 - Most of the smaller ones do not possess the managerial and technical competence to plan and implement expansion. They are in financial difficulties due to excessive short-term financing, reluctance to introduce adequate tariffs and poor organization. Procurement practices are unsatisfactory, and service is poor. In the absence of in-house facilities in the majority of entities, Government has undertaken a number of detailed functions, e.g. detailed reviews of expansion plans of the municipal entites, of procurement, etc., which should normally be undertaken by the operating entities, thus leading to considerable increase of avoidable processing and delays. The consequence has been a stag- nation in provision of facilities, and the generally poor service in the sector and particularly so in the small towns and rural areas. 2.07 Government decided in 1971 that TELECOM should set aside a part of the gross national long distance revenues for the acquisition and expansion of local entities. The progress of acquisition was relatively slow because TELECOM (a) had not gained sufficient experience in local services operations and wanted to gain some more before embarking on further acquisition; and (b) had to utilize all available financial resources to extend long distance services, its primary responsibility. 2.08 Following a Government request, the Bank carried out a sector study in May 1975. The Bank recommended gradual consolidation of the sector into a single entity. Two alternative courses of action were considered. The first, through compulsory acquisition of local entities, would entail changes in Colombia's legislation and could give rise to political problems as well as delays. The second was to supplement the present practice of purchasing local entities by TELECOM, by channeling investment for the entities' development through TELECOM in exchange for TELECOM's equity participation in the entity. The Government of Colombia endorsed this approach, and the proposed fourth project has been designed to support this objective. The sector strategy is to work within the present legislative framework and develop and improve the services to the small towns and rural areas. Access to Service 2.09 Starting with a density of 2.4 telephones per 100 population at the time of the Bank's first loan, the density has risen at end-1975 to 5.45 telephones per 100 population which is slightly above average among Latin American countries at similar development stages. Service, however, is con- centrated in eight large cities with about 85% of the total telephones in the country. Out of about 4,500 rural communities, only about 500 have access to telephones. Annex 3 sets out international telephone statistics. 2.10 As of December 31, 1975, the local telephone system in Colombia had about 1,285,000 telephones, of which TELECOM provided 58,000 telephones in provincial and rural areas. The unfilled demand was about 250,000. In addi- tion, the lack of adequate expansion has resulted in a heavy overload of the call-handling equipment, network congestion and subscriber dissatisfaction. Despite considerable improvement in long distance communications which expanded at an annual rate of about 20%, quality of service remains deficient. Congestion continued as the surge of traffic kept exceeding forecasts.  -4- Sector Objectives 2.11 The strategy followed during the last decade of Bank participation through two projects nearly completed has been to: (a) establish a modern long distance network with associated long distance exchanges to link together the principal areas of the country and provide a nationwide high quality sub- scriber dialing network covering nearly all automatic ex- changes in the country; (b) expand local telephone services in areas which were or became TELECOM's responsibility; (c) establish an institutional framework for sector development; (d) develop a financial basis for future expansion; and (e) initiate sector consolidation. 2.12 During Bank's involvement in two projects, TELECOM increased the number of exchanges from 376 to 430; the total capacity of those exchanges from about 12,000 lines to about 70,000 lines; and the total number of con- nections from about 11,000 to about 53,000. At the completion of the third project in 1978, TELECOM would operate 476 exchanges with a total capacity of about 101,000 lines and about 80,000 connections. In addition, TELECOM has also achieved considerable expansion of long distance facilities and has established facilities for subscriber dialing of long distance calls for about 95% of the total subscribers in Colombia. 2.13 The sector objectives to be accomplished under the proposed proj- ect are to: (a) help consolidate into TELECOM a significant proportion of the small municipal and state government-operated local telephone entities, and to rationalize and improve service in the small towns and rural communities they now serve; (b) greatly expand access to telephone service in rural areas by providing long distance call offices to 2,200, out of about 4,000, rural communities now without telephone facil- ities; (c) upgrade service in 150 rural areas currently using call offices, by installing manual exchanges; (d) upgrade and expand the long distance network to cater to the additional traffic generated over the network (in- cluding rural call offices); and  - 5 - (e) significantly develop local networks in small towns to meet part of the demand for local connections. An additional objective is to consolidate and improve the internal organiza- tion of TELECOM particularly to cope with the expansion of its responsibil- ities. At the completion of the project in 1982, TELECOM will have absorbed 32 (including the six associated entities) of the 47 other entities currently responsible for telecommunications in Colombia. TELECOM would then operate about 190,000 exchange lines with about 158,000 connections as well as serve 2,700 rural communities through call telephones. Sector Organization 2.14 As a result of the sector changes planned during the project period, TELECOM will be vested with most of the responsibility for telecommunications services in the provincial and rural areas, paving the way to better services and thus to contribute significantly to the effective functioning of the dif- ferent economic and extension services in these areas. The long-term effects of this integration would be (a) standardization of equipment with attendant large-scale procurement resulting in at least 20-30% lower costs; (b) strength- ening of the institutional framework for sector development; (c) elimination of duplication of services in many towns; (d) rationalization of staff with improvement of training, improving service standards and efficiency; and (e) developing a financial basis for further consolidation and future expan- sion. 2.15 With the new added responsibilities of TELECOM at the completion of the project, a comprehensive knowledge of the benefits in providing service in different areas is useful to achieve maximum effectiveness in future plan- ning and in deciding on the size of future investments, pattern of development and priorities. During negotiations, TELECOM has agreed to take up studies of qualitative and quantitative benefits as part of their normal planning work and to furnish not later than July 1978, a plan for undertaking such studies with the assistance, if necessary, of economists from Colombian universities or Government. Audit Report Findings 2.16 The Audit Report on the first project financed under Bank Loan 499-CO and executed between 1967-74, while holding an overall positive view of the Bank's achievements, points out the large delays in project implementation caused by poor planning and project management. Another comment relates to the continuing unsatisfactory position of the accounts receivable pertaining to the local entities and the Government. 