Papua New Guinea - Telecommunication Project

DR4-) bf -rwK6 6AY RESTRICTED Report No. TO-627a - This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF THE TELECOMMUNICATION PROJECT TERRITORY OF PAPUA AND NEW GUINEA DEPARTMENT OF POSTS AND TELEGRAPHS June 10, 1968 Projects Department  CURRENCY EQUIVALENTS US$1 = A$0. 898 A$1 = US$1. 113 A$1,000,000 = US$1,113,000 Fiscal Year July 1 to June 30  APPRAISAL OF THE TELECOMMUNICATION PROJECT TERRITORY OF PAPUA AND NEW GUINEA DEPARTMENT OF POSTS AND TELEGRAPHS Table of Contents Page No. SUMMARY i-u 1. INTRODUCTION 1 2. THE POSTS AND TELEGRAPHS DEPARTMENT 1 Staffing 2 Postal Services 2 3. EXISTING FACILITIES 3 4. THE PROJECT 4 Local Service 4 Long-distance Service 4 Cost of Program 5 Procurement and Disbursement 7 5. JUSTIFICATION OF THE PROJECT 7 Demand for Telecommunication Services 7 Local Service 8 Long-distance Service 9 Relation between proposed program and projected demand 10 Alternative ways of providing proposed services 11 6. TARIFFS 12 7. ACCOUNTS AND AUDIT 13 8. PAST PERFORMANCE AND PRESENT FINANCIAL POSITION 14 Past Performance 14 Present Financial Position 15 9. FINANCING PLAN 16 10. ESTIMATED FUTURE OPERATING RESULTS AND FINANCIAL PROSPECTS 17 Estimated Future Operating Results 17 Financial Prospects 17 11. CONCLUSIONS AND RECOMMENDATIONS 18 This report is based on the findings of Messrs. R.L.C. Grant and N. De Sirkar, who visited the Territory in October 1967 to appraise the operations and proposed program of the Posts and Telegraphs Deaprtment.  List of Annexes 1. Distribution of Responsibilities for Telecommunication Services 2. Organization Chart 3. Summary of Existing and Programmed Exchange Equipment Provision 4. Telecommunication Transmission Practices 5. Capital Program 6. Telephone Subscribers Development 7. Telephone and Telegraph Charges 8. Consolidated Income Statement 1964/65 to 1966/67 of the Department of Posts and Telegraphs 9. Income Statement for Telecommunication Services 10. Actual and Forecast Balance Sheets for Telecommunication Services 11. Forecast Sources and Application of Funds for Telecommunication Services NAP Territory of Papua and New Guinea Showing Proposed Radio Trunk and Telegraph Circuits  APPRAISAL OF THE TELECOMMUNICATION PROJECT TERRITORY OF PAPUA AND NhlW GUINEA SUMMARY i. This report covers the appraisal of a four-year telecommunication program to be carried out by the Posts and Telegraphs Department (Department) of the Territory of Papua and New Guinea from mid-1968 to mid-1972. The program includes the expansion and improvement of the local and long- distance telephone and telegraph services in the Territory to meet an established demand and to raise the standards of the service to a level adequate to facilitate Government administration and to meet, in particular, the needs of expanding trade and commerce. ii. The total cost of the program is estimated to be US$15.4 million of which US$9.6 million will be foreign exchange. The proposed Bank loan of US$7.0 million would cover the foreign exchange cost of part of the program to be procured after international competitive bidding and interest on the Bank loan payable during the construction period. iii. The Borrower would be the Administration of the Territory which functions under the Papua and New Guinea Act 1949-63 of the Commonwealth of Australia and which would make the loan funds available to the Department. The Department has no power to borrow. The loan would be guaranteed by the Commonwealth of Australia. iv. The program is technically sound, the estimated costs are reasonable, and the Department is capable of carrying out the work and of operating the system. The principal items are: (a) the installation of 10,000 lines of automatic switching equipment at 35 existing and new telephone exchanges; (b) the extension of the outside plant and subscribers installations associated with the above; (c) additions to the radio outstation service which serves settlers in remote localities; (d) substantial replacement of the high frequency radio long- distance network by modern microwave and very high frequency equipment. v. The Department is well managed and operated. vi. The present financial position of the Department is weak but considerable improvement is expected to result from a tariff increase in 1968 and a better balanced operation on account of the program. Financial forecasts show a satisfactory position by the end of the program. It is estimated that during the program earnings will contribute 26% of the total capital requirement, 43% would come from the proposed loan and the remaining 31% from Government. This financing plan is acceptable.  - ii - vii. The program is suitable for a proposed Bank loan of US$7 million, for a period of 20 years, including a grace period of five years on the basis of the assurances listed in paragraph 11.03 obtained during negotiations.  APPRAISAL OF THE TELECOMMUNICATION PROJECT TERRITORY OF PAPUA AND NEW GUINEA 1. INTRODUCTION 1.01 The Administration of the Territory of Papua and New Guinea has asked the Bank for a loan to cover part of the foreign exchange component needed to carry out a 4-year program to expand and improve the local and long-distance telephone services in the Territory. The total cost of the 4-year construction program which will be completed mid-1972 is estimated to be US$15.4 million, of which US$6.3 million will be met out of the proposed Bank loan, representing about 66% of the foreign exchange requirement. The requested loan would also cover most of the interest payable to the Bank during construction of the program. 1.02 The Borrower will be the Administration of the Territory of Papua and New Guinea which is established in accordance with the Papua and New Guinea Act 1949-63 of the Commonwealth of Australia. The Department is a Government department operating under the jurisdiction of the Administrator of the Territory in accordance with an ordinance of the Act and has no legal power to borrow in its own right. The loan will be guaranteed by the Commonwealth of Australia. 2. THE POSTS AND TELEGRAPHS DEPARTMENT 2.01 The Department is responsible for the provision of postal and telecommunication services within the Territory but this report deals in detail only with telecommunications. The Department's activities cover local and long-distance telephone and telegraph services within Papua and New Guinea. It also provides terminal facilities for an extensive network of privately owned radio stations at locations outside the range of normal line connections to exchanges. There are connections at four points within the Territory to circuits of the Overseas Telecommunications Commission of Australia (OTC) which has statutory responsibility for telecommunication services outside the Territory. The functional relationship between the Department and other departments in the Territory and in the Commonwealth of Australia is shown in APnex 1. 2.02 The chief executive officer of the Department is the Director, who is responsible to the Administration of the Territory. The day-to- day operations of the Department are controlled by two assistant directors and lower echelons in a well conceived functional organization which is shown in Annex 2. The organization, based at Port Moresby, is patterned on that of the Australian Post Office (APO) from which most of the senior officers of the Department are recruited. 