Mexico - Road Transport and Telecommunications Sector Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14400 PERFORMANCE AUDIT REPORT MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (LOAN 3207-ME) APRIL 21, 1995 Operations Evaluation Department 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. Glossary of Abbreviations BANOBRAS National Bank for Public Works and Services (Banco Nacional de Obras y Servicios Publicos) DGPNC Directorate General of Policies and Norms (Direcci6n General de Politicas y Normas de Comunicaci6n) FNM Mexican Railways (Ferrocarriles Nacional de Mexico) GoM Government of Mexico IDB Inter-American Development Bank MULTIMODAL A semi-public company for transportation of containers NAFTA North American Free Trade Agreement SCT Ministry of Communications and Transportation (Secretaria de Comunicaciones y Transportes) SECOFI Ministry of Trade and Industrial Development SHCP Ministry of Finance and Public Credit (Secretaria de Hacienda y Credito Publico) TAL Technical Assistance Loan TELECOMM Telecomunicaciones de Mexico TELMEX Telefonos de Mexico S.A. de C.V. Fiscal Year Mexico: January 1 - December 31 FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation April 21, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on Mexico Road Transport and Telecommunications Sector Adjustment Project (Loan 3207-ME) Attached is the Performance Audit Report on Mexico - Road Transport and Telecommunications Sector Adjustment Project (Loan 3207-ME), prepared by the Operations Evaluation Department (OED). The report includes comments by the Borrower. The project was part of the program of reforms undertaken by the Mexican Government to promote private sector development and a greater reliance of the economy on market forces. Specifically, it aimed at restructuring the telecommunications and road transport sectors by supporting: privatization and regulatory reform in telecommunications; deregulation of the domestic trucking industry; and institutional changes (including price reform) in both sectors. Thanks to thorough project preparation and strong Government ownership of an ambitious reform program, all of the project objectives were essentially achieved, and for some even exceeded (e.g. with regard to sector expansion, investments and pricing). The audit thus assesses the outcome of the project as highly satisfactory. Institutional development is considered as substantial, as major institutional goals-trucking deregulation and greater private sector involvement in telecommunications-were achieved (although the strengthening of Ministry of Communications and Transportation to adjust to its new regulatory functions in both sectors has been somewhat slower than expected). Sustainability is considered as likely in light of the Government's continuing commitment to sectoral reform. These ratings are in accordance with those of the Project Completion Report. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not dtherwise be disclosed without WorLd Bank authorization.  FOR OFFICIAL USE ONLY Contents P reface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Basic D ata Sheet . . . .. . .. . . . .. . . .. .. . . . . . . .. . . . . . .. . . . . . . . . . . 5 Evaluation Sum m ary .......................................... 7 1. Introduction ............................................ 11 Genesis of the Project ........................................ 11 Project Objectives and Description ................................ 11 2. Telecommunications Sector Reform .............................. 13 Privatization of TELMEX . ...................................... 13 Other Sectoral Reforms ....................................... 24 Strengthening SCT's Regulatory Capabilities .......................... 25 Sustainability ............................................ 26 Replicability of the Mexican Approach .............................. 27 3. Road Transport Sector Reform ................................. 28 Deregulation of Road Transport .................................. 28 Measures Complementing Deregulation ............................. 30 Strengthening SCT's Capabilities to Monitor Road Transport ................ 32 Sustainability of Deregulated Road Transport .......................... 32 Replicability of the Approach to Deregulation ......................... 33 4. Lessons Learned ........................................... 35 Telecommunications Sector ..................................... 35 Transport Sector . ............................................ 37 Overall Project Assessment............................... . . . .. 38 References . . . . . . ............. ....... ....................... 39 Annexes A. Letter from National Bank for Public Works and Services (BANOBRAS) ........ 40 B. Letter from Secretariat of Communications and Transport (SCT) ............. 43 C. Letter from National Bank for Public Works and Services (BANOBRAS) ........ 44 This report was prepared by A. Barbu (Task Manager) and Consultants K. Clare (transport) and R. Ramamurti (telecommunications), with administrative assistance by Ms. Lorna Sibblies. 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.  3 Preface This is the Performance Audit Report (PAR) of the Road Transport and Telecommunications Sector Adjustment Loan in Mexico (Loan 3207-ME). The amount of the loan was equivalent to US$380 million, and it was approved on May 29, 1990. The loan was fully disbursed and closed on June 30, 1991, as planned. The PAR is based on the Project Completion Report (PCR), issued in 1993, which was prepared jointly by the Mexican Government and the Latin America and Caribbean Regional Office of the World Bank.' In addition, the PAR is based on the Report and Recommendation of the President of the World Bank, loan agreement, loan guarantee agreement, transcript of the Executive Directors' meeting at which the project was considered, project files, discussions with Bank staff and discussions with Mexican Government officials. An Operations Evaluation Department (OED) mission visited Mexico in May 1994 to discuss the effectiveness of the Bank's assistance. The PAR does not differ fundamentally from the PCR in its conclusions, but it contains a more detailed assessment of the results of TELMEX's privatization, and elaborates further on lessons and policy issues raised by the experience of the project. It also includes some additional telecommunications indicators and one more year of actual data (1993). The draft PAR was sent to the Borrower for comments. Comments received are attached as Annexes. 1. Project Completion Report, Mexico Road Transport and Telecommunications Sector Adjustment Loan, OED Report No. 12623, December 23, 1993  5 Basic Data Sheet Key Project Data Appraisal Actual or Actual as % Item Expectations Current Estimate of Appraisal Loan Amount (US$ million) 380.0 380.0 100 Date of effectiveness 1990 6/25/90 Date of Completion 1991 1991 Months for Implementation Cumulative Estimated and Actual Disbursements (US$ million) FY90 FY91 Appraisal Estimate 190 190 Actual 190 190 Actual as a % of Estimated 100 100 Project Dates Original Plan Actual First Mention in Files 06/89 06/89 Appraisal 12/89 01/90 Negotiations 05/90 03/90 Board Approval 06/90 05/90 Signing 06/90 Effectiveness 05/90 Closing 06/91 6 Staff Inputs (staff weeks) FY89 FY90 FY91 FY92 Total Identification 13.9 13.9 Preparation 77.3 77.3 Appraisal 22.8 22.8 Negotiations 5.4 5.4 Supervision 0.2 13.8 0.5 14.5 Total 13.9 105.7 13.8 0.5 133.9 Mission Data Mission Type Month/Year No. of Persons Identification 06/89 4 Preparation 07/89 4 Preappraisal I 10/89 2 Preappraisal II 11/89 11 Appraisal 01/90 8 Supervision I 08/90 3 Supervision II 11/90 2 Supervision III 02/91 3 Supervision IV 04/91 4 Completion 02/93 2 Other Project Data Borrower: Banco Nacional de Obras y Servicios Publicos (BANOBRAS) Executing Agency: Secretaria de Comunicaciones y Transporte (SCT) 7 Evaluation Summary Introduction 1. The administration of President de la Madrid began a piocess of economic reform about 1983 to overcome a serious crisis characterized by an inability to service foreign debt, collapse of oil prices, rapid inflation and excessive governmental budgets. The reforms were continued and expanded under the Salinas Government. One of the basic goals was to rely to a greater extent on the forces of competition in the market economy and rely less on Government programs and regulations. The telecommunications and transportation sectors were selected for special action because of evidence that they accounted for major supply bottlenecks and market disorganization. 2. In the telecommunications sector, the state-controlled monopoly, Telffonos de M6xico (TELMEX), was unable to keep up with demand. Its quality of service was poor. Taxes and tariffs in the sector were highly distorted. Technology was obsolete, and the needs of business users were not being met. In the transport sector, the trucking industry prior to 1989 was comprised of a limited number of firms operating under conditions of minimal competition and rigid regulation. Under these circumstances, the public enjoyed neither good quality trucking services nor low rates. Studies showed government regulation to be a negative factor affecting the industry and the general economy. 