2.17 The delays in project implementation were mainly due to slow pro- curement and problems encountered in building construction, which mostly occurred in the early stages of the first Bank-financed project. Since then, TELECOM has improved its managerial and technical competence and has now good  experience in all aspects of project implementation as is shown by the pro- gress currently being made in the execution of the third project. While the status of accounts receivable shows improvement, there are still residual problems in the collection of a portion of past arrears. From 1976, TELECOM has been able to collect on a current basis dues from services rendered to the major connecting local entities who were the principal defaulters in the past. The position is similar in respect of dues from Government and Govern- ment Agencies. The current status of pre-1976 arrears and the action proposed to liquidate them have been set out in paragraphs 5.12 to 5.14. 3. THE PROGRAM AND PROJECT The Program 3.01 TELECOM has drawn up a six-year (1977-82) telecommunications devel- opment program which comprises the following main items: (a) completion of ongoing works, principally the project financed by Bank Loan 1073-CO -- and the expansion of the local automatic exchange equipment by a total of 5,000 lines; (b) installation of a satellite earth station at San Andres Island; (c) extension of telex equipment at Cali, Barranquilla and Medellin by a total of 3,300 lines; (d) installation of (i) a second satellite earth station with 153 circuits, and (ii) an international automatic telephone exchanae with 530 circuits; and (e) the project proposed for Bank financing. 3.02 Preliminary plans for items (b) and (d) have been completed, and construction is scheduled for 1978 and for 1979. Item (c) is in the planning stage and is scheduled for construction during 1980. The estimated cost of the six-year program is US$345.9 million equivalent, including a foreign exchange expenditure of US$222.4 million equivalent. The program costs year-by-year are summarized in Annexes 6 and 7. The Project 3.03 The project proposed for Bank financing is a self-contained part of the program and would be carried out between 1977 and 1982. It consists of the following: (a) the addition of 64,000 lines of local automatic equipment of which 31,000 will be installed in 26 exchanges currently  operated by municipal entities to be purchased by TELECOM raising their total capacity to about 52,000 lines, and 33,000 will be installed in six exchanges currently oper- ated by municipal entities raising their capacity to about 64,000 lines; (b) the addition of 31,000 lines in local automatic exchanges operated by TELECOM; and of about 6,000 lines in 150 manual exchanges to serve rural areas currently without exchange facilities; (c) the connection of about 75,000 additional subscribers; (d) the installation of microwave radio equipment on nine new routes; (e) the installation of about 8,800 additional long distance circuits on existing and new routes, and of the corres- ponding long distance exchange termination equipment; (f) the provision of long distance services to 2,200 communities; and (g) the construction of buildings to house equipment. The Inter-American Development Bank loan will essentially cover the costs of extension of facilities at item (f) above, while Bank financing will cover the corresponding additions to the network to handle traffic from these communities. Project Cost 3.04 The cost of the project is estimated at about US$167.7 million equiv- alent, including a foreign exchange expenditure of about US$101.3 million equiv- alent. The cost, shown in detail in Annex 7, is summarized as follows:  -8 - Col $ (million) US$ (million) Local Foreign Total Local Foreign Total In new lincensed areas /1 Local switching services including cables 826.5 672.2 1,498.7 22.7 18.5 41.2 Long distance equipment 11.3 202.2 213.5 0.4 5.5 5.9 Subtotal 837.8 874.4 1,712.2 23.1 24.0 47.1 In existing licensed areas Local telephone service Local switching equipment 135.1 274.2 409.3 3.8 7.5 11.3 Distribution network 260.4 7.3 267.7 7.2 0.2 7.4 Subscriber equipment 10.1- 26.7 36.8 0.3 0.7 1.0 Subtotal 405.6 308.2 713.8 11.3 8.4 19.7 Long distance service Microwave radio 14.9 195.7 210.6 0.4 5.4 5.8 Multiplex 30.6 372.7 403.3 0.8 10.3 11.1 Switching equipment 19.3 306.3 325.6 0.6 8.4 9.0 Subtotal 64.8 874.7 939.5 1.8 24.1 25.9 Rural call offices 411.7 971.0 1,382.7 11.3 26.7 38.0 Freight and insurance 199.7 - 199.7 5.5 - 5.5 Base cost 1,919.7 3,028.2 4,947.9 53.0 83.2 136.2 Physical contingencies 16.7 - 16.7 0.4 - 0.4 Price contingencies (23%) 1,233.0 1,739.8 /2 2,972.8 13.0 18.1 31.1 Total expected cost of prolect 3,169.4 4,768.0 7,937.4 66.4 101.3 167.7 /1 These are the licensed areas of entities to be purchased by TELECOM during the project period and of entities to be associated with TELECOM through TELECOM's equity participation in their expansion program during the project period. /2 Includes additional local costs due to anticipated change in US$/Col$ parity rate over the 1977-82 period.  - 9 - 3.05 The project costs reflect estimated December 1976 prices based on TELECOM's experience with recent contracts related to ongoing works and those being carried out under Loan 1073-CO with adjustments to bring them up to date. The project estimates are reasonable. TELECOM is exempt from payment of cus- toms duties on imported goods. Contingencies 3.06 Price contingencies for project costs amount to 23% of total base and physical costs. They result from the year-by-year estimated local cost increases of: 1977-20%; 1978-18%; 1979-15%; and 1980 through 1982-12% annual- ly; and the year-by-year estimated foreign cost increases of: 1977 through 1979-7.5% annually; and 1980-7%. The foreign cost increases are applied to the contract date since contracts in this sector are on a fixed price basis. The annual percentage cost increases assumed above are consistent with current Bank Group Guidelines. 3.07 Provision of local and long distance exchange lines, telephones, radio equipment terminals and multiplex channels to be procured and installed under the project are based on detailed forecasts and detailed engineering. In view of this, quantities are not expected to change significantly and according to experience unexpected increases in some routes would usually be compensated by decreases in other routes. In the case of cable networks, the dispersion of these networks throughout the country permits flexibility and adjustment to keep total costs within the estimates. No physical contingencies are considered necessary for the above work items. Variations in quantities, however, could occur in buildings and civil works; a physical contingency amounting to 5% of local costs has been provided for this purpose. Items for Bank Financing 3.08 Of the project's US$101.3 million foreign costs, the Bank loan would finance US$60 million; the Inter-American Development Bank would provide US$16 million (plus an additional US$13 million in Colombian pesos for financing local currency expenditures) for rural service equipment; and TELECOM's own resources would provide the balance of US$25.3 million for (a) rural services equipment (US$16.3 million); (b) long distance equipment (US$6.5 million); and (c) local service equipment (US$2.5 million). The items to be financed by the Bank are given below: Local Exchanges US$ million Subscribers' plant (new area) 17.8 Exchange equipment (existing area) 6.3 Subscribers' plant (existing area) 0.7 24.8 Long Distance Equipment Microwave radio 5.4 Equipment (new area) 3.9 Multiplex 10.3 Switching 4.9 24.5 Contingencies 10.7 Total 60.0  - 10 - Procurement 3.09 All goods provided under the project for Bank financing would be procured through international competitive bidding in accordance with the Bank's Guidelines. Other imported goods outside of Bank financing would be procured: (a) through negotiations with existing equipment suppliers in case of additions to existing equipment for reasons of standardization, (b) through competitive bidding for other new equipment; and (c) through international competitive bidding in accordance with IDB Guidelines. Goods such as cables, cable ducts, poles and fittings, all of which are manufactured locally, would be procured through competitive bids from domestic suppliers and financed with TELECOM's funds. 