2.03 Despite the difficult communication environment described in later sections of this report and the smaIl scale of operations the Department is operated efficiently. Operating costs, which are high in comparison to present revenues, do not thus reflect any inefficiency of operations. In order to improve the Department's earning position it was, therefore, decided to increase tariffs early in the period of con- struction of the project.  -2- Staffing 2.o4 At the time of appraisal, the total staff of the Department numbered 932, consisting of 367 expatriates, almost exclusively Australian and 565 indigenes. Of the total staff, 70% is employed in telecornmuni- cations. Daring the past five years indigenous staff has increased by 169, while expatriate staff has increased by 58. The number of staff employed is reasonable in relation to the work performed. 2.05 The Department maintains a Training College with residential facilities which caters for the training of personnel for the whole of the Department's operations throughout Papua and New Guinea. The College has a staff of eleven expatriate instructors and the average number of students in training is 85. The courses provided cover all aspects of telecommunication and postal activities at the operative levels. In the past, the Department has experienced difficulty in recruiting an adequate number of suitable students for training, due to the limited availability of educated indigenes. Education Department forecasts indicate that this position shouLd improve during the next five years. In spite of the recruiting difficulty, good results have been achieved in training those available. The APO offers facilities for the higher specialist training of locally recruited technicians and traffic officers. The Department plans to offer scholarships for advanced academic study in Australia to indigenous professional engineering recruits when suitable students become available. 2.06 The APO as well as supplying the core of experienced personnel for the Department assists with specialist advice and training, and makes available the results of technical research and development which its larger scale of operations is able to support. 2.07 Although the proposed expansion program represents a relatively large increase in the Department's facilities, a comparable staff increase will not be necessary because of gains from the increased scale of operation and from automatization. The training program which is designed to expand the existing force at approximately the past rate is assessed to be adequate. Postal Services 2.08 The postal and telecommunication services operate together in the one department on a satisfactory basis and separate accounts are maintained. Although postal services usually are operated at substantial deficits, this is not the case in Papua and New Guinea where they operate at a profit. This is achieved through philatelic profits and because mail is distributed only to Post Office boxes and no house deliveries are made. Savings are made by sharing buildings and staff, particularly in smaller localities and no reason can be seen to separate the services, provided that the present practice of maintaining separate accounts is continued.  - 3 - 3. EXISTING FACILITIES 3.01 The local telephone service in the main centers of population is based upon the use of a mixture of step-by-step and crossbar auto- matic exchange equipment. The first automatic equipment commissioned in 1956 was step-by-step equipment of British origin. MNre recently exchanges have been installed using crossbar equipment manufactured in Australia. This corresponds with APO practice. Equipment installation is carried out by construction teams supplied by the manufacturer. At Port Ioresby the exchange equipment is overloaded, but action is under way to expand the main exchange and install a new crossbar exchange at the suburb of Boroko. Maintenance of the automatic switching equipment in the Territory is reasonable. Fault clearing procedures still rely heavily on expatriates, although indigenous staff is receiving training in this work. 3.02 The Department operates a total of 28 automatic and manual telephone exchanges, having a total of 7,100 subscribers. At the time of appraisal, about three quarters of these were connected to automatic switching equipment mainly centered in the larger towns. In addition, progress has recently been made in converting some of the smaller rural exchanges to automatic, resulting in a reduction in operating costs by the elimination of operating staff. 3.03 Existing outside telephone exchange plant consisting of cables, open wire and telephone instruments is maintained in good condition. In accordance with standard APO practices cables are largely buried and on the routes of major cables in the towns underground pipe systems with spare capacity for further cable additions have been laid. 3.04 Outlying telephone subscribers who are beyond the service area of telephone exchanges are served by high frequency (HF) radio or very high frequency (VHF) radio service. Fifteen centers provide connection for subscribers who mostly own and maintain their own out- station equipment. The Department, however, provides and maintains radio equipment for some of the subscribers who are served by the VHF services and for Government establishments. 3.o5 In the long-distance system, the Department has not been able to achieve standards comparable with the rest of its service. This is because of the rugged terrain and the scattered islands of the Territory in which few roads and no railway links exist between centers of population. In consequence, the normal pattern of establishing pole line routes to carry telephone and telegraph circuits was not possible and HF radio was the only means of developing the long-distance service. The HF radio pybtems used in this early stage of development suffer from poor quality due to atmospheric interference, fading, and interference from stations on adjacent frequencies. In addition these circuits do not have the capability to act as bearers for further derived channels, the conventional way of economic expansion. The consequent lack of circuits and the poor quality of the service have suppressed the normal build up of long- distance traffic by a large factor.  3.06 The telegraph service uses mainly Morse signaling operated over HF radio circuits; some teleprinters are in use on the main routes. At present telex is available to subscribers in Port Moresby only, and the switching is performed manually. Telegraph traffic is fairly heavy due to the unsatisfactory nature of the long-distance telephone service but, operating expenses are high due to the large number of messages which have to be retransmitted manually at intermediate points. 