3. The project was an integral part of the Bank's continuing program of financial support of Mexico's reforms. Regarding the telecommunications sector, the project objectives were to privatize TELMEX, end price and tax distortions, expand private participation in the sector, and strengthen government regulation of the sector. To assist in the last task, a US$22 million Technical Assistance Loan (ME-3208) was approved by the Board in conjunction with the Road Transport and Telecommunications Sectoral Adjustment Loan. With respect to the transport sector, the principal objectives were to deregulate the trucking industry and to achieve certain complementary meaures including increased funding of highway maintenance, increased cost recovery from road users, a general increase in railway freight rates, preparation of a highway safety program and initiation of a program of vehicle emission inspection. Implementation 4. In the telecommunications sector, even before Board approval, TELMEX's labor contracts were restructured, the firm was transferred to the Ministry of Finance, which was made responsible for privatizing the firm, the special excise tax on telephone service was scrapped, telephone rates were raised and rebalanced, and investment bankers were selected to advise the government on TELMEX's privatization. After loan approval, a new concession agreement for TELMEX was drafted, a further adjustment was made to tariffs, bids were invited and control transferred to a consortium of Mexican and foreign firms, and all but a small percentage of the government's remaining shares were divested in tranches through global offerings. In addition, the government issued a new set of regulations for the telecommunications sector (Reglamento), and took some measures to clarify and strengthen the SCT's role. 8 5. The approach adopted in the deregulation of the trucking industry was a three stage process: (1) an agreement was reached in July 1989 between SCT and the trucking industry association on objectives and general means of achieving modernization and deregulation of the industry; (2) a decree was issued in July 1989 eliminating restrictions on entry, discretionary freight allocations and most rate regulation; and (3) another decree was issued in January 1990 eliminating the remaining rate regulations. 6. Various planned actions complementary to the trucking deregulation took the form of conditions for the release of the second tranche of the loan, the first having been released on June 25, 1990, the effectiveness date of the loan. These complementary actions were implemented by the Government prior to the target date of November 15, 1990. Results of these actions are shown below. Results 7. The impact of the telecommunication reforms was as follows: (1) the rate of network expansion doubled relative to that of the early 1980s and exceeded targets prescribed by government; (2) distortions in taxes and prices were sharply reduced, and average prices were raised to international levels; (3) TELMEX's internal efficiency improved; (4) workers benefitted; (5) cash flow to the government rose marginally relative to the pre-privatization level, not counting the $6 billion realized through the sale of the government's shares; (6) the quality of service improved for business users but less so for residential users, especially those in the Greater Mexico City region; (7) private participation in the sector expanded in areas such as cellular service, trunking, paging, value-added services, and cable TV; and (8) the SCT's mandate was focused on regulation rather than the provision of telecom services, but its organizational capacity to regulate was not strengthened to the degree that may have been desirable. 8. The impact of deregulation of trucking was as follows: (1) a large number of new truckers entered the field thus increasing competition; (2) trucking rates fell about 23 percent in real terms between 1987 and 1994; (3) the quality of services improved: (4) truck fleets were modernized by adding many new vehicles; (5) operating efficiency and management capabilities of trucking companies improved; and (6) competition between trucking and the railway became more intense. 9. With regard to measures complementary to trucking deregulation, the following actions were taken: (1) the 1991 budget for highway maintenance was increased to 475 thousand million Pesos; (2) the price of diesel fuel was increased more than the 10 percent required by the condition; (3) railway rates were increased more than the 25 percent required under the condition; (4) an action plan for highway safety was prepared and a safety study initiated; and (5) a system of vehicle emission inspections was introduced. Findings 10. Essentially, all of the project objectives have been achieved, and for some even exceeded (e.g. sector expansion, investments, pricing). The audit thus assesses overall project outcome as highly satisfactory (versus satisfactory in the PCR). All main loan covenants were complied with (with minor delays in some cases) and project implementation by the Borrower 9 must be regarded as excellent, considering the obstacles along the way and the time available. The Bank played a very useful catalytic and advisory role, and its performance is assessed as fully satisfactory-although, in hindsight, it could have paid more attention to the planning of SCT's activities in the road sector following deregulation. All applicable Operations Manual Statements (OMS), Operational Policy Notes (OPN) and Bank guidelines were observed and followed. Institutional development is considered substantial as the project's major institutional goals (trucking deregulation and greater private sector involvement in telecommunications) were achieved; the strengthening of SCT to adjust to its new regulatory functions in both sectors has however been slower than expected. The above ratings and the PAR's general conclusions are in accordance with those of the PCR; it should be noted, however, that the PAR does not share the PCR's criticism of the Bank's conditionality on railway pricing (see para. 3.16 of text). Sustainability 11. The telecom reforms are likely to be sustained because of (a) the government's strong commitment to privatization and deregulation; (b) a growing number of private firms in the sector with a vested interest in keeping the sector open; and (c) the growing likelihood that TELMEX's monopoly in local and long-distance service will end in 1996. The main risk of policy reversal is the public discontentment with TELMEX's quality of service and high tariffs, but that risk is mitigated by TELMEX's recent efforts to improve its service/image and the fact that the firm's monopoly power is drawing to a close. 12. The trucking deregulation is also likely to be sustained as indicated by the strong commitment of the Government to the new policy, a lack of serious opposition to the deregulation policy from the trucking industry and the solid evidence of the beneficial effects of the deregulation. 13. Replicability. The technological and economic arguments for privatization and deregulation of the telecom sector are likely to apply just as strongly to other countries as they did to Mexico, but the precise pace and scope of the reform strategy will have to differ in other countries because of differences in national circumstances. 14. The three stage approach to trucking deregulation employed in Mexico appears to be replicable in other countries where the trucking industry is highly regulated. Lessons Learned 15. The experience with this loan suggests that in both the telecommunications and transport fields, significant opportunities exist for reducing cost and improving service through privatization and/or deregulation of the sector. Therefore, the Bank might want to ask what role policy lending, emphasizing privatization and deregulation, ought to play vis-a- vis the Bank's traditional practice of project lending. 10 16. In both sectors, structural reforms changed the nature of the regulatory task; in transport, economic regulation gave way to environmental and safety regulation, while in telecommunications, price and quality regulation, as well as competition policy became far more critical issues than before. Countries require technical assistance not only to define their new regulatory role in the sectors but to manage the transition from the old to the new role. 17. The experience in both sectors also confirms the criticality of "borrower ownership" for the success of a sectoral adjustment operation. The Bank's role in this operation was that of a catalyst or adviser rather than the engine of change. Consequently, numerous potential obstacles to reform were speedily overcome by the Government, and changes within the two sectors were reinforced by other structural changes in the economy. 18. Beyond these fundamental lessons, the audit also lists (para. 4.03) a number of practical and sector-specific lessons derived from the Mexican experience and worth keeping in mind in the design and supervision of future telecommunications and road projects. 19. The Mexican experience also raises two policy issues that the Bank might wish to investigate more thoroughly: (1) What is the optimal rate of introduction of competition in a sector like telecoms, where there is a large sunk investment in the state-owned telecom firm? and, (2) Should the Bank urge countries to create multiple, autonomous regulatory agencies (one for each monopolistic sector) or is the Mexican approach of creating one truly high- powered agency, such as the Anti-Trust Commission, a more realistic and efficient alternative? 11 1. Introduction Genesis of the Project 1.1 The project traces back to about 1983 when the de la Madrid Government began a process of economic reform in Mexico to overcome a crisis that was characterized by inability to service its foreign debt, collapse of oil prices, rapid inflation, excessive governmental budgets and other problems. The Government initiated corrective policy measures to eliminate macroeconomic distortions affecting the Governmental budget and to take actions that would enable the economy to move forward on a growth path. There were many facets to the reforms, but one of the basic goals was to rely to a greater extent on the forces of competition in the market economy and rely less on Government programs and regulations. Once the main policies were established and basic macroeconomic structural reforms were introduced, the Mexican authorities considered particular economic sectors where specific reforms would likely lead to major economic benefits. Transportation and telecommunications sectors were selected for special attention because of evidence that they accounted for major supply bottlenecks and market disorganization. 1.2 In the telecommunications sector, the state-controlled monopoly, Tel6fonos de M6xico (TELMEX), was unable to keep up with demand, its quality of service was poor, taxes and tariffs in the sector were highly distorted, technology was obsolete, and the needs of business users were not being met. In 1989, the Government of Mexico announced a bold reform program for the sector that would raise service to international standards, expand coverage in rural and urban areas, update services, rationalize tariffs, and promote greater private sector participation and competition. The centerpiece of this plan was the privatization of TELMEX. 