3.10 None of the Bank-financed project goods are currently manufactured in Colombia; hence the matter of price preference for locally manufactured goods does not arise. Project Implementation 3.11 The proposed schedule for execution of the project is set out in Annexes 8 and 9 and is realistic. TELECOM's staff would prepare engineering designs and bid documents; would evaluate bids; and would draw up equipment contracts. TELECOM would lay, joint and commission all distribution cables, and would supervise construction of cable ducts by local contractors. All installation and maintenance of telecommunications equipment would be carried out or coordinated by TELECOM's technical staff, and, where new technologies are involved, TELECOM would install equipment with the support of the manu- facturer's specialist staff. TELECOM would carry out acceptance tests of all installed equipment. TELECOM's management is experienced and is capable of handling the above items of work satisfactorily. Disbursement 3.12 The estimated loan disbursements are set out in Annex 10. Disburse- ment would be for the FOB costs of imported equipment and the foreign costs of its installation. TELECOM is required by Government regulations to utilize Colombian ships for transport of goods imported for its operations and to insure those goods with Colombian insurance companies and, therefore, pays for insurance and freight with local currency. However, any indemnity for such insurance would be payable in a currency fully usable to replace or repair such goods. Because the project as designed does not meet all of the esti- mated demand for service, any unused balance of the loan should be used to finance additional equipment similar to that already procured under the loan, in agreement with the Bank.  - 11 - 4. JUSTIFICATION 4.01 This project represents a significant step forward in assisting the Government of Colombia to rationalize and improve the efficiency of operation of the telecommunications sector; to increase development of services in its rural areas; and to provide employment opportunities in smaller urban centers. Sector Reorganization 4.02 An important aspect of this project is to facilitate the institu- tional consolidation of the sector, thereby moving toward the elimination of the major constraints to provision and operation of an efficient nation- wide telephone system. The institutional consolidation of the fragmented local entities in the sector is essential if efficient planning, financing, and project implementation are to be achieved. Currently, there is no ef- fective national plan for total telecommunications development, no emphasis on standardization of procedures and equipment, and many of the potential economies inherent in international bidding and bulk purchasing are not realized. This proposed project which reinforces and speeds up the process of consolidation of local telephone entities through TELECOM is a major step toward the attainment of the desired sector objectives. Rural and Urban Development 4.03 Government considers the extension of telephone services to all rural communities essential in the provision of health and agricultural extension services, efficient regional transport, and proper marketing of rural agricultural output. The project will expand service into 2,200 smaller hitherto unserved rural communities, and by installing 8,800 long distance circuits, it will facilitate better rural-to-urban an inter-urban communications which complement national priority programs in agricultural development, rural and regional transport improvement, and the integration of rural dwellers into modern sectors of the economy. Urban Efficiency 4.04 Telephones in the smaller urban areas in Colombia tend to be used as intermediate inputs in the production of goods and services. This proj- ect, by expanding exchange capacity and upgrading the quality of telephone service in selected small urban centers will (a) help slow the growth of telephone waiting lists, (b) reduce wastage of time caused by having to make repeated call attempts, and (c) improve urban transport and delivery service. Furthermore, to the extent a more efficient and wider access to telephone service for Government and business results in the substitution of telephone communication for face-to-face communication, the growth in transport and energy costs will be slowed, as well as traffic congestion and resulting air pollution.  - 12 - Demand Forecast 4.05 Forecasts of local telephone demand were prepared for all TELECOM exchanges in early 1976 in collaboration with TELECONSULT of USA, a tele- communications consulting firm retained by TELECOM under Bank Loan 740-CO. These demand forecasts were utilized in the preparation of TELECOM's 1977-82 development program. On this basis TELECOM forecasts a total additional exchange equipment requirement of about 30,990 lines and an average overall growth rate of 10% which is considered reasonable. 4.06 The capacities of practically all the lo5cal telephone exchanges which are planned to be acquired by TELECOM by purchase, or by association through majority equity participation, have not been increased during the past five years; quality of service has deteriorated, and waiting lists have not been maintained. TELECOM has assumed a conservative annual growth rate of from 8 to 12% for each of these exchanges based on experience in similar population and economic activity areas and has decided to extend all 32 ex- changes on this basis. Any variations resulting from this assumption will be accommodated in the subsequent phase of the exchanges' development. 4.07 With regard to long distance services, TELECOM, with the assistance of its consultants, has made a study of circuit requirements (route-by-route) for the whole country to remove existing congestion and to provide for the additional traffic expected as a result of additional utilization by existing and new subscribers. In accordance with the above, the project aims at pro- viding an additional 8,800 long distance circuits which will reduce the likelihood that major bottlenecks will form during the 1977-82 development program period. Least-Cost Solution 4.08 The least-cost solution to the provision of telecommunications depends on (a) having made the correct technological and economic decisions initially when the networks were planned, and (b) following the optimum path in the design, dimensioning and timing of the many installations which comprise the continuous development process. Despite the constraints on total telecommunications development planning as set out in paragraph 4.02, certain fundamental decisions establishing the national numbering, switching and transmission plans, the use of common control switching equipment and the use of microwave and other radio systems have been made. These decisions, verified and updated by the consultants in early 1976, are designed to pro- vide least-cost additions over the long term. Return on Investment 4.09 The internal rate of return on the project defined as the discounted rate which equalizes the stream of expected revenues attributable to the proj- ect with capital and operating cost is 19% (Annex 11). This rate of return reflects a foreign exchange shadow price of 120%. Sensitivity analysis shows  - 13 - that under the most unfavorable combination of main parameters (increase of 10% each in capital and operating costs; 10% decrease in revenue; and two-year delay in project completion) the rate of return would not be less than 11%. 4.10 The above calculation of the internal rate of return is a signifi- cant underestimate of total project benefits since it is based only on the measurable willingness of subscribers to pay for telecommunications services. As such, it does not include estimates of the consumer surplus which callers receive, or estimates of benefits received by non-callers; benefits incurred by receivers of calls, by all other subscribers when additional subscribers pay to join the system, and by all those who benefit indirectly through the better administration of rural development, health, transport, and agriculture programs, increased urban and rural business and Government efficiency. 