4. THE PROJECT 4.01 The project consists of the Department's four-year expansion program commencing mid-1968 and terminating mid-1972. The program is designed to reduce arrears in demand at a rate within the technical and physical capability of the staff that can be provided and at the least cost. It includes the expansion of local telephone exchange service by 10,000 lines of automatic telephone exchange equipment at 35 existing or new exchanges, and provides for the necessary increase in associated subscribers plant, telephones, and radio outstations. The most important part of the project is the substantial replacement of the long-distance toll and telegraph network with one of several times the present capacity and with the potential for future expansion. Local Service 4.02 The year-by-year equipment installation program for local tele- phone service is tabulated in Annex 3. Extensions at the larger step-by- step and crossbar exchanges will account for half of the new equipment; the balance will be used for the establishment of six smaller new auto- matic exchanges and for the conversion of 14 small manual exchanges to automatic operation. The expansion of outside plant and the installation of telephones follow sound practices and will take place in the areas of new commercial and residential construction. 4.03 The program includes additional radio outstations for sub- scribers who are beyond the range of conventional telephone connections. In accordance with international agreement, single sideband equipment will be used for extensions in this field to conserve frequencies. Long-distance Service 4.04 This is the main area proposed for Bank financing. As shown in the overprint of the map attached to this report it consists of estab- lishing on the mainland a microwave backbone route with a basic capacity of 300 channels linking Port Mbresby, Lae, Madang, Goroka, and Mt. Hagen, equipped with speech and telegraph channels to cover immediate needs. Nine hilltop repeater stations are required, three of which will be without road access. From some of the stations, VHF spur links of 10 or 24 channels will serve five smaller terminal stations and a further 10-channel VHF system is proposed to link Rabaul in New Britain with Kavieng in New Ireland. Two HF links of single sideband equipment having eight channels will be provided to link Rabaul and Lae and a further seven HF links having one to four channels will be provided on minor  - 5 - routes where the smaller traffic requirements or length of path make this appropriate. This HF equipment will utilize recent developments in this field which partly overcome the weaknesses of earlier HF equipment currently in use in the Territory. Annex 4 summarizes current practices in long-distance communications. 4.05 It has been apparent for some years that development of the long-distance netwtork would involve the establishment of broadband bearer circuits in the microwave and VHF parts of the radio frequency spectrum. This requires the siting of repeater stations to give clear line of sight paths; physical difficulties of access and power supply at some of the more remote repeater station sites on key routes have deferred the taking of this step earlier. The technical development that has gone into microwave systems recently has now made possible equipment of such reliability and modest power requirements that it is within the capability of helicopters to lift the equipment necessary to install, maintain and refuel these stations at otherwise inaccessible sites. The primary power will be from storage batteries of large capacity, charged by wind- driven generators and using propane heated thermocouple electric generators or diesel sets as a back-up for long periods of calm. 4.06 In 1966 A.W.A. (Australia) Ltd. were contracted to make path propagation tests over one of the more difficult sections of tha route, and to make a system performance evaluation to confirm the feasibility of the proposal. Two temporary stations were set up by helicopter and records of signal strengths and performance over a period of two weeks were obtained. The tests demonstrated the practicability of operating a 300-channel system over the proposed route, and will provide a basis of design when tenders are invited. 4.07 As a further feature of its expansion, to minimize operating costs, it is also the Department's objective to progressively introduce national subscriber dialing of calls as interurban links are brought up to the necessary standards, and by the end of the project 80% of al subscribers will have access to this class of equipment. 4.08 The international circuits administered by OTC will be extended from the Seacom cable terminal at Madang to the national switching center at Lae using leased circuits over the proposed microwave system. 4.o9 The increased capacity of the interurban and international routes will enable the telegraph system to expand to fully meet the demand. The necessary telegraph channelling equipment is included in the plans and estimates for the long-distance routes, and the Department plans to increase the number of teleprinters in its own network as well as those of telex subscribers. Cost of the Program 4.1o The estimated cost of the four-year program is detailed in Annex 5 and summarized below:  -6 - Foreign Exchange Cost Bank Other Local Cost Total _hn thousdnds of Australian dollars Local Exchange Service Switching equipment - 862 354 1,216 Outside plant and telephones 942 951 2,113 4.,oo6 Radio outstations 466 288 268 1,022 Long Distance Switching equipment - 60 44 104 Radio bearers 3,o54) Channelling equipment 525) 358 1,213 5,554 Power equipment 404) Telegraph and telex - 220 28 248 Transport, tools and mechanical aids - 210 - 210 Consultants 270 - - 270 Buildings - - 1n220 1,220 TOTALS 5,661 2,949 5,240 13,850 Millions of US$ equivalent 6.3 3.3 5.8 15.4 Interest during construction .7 Proposed Bank loan 7.0 Estimates are based on costing data compiled recently in the Territory from the actual costs of telecommunication works and contingency allowances of 10% have been provided in individual estimates. 4.11 The form of the Department's request for Bank financing is influenced by its own policies in procurement. It has adopted a policy of standardization in line with APO practices and purchases much of its supplies in conjunction with orders placed in Australia by that organi- zation. In respect of switching equipment and teleprinters this reduces engineering effort and simplifies the training and interchange of staff and the procurement of parts. This policy is sound and the Department wishes to continue it. In respect of cables and other outside plant the reason for bulk purchases through the APO was to obtain benefits of large scale orders. However the Department can well purchase part of its requirements of this class of material in accordance with Bank requirements.  - 7 - 4.12 Exploratory tenders for a complete microwave system were invited in 1965 but on account of the difficulties of access to repeater sites, the tenders received were inflated by a high contingency margin. On the recommendation of Preece, Cardew & Rider, the Department's consultants, who were asked to consider the tenders, only the contract to carry out the propagation tests mentioned in paragraph 4.o6 was entered into. For the proposed project, the Department will use to the maximum extent its local experience to erect the buildings, masts and aerials at mountain tops as this was the field where contractors allowed large contingencies to cover the difficulties with which they were not familiar. The contracts to be let will cover only the supply, installation and commissioning of the radio bearer and channelling equipment. Procurement and Disbursement 4.13 All goods and services to be financed under the proposed Bank loan will be obtained on the basis of international competitive tenders. The principal items are long-distance equipment for which tendering documents will be prepared by the engineering consultants. The Department also proposes to purchase by international tender part of its cable and pipe requirements, telephone sets and some of the radio equipment required for the service to remote outstations. 4.14 The basis of disbursements would be the cost of imported equipment and services only. Expenditure prior to the date of the loan would not be eligible for reimbursement and if savings are made any excess loan funds would be available for cancellation. 5. JUSTIFICATION OF THE PROJECT 5.01 The justification for the project may be considered under three main headings: (a) what is the projected demand for telecommunications in the Territory and what contribution to economic growth would be made by meeting that demand? (b) is the. proposed investment program properly related to the projected demand in respect of growth and quality of facilities proposed? (c) is the proposed program the least cost method of providing the services proposed? Demand for telecommunication services 5.02 In analyzing the demand for telecommunication services in the Territory two specific areas of operation have to be considered: (a) the demand for connection to local telephone networks and (b) the demand for the use of long-distance connections between individual exchanges and for  - 8 - the improvements of their quality. Although closely interrelated these are discussed separately in this section. Local Service 5.03 The overall telephone density of o.58 telephones per hundred of population leaves scope for a considerable future growth, but a large proportion of the indigenous population is at such an early stage of development, living in isolated groups and having no common language, that it will be some years before any real demand can be expected from this quarter and before any significant economic purpose would be served by provision of telephone facilities. A few local cooperative societies have advanced to the stage where a telephone is a business necessity but indigenous population living in the towns is largely served by public coin telephones. The present subscribers and waiting applicants mainly consist of the Territory's administrative structure, commercial and industrial firms, and Australians who fill key positions in these sectors. 5.o4 As shown in Annex 6 the recorded demand (subscribers plus waiting applicants) increased from 4,700 in mid-1962 to 8,680 in mid-1967 which corresponds to an annual growth rate of 13% for the five years. During this time the Department built up the network from 4,150 sub- scribers to 7,100 subscribers, increasing its installation capabilities from about 300 subscribers per annum prior to 1962 to about 1,000 sub- scribers in 1967. In spite of this the waiting list increased from 550 in 1962 to over 1,600 in 1967 which is an increase from 12% to 19% of the total demand. Although the length of waiting period may have discouraged some potential applicants for service, -from other considerations the Department concludes that the present list offers a realistic measure of unsatisfied demand. 5.05 The increase in demand has been comparable with the increase in real GNP (12.9% average 19604 to 1965/6) and with the increase in the volume of assistance which the Territory has received from Australia (12.4% average increase 1961/2 to 1965/6 in grants to Administration budget), an important factor in the Territory's economic development. The Department assumes that these trends will continue at least in the immediate future and has forecast the demand for service on this basis. In addition the Department maintains area by area forecasts based on specific studies of local developments and these are reviewed'periodically in the light of new information to give a basis for specific technical planning. 5.o6 For the immediate future, the Department's objective is to increase its rate of connecting new applicants to 1,500 per annum which will result in a reasonable reduction of waiting lists during the program. This takes account of such limitations as the availability of trained staff and represents a sound compromise between the ideals of readily available service and of adequate returns from installed plant and equipment. The program would result in a growth rate of 16% per annum in connected subscribers over the period.  -9- Long-distance Service 5.07 In the long-distance field, for which the major portion (74%) of Bank finance is being requested, 40% of the traffic is Government business and the balance is mainly commercial. The present service falls short in both the quality and the number of channels on existing routes. The indication of a demand for more channels is usually the record of delays or queuing time in providing connections. In Papua and New Guinea the delays are so long, several hours being normal and in excess of one day not uncommon, that the system is not fulfilling its role of providing fast communication for those activities which require this for efficiency. Under these circumstances potential traffic can only be assessed by comparison with the known position in similar communities where adequate circuits are available. Studies along these lines have been made by the Department, by an APO planning group which was asked to prepare a National Development Plan in 1964, and in respect of overseas traffic by OTC, with reasonable concurrence of results. 5.o8 The APO study concluded that with adequate circuits the average calling rate per subscriber into the trunk system would quickly increase three to five times and that the ten links existing in 1964 in the Territory needed to be replaced by 70 to 90 to meet requirements at that time, and by about 120 to handle potential traffic in 1968. The Department's proposed program provides for 189 speech circuits by the end of the program in 1972 which takes into account the presently esti- mated growth in connected subscribers; it is also partly determined by the fact that equipment is supplied in standard sizes providing packages of specific channel capacity (see Annex 5). As explained in more detail in paragraph 5.11, the critical decisions to be taken at this stage are those relating to the choice of basic systems rather than those concerning the number of circuits to be established initially. 