1.3 In the transport sector, road transport on federal highways prior to 1989 was subject to an extreme degree of regulation, as detailed in the PCR (paras. 18 and 10). As a result, the trucking industry was characterized by a limited number of firms operating with minimal competition. Conditions were not conducive to either low rates or high quality services. Analysts saw government regulation as a key negative factor in this troublesome sector. Moreover, the recent experience with deregulation of trucking in the United States and other countries was reviewed, and its effects were seen to be beneficial. Project Objectives and Description 1.4 The Bank and the Government of Mexico regarded the project an integral part of the Bank's continuing program of financial support of Mexico's reforms. As stated in the Report and Recommendation of the President of the Bank, "The proposed loan is part of a program of Bank support to the Mexican Government's objectives of promoting private sector development and increasing the efficiency and effectiveness of public sector institutions so as to enable the resumption of economic growth." The proceeds of the US$ 380 million loan were to be used to reimburse 100 percent of the CIF cost of eligible general imports. 12 1.5 The telecommunications component of the project consisted of a program to: (1) privatize TELMEX; (2) issue new regulations governing private sector participation in the sector; (3) separate the operating functions of the Communications and Transportation Ministry (SCT) from its regulatory functions; and (4) strengthen the regulatory capacity of the telecommunications department of the SCT (the DGPNC). To assist in the last task, a US$22 million Technical Assistance Loan (ME-3208) was approved by the Board in conjunction with the Road Transport and Telecommunications Sectoral Adjustment Loan. 1.6 The transport component of the project consisted of two parts: (1) deregulation of road transport and (2) measures concerning the transport sector which were considered necessary to complement the deregulation process. More specifically, deregulation was to remove restrictions on entry into the trucking field, eliminate discretionary allocations of freight among truckers, allow freight rates to be determined by market forces and break up the MULTIMODAL transport monopoly. The particular measures to complement deregulation were to increase funding of highway maintenance for 1991 to at least 475 thousand million pesos; increase the price of diesel fuel by at least 10 percent; increase railway tariffs by at least 25 percent; prepare an action program for highway safety improvements and undertake a study of the problem; and initiate a program of vehicle emission inspections. 13 2. Telecommunications Sector Reform Privatization of Telmex Approach to the Sector 2.1 Problems facing the sector. As in many developing countries, the telephone sector in Mexico was dominated by a state-controlled firm, TELMEX, that was the sole supplier of fixed-link public telecommunications service. For financial and organizational reasons, TELMEX had been unable to keep up with demand. Despite connection charges as high as $600 for residential users and $1,100 for commercial users, in 1990, the waiting list had 1.3 million names on it and the waiting period for a new connection was 2-3 years. Telephone penetration stood at only lines 5 per 100 persons, and thousands of rural areas had no telephone service. The quality of telephone service was also poor. 2.2 Business users were unable to obtain reliable, high-volume, voice, data, and image transmission systems. After the 1985 earthquake severely damaged TELMEX's network, the government permitted businesses to bypass the TELMEX network through high-cost private networks using satellite or microwave transmission. Beyond that, the private sector's role in emerging technologies, such as cellular telephony, value-added services, and cable TV, was unclear. 2.3 Finally, taxes and tariffs in the sector were highly distorted. Mexico's average telephone excise tax of 60 percent was one of the highest in the world; although originally intended to help finance the sector, the government had progressively diverted those taxes to other sectors of the economy. In addition, charges for local service were much below cost while those for long-distance service were above cost. 2.4 Planned reforms. In September 1989, the Government of Mexico announced a bold reform program to expand, modernize, and rationalize the sector. Besides maintaining a dialogue with Mexican authorities during the development of that program, the Bank became involved in its implementation through this sectoral adjustment loan. The program called for the privatizatjon of TELMEX, the adjustment of taxes and tariffs, private sector participation and competition within the sector, the issuance of new regulations, and the reorganization and strengthening of the Department of Communications (DGPNC) in the Ministry of Communications and Transport (SCT). 2.5 The scope and pace of reforms in the telecommunications sector exceeded the expectations of Bank officials. Even before Board approval in May 1990, TELMEX's labor contracts were restructured, the firm was transferred to the Ministry of Finance, which was made responsible for privatizing the firm, the special excise tax on telephone service was scrapped, telephone rates were raised and rebalanced, and a local commercial bank and an international investment bank were selected to advise the government on TELMEX's privatization. 14 2.6 Implementation. After the approval of the loan, the remaining steps in the privatization of TELMEX were implemented, including the development of a new concession agreement, the selection of a buyer that included well-known international firms, and a further adjustment in tariffs. By May 1994, all but two percent of the government's shares had been divested in tranches through global offerings. In addition, in October 1989, the government issued a new set of regulations for the telecommunications sector (Reglamento), and took measures to clarify and strengthen the role of the Communications Department (DGPNC) of the SCT. 2.7 The principal elements in the strategy for privatizing TELMEX were as follows:2 * The company was sold intact rather than privatized in parts; * Before privatization, the average revenue per line was raised to about $750, and thereafter the price-cap method of regulation was used to compensate for inflation, with "X" equal to zero;' * TELMEX was granted the exclusive right to offer domestic and international long- distance service to the public for a period of six years after privatization; * All other activities, such as Yellow Pages, value-added services, cellular telephony, cable TV, etc were opened up to private participation; * TELMEX was permitted to diversify into most other businesses so long as the unregulated activities were carried out through separate subsidiaries; * TELMEX was granted the only national license for cellular service; * TELMEX was initially required to be under Mexican control, although foreign investors, especially international telephone operators, were permitted to participate as minority partners in the bidding consortia; * In the first stage of divestment, a controlling block of shares was sold to a consortium led by Mexican investors, and the remaining state holdings were divested through a series of global offerings. * All sales were for cash. * A small block of shares (4.4 percent) was sold to the company's workers. 2. For a fuller discussion of the strategic options facing Mexican policy makers at the time of privatization, see Ramamurti [19931. 3. Under the price cap method of regulation, prices for the basket of regulated services can be raised by the firm by (RPI-X) percent, where RPI is some measure of the retail price index, and X is a productivity adjustment. Initially, in the U.K., "X" was set at 3 percent, compared to zero in the case of Mexico. 15 2.8 Evaluation of design and implementation. Despite the time pressure, the strategy adopted by the Mexican authorities was remarkably comprehensive. Considering the snail's pace at which privatization has tended to move even in the case of small firms in most countries, including in the past in Mexico, the scope and pace of reforms implemented within the telecom sector were truly extraordinary. 2.9 The strategy employed was also very clever. Mexican officials sought ideas from other countries, including the United States and the U.K., and obtained comments at critical junctures from World Bank staff and consultants, but throughout were willing to innovate at the margin to develop a strategy that fit Mexico's circumstances. 2.10 The British approach to privatizing British Telecom (BT) was to be particularly influential, but significant deviations were made. In Mexico, the price cap used was more generous than in the U.K.; and while one new entrant was allowed to compete with BT for the first seven years, none was authorized in Mexico for the first six years; and while the British government retained a "golden share" in BT, the Mexican government intended to fully divest its holdings and end the SCT's representation on the company's board by August 1993.' 2.11 The most important reason why this loan attained its stated objectives was the Mexican government's very strong commitment to the reforms. This was basically a program initiated, designed, and championed by Mexican officials, with the Bank playing, in the words of one senior official, "a marginal but helpful role." Without that level of government comnitment, the reforms in the telecom sector could not have been as deep or made as quickly. 2.12 Within that context, the Bank's contribution lay in four areas: (1) Providing international legitimacy for the Mexican reform strategy and for the privatization of TELMEX; (2) Providing technical assistance for drafting the new concession agreement and telecommunications regulations; (3) Contributing to the stability and continuity of the reform program by helping set up an appropriate regulatory framework; and (4) Providing foreign exchange that, along with other Bank loans, helped Mexico get out of the debt trap. Impact of Privatizing TELMEX' 2.13 Several performance indicators for TELMEX for the three years prior to and following privatization are shown in Table 1. 