4.11 The calculated rate of return is also an underestimate of total project benefits because, while the costs included in calculating the 19% internal rate of return are those for extending the network and providing facilities in the newly served rural areas now, the full benefits are not included because the available capacity of various components of equipment will only be fully utilized when additional marginal investment is made in the future. Thus, benefits will be incurred in future projects which will be primarily attributable to costs incurred in this project. 5. THE BORROWER Organization and Management 5.01 TELECOM was established in 1947 as a government-owned autonomous entity and is managed by a Board of Directors appointed by the President of the Republic with the Minister of Communications as the ex-officio Chairman of the Board. An organization chart is shown in Annex 12. Day-to-day man- agement of the entity is the responsibility of TELECOM's President, also appointed by the President of the Republic. TELECOM's President is assisted by five vice presidents, each one in charge of technical (engineering), opera- tions, integration, industrial relations, and finance. Additionally, the legal adviser, organizational development chief, public relations adviser and secretary general -- who is responsible for board matters, project coordina- tion and general services -- report directly to the president. 5.02 TELECOM retained technical and financial consultants under Loan 740-CO to develop the optimum management organization which will be required to administer its rapidly growing operations. The recommendations of the consultant are being implemented. TELECOM has also, with the Bank's encour- agement, decentralized maintenance, planning and operational work to the seven regional managers. However, with the completion of the proposed project, local exchange operations will have grown significantly to about 190,000 lines, largely administered by the several regions. Under these conditions, responsible and efficient administration of the system as a whole becomes  - 14 - increasingly dependent on effective reporting by the regions and coordination and timely control by headquarters. Timely regional management reporting to cover all areas of importance for proper coordination and control should be designed and instituted. TELECOM has initiated a reporting system in one region as a pilot installation in consultation with the Bank. Assurances were obtained during negotiations that TELECOM would establish a suitable reporting system in all regions by January 1, 1979. 5.03 TELECOM has decided to use its own funds to continue the employment of the financial consultants obtained under Loan 740-CO through the year 1977. TELECOM intends to utilize their services to develop a completely integrated financial system which would more fully utilize computer applications and improve TELECOM's ability to monitor operating performance. 5.04 TELECOM's senior engineering and financial staff are well qualified and experienced and are capable of managing the present operations as well as those proposed for the project period. Junior management have been trained by consultants engaged under Loan 740-CO and are competent to meet the chal- lenges of the expanding operations. Management of Acquired Systems 5.05 In the case of the entities which are purchased by TELECOM, TELE- COM's managers in regions within which the entities are located will take over responsibility for the operations. TELECOM would supplement the entity's existing staff by its own experienced staff. In the case of entities with which TELECOM would be associated, TELECOM would become the majority share- holder and have appropriate representation on each Board of Directors. TELECOM would second suitable experienced technical, planning and financial personnel to improve the management, the operations of the entity, and make possible profitable operation. Staff and Training 5.06 As of December 31, 1976, TELECOM had a total of about 13,400 staff, of which about 9,300 were being used in telephone operations and about 4,100 in telegraph and telex operations. The existing staff level is considered reasonable considering that it is largely related to long distance facilities and local facilities in rural areas. TELECOM proposes to add about 3,100 staff to operate the additional long distance, rural facilities, and about 75,000 additional subscriber connections planned to be provided during the period 1977-82. The staff level at the project's completion date is also considered reasonable. Annex 13 gives details of the number of employees in each department for the years 1976-82 as well as staff pay scales and ser- vice conditions. The pay scales are generally commensurate with the duties, and the salaries are comparable with, or, in some cases, slightly higher than those paid by other telecommunications organizations for similar duties and qualifications. Turnover of staff is reported to be negligible.  - 15 - 5.07 TELECOM has no difficulty recruiting qualified professional engineer- ing and managerial staff from graduates of local institutes and universities. It is similarly able to recruit, without any difficulty, technicians and other operating and administrative staff. During the project period, TELECOM would recruit a total of about 4,200 staff, of which 1,200 would be technical and financial staff, about 2,000 operational and administrative staff, and about 1,000 telegraph operating staff. 5.08 Graduate engineers are generally given on-the-job training, and, in some instances, are sent abroad for specialized training under arrangements made with suppliers and under bilateral government-level technical assistance programs. TELECOM operates a training institute at Bogota -- Technical Institute of Electronics and Communications (ITEC) and regional training centers in Barranquilla, Bucaramanga, Cali, Ibague, Manizales and Medellin. ITEC provides basic and refresher training for up to 2,000 technicians and other operational and administrative staff. The regional training centers provide concurrently some operational courses for up to 1,000 personnel. TELECOM's training facilities are adequate for meeting its staff needs during the project period. Accounting and Audit 5.09 TELECOMl's accounting system has steadily improved with Bank assistance under the previous loans and is now at a generally satisfactory level. Further improvements are planned utilizing the services of consultants to introduce a fully integrated financial system to provide additional management information through additional use of computers. The only significant accounting problem which is being experienced is the failure of TELECOM to be able to produce annual financial statements for submission to the Bank within four months of the end of the fiscal year. This failure has been attributed to TELECOM's in- ability to obtain source data from remote field locations. The consultants, as part of the integrated system work, will review data flow and correct this problem. Until the consultants have completed their work, TELECOM believes they will have difficulty complying with the four-month requirement but never- theless believe the schedule remains a worthwhile goal which should be achiev- able after 1977. 5.10 The existing external audit arrangements are satisfactory and meet the requirements of loans 740-CO and 1073-CO. During negotiations, agreement was reached that the Bank would repeat the existing covenant for the appoint- ment of external auditors and for the submission of financial statements in the new loan agreement. Billing and Collection 5.11 TELECOM's billing and collection arrangements depend on whether the subscribers using TELECOM's facilities are connected to exchange systems operated by TELECOM or by others. TELECOM bills the subscriber and makes collection where it operates the.exchange. Similarly, TELECOM bills the subscribers directly for all telex and telegraph services. In respect of  - 16 - subscribers not connected to TELECOM-operated exchanges, TELECOM normally bills the local telecommunications enterprises for all long distance traffic originated in these exchanges providing supporting data to enable the local enterprise to bill the individual subscribers. Collections for these ser- vices are the responsibility of the local enterprise. However, in partial modification of the above, TELECOM bills and collects separately for operator-handled long distance traffic in Bogota and Calarca. 