Philippines - Telephone System Expansion Project

SF' 'V *A-C) t-,) l Documnft of The World Bank FOR OMCIAL USE ONLY MILROF ICHE COPY Peport No.:P-- 5518 PIH Type: (PM) Title: TELEPHONE SYSTEM EXPANSION PRO RspotNo. P-5518-PH Author: LONTZKE, H. Ext.:92693 Room: Dept.: (iSTlV MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN THE AMOUNT EQUIVALENT TO US$134 MILLION TO THE DEVELOPMENT BANK OF THE PHILIPPINES WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES FOR A TELEPHONE SYSTEM EXPANSION PROJECT AUGUST 19, 1992 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.  CURRENCY EOUIVALENTS (As of December 1990) Currency Unit - Philippine Pesos (P) US$1.00 - P 28.0 a 1,000 - US$35.7 P 1 - 100 Centavos (ctvs.) WEIGHTS AND MEASURES MHz _ Megahertz (1,000,000 hertz) GHz Gigahertz (1,000 megahertz) km _ Kilometer (0.6214 mile) ABBREVIATIONS AND ACRONYMS ASEAN - Association of South East Asian Nations DBP - Development Bank of the Philippines DOTC - Department of Transportation and Communications IBRD - International Bank for Reconstruction and Development ICB - International Competitive Bidding IFC - International Finance Corporation LCB - Local Competitive Bidding NTDP - National Telecommunications Development Plan NTP - National Telephone Program NTC - National Telecommunications Commission PCO - Public Call Office PLDT - Philippine Long Distance Telephone Company TELOF - The Government's Telecommunications Office FISCAL YEAR January 1 - December 31  FOR OMCL4 USE ONLY PHILIPP1UN TELEPHONE SYSTEM EXPANSION PROJECT Loan and Project Summary Borrower: Development Bank of the Philippines (DBP) Guarantor: Republic of the Philippines Beneficiary: Philippine Long Distance Telephone Company (PLDT) Amount: US$134 million equivalent Terms: Repayable over 20 years, including five years of grace, at the Bank's standard variable interest rate. Re1ending Terms: DBP would relend the funds to a banking syndicate that in turn would relend the proceeds to PLDT through two facilities: (a) the first, wherein DBP would subscribe the entire $35 million to be lent to PLDT for 12 years, including four years of grace, and (b) the second, wherein each of the other participating banks would assume the intermediation risk for its subscrib- ed portion of the remaining $99 million, would be lent to PLDT for a term of 10 years with four years of grace. The interest rate applicable to both facilities would be 3V4 above the Bank's rate. PLDT would assume the exchange rate risk between the Philippine Peso and the US dollar for both facilities. From the 3V4 spread, the Government would receive a fee of 1X for guaranteeing the loan and a second fee of 1X for assuming the cross :urrency risk between the US dollar and the other currencies involved in the Bank's loan. Secondary Lending: The float resulting from the differences in maturities between the Bank loan and the two relending facilities would be made available to the Government according to terms that mirror those of the Bank loan, and con- sequently, would hold DBP free of benefit or loss. Financing Plan: Local Foreign Total --------US$ Million------ PLDT 127.0 27.0 154.0 IBRD Q.0 134.0 134.0 Total 127.0 161.0 288,C Economic Rate of Return: 21X Staff Appraisal Report: Report No. 9444-PH IBRD 22934 This document has a restricted distribution and may be used ty recipt gnts only in the performance of their official duties. Its contents may not otherwise be disclo ed with! tit World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DEVELOPMENT BANK OF THE PHILIPPINES FOR A TELEPHONE SYETEM EXPANSION PROJECT 1. I submit for your approval the following memorandum and recommend- ation on a proposed loan of the equivalent of US$134 million to the Develop- ment Bank of the Philippines (DBP) for relending through a banking syndicate to the Philippine Long Distance Telephone Company (PLDT) for the equivalent of US$134.0 million. The proceeds of the loan would help finance the extension and improvement of telephone facilitiec in the Philippines, mostly in provin- cial areas. The Bank loan would have a term of 20 years, including 5 years grace, with interest at the standard variable rate; the Republic of the Philippines would guarantee the loan. DBP would onlend the proceeds of the loan to PLDT in US dollars at a variable rate based on the Bank's stand2rd variable rate plus a spread of 3Y4Z p.a., which would include a 1X fee for the Government's guarantee, and a second 1X fee for the Government to cover the cross currency zr.sk between US dollar and the Bank's basket of currencies. The onward loan would be split between two facilities: (a) the first, wherein $35 million would be relent to PLDT for 12 years including four years of grace; and (b) the second, wherein the remaining $99 million would be relent to PLDT for 10 years including four years of grace (para. 9). 2. Background. Telecommunications is one of the least developed infra- structure sectors in the Philippines. Services are concentrated in Metro Manila and other principal cities; some provincial cities, towns and rural areas have little or no telephone service. At 1.0 line per 100 population, the nationwide telephone density is among the lowest in ASEAN countries. The telephone density in Manila of about 9.6 per 100 population is very low for a southeast Asian capital city, and waiting lists for service average three to five years. Elsewhere in the country, telephone density is a low 0.3 lines per 100 people. 