5.09 One recent indication of the need for the additional long- distance circuits proposed is available in the experience of OTC with overseas traffic from the Territory. During 1967 the new British Commonwealth "Seacom" telephone cable between Australia and South East Asia was brought into service via Madang in New Guinea. This gives overseas connections of the highest quality with all major countries, but only Madang can benefit until the internal long-distance links in the Territory are improved. OTC had assessed that a five-to-six-fold increase in overseas traffic presently carried by HF radio would result from this improvement in service once the internal links with Madang were adequate to play their part. So far overseas traffic from Madang has increased much more than that, i.e. by about 20 times. The fact that so much additional traffic has been generated from Madang alone is an indication of the suppressed demand for telephone services in the Territory. It can also partly be ascribed to the absence of adequate internal long-distance service which causes the subscribers in Madang to use the Seacom cable to Australia in preference to calling within the Territory. It is expected that the traffic pattern for Madang and the Seacom cable will normalize once the internal long-distance routes are established. The internal long-distance system of the Territory in its  - 10 - present inadequacy is the remaining weak link between the local exchange networks which are of a good technical standard and between the rest of the telephoned world which can now be reached through the new high grade overseas circuits of OTC. The proposed Bank project will rectify this situation. 5.10 The proposed loan, by helping to meet the demand summarized above would make an important contribution to the Territory's economic development. As pointed out in paragraph 5.07, the long-distance traffic is almost wholly governmental and commercial. The importance of meeting this demand may be better appreciated if it is realized that this is a country with a very rugged terrain where it is difficult or impossible to provide low cost surface transportation and slides may make roads impassable for several days. Telecommunication plays here an important role in case of emergencies, for administration purposes and indirectly for the movement of persons and goods. There has to be heavy reliance on air transportation which is costly and is frequently interrupted by weather conditions. In such circumstances it is particularly important to make the most efficient use of available transportation facilities; and a good telecommunication netvwork can contribute towards this by making it possible to assemble quickly the information needed to program trans- portation. The Territory's economic development depends mainly on the production and export sale of primary products, such as copra, cocoa, coffee, timber. The effectiveness of the production and marketing efforts of producers and the most economic employment of their resources are dependent upon their receipt of up-to-date market information, their contacts with purchasers, their ability to coordinate closely with the transport sector to minimize the deterioration of crops held up in unfavorable climatic conditions, and quick access to sources of spare parts and expert assistance in the event of machinery breakdowns. Particularly in view of the physical isolation of producing units and areas, communication facilities are critically important. The delays and lack of reliability of the present long-distance network limit its use in this respect. In addition to assisting the Territory's production and export growth, a better telecommunications netwiork would also help in improving the efficiency of government. Finally it should be noted that the proposed program, while large in relation to the Department's present assets, is likely to absorb less than 2% of total gross invest- ment in the Territory during 1968-1972. Relation between proposed program and projected demand 5.11 The size of the proposed long-distance program is determined by three factors: (a) the assessed long-term demand; (b) the assessed immediate or short-term demand; (c) the standards of quality to be adopted.  - 11 - Discussing these factors in more detail: (a) the assessed long-term requirements determine the basic type and ultimate capacity of the system to be embarked upon. In the case of the microwave backbone system, the potential 300-channel system selected would be more expensive by about 5%, than one of 120-channel capacity; but high replacement costs would be incurred on sections of the smaller system in 2-3 years to cope with long- distance traffic growth; (b) the immediate demand determines the quantity of channelling equipment to be purchased under the project. As explained under paragraph 5.07, there is a measure of uncertainty in this, but as this channelling equlipment is initially a small part of the total system cost (e.g. in the case of the above microwave system, 10% of the cost of the bearer), and as further channels can be added as required at approximately the same unit cost, this decision is not a critical one in relation to the cost of the overall program. With operational experience of the system in its new form, reasonably close forecasting of demand will be possible in ordering for future augmentation; (c) objective standards of customer quality and international corab-ility -are recommuended from time to time by specialist committees of experts from the staffs of member countries of the International Telecommunication Union, the International Telegraph and Telephone Consultative Committee (CCITT), and the International Radio Consultative Committee (CCIR). These standards are widely followed and manufacturers concentrate development and production of equipment on designs which comply with them. Price as well as operational advantages are therefore to be gained by specifying equipment to CCITT or CCIR standards. This is the case withl the equipment which will be obtained under the proposed loan. Alternative ways of providing proposed services 5.12 All the links replace existing circuits of some description and thus the decisions to be taken concern the precise radio link - microwave, VHF, or HF - which is considered to be appropriate to supply the needed number of circuits at an acceptable level of quality. In addition to the need to replace circuits to improve quantity and quality, the existing HF links providing circuits to the smaller offshore islands must be replaced by 1970 to meet the Department's obligations under ITU recommendations to eliminate conventional transmission in the point to point services in favor of single sideband suppressed carrier working (see Annex 5). This is to increase the number of channels which can operate in the available frequency spectrum and to reduce interference between adjacent transmissions.  - 12 - 5.13 Engineering alternatives such as submarine cable connections, overland cable and pole lines have been considered in place of the pro- posed radio links. The distances involved to connect offshore islands and the relatively small circuit requirements ruled out the submarine cable alternatives while the high cost which would be incurred as a resuit of the inaccessible terrain eliminated the overland alternatives. 