5.12 TELECOM has faced continuing problems with accounts receivable, which as of August 31, 1976, amounted to a total of Col$ 700.5 million (excluding those from international connecting companies) and made up of the following: (a) national government - Col$ 97.7 million; (b) intercon- necting local exchange operating entities - Col$ 357.9 million; (c) private customers - Col$ 82.7 million; and (d) all other - Col$ 162.2 million. 5.13 TELECOM has made some improvements in its collection performance during 1976. Current accounts of Government and local connecting companies are being collected on a timely basis but the collection of old balances continues to be a problem. Of these old balances: (a) the account of Bogota (ETB), which amounted to Col$ 108.4 million at August 31, 1976, is substantially the result of previous erroneous billing and is being corrected to give ETB full credit for its share of international billings. TELECOM's deficiencies in billing resulted from an inter- national billing problem (see para. 5.14); (b) the account of Cali (EMCALI), Col$ 81.2 million at August 31, 1976, has been converted to promissory notes which in turn have not been paid in accordance with their amortization schedules. TELECOM has failed to obtain settlement of this large debt. (c) the account of Barranquilla (Col$ 66.7 million) is also being converted to a promissory note supported by a stronger agreement relating to the sharing of long distance revenues. The remainder of the old balances in local connecting company accounts, although of substantially lesser individual value, will be very difficult to collect as the funds required are not available. These balances should, how- ever, be applied against the purchase price of these entities when they are eventually integrated into TELECOM. 5.14 The International Connecting Company accounts receivable amounted to Col$ 142.8 million as of December 31, 1975, due principally to the failure of TELECOM to provide required settlement data. During 1976 TELECOM has strengthened the organization responsible for international toll settlement and had collected Col$ 60 million of the balances by September 30, 1976. TELECOM must continue to emphasize the importance of this function so that settlements are continuously made with all international connecting companies on a current basis.  - 17 - 5.15 The financing plan (see para. 6.06) is based on the assumption of continued improvement in TELECOM's collection performance reducing accounts receivable balances of 33% of annual billings in 1976 to 16% in 1982. These improved collections are necessary if TELECOM's cash position is to be main- tained during the project period. Therefore, during negotiations TELECOM agreed to furnish the Government and the Bank by October 31, 1977, a draft plan for obtaining prompt payment of all outstanding debts and by February 28, 1978, obtain the agreement of the Government and the Bank on the final plan for immediate implementation. Tariffs 5.16 TELECOM's principal tariffs are given in Annex 14 and comprise of monthly telephone rentals of about US$1 for business subscribers and US$0.75 for residential subscribers with a call charge of USg0.5 per three minutes for all subscribers. Subscribers also pay a one-time installation charge of about US$10.50; a guarantee deposit of about US$22; and a noninterest-bearing deposit which varies from about US$19 to US$33 equivalent per line. The two deposits are returned to the subscriber, or adjusted against pending accounts, if service is discontinued. 5.17 The level of TELECOM's tariff has been satisfactory in the past. It has produced rates of return which have exceeded the 11% required by previous Bank loans and has provided adequate funds to support TELECOM's development program. The existing level of tariffs will not, however, be adequate during. the project period and TELECOM has agreed to make annual revisions and has suggested the following telephone tariff revision program: 1976 1977 1978 1979 1980 1981 1982 Local Telephone Impulse value (pesos) .15 - .25 .30 .35 .40 .45 Percent increase - 67 20 17 14 13 Interurban Telephone Percent increase 15 10 10 10 10 10 TELECOM has given effect to a tariff increase from March 1977. This approach to tariff revision proposing progressive increases of the local call charges can be justified as local charges are presently very low. However, during the project period, TELECOM should review their tariff philosophy to make sure that a reasonably balanced tariff structure continues to exist.  - 18 - 5.18 TELECOM tariffs, although comparable with those of other telephone entities in Colombia, are low by international standards. Even after imple- menting the full tariff revision program suggested in paragraph 5.17, TELECOM's tariffs will not be excessive when compared with other developing countries throughout the world. 5.19 TELECOM has executed a contract with each local telephone entity for sharing of long distance call revenues. The percentage share of revenues for each outgoing call accruing to the local connecting entities varies from 22.5% to 33% for manual and semi-automatic service (decreasing with increasing size of the exchange area) and from 24.5% to 35% for automatic service. For international traffic, these percentages apply to Colombia's net share of such revenues. 5.20 Local and long distance national tariffs are set by TELECOM's Board of Directors, and approved by the National Tariff Board comprising representa- tives of the Ministry of Finance and the National Planning Department. This arrangement has worked very effectively in the past and has provided Govern- ment with an adequate control over the level of telecommunications tariffs while not delaying justified increases in TELECOM's tariff. Insurance 5.21 TELECOM carries fire and related perils insurance coverage for the properties which house technical installations valued at Col$ 5 million (US150,000) or more and for stores inventories. In addition, TELECOM carries business interruption (loss of profits) coverage for its earth satellite ground station. These insurance practices are acceptable. 6. FINANCES Background 6.01 TELECOM's past operating results have been satisfactory and its financial position is reasonably sound. In 1974 and 1975 it was able to generate 67% of its fund requirement, which is excellent. In the future this pattern of heavy internal generation is expected to continue but will be associated with a greater amount of debt in order to make necessary funds available to support the expanded development program. Present Financial Position 6.02 Balance sheets for 1974-75 are shown in Annex 15. TELECOM's present financial position at December 31, 1975 was satisfactory with a debt-equity ratio of 60/40 and a current ratio of 2.2. TELECOM, however, does have a large liability for pensions and severance pay which will eventually have to be met. A summary of this balance sheet follows:  - 19 - Col$ US$ (in millions) Assets Fixed Assets Net plant in service 1,921 55 53 Plant under construction 365 10 10 Total Fixed Assets 2,286 65 63 Other Assets 638 18 18 Net Current Assets 671 19 19 3,595 102 100 Liabilities Equity 867 25 24 Long-term debt 1,300 37 36 Reserve for pension and severance pay, etc. 1,428 40 40 3,595 102 100 Past Financial Performance 6.03 Financial statements for the 1974-76 period are shown in Annexes 15, 16 and 17. The results of the period are summarized as follows: 1974 1975 1976* Revenues (Col$ millions) 1,538 2,101 2,820 Operating expenses (Col$ millions) 1,270 1,655 2,115 Rate of return 11.6% 13.6% 18.4% Debt-equity ratio (excluding pension and severance liability) 64/36 60/40 53/47 Current ratio 1.7 2.2 2.4 Debt service coverage 2.0 2.7 3.6 * Provisional 6.04 Loan 1073-CO requires TELECOM to achieve an annual rate of return of at least 11% on the value of net fixed assets in service calculated on the current peso equivalent of the dollar value of the assets. Rates of return of 11.6% and 13.6% were recorded in 1974 and 1975, respectively, and based on provisional results a return of 18.4% is anticipated for the year 1976. TELECOM's revenues increased 37% in 1975, partially due to a tariff increase  - 20 - effective July 23, 1975, more than offsetting an operating expense increase of 31%. Revenues increased 34% in 1976 again partially due to the 1975 tariff increase, while operating expenses increased 28%. The financial performance is considered to be satisfactory. 