2.14 Expansion of coverage. As required under the concession agreement, TELMEX expanded the number of lines in service by 12 percent or more in each of the first three years of the concession (1991, 1992, and 1993) and expected to do the same in 1994. This contrasts with the 6-7 percent growth through much of the 1980s, and is higher than the 10.5 4. In fact, as of May 1994, the Minister of Communications and Transport still had a seat on TELMEX's board. 5. For other analyses of the results, see Ramamurti [1994] and Tandon 11992]. 16 percent achieved in the two years immediately preceding privatization. As a result, the density of telephone coverage rose from 6.6 lines per 100 persons in 1990 to 8.7 in 1993.6 The number of communities with telephone service rose from 10,221 in 1990 to 18,281 in 1993, representing a 78.9 percent increase, and the target of 2 public telephones per 1,000 population was achieved in 1993, a year ahead of schedule. Table 1: Assorted Performance Indicators for TELMEX, 1988-1993 Indicator Units 1988 1989 1990 1991 1992 1993 1. Lines in service Annual increase '000 288 460 508 670 729 867 Percentage increase % 7.0 10.5 10.5 12.5 12.1 12.8 Total lines '000 4,387 4,847 5,355 6,025 6,754 7,621 2. Lines installed Annual increase '000 354 535 705 759 711 975 Percentage increase % 7.4 10.4 12.4 11.9 9.9 12.4 Total lines '000 5.152 5,687 6,392 7,151 7,862 8,837 3. Telephone density lines/100 population 5.6 6.1 6.6 7.2 8.0 8.7 4. Capital expenditure US$ Mill 1,080 987 1,831 1,967 2,352 2,282 5. Employees (telephone service only) Nos. 49,995 49,203 49,912 49,488 48,937 48,771 6. Employees per 1000 Empl. per 11.7 10.5 9.6 8.5 7.5 6.6 lines 1000 lines 7 Taxes paid to Govt.' US$ Mill. 658 1,098 1,293 1,301 1,677 1,749 a. Includes the following taxes paid by TELMEX to the Government: income tax, value-added tax (IVA), payroll taxes, dividend withholding tax, and, from 1990 onwards, the telephone tax (29 percent of TELMEX's revenues from telephone service). In 1988 and 1989, the telephone tax was levied on users rather than the company and the figures in the table do not include the government's receipt of those taxes, which were of the order of $800 million each year; approximately half of those amounts was reinvested in TELMEX by the government, so that the net proceeds to the Treasury from the telephone tax was probably $400 million in each of 1988 and 1989. Source: TELMEX 2.15 TELMEX's annual investment rose from an average of $1.3 billion in the three years before privatization to $2.2 billion in the three years after privatization (item 4, Table 1). The government's expectation that a total of $10 billion would be invested in the sector in the sexenio (1989-94) was attained in just the first five years. 2.16 In sum, investment by TELMEX was high enough to expand the telephone network into urban and rural areas at more than the pace required by the concession agreement. 6. The plan announced for the sector in 1989 had hoped to raise the density to 8.4 lines per 100 persons by 1994. 17 2.17 Pricing. By January 1991, when TELMEX was privatized, the firm's revenue per line had been raised to $750, which was comparable to levels in the advanced countries. Thereafter, as provided under the price cap method of regulation, prices for the basket of regulated services rose to offset the inflation in consumer prices (see Table 2). 2.18 Since the price cap began to apply (that is, after 1991), TELMEX's rates on regulated services have risen cumulatively by about 3 percentage points less than inflation in the 1991- 1993 period. In 1993, prices were raised by less than the amount permitted under the price cap formula because the economy was slowing down, the waiting list for telephone connections had shrunk to about 300,000 (from over 1 million in 1990), the public was upset with TELMEX's high prices and insufficient improvement in quality, especially in Mexico City, and, finally, the prospect of competition in long-distance service was beginning to look more and more real. 2.19 Prices were also significantly rebalanced, as seen in the sharp increases for local service (monthly rent and measured service) and the decline in the rates for international long- distance service. Domestic long-distance rates rose in real terms until about 1992, thereby creating more room for raising local rates in later years, when the prospect of competition would force domestic long-distance rates down. 2.20 In practice, pricing deviated in a few areas from the rules laid out in the concession agreement. For instance, beginning in 1992, rates were adjusted less frequently than the concession permitted in order to contain the adverse public reaction that followed price increases. But installation charges, which were supposed to decline steadily to $100 by 1996, went up in real terms in 1992 and 1993 so that TELMEX could hold down increases in monthly rent, which affected far more people than the connection charge. As a result, in 1994, connection charges were still very high by world standards: $540 for a residential line and $940 for a commercial line. 2.21 While the cross-subsidization of local service by long-distance has been sharply reduced, the subsidization of residential users by businesses continues. In 1993, the installation charge for businesses was almost double that for residences, while the monthly rent was more than double. If competition is permitted in local and long-distance services after August 1996, as seems likely, a further rebalancing of rates between residential and business users may be necessary. 18 Table 2: Annual Increase in Regulated Rates for Various Service End-of-year Comparisons, 1988-93 (Figures in Percentages, except as noted) Service 1988 1989 1990 1991 1992 1993 1994' Basic rent Residential 85.0 0.0 68.02 79.0 17.0 34.7 24.15 Commercial 85.0 50.0 80.6a 63.5 17.0 17.2 14.95 Measured service 85.0 22.4 869.8 11.8 17.0 9.7 8.72 Installation charges Residential 68.9 0.0 0.0 29.3 28.2 9.1 8.72 Commercial 206.7 0.0 0.0 27.9 30.1 10.3 8.72 Domestic Long-distance 56.0 50.0 45.0 37.5 16.8 6.9 0.0 Intl. long-distance 0.0 0.0 (21.7) 6.1 8.0 6.2 0.0 Weighted nominal increase DATA AWAITED FROM TELMEX Inflation for the year 51.7 19.7 29.9 18.8 17.9 8.0 ? Weighted real increasea Average tel. revenue per line in service' 740 773 896 908 1021 960 NA (US dollars/line) a. Weighted nominal increase minus inflation for the year b. Telephone revenues only, converted to US$ at the average exchange rate during the year, divided by the average lines in service at the beginning and end of the year. Source: TELMEX and TELMEX Annual Reports 2.22 On the whole, privatization achieved the objective of raising the average revenue per line and rebalancing local versus long-distance rates in a relative short period of time. If competition is permitted in 1996, a further rebalancing of rates between residential and commercial users may become necessary. 2.23 Quality of service. The targets for service improvement set under TELMEX's concession agreement were consolidated into two aggregate measures, one for service continuity (ICON) and another for quality of lines in service (ICAL). The targets prescribed appear to have been modestly difficult on service continuity (ICON), where the principal challenge was to reduce the percentage of lines out of order from 10 percent in 1990 to 6 percent by 1994, and relatively easy on service quality improvement (ICAL). 19 2.24 At an aggregate level, TELMEX exceeded the targets for ICON and ICAL in 1991, 1992, and 1993 (see Table 3). Yet, TELMEX has been widely criticized by the public and the press for unsatisfactory service. The explanation for that apparent contradiction lies not only in the heightened public expectations following privatization but in important shortfalls within components of ICON and ICAL and in significant variations across regions and months. 2.25 Within ICON, TELMEX consistently had more lines out of order than allowed under the concession agreement, and, until 1993, the improvement relative to the 1990 level was only slight. This has been the single most important complaint against TELMEX. The company also failed consistently to meet the target for improving operator service; here, if the data is to be believed, service actually deteriorated relative to 1990. 2.26 In terms of regional differences, the quality of service in the Greater Mexico City region, which was always worse than elsewhere to begin with, fell considerably short of the national targets for ICON (see Table 4). In the rainy season, when line failures shot up, as many as one in six lines in the region was out of order, compared to the target of one in fourteen. Equally frustrating to consumers in the region was the continued delay in repairing faulty lines. In 1992, on average, TELMEX received more than a million complaints per month from customers, and the numbers fell only slightly in 1993 and the first quarter of 1994. More than half the complaints originated in the Greater Mexico City region. 2.27 In 1993, based on the company's quality results for 1992, the SCT required TELMEX to credit every user in the Greater Mexico City region one month's worth of rent, which reportedly cost the company about US$75 million. Overall, however, the SCT seems not to have received high marks for enforcing the quality targets and sanctions prescribed in the concession agreement. The SCT has not conducted an independent audit of TELMEX's self-reported performance on the quality front. Some concern was also expressed about the reliability of the statistics generated by TELMEX and the ministry's access to information from the company. 