3. Telephone services are provided mainly by the private sector, and PLDT is the dominant carrier. PLDT also owns most of the long distance net- works that interconnect with local exchanges, and carries virtually all inter- national and domestic long distance traffic. Its local service areas consist of most major cities and some of the larger towns, so that the Company serves many of the nation's lucrative markets. While PLDT provides the best tele- phone service available in the country, it is generally below the standard of other ASEAN countries. This is largely due to aging equipment and overloading of existing services, factors that are being addressed through the proposed project and other components of PLDT's expansion program. PLDT is one of the nation's largest companies; at the end of 1991, its net worth exceeded P 17 billion and its annual revenues were about P 16.6 billion. PLDT provides service to about 90X of the country's 625,000 working lines. About 50 other investor and local government owned operators provide a further 82 of tele- phone connections. Generally, they are small, financially weak, and provide poor quality service; some are not even interconnected with any other net- works. The Government's Telecommunications Office (TELOF), responsible to the Department of Transportation and Communications (DOTC), provides the remaining 22 of lines. TELOF's efforts to provide service have proven ineffectual, so that DOTC is planning to divest itself of those activities. 4. DOTC is the core government agency responsible for administering the sector and the National Telecommunications Commission (NTC), an attached agency, is responsible for regulating the activities of the operators.  However, because of the low priority accorded the sector, until recently DOTC has lacked a clear strategy for development of the sector, and a clear policy regarding sector structure. Consequently, NTC has been left without a clear direction for its regulatory activities. The resultant lack of effective regulation has led to operators pursuing parochial interests without any official authority interceding to ensure that (a) national developmental priorities would be served, and (b) consumers would receive satisfactory service quality. Moreover, at 6X per year throughout the 1980s, PLDT's expansion of its services has been too slow to keep pace with demand growth and with the development needs of other sectors of the economy. 5. PLDT's expansion program for the 1990s, which would more than double the company's working telephone lines, would require borrowing of about $1 billion in foreign loans over and above the $656 million on its balance sheet as of December 31, 1991. PLDT (a) has a policy of raising only dollar denom- inated debt; and (b) realizes about 901 of its revenues from local rentals and international call charges, which are effectively indexed to the US dollar. Given a strong balance sheet and dollar based revenues, PLDT is well placed to borrow to finance its growth. However, PLDT's capacity to borrow from com- mercial sources has been severely restricted because of the country's weak financial position. DOTC has recently decided that future construction and operation of telecommunications facilities would rest with the private sector, and the Government would play the role of facilitator. Consequently, the Government has agreed to support PLDT's expansion plans by making available official borrowings. 6. Proiect Objectives. The proposed project is a self-contained part of PLDT's investment program for the period 1992-96. The project aims to (a) increase telephone penetration and leased line facilities in PLDT's ser- vice areas, with an emphasis on provincial development; and (b) improve PLDT's quality of service. Most of the proposed project was designed to provide improved telephone facilities in areas of major economic importance. In con- junction with, yet apart from, the proposed project, the Government has agreed to take action to strengthen sector management and regulation (para. 13). / 7. Proiect Description. The main components of the project are: (a) provision of new, and expansion of existing telephone services in 128 pro- vincial municipalities; (b) provision of public calling offices (PCOs) in 97 other unserved municipalities; (c) extension of PLDT's toll network to inter- connect the remaining isolated exchanges managed by other operators; (d) pro- vision of outside plant to connect about 41,000 more customers and utilize more completely exchange equipment becoming available in Metro Manila; (e) provision of networks, throughout the Philippines, for leasing to busi- nesses and other operators; (f) provision of equipment to improve PLDT's operations and maintenance capabilities and training facilities; and (g) strengthening of PLDT's project management capabilities. 