6.05 TELECOM's debt service coverage has also been acceptable at 2.0 times in 1974, 2.7 times in 1975 and an estimated 3.6 times in 1976. Financing Plan 6.06 The funds required for the six-year project period (1977-82) and the sources from which these funds would be obtained, are summarized in the following table. Forecast statements of sources and applications of funds on an annual basis, are shown in Annex 17. Col$ US$ % (in millions) Requirements for Funds Construction Program 15,538 333 77 Equity participation in other telecommunication entities 1,186 25 6 Purchase of telecommunications entities 188 4 1 Increase in working capital 2,712 55 13 Other 637 13 3 Total Requirements 20,261 430 100 Sources of Funds Internal generation From operations 13,231 269 From subscriber deposits 390 8 From non-cash provisions for pensions, severance, etc. 4,548 93 Other 175 4 Total internal generation 18,344 374 Less: Debt service 5,502 109 Net internal generation 12 842 265 62 Borrowing Proposed Bank loan 2,796 60 14 IBRD Loans 740-CO and 1073-CO 319 8 2 Inter-American Development Bank credit 1,313 29 7 Other internat'l bank & suppliers' credits 2,907 66 15 National bank loans 84 2 - Total borrowing 7,419 165 38 Total Sources 20_261 430 100  - 21 - 6.07 TELECOM would provide from internal cash generation 62% of the required funds including part of the foreign exchange requirements, and the balance of 38% would be obtained through debt financing. 6.08 Planned borrowings consist of the proposed US$60 million Bank loan (assumed to be for a 17-year term including a three and one-half year grace period), US$8 million to be drawn down under previous Bank Loans 740-CO and 1073-CO, a US$29 million IDB loan for rural telephone development, US$2 mil- lion of national loans primarily relating to the purchase of other telecommu- nications entities and US$66 million of international bank loans or suppliers' credits. The Bank project is self-contained and supported by necessary addi- tional foreign exchange financing. TELECOM will have no difficulty generating the required local funds to insure successful completion of the project works. Financing for the remainder of the program, while not fully assured, is ex- pected to become available. US$20 million has presently been approved by the Finance Ministry for the purchase of switching centers, antennas and tele- printers, leaving US$46 million to be obtained during the project period. If the necessary funds cannot be obtained, the program would have to be reduced. This reduction would not affect TELECOM's earning ability during the project period as it relates to plant which will be put into service after the project period. 6.09 TELECOM makes an annual provision for its severance pay liability and makes payment from its funds directly to employees who are terminating their services with TELECOM. It originally was planned, as of January 1, 1972, to replace this practice by a payment to the Fondo Nacional de Ahorro (FNA), who would then take the responsibility for making these severance payments. However, TELECOM has been allowed by Government and FNA to con- tinue the existing practice and plans to follow this course throughout the project period and has requested the extension of the arrangement with FNA. The financing plan assumes the retention of these funds by TELECOM and the use of these funds to finance the 1977-82 development program. This practice, although it has helped TELECOM obtain financing for its development programs and forms an essential part of the financing for the present overall program, should not continue indefinitely and future development plans should not rely on use of these sources of funds. However, since part of these funds are utilized to provide employee housing at a low interest rate, the immediate discontinuation of the practice was not considered advisable as it would increase the financing cost to the employees and could lead to labor problems. 6.10 TELECOM has a non-contributory pension scheme for its employees. In accordance with the requirements of Loans 740-CO and 1073-CO, TELECOM has carried out an actuarial evaluation of the requirements for its pension contribution and has brought into its accounts the liabilities as evaluated. The financing plan assumes a continuation of this arrangement. However, during negotiations, TELECOM and Government: (1) confirmed that the present arrangements will continue during the project construction period; and (2) agreed to review before end-1978 the adequacy of this arrangement for ensuring security of future pension payments to TELECOM's employees, prepare a plan needed to implement the decision, and inform the Bank of the decision.  - 22 - 6.11 TELECOM's capital investment program is large and a limitation is necessary on new investments outside the proposed program. Assurances were obtained during negotiations that TELECOM would obtain Bank agreement before committing itself during the project period to any capital expenditure not required for the program, if the aggregate of such capital expenditure made or to be made in any one fiscal year should exceed an amount equivalent to US$1.0 million, or an amount equivalent to 10% of the aggregate amount of all its capital expenditures made during the previous fiscal year, whichever amount is greater. 6.12 During the project period funds made available by internal generation through operations are estimated to amount to at least 2.1 times debt service requirements. This performance is acceptable and reflects a satisfactory financing plan. However, during negotiations agreement was reached to continue the covenant in the previous Loan Agreement requiring Bank agreement before contracting new debt unless the net revenues of TELECOM in the preceding 12 months cover the maximum debt service at least 1.5 times. Agreement was also obtained that TELECOM will not acquire any short-term debt in excess of US$500,000 equivalent without promptly informing the Bank. Future Operating Results 6.13 The forecast Income Statement and Financial Position Statement for the project period (1977-82) are given in Annexes 15 and 16. A summary of the expected financial results follows: 1977 1978 1979 1980 1981 1982 Total revenues (Col$ ) 3,738 4,969 6,349 8,126 10,167 12,570 Net operating income (millions) 775 1,021 1,326 1,715 1,991 2,175 Rate of return % 18.5 19.7 19.1 18.0 15.3 13.0 Operating ratio % 79 79 79 79 80 83 Debt-equity ratio 58/42 63/37 66/34 70/30 68/32 64/36 Current ratio 3.7 3.6 3.0 2.7 2.7 3.1 Debt service coverage 3.2 3.3 2.6 2.4 2.1 2.2 6.14 Revenue and operating expenses have been projected in accordance with past experience and projected increases in telephone connections and other facilities. Operating expenses include an inflation factor of 10%. Details of the projection methods are given in Annexes 18 and 19. 6.15 Based on the forecast the rates of return on net fixed assets will vary from 18.5% in 1977 to 13.0% in 1982. The operating ratio during the period will be between 79 and 83. Both of these results would be satis- factory.  - 23 - 6.16 TELECOM's debt-equity ratio will increase from 53/47 at December 31, 1976 to 70/30 in 1980 but will return to 64/36 by the end of the project in 1982. This high debt-equity ratio is the result of TELECOM's required accounting practices which stipulate that the value of fixed assets be maintained at original cost and long-term debt at the parity of the Colombian peso. The Bank has required that, for the computation of the rate of return for loan purposes, the assets be revalued. To meet this requirement, TELECOM maintains memo records reflecting this revaluation and, hence, the measurement of the adequacy of earnings is not affected by TELECOM's accounting practices. There is, however, an understatement of equity resulting in a debt-equity ratio higher than would exist if the fixed assets had been suitably revalued in TELECOM's accounts. 