20 Table 3: Tehnex's Quality of Service, Average Performance on Various Indicators Across All Regions and Months (1991 through 1994, Targets and Actuals) (Figures in %) 1991 1991 1992 1992 1993 1993 1994 Indicator Target Actual Target Actual Target Actual Target Service Continuity Index (ICON)' 83.42 86.27 86.19 89.53 87.07 90.89 87.95 - Lines with failure (%) 8.00 9.43 7.00 9.12 6.00 7.53 5.00 - Same day line repair (%) 48.00 52.94 50.00 68.81 50.00 74.10 50.00 - 3-day line repair (%) 86.00 90.96 90.00 93.23 91.00 93.60 92.00 Service quality index (ICAL)' 91.66 92.36 92.38 93.68 92.82 95.93 93.64 - Dial tone in 4 secs. (%) - Local calls, Ist try (%) 97.00 98.46 97.00 99.26 98.00 99.65 98.00 - LD calls, 1st try (%) 92.00 93.45 94.00 95.65 94.00 97.19 95.00 - Special operators answer- 92.00 92.46 92.00 94.24 92.00 97.82 93.00 ing in 10 secs. (%) - Public tels in service (%) 90.00 83.11 91.00 83.62 91.00 83.64 92.00 88.00 90.84 89.00 91.73 90.00 95.16 91.00 Source: TELMEX 21 Table 4: Quality of Service in the Greater Mexico City Region, (Targets and Actual Averages for 1992 and 1993) Indicator 1992 1993 Target Annual Worst Target Annual Worst Avg. month Avg. month A. Service Continuity Index 86.19 84.24 81.54 87.07 86.23 81.40 (ICON) - Lines with failure (%) 7.00 11.26 16.18 6.00 9.24 10.96 - Same day line repair (%) 50.00 60.59 50.15 50.00 63.02 49.40 - 3-day repair rate (%) 90.00 86.70 79.30 91.00 88.58 78.20 B. Service Quality Index (ICAL) 92.38 92.66 91.48 92.82 94.60 92.98 - Dial tone in 4 secs. (%) 97.00 99.38 98.82 98.00 99.40 99.05 - Local calls, 1st try (%) 94.00 92.55 89.60 94.00 93.60 90.73 - LD calls, 1st try (%) 92.00 94.54 93.50 92.00 97.30 94.26 - Special operators answering in 10 secs. (%) 91.00 81.52 77.64 91.00 75.37 67.16 - Public tels in service (%) 89.00 90.34 86.66 90.00 96.45 95.07 Source: Compiled from data supplied by TELMEX 2.28 By 1993, the company had launched an aggressive campaign to improve quality. That year, the number of old lines replaced or modernized increased more than three-fold from levels in the previous two years, and the external plant was being upgraded aggressively. By the year 2000 the company expected to replace 2.8 million lines, or nearly half of all lines in operation in 1989. TELMEX also assigned special operators to take consumer complaints over the phone, created new centers where bills could be paid, and launched a public relations campaign to improve its image. 2.29 Among business users, the company's reputation for service seems to have improved. Two large users visited during the audit-a private bank and the Mexican Stock Exchange-described TELMEX's new fiber-optic overlay network as very good but expressed disappointment with its older trunk lines. They also noted a significant improvement in the company's responsiveness to their needs. Since future competitors are most likely to attack this segment, TELMEX management, with the help of its foreign partners, Southwestern Bell and France Telecom, is working to improve ties with business users. One internal survey conducted for TELMEX by a third party reportedly found that 70 percent of the 100 largest users felt the company's service had improved since privatization, 20 percent thought it had neither improved nor worsened, while 10 percent felt it had become worse. 2.30 On the whole, although privatization has not produced a spectacular improvement in quality of service in all areas, it has brought the question of quality into focus, the firm is 22 under much great-r pressure than before to improve quality, and a system has been developed to monitor TELMEX's performance on this front. However, the Mexican experience points to the difficulties in getting the privatized firm to deliver on the quality improvements that may have been expected when price increases were granted. In retrospect, it may have been better to link price increases to quality improvements, or to have set explicit goals for the modernization and replacement of old lines and external plant. 2.31 Internal efficiency. Although no targets were set in the concession for efficiency improvement, the price cap method of price regulation gave TELMEX the incentive to reduce costs without fear that those savings would be administratively expropriated by the government through tariff reductions. 2.32 The most dramatic change is seen with respect to labor productivity (see items 5 and 6 in Table 1). Although TELMEX's network expanded by 42 percent between 1991-1993, employment in telephone operations fell by 2.3 percent. Consequently, the number of lines per employee rose from 107 in 1990 to 156 in 1993, a 46 percent improvement. The annual savings on salaries and benefits because of the increase in labor productivity probably amounts to $685 million before taxes and $445 million after taxes.' While the number of unionized workers declined through attrition, as many as 350 nonunion employees, including some in the senior management ranks, were let go soon after privatization. The company feels, however, that additional productivity gains lie ahead, especially in the two classes of employees whose services will be required less and less: telephone operators, of whom there were 10,000, and repairmen, of whom there were several thousand. 2.33 The company also realized savings on capital expenses by renegotiating the terms of a five-year supply agreement signed by the government before privatization with TELMEX's principal suppliers of switching equipment in Mexico. The 20-25 percent price reduction thus obtained probably saved the company $150 million per year, not counting any savings that may have been achieved in other areas of capital expenditure.! 2.34 Managers of TELMEX now participate in a stock option plan. In addition, employees who had been with the company for many years noted that internal decision-making had been greatly speeded up. 2.35 Impact on employees. Privatization had a positive impact on most employees. As promised by President Salinas at the time of privatization, there were no layoffs among unionized workers, except through attrition, although the new management also refrained from hiring new workers despite rapid expansion of the network. The union's strong hold on the company seems to have persisted despite privatization, and management continued to find it difficult to move personnel across job categories. Employee compensation grew in real terms because of hikes in wages as well as sharply higher payments under the profit-sharing scheme. The average worker also realized a capital gain in excess of US$15,000 on the 7. Calculated using the average salaries and benefits per employee of more than $30,000 in 1993. 8. Switching and other equipment supplied by the two Mexican suppliers. Alcatel and Ericsson, accounted for about 30 percent of TELMEX's annual capital spending ot $2.2 billion. A 20-25 percent reduction in their prices translates into an annual savings of about $150 million. 23 shares assigned to workers at the time of privatization. The only losers from privatization may have been the non-union staff who were laid off when TELMEX's management structure was streamlined by the new owners. 2.36 If competition is introduced into the sector the union may have to show greater flexibility than it has so far. Perhaps competition will produce the change in union attitudes and work rules that privatization was apparently unable to produce. 2.37 Impact on government revenues. TELMEX's contribution to the Treasury consists of the telephone tax, income tax, the value-added tax, payroll tax, and the dividend withholding tax. As shown in Table 1, the actual payments made by TELMEX to the government under all these categories rose from about US$1 billion in 1989 to US$1.75 billion. However, before 1990, the telephone tax was levied on users rather than the company. Adding an estimated US$800 million in telephone tax to the figures for those years would imply that the total revenues to the government probably dipped by a few hundred million dollars in 1991 and 1992 but recovered to the earlier levels by 1993. However, since in the earlier years the government also reinvested about half the telephone tax in TELMEX, its net cash flow from the sector probably increased after privatization. 2.38 In addition to the tax revenues, the government received more than US$6 billion from the sale of its 55 percent holding in TELMEX. There has been some debate about whether the government realized a fair price for its shares. Judging from the company's market value in 1994 of US$30 billion, it can be argued that it did not, but the opposite conclusion can be reached if one looks at TELMEX's market valuation in 1989 of only US$2-3 billion. Since the company's stock was traded at every stage of the divestment, and since the government always realized a price that was close to the prevailing market price, it can be argued that the government could not have sold its shares below "market" value, although it can be argued that the market itself was valuing the stock incorrectly. Indeed, foreign investors such as Southwestern Bell, who could anticipate better the implications of price and tax changes on future profits and cash flows, were more bullish about the company than the average investor, including Mexican investors. It is very likely that the government would have realized a higher price if foreigners had been allowed to gain control over the firm. 2.39 Return to investors. Investors were clearly the biggest winners from TELMEX's privatization because of the sharp run-up in the stock price in the period after privatization. In 1993. TELMEX's after-tax profit of US$ 2.7 billion represented a margin on sales of 37 percent (see Table 4, Annex 3 of PCR for TELMEX's financial results from 1989-92). Since almost 80 percent of TELMEX's stock is owned by foreigners, most of the capital gain has been reaped by foreign investors.' For instance, in 1991 Southwestern Bell made a paper profit on its investment in TELMEX of about one billion dollars, which was greater than its annual operating profits in the United States. 9. See Tandon [19921. 24 Other Sectoral Reforms 2.40 Two other reforms, fully consistent with the notion of promoting private participation in the telecom sector, were intended to complement the privatization of TELMEX. The first was transferring all operating functions being carried out by the SCT and Tel6grafos Nacionales (satellite communications, the federal microwave network, telematic, telegraph and other services) to a new commercially-oriented public agency, TELECOMM, thus permitting the Ministry to concentrate on regulation of the sector. The second was facilitating private participation in the sector by formulating detailed sectoral regulations regarding entry, operation, and pricing. TELECOMM's Role 2.41 Even before Board approval, in November 1989, the SCT's operating functions were transferred, along with telegraph service provided by Tel6grafos Nacionales, to a new agency, TELECOMM. However, the idea of turning TELECOMM into a potential competitor to the privatized TELMEX did not materialize. On the contrary, shortly before TELMEX's privatization the terrestrial microwave network belonging to TELECOMM was sold to TELMEX for US$300 million and it was decided that TELECOMM would not participate in the development of a fiber optic long distance network. 