5.14 In summary, it can be stated that the demand for telecommuni- cation services in the Territory arises out of production, manufacturing, transportation and other essential economic and administrative activities. The proposed facilities are designed to meet this demand with a view to minimum satisfactory qualitative and quantitative standards. The program represents the least cost solution to meet this demand. 6. TARIFFS 6.01 Domestic telephone and telegraph tariffs are fixed by regulations issued by the Administrator of the Territory. Charges for a variety of telecommunication facilities, such as telegraphic equipment rental, private telegraph channels and telex charges are fixed by the Director of the Department. 6.02 The present domestic tariffs, which were introduced November 1, 1964, do not meet operating cost, and it was agreed during negotiations that the tariff for local telephones and telegraphs and connection charges will be increased not later than October 30, 1968 and that long distance charges will be increased in fiscal 1969-1970. A copy of the existing and proposed basic telephone and telegraph tariff schedules is shown in Annex 7. The average increase in local telephone tariff will be about 24%, in telegraph tariff about 20% and long distance tariff about 33%. 6.03 At present the Department retains 10% of the revenuie received froik international calls. However, when high-grade circuits are provided to distribute these calls effectively throughout the Territory it should be possible for the Department to negotiate with the OTC for a larger share of revenue, perhaps as much as double the present pro- portion. This and other rentals received from the OTC for lease of circuits between Madang and Lae, the main toll switching center of the Territory, would improve the revenue situation materially. These probable increases have not however been considered in the financial forecasts since the benefit would not materialise before the end of the program. 6.o4 The forecasts of revenues in this report are based on the proposed new tariffs and assume, in addition, that the Administration would, as tentatively planned now, further increase toll charges by another 20% July 1, 1971 when substantial improvements in the quality of service would permit it. Based on the tariff increases assumed, and the more economic operation which would result from the larger volume of business made possible by the proposed program, the financial performance  - 13 - of the Department would improve gradually over the next few years and reach a satisfactory level in fiscal year 1973, the first year following completion of the program. It was agreed during negotiations that: (a) the proposed new tariff schedule, as described in Annex 7 will be made effective and will not be amended without consultation with the Bank; (b) tariffs will be adjusted so as to maintain revenues which would result in a return of not less than 8% on the average net fixed assets in operation as soon as practicable after completion of the Project; (c) to assure that required level of earning is reached the tariff situation will be reviewed prior to July 1, 1971 in consultation with. the Bahk. 7. ACCOUNTS AND AUDIT 7.01 The Post and Telegraph Department of the Territory operates under a Government grant system of accounting. All expenditures are met from the annual legislature appropriation and all cash receipts from operations are paid into the Territory Revenue Fund. The system based on cash receipts and expenditures does not yield the cost of service data which are necessary for efficient management nor does it provide information for financial evaluation of the business. It is also too inflexible, due to detailed legislative control of the expenditure, for normal business operation. 7.02 In order to overcome some of the shortcomings, the Department has maintained since 1962 in addition to the Territory cash accounts, a set of commercial accounts which discloses its revenues, operating expenses and depreciation charges on a commercial basis. Accrued liability as employer for superannuation, rental of premises occupied by the Department, subsidy on housing and other current liabilities and assets are computed and taken into account. A consolidated balance bheet is drawn for the Department as a whole; separate balance sheets for the telecommunication service were prepared for the purpose of the appraisal. The set of commercial accounts available constitutes an improvement over the cash accounting followed exclusively in the past, inasmuch as it presents a fairly correct picture of the business. As long as cash accounting is maintained, however, the commercial accounting remains essentially notional because performance will still be judged on the basis of cash concepts. 7.03 The Australian Post Office, which at present, also maintains two sets of accounts, one under the appropriation system and the other under the commercial system will, it is understood, maintain only one account under the commercial system from July 1, 1968. During negotiations it was agreed that the Department will adopt a commercial system of accounting starting as soon as possible and not later than July 1, 1969.  - 14 - Under the proposed system the Department should be allowed, following Australian analogy, to retain its trading surplus for the purposes of capital expansion; the advances from the Treasury would be treated as equity on which dividend would be payable or as long term debts with commercial terms. The financial forecasts have been prepared on this basis. 7.04 The Accounts Department is well organized and staffed with qualified accountants. The Treasury Accounts are audited by the Auditor General, Commonwealth of Australia, but the comrnercial accounts are not audited in the absence of legal requirement. The Auditor General's organization in the Territory would be capable of carrying out commercial audit and would be prepared to do it upon the formal request by the Treasurer of the Territory. Agreement to this effect was obtained during negotiations to be effective for the audit of 1968/69 commercial account. 8. PAST PERFORMANCE AND PRESENT FINANCIAL POSITION Past Performance 8.01 Consolidated income statements for the last three fiscal years ending June 30, 1967 are shown in Annex 8 in order to give an idea of the relevant size of operations of the postal and telecommunication services. They also indicate on a notional basis that the telecommmunication section of the Department was operating at a loss while the postal services were making small profits. 8.02 Separate income statements for the telecommunication section of the Department covering the past three years are presented in Annex 9 and are summarized below: Fiscal year ending June 30 1965 1966 1967 Total revenues 1,012 1,252 1,580 Operating cost: Cperation and maintenance 1,286 1,470 1,812 Depreciation 318 409 487 Total operating cost 1,604 1,879 2,299 Net loss from operations (592) (627) (719) 8.03 This apparent unfavorable financial situation is due to a number of operational and financial reasons. Telecommunication services in the Territory are costly and the volume of traffic is small. The Department operates in an unusually rugged country which makes installations comparatively expensive. The exchange centers are located long distances apart and toll connections are inadequate. The exchanges are very small averaging about 250 subscribers per exchange at the moment.  - 15 - 8. o Tariffs are low when compared to cost of service, and the past earnings record of the telecommunication service is poor. The grant system of accounts is partly to blame for this condition. This system does not consider certain components of cost such as depreciation, it thus makes the picture look more favorable on a cash basis and obscures the need for higher tariff. The poor earnings shown in the books are partly also due to a practice fairly common under the grant system which tends to encourage inclusion of capital cost in maintenance because grants for maintenance are easier to obtain than for capital expenditure. In the fiscal year 1966 for example, replacement expenditures of A$170,000 were included under operating cost. When commercial accounts were prepared depreciation was charged at an average rate of more than 6% of gross fixed assets in operation, which is high compared to more usual rate of 4% to 5%. This higher depreciation also had the effect of depressing net income and returns. If the maintenance costs and depreciation charges had been kept on a more normal basis the results for the last three years would have been somewhat better but still less than satis- factory. Present Financial Position 8.05 Balance sheets of telecommunications section as at June 30, 1965 through 1967 are shown in Annex 10. A summary of the balance sheet as at June 30, 1967 follows: Assets in millions of A$ Telecommunication fixed assets in operation 8.9 Less: depreciation reserve 2.0 Net fixed assets in operation 6.9 Current assets 1.8 Total Assets 8.7 Liabilities Government equity 8.3 Current liabilities o.4 Total Liabilities 8.7 The book value of assets is based on historical cost and as there was no significant inflation or devaluation of the currency, asset values are generally realistic. The current assets include inventories and accounts receivables. The inventories (A$1.6 million) are comparatively high due to the distance from foreign sources of supply and the need to maintain scattered inventories around the country. Accounts receivables are small because billing and collection are prompt, with consumers being billed quarterly on a staggered basis. No cash balances are included under current assets since the Department does not have control over its own cash funds.  - 16 - 8.o6 All capital expenditures were financed by budget appropriations 'which are shown in the pro forma balance sheets for telecommunication (after deducting the operating deficits of past years) as notional equity capital of the Government. During negotiations an understanding was reached that all past Government advances of a capital nature would be considered Government equity. The current liabilities consist of a small item accounts payable and of the employer's liability for superannuation. It should be emphasized again that only after the introduction of commercial accounting would the various items included in the balance sheet attain their full significance. 9. FINANCING PLAN 9.01 A forecast of sources and application of funds for the seven fiscal years 1968 to 1974 is given in Anmex 11. The forecast covers the operations of telecommunication services only and does not consider the postal services. It should be remembered that like all other financial forecasts in this report it is at present notional and will become meaningful only when the commitments in paragraph 7.03 have been met which will permit the Department to retain its trading surplus and to treat the Government advances as equity or loan capital. 9.02 Financial requirements for the four years 1969 to 1972 during which the program would be executed, and the forecast financing sources can be summarized as follows: Financial Requirements in thousands of A$ Construction expenditure 13,850 Provision for working capital 696 Total requirements 14,546 100% 14buld be met from: Internal cash generation 4,671 Less: debt service 858 Net internal cash generation 3,813 26.2% Proposed Bank loan 6,289 h3,.2% Government advances 4,444 30.6% Total Sources 14,546 100.0% The total requirements of the period of A$145. million, including the necessary increase in working capital, would be financed about 26% from internal cash generation (after debt service), about 43% by the proposed Bank loan and the remaining 31% through Government advances. These advances have been assumed to be in the form of equity and an understanding to this effect was reached during negotiations. The proposed Bank loan of US$7.0 million is assumed to be for a term of 20 years, including a grace period of 5 years, and to carry a 6-1/4% interest rate. Further  - 17 - loans have been assumed in the two years following the Bank program to finance future expansion on comparable terms. 9.03 Despite the sizeable requirement for equity contributions from the Government, this financing plan is acceptable on the basis of a Government assurance to contribute all funds required over and above the Bank loan to complete the Project. A further increase in tariffs to produce a higher share of financing from telecommunication operations would not seem appropriate at this point; the estimated financial improvements during the construction period of the Project clearly characterize the cash shortage over the coming years as a temporary problem which should not be solved through further tariff manipulations. With all major financing sources reasonably assured the proposed financing plan can be considered as satisfactory. 10. ESTIMATED FUTURE OPERATING RESULTS AND FINANCIAL PROSPECTS Estimated Future Operating Results 10.01 Forecast income statements of the telecommunication services for the seven fiscal years ending June 30, 1974 are shown in Annex 9. These statements clearly show a steady improvement. The proposed program will remove some of the reasons of unfavorable financial results in the past. The average number of telephones per exchange will increase from 250 to more than 350. The toll connections between different centers will be greatly improved. Quality of service will also improve. These changes will result in a higher volume of traffic. Total revenues from the various services will triple from A$2 nillion in fiscal year 1968 to A$6 million in 1974 due to the assumed growth in business and to the tariff increases mentioned in paragraph 6.02. Operational and main- tenance costs were calculated in detail on the basis of staff requirements, an increased efficiency of operations in future years and maintenance cost properly chargeable to operations. The provisions for depreciation were calculated at a rate of about 6% following the same pattern as in the past. This rate of depreciation appears high and should be reviewed during the execution of the program, at the latest during the tariff review in 1971 (see paragraph 6.o4 c). On the basis of these assumptions the telecommunication operations of the Department would improve from a net operating loss of A$526,o00 in fiscal year 1968 to a net income of A$2,031,000 in 1974. During the last year of the program in fiscal 1972 a rate of return of 