6.17 TELECOM correctly plans to turn to tariff revision to obtain a substantial portion of this fund requirement during the project period. The tariff revision program suggested by TELECOM (see para. 5.17) will produce the required funds without being unduly burdensome to the subscriber and the economy, but will temporarily produce rates of return substantially above the 11% required in Loan 1073-CO. Therefore, during negotiations, agreement was obtained that TELECOM will maintain at least a 16% rate of return cal- culated on the peso equivalent of the US dollar value of net plant in service for the years 1977-80 and will review its rate of return requirements with the Bank in 1980. However, in no case will the rate of return after 1980 be less than 11%. Acquisition of Other Entities 6.18 TELECOM has initiated the process of acquiring on a full ownership basis 26 of the operating entities, which are shown in Annex 2. The discus- sions for the takeover are in an advanced stage and will be completed pro- gressively before the end of 1980. TELECOM will negotiate and arrive at the amounts payable based on the book value of the assets and liabilities. During negotiations, TELECOM provided assurances that these acquisitions will be completed before the end of 1980 and will consult with the Bank on the purchase contracts' terms before finalizing and signing the contracts. 6.19 During the project period, TELECOM intends to progressively acquire equity interests in six local service telephone companies in accordance with Colombia's program for integration of the sector. TELECOM proposes to use funds obtained from the proposed Bank loan to provide necessary equipment to extend and improve the facilities of these companies. In exchange for this equipment they will obtain the majority equity interest in the new companies formed from the assets of the old companies and the new equipment additions provided by TELECOM. Each new company will have the authority to revise its tariffs as required subject to the approval of the National Tariff Board. TELECOM has the right to appoint the majority of the members of the Boards of Directors and will be able to influence operations. During negotiations it was agreed that TELECOM would present draft agreements setting out the terms of association with each of the s,ix operating entities to serve as a basis for  - 24 - investing in these companies. The draft agreements will include satisfactory arrangements for TELECOM in matters relating to, inter alia, capitalization, organization, management, financing, accounting, auditing and tariff policy for each of the six new companies. 6.20 Indicators which will help monitor TELECOM's performance are given in Annex 20. 7. AGIEEMENTS REACHED AND RECOMMENDATIONS 7.01 During loan negotiations, agreement was reached on the following principal points: (a) TELECOM would take up economic studies as part of its normal planning and would furnish to the Bank not later than July 1978, a plan for undertaking the studies (para. 2.15); (b) the system of reporting operational information is extended to all regions by January 1, 1979 (para. 5.02); (c) TELECOM would (i) have its accounts and financial statements (balance sheets, statements of income and expenses and related statements including cash flow statement) for each fiscal year audited by independent auditors acceptable to the Bank, and (ii) furnish to the Bank as soon as possible, but in any case, not later than four months after the end of each such year, (A) certified copies of its financial statements for such year, and (B) the report of the auditors (para. 5.09); (d) TELECOM will, by October 31, 1977, furnish a draft plan to Government and the Bank for obtaining prompt payment of outstanding debts and by February 28, 1978 agree on a final plan for immediate implementation (para. 5.15); (e) Government and TELECOM would (i) confirm that the present arrangements for pension contribution will continue during the project period, and (ii) by end-1978 agreed to review the adequacy of the present practices and inform the Bank of the results of the review (para. 6.10); (f) TELECOM would obtain Bank agreement before committing itself during the project period to any capital expenditure exceeding certain limits not required for the program (para. 6.11);  - 25 - (g) Bank approval would be obtained before TELECOM incurs long- term debt unless its maximum debt service in any future year is covered 1.5 times by the net revenues of the preceding fiscal year or of a later 12-month period prior to the incurrence of the debt (para. 6.12); (h) TELECOM will not acquire short-term debt in excess of US$500,000 equivalent without promptly informing the Bank (para. 6.12); (i) TELECOM would maintain adequate tariff levels to enable the maintenance of at least a 16% rate of return calculated on the peso equivalent of the US dollar value of net plant in service for the years 1977-80 and will review its rate of return requirements in 1980, subject to it not being less than 11% (para. 6.17); (j) TELECOM would acquire about 26 local entities before end-1980, and will consult with the Bank on purchase contract and terms before finalization (para. 6.18); and (k) TELECOM would present draft agreements setting out association terms satisfactory to the Bank which would include capitaliza- tion, organization, management, financing, accounting, auditing and tariff policies, with each of the six local entities (para. 6.19). 7.02 The proposed project constitutes a suitable basis for a Bank loan of US$60 million for a term of 17 years including a grace period of three and one-half years. May 1977   ANNEX 1 COLOMBIA EMPRESA NACIONAL DE TELECOMUNICACIONES (TELECOM) Summary of Existing Facilities as of December 31, 1976 1. The local automatic exchange network as now existing is set out in Map 1 and the existing long distance network is shown in Map 2. Basic network data are given in Annex 4. A brief description of TELECOM's facilities as of December 31, 1976, is given below. Local Services 2. TELECOM was responsible for 87 local automatic and 343 manual ex- changes mostly in rural and semi-urban areas with a total capacity of 69,759 lines and 52,610 connected lines of which 72% were connected to automatic exchanges. The unfilled demand was about 22,000. Annex 5 sets out data on exchange capacity and the number of connected lines from 1970 to 1976. Long Distance Services 3. Long distance services are provided by microwave radio, VHF radio, HF radio, open-wire carrier systems, and open-wire physical lines. Facili- ties for subscriber dialing of long distance calls are available to nearly all subscribers on the automatic exchange network; for the others long distance sercice is provided on a semi-automatic or fully manual basis. Toll ticketing equipment is in service at Barranquilla, Bogota and Cucuta, and will be in service at Ibague from March 1977. Telex and Telegraph Services 4. Telex is provided through 41 exchanges with a total capacity of about 3,300 lines with about 2,600 connected subscribers. A network of about 1,600 telegraph offices (about 250 connected to telex) covers the whole country and serves telegraph service needs. International Facilities 5. Colombia has good international telecommunications facilities to countries in Central and South America, Europe and the USA. These facilities are provided through VHF radio circuits to Venezuela, Ecuador and the Antilles; through cable to the USA; and through the earth satellite station to the USA and Europe. One hundred and forty-six circuits, 67 of which are worked on a semi-automatic basis, handle a total daily traffic of about 4,000 calls.  