2.42 Partly as a result of the changes in TELECOMM's role, the preparation of a business plan for TELECOMM, which was a condition for second tranche release under the project, was delayed by six months. As of 1994, TELECOMM's role was limited to the launching of two more satellites (Solidaridad I and II), although it was unclear how the project would be financed. Private Participation in the Telecommunications Sector 2.43 As required under the project, in October 1990, the government issued comprehensive regulations governing entry and operations of private firms in the telecommunications sector. As a result, by 1994, besides privately-owned TELMEX, the sector consisted of nine private firms offering cellular telephone service to 392,000 customers, 42 companies providing paging services to 136,000 users, 15 companies providing trunking service to 23,000 users, about 20 providers of value-added services, 5 private companies with public teleports, and one cable TV consortium (made up of five private TV companies). In addition, large companies such as Banobras operated private networks within Mexico. Most of these firms emerged after the new telecommunication regulations were issued in 1990. Although public telephone service provided exclusively by TELMEX accounted for 80 percent or more of the telecom sector's total revenues, many of the newer services were growing at faster rates. Thus, even if the sector reforms did not end TELMEX's dominant position, they did produce a nucleus of private firms that could some day challenge TELMEX. 25 Strengthening SCT's Regulatory Capabilities 2.44 The weakest link in the Government's reform program was the effort to strengthen the SCT's regulatory capacity. Indeed, a few peripheral activities being carried out within SCT were privatized, while others were transferred to TELECOMM. but the idea of turning SCT into a well-staffed, autonomous regulatory agency following the British model for OFTEL was not pursued despite the Bank's encouragement. 2.45 Interviews conducted during the audit revealed three possible explanations for the government's reluctance to do so. First, the idea of creating an autonomous regulatory agency for telecoms was reportedly resisted by the SCT, possibly because that would have compounded the ministry's loss of power following the privatization of TELMEX. Second, creating an autonomous regulatory agency for telecommunications may have created similar demands from other ministries at a time when Mexican officials were intent on reducing the size of government. In the end, the government seems to have opted to create one high- powered Anti-Trust Commission, as required under NAFTA, with jurisdiction over all sectors. Third, a strong regulatory agency may have made TELMEX less attractive to prospective buyers, a point also made in the PCR." 2.46 Indeed, the DGPNC has continued to suffer from a shortage of policy-level staff. More than half the DGPNC's staff consists of administrative personnel. One official estimated that only about 20 persons within the SCT were truly capable of handling complex, regulatory issues; about half of this group might well leave the ministry when a change of government occurs next year. 2.47 The TA Loan approved for strengthening the SCT has been used mainly to acquire equipment and training for managing the radio spectrum (approximately 60 percent of the TA Loan budget of US$ 22 million). Very little was earmarked or used for training personnel in policy issues. The hiring of consultants to prepare an Action Plan for strengthening the SCT was delayed by several months, as was the commissioning of consultants to prepare a plan for the sector ("Vision 2000"). Frequent changes in the head of the DGPNC as well as differences of opinion between SCT officials and the Bank on the selection of consultants seem to have contributed to these delays. 2.48 Despite these shortcomings,- the audit suggested that Mexican officials are handling the regulatory issues in the sector fairly competently. One reason for this is the high level of competence of senior Mexican policy makers. Another is the SCT's ability to engage national or international consultants to conduct background studies and provide advice, including those obtained through the TA Loan. A third factor is the SCT's tendency to place the burden for some of the analytical studies on TELMEX itself, subject to fairly strict guidelines about the qualifications and objectivity of the consultants selected by TELMEX to carry out those studies. For instance, TELMEX, rather than the SCT, prepared a draft policy paper on interconnection and access charges for the post-1996 phase. A fourth factor is the growing number of private firms in the industry that have begun to serve as checks and balances on each other. Of special importance is the association of Mexican cellular companies (from 10. See PCR, p. 13. 26 which TELMEX is excluded) that has lobbied for its interests and served as a counterbalance to TELMEX's expertise and power; among other things, this association has reviewed and commented on the interconnection policy proposed by TELMEX. 2.49 These short-term remedies for containing the regulatory challenge can be profitably copied by other developing countries. In the long run, however, competition is the best answer to the problems of regulation, and fortunately Mexico seems to be moving in that direction. Sustainability 2.50 On the whole, the reforms implemented seem unlikely to be reversed; on the contrary, further liberalization of the sector is a distinct possibility. 2.51 Government commitment to reforms. A future government, especially a hostile one, could find some pretext to re-nationalize the firm, but the adverse impact of such on move on private sector sentiment and the investment climate might serve as a deterrent, as would the $6 billion required to wrest control over TELMEX. A more realistic possibility is that a future government, including possibly one formed by the current ruling party, could tighten the regulatory screws on TELMEX without actually nationalizing the firm. The risks of that happening will depend in part on how the issues below are resolved. 2.52 TELMEX's Image. TELMEX's negative image with the public at large not only raises the political risks for the firm but for privatization in general. The company seems to have recognized the seriousness of this issue and was working to improve its service to residential users, especially in Greater Mexico City, and to enhance its public image. One company official described it rightly as a matter of life and death for the company. 2.53 Competition Policy. The other serious outstanding issue in 1994 was the government's competition policy for the sector after 1996, when TELMEX's exclusive right to provide public long-distance service expires. Fortunately, at the time of this audit, the government seemed likely to permit competition rather than to extend TELMEX's monopoly. 2.54 To the government's credit, it has recognized that for competition to materialize in 1996, concessions would have to be granted about two years earlier, that is, some time in 1994. Accordingly, the following issues were under discussion in May 1994: Should entry be completely open after 1996 or should it be restricted, and if so, to how many firms? What obligations for network expansion ought to be imposed on the new concessionaires? How should concessionaires be selected, especially if a public auction is not used? What rules should govern interconnection between the new entrants' networks and TELMEX's network? And what public service obligations ought to apply to TELMEX after 1996? 2.55 As of May 1994 it appeared that the government was unlikely to permit free entry into long-distance or local service, that a limited number of concessions would be issued, and that the new entrants would be required to help expand the basic network. Once the additional concessions are awarded and competition within the sector is strengthened, the reforms made earlier will be cemented. 27 Replicability of the Mexican Approach 2.56 In considering the replicability of the Mexican experience, one must distinguish between industry-specific, firm-specific, and country-specific factors. 2.57 In terms of industry-specific factors, the telecom sectors of most developing countries have been plagued by capacity shortages, obsolete technology, and inefficiency. Furthermore, as in Mexico, the telecom sector in many developing countries has enormous potential for growth as well as upward price adjustments, thereby making it particularly attractive to private investors. 2.58 In terms of firms-specific factors, however, TELMEX enjoyed two advantages that may or may not be true of other state-owned telecom firms. First, by the standards of the public sector, TELMEX was a fairly well-run company, even though in the last decade its performance had begun to deteriorate. Second, it was probably easier to price and sell the firm because its shares were being traded before privatization in Mexico and the United States. 2.59 In terms of country-specific factors, Mexico had certain advantages that other developing countries may not enjoy. The most important of these was the very strong commitment to privatization and deregulation at the highest levels of the Salinas administration. Without such commitment, implementation would have faltered. Second, senior civil servants in Mexico are extremely talented and well-trained. Countries without that kind of administrative capacity are likely to find it difficult to privatize and regulate large, monopolistic firms, such as telecom enterprises. Third, the private sector in Mexico is sufficiently well-developed to buy and run giant enterprises. Countries with weak domestic private sectors may have to rely heavily on foreign investors to privatize the sector. Fourth, there were no legal or constitutional obstacles to turning control over TELMEX to the domestic private sector. And, finally, Mexico's large size and proximity to the United States probably made TELMEX a particularly attractive target for foreign investors. 