8. The total cost of the project is estimated at US$270 million (ex- cluding interest during construction), with a foreign exchange component of US$148 million (55%). A breakdown of costs and the financing plan are shown in Schedule A. The project, which was developed in close consultation with IFC, forms only a small part of PLDT's overall development program with which IFC is heavily committed and involved. As such, the project elements were selected specifically knowing that PLDT can procure the equipment and services needed using the Bank's stringent international bidding procedures. Amounts  - 3 - and methods of procurement and disbursements, and the disbursement schedule are shown in Schedule B. A timetable of key project processing events and the status of Bank Group operations in the Philippince are given in Schedules C and D, respectively. A map is attached. The Staff Appraisal Report No.9444-PH dated August 14, 1992 is being distributed separately. 9. Financing Arrangements. The Bank loan of $134 million would be made to DBP which in turn would onlend the proceeds (according to terms and conditions satisfactory to the Bank) to PLDT through a banking syndicate. The onlending would be coursed through two separate facilities: (a) the first, wherein DBP would subscribe the entire $35 million for onlending to PLDT for 12 years, including four years of grace, and (b) the second, wherein each of the other participating banks would assume the intermediation risk for its subscribed portion of the remaining $99 million, would be onlent to PLDT for a term of 10 years including four years of grace. The interest rate applicable to both facilities would be 31/4 above the Bank's rate. PLDT would assume the exchange rate risk between the Philippine Peso and the US dollar for both operations. From the 3Y4 spread, the Government would receive a fee of 1X for guaranteeing the loan and a second fee of 1% for assuming the cross currency risk between the US dollar and the other currencies involved in the Bank's loan. DBP would earn Y4 on the entire amount for its role as originator and administrator of the onlending arrangements, and each participating bank (including DBP) would earn 12 on the amount of the outstanding balance for which it has taken responsibility. The resultant rate to PLDT of 3Y4X above the Bank's rate is considered at, or somewhat above, market for US dollar funds of similar amount and term. 10. Because the maturities applicable to the relending operations are shorter than the term of the Bank's loan, DBP will need to manage a float re- sulting from the excess of the principal repayments made by PLDT over the amounts that would be due to IBRD. The Government will use this float for gen- eral macroeconomic purposes, according to a secondary lending arrangement that would function as though the Government were the Borrower of the Bank loan. 11. Project Imnlementation. PLDT will be responsible for project implementation. With minor assistance from the contractor(s), they will prepare the necessary detailed designs and provide the technical staff to install exchanges and transmission systems under the supervision of the respective equipment suppliers. PLDT will contract out civil works and the supply and erection of most outside plant cabling. Similar arrangements have proven effective for PLDT's management of other, larger, expansion projects and are considered appropriate. Nevertheless, PLDT has agreed to appoint project management consultants, financed by the Bank, to assist with project management and strengthen their management capabilities. 12. Proiect SustainabilitW. PLDT would operate and maintain the facilities being financed under the proposed project. The proposed project will add only a marginal amount to PLDT's aggregate plant and equipment, and the company has an established track record for operating and maintaining similar facilities. The cost of operating and maintaining these facilities would be met from PLDT's operating revenues, which are expected to be more than sufficient for that purpose. 13. Lessons Learned. The Bank has actively supported the sector by pro- viding finance and technical assistance in the areas of regulation and policy  -4- development. In 1985, under the Technical Assistance Project (Loan 2495-PH), the Bank made a $4 million loan aimed mainly at strengthening NTC. During project supervision, the Government followed the Bank's advice to constitute a National Telecommunications Development Committee (NTDC) as a forum for discussing sector policy issues. Flowing from that initiative the Government has more clearly defined its sector policy, prepared a National Telecommunica- tions Development Plan (NTDP) and provided inputs to legislation for strength- ening NTC. Recognizing the importance of sector strengthening, the Government obtained through the Bank a Japanese Grant to finance consultancy services to (a) continue NTC's institutional development efforts; and (b) ensure adequate operating arrangements for the National Telephone Program (NTP). Separately, IFC has maintained a long-standing financing relationship with PLDT. Since 1969, IFC has made five investments (for a total of $128.5 million) in the company; these resulted at one point in IFC's owning some 376,000 shares of PLDT's stock. Apart from delays in completing assembly of project financing plans, regulatory clearances, and equipment deliveries, PLDT has usually met its implementation targets in connection with IFC-financed projects, and its implementation capability is therefore rated as good. For this project, the proposed loan would meet all of PLDT's external financing requirements; pre- financing regulatory clearances have been obtained; and use of ICB and appro- priate contractual arrangements will help to protect PLDT against late deliveries. 