ANNEX 2 Page 1 of 2 pages COLODDIA EMPRESA NACIONAL DE TELECOMUTiICACIONES (TELECOM) Telephone Entities Operating in Colombia as of December 31, 1975 Name of Entity Eguipment Lines erated 1. Empresa de Telefonos de Bogota 418,000 2. Empresas Publicas de Medellin 2014,200 3. Empresas Municipales de Cali 80,900 4. Empresa Municipal de Telefonos-Barranquilla 50,000 5. Empresa Nacional de Telecomunicaciones-(TELECOM) I42,450 6. Empresa Municipal de Telefonos-Bucaramanga 22,400 7. Empresas Publicas de Manizales 17,000 B. Empresas Publicas de Pereira 15,750 ** 9. Compania Telefonica de Cartagena S.A. 12,500 10. Empresas Departamentales de Antioguia 8,700 11. Empresas Publicas de Armenia 8,500 12. Compania Telefonica del Huila S.A. 8,1400 13. Empresas Publicas Municipales-Palmira 7,550 1.4. Empresas Publicas Municipales de Ibague 7,000 *15. Empresas Municipales de Girardot 5,000 **16. Telefonica Municipal de Santa Marta 5,000 17. Empresas Municipales de Cartago 4,400 **18. Empresa Departamental de Telefonos de Narino 4,000 **19. Telefonica Municipal de Popayan 4,000 20. Empresas Municipales de Tulua 3,600 **21. Planta Telefonica Departamental-Meta 3,100 22. Empresas Municipales de Buga 2,800 4**23. Empresa Municipal de Telefonos-Barrancabermeja 2,500 *24. Empresas Municipales de Calarca 2,000 *25. Empresa Telefonica Municipal de Fusagasuga 1,400 *26. Empresa Municipal de Telefonos de Ipiales 1,400 *27. Empresas Publicas Municipales-Sta. Rosa Cabal 1,400 *28. Telefonica Municipal-Espinal 1,200 *29. Telefonica Municipal de Caicedonia 1,100 *30. Empresas Publicas Municipales de Sevilla 1,100 *31. Empresa Municipal de Telefonos de Armero 1,060 *32. Telefonica Municipal de Chinchina 1,000 *33. Empresa Municipal de Telefonos de La Dorada 1,000 *34. Empresa Municipal de Telefonos de Rio Sucio 1,000 *35. Telefonica Municipal de Yarumal 980 *36. Telefonica Municipal de Zarzal 800 *37. Telefonica Municipal de Florencia 700 *38. Empresas Publicas Municipales de Honda 700 *39. Empresa Telefonica Municipal de Salamina 700 *40. Empresa Municipal de Telefonos-Garzon 600 *41. Telefonica Municipal de Aguadas 500 *42. Telefonica Municipal de Anserma 500  ANNEX 2 Page 2 of 2 pages Name of Entity Equipment Lines Operated *43. Telefonica Municipal de Marl a 500 *44. Telefonica Municipal de Zipaquira 500 *45. Empresa Municipal de Telefonos de Riohacha 400 *46. Telefonica Municipal de Cajica 200 *47. Telefonica de Maicao 200 *48. Telefonica Municiapal de Tumaco 200 Total 967,390 * These entities are proposed for acquisition by TELECOM. ** These entities TELECOM proposes to be associated with. Swmnary - Entities which would operate on conclusion of Bank financed project: 1. Independent Entities 15 2. TELECOM 1 3. Associated Entities (TELECOM) 6 22  Annex 3 COLOMBIA EMPRESA NACIONAL DE TELECOMIUNICACIONES (TELECOM) International Telephone Statistics POFULA- GROSS NATIONAL TEIEPHONES - JANUARY 1975 TION i/ PRODUCT - 1973 NATIONAL PRINCIPAL CITIES REST OF COUMRY Per Capita Per Av. Annual ' Per- Per- Co-TTRY 1/1/75 Per Growth Total 100 Growth Rate Automa- Total Per centage Total Per centage Capita Rate Number Popu- (1965-75) tization Number 100 of Nat'l Number 100 of Nat'l (ooo's) us$ (1965-73) (000's) lation , (000's) Pop. % (000's) Pop. ( AFRICA East Africa 39,937 149 2.7 230 0.57 10.5 84.6 166 8.3 72.2 64 0.2 27.8 Egypt, Arab Rep. 36,730 250 0.8 503 1.37 n.a. 96.7 364 4.o 72.4 139 0.5 27.6 Ethiopia 27,495 go 1.6 66 0.24 12.1 88.5 52 3.4 78.8 14 0.1 21.2 Morocco 16,726 320 2.5 189 1.13 2.5 82.0 128 3.2 67.7 61 0.5 32.3 Nigeria 69,674 210 8.3 111 0.16 6.4 83.4 68 3.9 61.3 43 0.1 38.7 Rhodesia 6,205 430 3.5 172 2.77 6.2 93.4 138 14.2 80.2 34 0.7 19.8 South Africa 24,914 1,050 2.0 1,936 7.77 5.5 82.6 1,399 24.2 72.3 537 2.8 27.7 Sudan 18,112 130 -o.6 56 0.31 4.5 91.4 49 3.0 87.5 7 0.1 12.5 Tunisia 5,628 460 4.9 114 2.03 12.7 92.6 49 2.4 43.0 65 1.8 57.0 Zambia 4,687 430 -0.2 68 1.45 8.2 97.8 29 3.3 42.7 39 1.0 57.3 AMERICA Argentina 25,225 1,640 2.9 2,374 9.41 4.9 96.8 1,378 18.9 58.1 996 5.6 41.9 Brazil 106,069 760 6.o 2,652 2.50 7.7 94.6 1,992 8.3 75.1 660 0.8 24.9 Canada 22,661 5,450 3.5 12,454 54.96 5.9 97.8 6,254 59.0 50.2 6,200 51.5 49.8 Colombia 23,590 550 3.4 1,285 5.45 8.0 98.6 898 7.8 70.0 388 2.6 30.0 Costa Rica 1,960 710 3.5 98 5.02 16.1 99.0 88 10.5 89.8 10 0.9 10.2 Ni Salvador 4,065 350 0.8 50 1.22 8.6 97.2 44 2.9 88.o 6 0.2 12.0 t4exico 58,265 890 2.8 2,546 4.37 13.4 94.8 2,069 10.2 81.3 477 1.3 18.7 Trinidad & Tobago 1,060 1,310 2.2 66 6.26 6.o 99.9 41 41.8 62.1 25 2.6 37.9 us 212,013 6,200 2.5 143,427 67.65 5.0 99.9 75,904 73.5 52.9 67,523 62.1 47.1 Venezuela 11,918 1,630 1.3 554 4.65 7.9 99.2 477 9.3 86.1 77 1.1 13.9 ASIA China, Rep. 15,856 660 7.3 go9 5.68 19.8 92.5 591 12.0 65.6 310 2.8 34.4 India 582,596 120 1.5 1,690 0.29 8.4 82.3 879 2.7 52.0 811 0.2 48.o Indonesia 123,840 130 4.5 285 0.23 3.4 63.3 201 1.4 70.5 84 0.1 29.5 Iran 33,565 870 7.4 806 2.40 16.1 94.1 541 5.3 67.1 265 1.1 32.9 Iraq 10,770 153 1.42 9.4 93.1 126 2.9 82.4 27 o.4 17.6 Israel 3,408 3,010 6.7 735 21.57 13.1 100.0 562 30.9 76.5 173 10.9 23.5 Japan 110,626 3,630 9.6 41,905 37.88 13.1 97.4 26,527 42.9 63.3 15,378 31.5 36.7 Malaysia 11,738 570 3.7 259 2.21 7.9 96.6 n.aE. n.a. n.a. n.a. n.a. n.a. Nepal 2/ 12,423 go -0.1 11 0.09 13.9 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Pakistan i/ 69,710 120 2.5 214 0.31 5.9 83.0 n.a. n.a. n.E. n.a. n.a. n.a. Philippines 40,941 280 2.6 446 1.09 11.4 96.o 374 4.3 83.9 72 0.2 16.i Singapore 2,237 1,830 9.4 280 12.53 13.5 loo.0 280 12.5 100.0 - - - Syria / 7,121 400 3.6 152 2.14 7.8 89.7 126 5.2 82.9 26 o.6 17.1 Thailand 41,036 270 4.5 271 o.66 15.3 96.o 234 4.4 86.4 37 0.1 13.6 EURo PE France 52,742 4,54o 5.0 12,405 23.52 8.1 94.o 4,546 46.2 36.7 7,859 18.3 63.3 Germany, Fed. Rep. 62,040 5,320 4.o 18,767 30.25 8.7 100.0 8,185 46.1 43.6 10,582 23.9 56.4 Sweden 8,178 5,910 2.4 5,178 63.32 4.3 100.0 2,529 75.1 48.9 2,649 55.1 51.1 Switzerland 6,375 6,100 3.0 3,790 59.46 5.9 100.0 1,798 76.2 47.4 1,992 49.6 52.6 Turkey 39,127 600 4.4 900 2.30 11.3 78.9 618 8.6 68.7 282 0.9 31.3 UK 56,102 3,o60 2.3 20,342 36.26 7.4 99.9 8,087 45.8 39.8 12,255 31.9 60.2 USSR 253,323 2,030 3.5 15,782 6.23 8.2 94.8 4,234 17.4 26.8 11,548 5.1 73.2 Yugoslavia 21,243 1,060 6.0 1,143 5.38 11.9 97.2 532 17.3 46.6 611 3.4 53.4 OCEANIA Australia 13,337 4,350 3.0 5,000 37.49 6.5 95.2 3,840 42.9 76.1 1,196 26.8 23.9 New Zealand 3,106 3,680 2.0 1,495 48.12 4.5 92.7 1,135 53.0 75.9 360 37.4 24.8 / Population at January 1, 1975 derived from the "Total Telephones" and "Telephones per 100 Population" appearing in AT&T's publication, World Telephones (January 1, 1975). 2/ Telephone and population statistics for Nepal and Pakistan are not available in AT&T's World Telephones (January 1, 1975). These figures shown are estimates derived from information available from reports in the Bank. 2/ Telephone and population statistics for Syria is not available in AT&T's World Telephones (January 1, 1975). The figures shown are derived from STE's Statistical Abstract of Telecommunications, 1975. Sources: - Telephone statistics: World Telephones by AT&T (1975). - MP statistics: World Bank Atlas 1975. March 4, 1977  ANNEX 4 Page 1 of 2 pages COLONIA :NPE;SA NACIONAL IE TIZCOKUIACIONS (TBICCIK) Baaic Data as of Deember 31. 1976$ as of December 31. 1978 (on comDltion of third Vroject): and as of December 31. 1982 Plant and facilities in service as of end-December: 1976 1978 1982 LOCAL SERVICE a) Number of local exchanges 430 476 541 b) Total number of local automatic exchange. 87 150 173 c) Total installed capacity of automatic exchanges 53,300 87,695 171,835 d) Total number of automatic exchange connections 37,810 68,117 141,793 e) Total maber of manual exchanges 343 326 368 f) Total mnuber of manual exchange connections 14,800 12,325 15,925 g) Total capacity of local exchanges 69,759 101,389 189,529 h) Total nmber of connections 52,610 80,442 157,718 i) Perentag of automatic lines 72 85 90 LONG-DISTANCE SERVICE a) Number of interurban exchanges 39 44 44 b) Total number of long-distance circuits 5,084 11,379 20,212 c) Total terminations on interurban circuits 22,017 30,602 45,450 d) Length of interurban circuit (circuit km): Physical line 39,915 40,800 42,293 Carrier on physical 67,614 67,620 80s153 HF 39,228 46,925 62,485 VHF and UHF 255,395 227,850 324,050 Microwave 1,852,774 2,287,700 2,685,193  ANNEX 4 Page 2 of 2 pages Plant and facilities in service as of end-Decembers 1 1978 1982 TIEGRAPH & TEL S1R1IM a) Number of telegraph offices 1,645 1,626 1,834 b) Offices conne