2.60 Notwithstanding the special circumstances in Mexico, both privatization and deregulation are ideas that many developing countries can adopt in their telecom sectors. Other countries also have the advantage of being able to learn from the experience of countries like Mexico that pioneered telecom privatization. However, the precise strategy used will have to be varied according to national circumstances. 28 3. Road Transport Sector Reform Deregulation of Road Transport 3.1 Adverse Effects of Road Transport Regulation. Government regulation of entry into the Mexican trucking industry and of freight rates extended back at least to the 1950's. For several years prior to the deregulation action of 1989, the Government had under consideration the issue whether it should abandon these regulations because of perceived adverse effects on both trucking rates and the quality of trucking services. Mexicans were influenced by the experience of the Government of the United States in deregulating the trucking industry in the early 1980s. The World Bank at times recommended that the Government of Mexico relax its trucking regulations, and from 1987 onward, the Bank's sector dialogue with Mexico was increasingly focussed on the issue of trucking regulation. In 1987, SCT completed a report which found that regulation in the sector had serious adverse effects on the economy. 3.2 During the period 1988-1989, major economic reforms were introduced by the Salinas Government including efforts to expand the market economy and strengthen the forces of competition. With regard to the transport sector, SHCP and SECOFI, in particular, took the initiative in pressing for deregulation of trucking. Their proposal to deregulate road transport was viewed as a part of the larger program of structural reform which in 1989 was already well underway with considerable assistance from the World Bank. By 1989, the Government concluded that the overall effect of the regulatory system for road transport was negative, and a new policy framework for the road transport industry was formulated. 3.3 Approach. The Government achieved deregulation of the road transport industry in three stages. The first stage was to negotiate an agreement with the trucking association under the terms of which the latter agreed to cooperate with the government in the modernization and deregulation of the industry; the agreement was signed in July 1989. The agreement stressed the advantages of restructuring and modernizing the industry under deregulation. 3.4 The second stage was the issuance by the government of a July 1989 decree eliminating many restrictions on entry into the business of providing road transport services, thus abandoning the public service notion which was behind the concept that trucking operations require a concession; with this decree, permits became easy to obtain, the applicant needing only to prove his identity and demonstrate that he owned a vehicle. The decree also eliminated the scheme of discretionary freight allocations and ordered the breakup of the MULTIMODAL transport monopoly. Under the decree, some tariff control was retained as truckers were still required to charge no more than the "official tariffs" issued by SCT although they could negotiate, with shippers, rates lower than the official tariffs. 3.5 The third stage in the approach was the issuance by government of a decree in January 1990 abandoning tariff ceilings thus freeing truckers to set their own rates. The principal reason for issuing two decrees separated by six months was SCT's concern that if only one deregulation action were taken, the forces of competition might initially be too weak 29 to prevent sharp rate increases. Although the deregulation could have been accomplished in one decree, it was probably prudent, in view of the uncertainty regarding the extent of competition, to do so in two steps. 3.6 Impact of Deregulation. The PCR found evidence that, "...transport deregulation is having a major positive impact in Mexico" (para. 41). The Audit agrees with this assessment. An immediate effect of deregulation was that many new truck operators entered the field and that many truckers, previously operating illegally, were able to obtain permits for operations. By the end of August 1990, a total of 50,694 federal road permits for freight transport had been issued, of which 30,153 were for new entrants, 13,830 for previously illegal operators and 6,711 for expansion of existing fleets. Thus the major category of new permit owners was that of new entrants, and the addition of this large number of operators to the existing industry means that the amount of competition among truckers increased significantly. 3.7 A second major effect of the deregulation was that tariff levels for trucking services were substantially reduced. Rate analysts in SCT found that between 1987 and 1994 trucking rates declined about 23 percent in real terms. One official in SCT estimated that general cargo trucking rates in 1994 on the major route between Laredo and Mexico City were about 30 percent lower in real terms than the rates prevailing in 1987. As a result of reductions in truck tariffs, SECOFI has estimated that the overall distribution costs of commodities in Mexico declined about 25 percent in real terms during the period from 1987 and 1994. The general economic impact of the reduction in distribution costs was significant, undoubtedly reducing inflation and promoting economic growth in Mexico. 3.8 A third impact of the trucking deregulation was that the quality of services improved somewhat in terms of increased frequency of services, improved access to service, and speed of delivery. While data on this aspect of trucking operations is limited and subjective, the principal improvements in service occurred on major routes where competitive forces have been strongest. Larger operators for the most part continued, after deregulation, to serve the same routes they served prior to deregulation but competition here became more intense. 3.9 A fourth effect of the governmental action was to stimulate the modernization of the trucking fleet. A common criticism of trucking deregulation by its opponents has been that it would result in deferred purchase of vehicles as operators under financial pressure would extend the use of existing equipment, thus leading to an aging fleet. Contrary to this argument, the Mexican experience seems to have had the opposite effect as new operators brought many new vehicles into the industry, and existing operators found it financially advantageous to modernize their fleets (See PCR, Annex 4). 3.10 The increased pressure of competition in the trucking industry appears to have caused significant improvement in operating efficiency and management, according to SCT officials. While the exact extent of such improvements is not known, such an effect seems a logical result of the increase in competition among trucking companies. 3.11 Deregulation of the trucking industry also had an impact on the Ferrocarriles Nacional de Mexico (FNM). The reduction of trucking rates after 1989 enabled truckers to compete more effectively with the FNM, causing diversion from the railway to truck transport, 30 particularly during the period 1989-1991 when rail traffic declined significantly. While a number of factors have influenced recent rail traffic trends, it appears that the flexible rate policy adopted by FNM in 1992 has enabled it to recover some of the lost traffic. Since truck transport, however, handles over 90 percent of the Mexican total freight traffic, the diversion from or to the railway has had only a minor impact on the dominance of trucking in the movement of freight. More significantly, the greater pricing flexibility of both trucking and FNM under deregulation has led to increased competition in the transport industry and consequent lower transport costs. These cost reductions in turn have had far reaching favorable effects on the economy of Mexico. Measures Complementing Deregulation 3.12 Rationale for Complementary Measures. At the time the Bank approved the project loan, the Government of Mexico was strongly supportive of deregulation of the trucking industry. In fact, the Government had already, prior to this approval, issued decrees carrying out the deregulation. In addition to these actions, the Bank considered it necessary that the Government take certain additional actions regarding a number of important sectoral issues. These latter measures took the form of conditions for release of the second tranche of the loan, the first tranche having been made on effectiveness of the loan. All of the conditional measures related to the transport sector were implemented prior to the November 15, 1994 target date established for meeting the conditions. 3.13 Increased Financing for Highway Maintenance. The existence of a large backlog of road maintenance in Mexico, at the time the project was approved, was well recognized by both the Mexican Govermnent and the Bank. The condition of the second tranche release, specifying that the Government would budget in 1991 for this purpose at least 475 thousand million Pesos in real terms, was intended to reduce that backlog to some extent; the condition was met. Actual financing of highway maintenance since 1991 indicates that the increased commitment to road maintenance has been continued, as indicated by the 1,507 million New Pesos budgeted for highway maintenance in 1994. Notwithstanding this strong commitment to highway maintenance, a large maintenance backlog still exists and therefore a continuing major effort will be required for many years. The recent expanding budget levels in Mexico for this purpose demonstrates that the Government has come to appreciate the high economic returns from funding highway maintenance. 