14. Rationale for Bank Involvement. To expand telecommunications services in the Philippines adequately, the sector needs (a) considerable investments, at a time when country conditions inhibit companies from accessing commercial investment capital; and (b) greater commitment by the Government and the major providers of service to improve their effectiveness in their allotted roles. Because of the trust it enjoys with both the Government and PLDT, the Bank is ideally positioned to use its involvement in the project to address these issues: (i) by financing a project that focuses on developing service in areas accorded a high priority by the Government, the Bank would lead PLDT to take a more balanced approach toward future expansion; (ii) the Bank's involvement in the proposed project would enhance PLDT's cred- ibility in international financial markets, and thereby facilitate the Comp- any's efforts to obtain the balance of commercial financing for other compo- nents of its expansion program; (iii) by emphasizing cost optimization and quality of service as well as a more expansive approach to investment, the Bank would induce PLDT to become more responsive to its consumers and (iv) through its continued attention and conditionality related to sector policy and regulatory issues, the Bank would (a) foster needed institutional strengthening, thereby enhancing DOTC as the manager and NTC as the regulator of the sector; and (b) facilitate a constructive dialogue between the Government and PLDT with the objective of increasing the effectiveness of PLDT's role in sector development. 15. Agreed Actions. PLDT has agreed to: (a) conduct with the Bank an annual joint review of its (i) investment program for the next five years, (ii) investment accomplishments for the previous two years and (iii) construc- tion and operational performance relative to specified targets; (b) adopt the mutually acceptable recommendations of those annual reviews; (c) realize an 8X rate of return on revalued assets annually; (d) meet or exceed an annual debt service coverage ratio of 1.1; (e) furnish to the Bank, by June 30 each year, (i) its annual financial statements certified by an auditor acceptable to the Bank, and (ii) the results of an audit of its records in relation to State-  - 5 - ments of Expenditures; and (f) appoint consultants for project management by June 30, 1993. The government has agreed to share with the Bank results of its annual review of implementation of its telecommunications policies and solicit the Bank's comments with regard to these reviews prior to making any significant decisions that would change the Government's role in the sector. Also, in conjunction with the proposed project the Government has sent a letter to the Bank which in addition indicated that it would develop a policy framework for reviewing the structure of telecommunications tariffs by 1994. DBP has agreed to furnish to the Bank, by June 30 each year, (i) a copy of its annual financial statements audited by an acceptable auditor, and (ii) an audit report of its records in relation to the project's Special Account. The execution of (i) satisfactory relending agreements between DBP, the other banks participating in the banking syndicated, and PLDT; and (ii) guarantee, cross currency coverage and secondary lending arrangements between the Government and DBP, are Conditions of Effectiveness of the proposed loan. 16. Environmental Aspects and Project Objective Categories. The disruption to the environment through the project is expected to be minimal. Nevertheless, during project supervision special attention will be paid to ensuring that contractors are required to fully reinstate any areas disrupted by project related works. The project covers areas of major economic import- ance identified by the Government as having high priority for infrastructure development. It is not directly linked to the country's antipoverty strategy. 17. Pro1ect Benefits. The benefits of the project would accrue to all sectors of the community through improved access to telephone facilities and improved network quality. The greatest benefits are likely to accrue to businesses and the public in the 128 provincial municipalities where new and expanded facilities will markedly improve existing communication facilities. Apart from direct benefit to businesses, improved communications will add to the quality of life by providing voice communication opportunities between separated family members and improving performance of Government services, especially medical and emergency relief. 18. Riskg. There are no maj3c risks associated with the project. 19. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve it. Lewis T. Preston President Attachments Washington D.C. August 19, 1992  -6- S