6.7% is projected with further improvements to 8.6% and 10.9% in the two following years. It has been assumed that the Department will be in a position to pay a dividend at 6% on the Government equity from fiscal 1973. On the basis of the commitments obtained during negotiations (see paragraph 6,o4) this situation is acceptable. Financial Prospects 10.02 Forecast balance sheets for the telecommunication services as of June 30, 1968 through 1974 are shown in Annex 10. Fixed assets in operation will increase from A$8.1 million in fiscal 1967 to A$20.7 million  - 18 - at the end of the proposed program and to A$26.6 million by June 30, 1974 which is an increase of more than 200%. Starting with fiscal year 1970 the balance sheets include an item cash, under current assets and show a separate surplus account; this is under the assumption that commercial accounting would be introduced in this year (see paragraph 7.03). No further increases in Government contributions are projected after the completion of the program and it is assumed that the Department will be able to meet its capital requirements from its own resources and by borrowing on commercial terms. The ratio of long-term debt to equity will reach 35/65 at the end of the forecast period. This situation is satisfactory. 11. CONCLUSIONS AND RECOMMENDATIONS 11.01 The telecommunication program submitted for Bank financing is technically sound and well designed to meet the eseential needs of the Territory of Papua and New Guinea. The Posts and Telegraphs Department of the Territory is well organized and its operations are efficient. Estimates of costs are reasonable and procurement procedures satisfactory. 11.02 The Department's financial position is weak at present, but is expected to improve in the future on the basis of proposed tariff increases. The arrangements for financing the program are satisfactory and the Department will be able to meet a reasonable proportion of the financial requirements during the execution of the program from its own funds. 11.03 The Program is suitable for a Bank loan of US$7.0 million with a term of twenty years including a grace period of five years. During negotiations assurances were obtained on the following: (a) the Administration will increase the local telephone and telegraph tariffs (not later than October 31, 1968) and long-distance tariffs not later than June 30, 1970 as detailed in their proposal (paragraph 6.o4 (a) ); (b) the Administration will not change the new tariffs without consultation with the Bank during the execution of the Program (paragraph 6.o4 (a) ); (c) after completion of the Program the Administration will maintain tariffs so as to maintain a return of 8% on the average net fixed assets in operation. The adequacy of the existing tariffs to meet this objective will be thoroughly reviewied in 1971, the year prior to the completion of the Program (paragraph 6.oh (b) and (c)); (d) the Department will change over to full commercial system of accounting not later than July 1, 1969 (paragraph 7.03);  - 19 - (e) the commercial accounts of the Department will be properly audited starting with the pro forma accounts for fiscal year 1968/69 (paragraph 7.04); (f) the past and forecast advances by the Governaent to the Department for capital expenditure on telecommunications will be treated as Government equity (paragraphs 8.06 and 9.02). june 10, 1968  ANNEX 1 DISTRIBUTION OF RESPONSIBILITIES FOR TELECOMMUNICATION SERVICES IN THE TERRITORY OF PAPUA AND NEW GUINEA TERRITORY G-I COMMONWEALTH | DEPARTMENTS | | FUNCTIONS | | ENTITIES Telephone Services 1. Local Telephones 2. Internal Long-Distance Telephone Circuits 3. International Telephone Circuits to Australia and Overseas Department of The Overseas Posts and Telegraphs _ - Telecommunications Commission (Australia) Telegraph Service 1. Telegraph equipment, telex and leased teleprinters 2. Internal circuits 3. International telegraph circuits < 4. Telegrams: (a) Internal (b) International (c) Overseas shipping (d) Coastal shipping Communication Services to Civil Aviation Department of 1. Communication with aircraft Civil kviation 2. Aeronautical telegrams: (a) Internal (b) To Australia & Overseas Broadcasting Services Australian Broadcasting 1. Programs of a national or Commission regional nature: (a) Programs (b) Provision and maintenance Australian Post Office of technical equipment Department of 2. Programs of purely local or Information and _ district nature: Extension Services (a) Provision & maintenance of technical equipment (b) Programs Notes: Lines and arrows indicate Department or Entity performing the given function. "Internal", means within the Territory of Papua and New Guinea.  TERRITORY OF PAPUA AND NEW GUINEA DEPARTMENT OF POSTS AND TELEGRAPHS ORGANIZATION CHART | DIRECTOR l | ASSISTANT DIRECTOR ll ASSISTANT DIRECTOR |(ENGINEERING) |. |(PERATIONS AND ADMINISTRATION)| SECTIONAL ENGINEER | SECTIONAL ENGINEER SECTIONAL ENGINEER SUPERINTENDENT SUPERINTENDENT (PLANNING) (GENERAL WORKS) (INSTALLATION AND SERVICES) (ADMINISTRATION) (OPERATIONS) ENGINEER (RADIO) ENGiNEER (SWITCHING) ENGINEER (RADIO) PLANNING MAINTENANCE MAJOR CONSTRUCTION ACCOUNTANT _PMAL SER MINOR CONSTRUCTION ENGINEER (SWITCHING) ENGINEER (OUTSIDE PLANT) ENGINEER (SWITCHING) MANAGER PLANNING PLANNING MAJOR CONSTRUCTION PERSONNEL OFFICER (TELECOMMUNICATIONS MAINTENANCE SERVICESSEVC) CONSTRtUCTION ENGINEER (RADIO) . MAINTENANCE PRINCIPAL CONTROLLER MINOR CONSTRUCTION ( TRAININGI (POSTAL SYSTEMS I 0 CHIEF DRAFTSMAN l 0 COSTING OFFICER l X IRADICONTROLLER (RADIO INSPECTIONS) z z November, 1967 I BRDO- 3614, %*  ANNEX3 TUMJtlZ O' ?APUA AND NIW Gflm DR-ANEXU 0F POSTS AC TRansU SIJW4AY OF EXTSTINr AND pNRON.AJOqD TELEFtIOE EXCHANGE EQUIPMENT PROVISX0N ~S`!AN:IE EXISTING TYPE OF EQAIPP4ENT CAPACITY PPOPOXED I'NSTALLATI')NS CAAIYNOTE,S June, 1968 1968/69 1969t7o 1970t71 1971jt72 June, 1972 P1ST MYOSSA Stronger Step-by-Step NPO Pre 2000 type Boo b00 100 1,600 1/ Ut IN~~~~~L -ri-ssono AJiM 102 Crossbar 3,000 1,000 1,000 5,000 1/ ))o fiS trooger Step-by-Step NPO Pre 2000 type Soo 400 1,200 1/ hY'.ANA OI-'L Aurax Step-by-Step 100 100 l/ 30IaNI 5TL Tiuno Step-by-Step 50 50 100 1/ AA0ANG LM Sr,icsson ARF 102 Crossbar 800 200 1,000 1' LAn. Stronger Step-by-Step SF0 Pre 2000 type 1,000 boo boo 1,800 l/ RABAUL St,roner Step-ny-Step BPO Pre 2000 type 1,000 boo 400 1,800 TJ)LLkP LMi Ericsson ARK $21 Crossbar 100 100 200 KOKOPO n.TL Nurax Step-by-Step 100 50 150 WD,nAK CB Nion Multiple Manual. 400 600 2/ 6oo 1i LM Ericsson ARF 102 Cros.sbar ORiS X;TL Boran Sten-by-Step 100 50 150 l/ ~ {&AA EN. ?-hobnge - 50 50 ETI. oR-e Ee--by-Step 0ORN 0i31 a C Hon Multiple Monual boo a00 2/ Boo I/ LM Ericsso AS? 102 Crossbar PIA?L New ..a.bange - 50 50 100 l/ ETL Raran SteP-by-Step M,AGAMIINA Inc :onbange - 100 100 200 1/ ETL Aurax Step-by-Step SIPUSA CB ine Multiple Manual boo BoO 2/ 800 1/ IM Ericsson ASP 102 Crossbor SUMASAI CB Nun Multiple Manual 100 100 2/ 100 ETL Moran Step-by-Step ALOTAS Now- Eunbange - 100 100 2/ 100 200 ETL Aurax Stepo-by-Step 5A5 izOO .CA Non Multiple Manual 200 200 2/ 200 ETL Aur- Step-by-Step WAU LM Ericsson ANN 521 Crossbar 200 2001l/ 8UCLOLO IA. Ericsso.n ARK $21 Cross.bar 100 100 l