3.14 Increase in the Price of Diesel Fuel. Another condition of the second tranche release was that the price of diesel fuel be increased at least 10 percent in real terms to raise the level of cost recovery from truckers using this type of fuel. The action was considered necessary to increase the contribution of road users to the financing of highway maintenance and administration. While the condition of the second tranche release was satisfied in 1990 and road users as a whole thereafter contributed adequately to road financing, heavy-truck road users continued to be cross subsidized by automobile road users to some extent. In recent years, cost recovery from heavy-truck road users has increased. According to SHCP, the user charges paid by heavy trucks in 1994 represented nearly full cost recovery. In any case, the entire issue of highway finance including highway user charges is the subject of a special study to begin in late 1994 under financing of the Highway Rehabilitation and Traffic Safety Project. 31 3.15 Railway Tariff Adjustments. Still another condition of the loan release was that railway tariffs were to be increased by January 1, 1991 on selected commodities which together accounted for at least 70 percent of total railway freight traffic; the increase was to be at least 25 percent in real terms or sufficient rate increases to cover long run variable costs for the respective commodities, whichever was lower. The rates were increased sufficiently in 1990 to comply with the requirement. 3.16 The Bank's motivation for including this railway pricing feature in the loan release conditions was primarily to reduce the large and unwarranted level of subsidies received by the railway. This was a legitimate concern of the Bank, and it was appropriate to require some alteration of railway rates to mitigate this problem. The audit disagrees with the PCR's assertion that "...the Bank's overwhelming concern with correct price setting was misplaced in the context of important structural changes in demand... and cost conditions that reflect inefficient firm size and operation practices. Given these inefficiencies, the simple rule that prices should cover long run variable costs would not lead to an efficient resource allocation" (para. 50 of PCR). This is clearly not the case since such rule still maximizes consumer surplus (increasing efficiency over time and decreasing prices will further optimize demand). The audit does agree, however, that the condition could have been made somewhat more flexible by allowing for some form of temporary cross-subsidization across various commodity tariffs (instead of the required across-the-board increase). The PCR further indicates that the Bank should have sought a railway modernization program (such as that subsequently introduced in a railway project scheduled for negotiation in 1994) rather than simply requiring general increases in railway tariffs. The audit believes, however, that it would have been impractical to include such a complex modernization component in a project which was focused on deregulation of road transport and telecommunications. In the meantime, the more appropriate condition concerning action on railway pricing would have been to allow the railway flexibility in establishing rates; such action was, in fact, taken in 1992. In 1990, there was (and in 1994 remains) a fundamental need to deal with the many causes of inefficiency in the railway, thus to develop the basis for a lower cost structure, but the project under review was not the appropriate one to address that complex problem. 3.17 Highway Safety Control Programs. The alarming accident rate on the highways of Mexico was well documented in 1990. The urgent need to attack the problem was clearly recognized in a condition for loan release. As already indicated, the project component dealing with deregulation of the trucking industry concentrated on the elimination of entry controls and rate regulation; the Government, however, had no intention of vacating the field of highway safety regulation. On the contrary, the project component dealing with this subject required a study which would include recommendations for increased regulation of the sizes and dimensions of trucks. Following completion of the study, new regulations were issued in February 1994 and the legal limits were to be phased in gradually over a period of three years. These legal limits will not only yield benefits in terms of highway safety but also should reduce significantly deterioration of the road system, assuming the regulations are adequately enforced. A plan for improved enforcement of the regulations was being prepared in May 1994. 32 3.18 Vehicle Emission Inspection Program. The severe problem of air pollution in certain major cities of Mexico, particularly Mexico City, was well appreciated in 1990. A strong basis existed for a loan release condition requiring that the government issue regulations for mandatory periodic inspection of trucks to monitor compliance with federal emission standards. In fact, regulations. for mandatory emission inspections were issued in May 1990, the same month that the project was approved by the Board. As of May 1994, 372 stations for emission inspections had been established in Mexico and 147 of these were located in the Mexico City metropolitan area. Early in 1994, the number of commercial vehicles subjected to inspection for emissions in the Mexico City area was about 1,800 per month. Therefore, the Government has continued and expanded its activities in this field in recent years. Strengthening SCT's Capabilities to Monitor Road Transport 3.19 Change in the Role of SCT. The PCR stated that: "the weakest part of the reform program remains the lack of sufficient strengthening of SCT to assume its new role" (para. 42). The Audit agrees with this conclusion. One of the important areas not yet developed in SCT is the design and implementation of a data collection system that would generate the information needed to monitor the trucking industry. 3.20 The elimination of entry control and rate regulation by SCT in 1989 and 1990 greatly reduced the responsibilities and activities of the secretariat. There was some lag in shifting staff within the SCT and reducing the overall SCT staff level but by May 1994 the staff levels in departments previously involved in entry control and rate regulations were reduced substantially. Among the important remaining functions of SCT was that of monitoring the transport sector and formulating transportation policy. Some new functions regarding highway safety were assigned to the SCT and increased attention was devoted to certain continuing activities. 3.21 Strengthening The Capabilities of SCT. While the project aimed at the elimination of major activities of SCT, it was silent on how the SCT would adapt to the new circumstances. The project was not directly concerned with the redefinition of SCT's role, reorganization of the SCT, changes in staff assignments or retraining of staff whose jobs were eliminated. Nevertheless, these issues have been important concerns of the SCT. Loss of certain regulatory responsibilities have not resulted in major SCT reorganization although there have been some changes in the organization of the Road Transport Directorate. The principal changes accomplished since deregulation have been in the work assignments of staff within existing organizational entities." Sustainability of Deregulated Road Transport 3.22 Whether the new sectoral policy, based on a competitive trucking industry free of government regulation, will be retained in the future depends on a number of factors, one of 11. SCT's role and responsibilities in the supervision of road maintenance have not changed as a result of deregulation. 33 which is the accumulated evidence of its beneficial effects. The SCT has not undertaken a comprehensive study of the impact of the trucking deregulation. In view of the importance of such a study to consideration of basic sectoral policy, it would seem advisable for SCT to prepare a report on the subject. In the meantime, SCT appears convinced that the available evidence strongly supports the existing policy. 3.23 According to SCT, no serious proposals have been offered by constituents of the trucking industry for reregulating the industry. There is no doubt that in some respects truckers are displeased with certain adverse effects of the increased competition. The financial pressures on them could, of course, be mitigated by minimum rate control or other regulatory measures. It is significant, however, that no concerted attempt at reregulation has been put forward. Conceivably, many trucking industry representatives may feel that it is better, on balance, for the industry to continue operations under the existing policy than to return to a regulated environment. The indications are, however, that the primary reason the industry has not proposed reregulation measures is that there is strong political support for the present policy, and therefore it would be extremely difficult or impossible to change it in any fundamental way. 3.24 SHCP and SECOFI, as indicated above, were particularly aggressive in their attempts to secure deregulation of road transport prior to the actions of 1989 and 1990. These organizations continue their strong support for the present policy. SCT favored the deregulation actions of 1989-90, although some elements of the secretariat had reservations. As the beneficial effects of the new policy have become evident, and following the departure of certain SCT staff previously involved in regulatory matters, the present commitment of the SCT to the new policy appears to be very positive. In summary, the strong commitment of the Government to the new policy, the lack of serious opposition to the deregulation policy from within the industry and the solid evidence of the beneficial effects of trucking deregulation all suggest that the policy will be sustained in the foreseeable future. 3.25 The sustainability of the various complementary measures in the transport sector also seems probable. With regard to highway maintenance budgets, the Government seems committed to continue substantial funding for this purpose; this commitment is reinforced by the recent approval of the Bank-financed Highway Rehabilitation and Safety Project. As to diesel fuel prices, and highway user charges in general, recent trends have been favorable for improved cost recovery and those trends should continue. While railway tariff adjustments of the sort required under the project may or may not be continued, recent trends in flexible pricing by the FNM have been appropriate and beneficial; moreover, the anticipated Railway Restructuring and Modernization Project offers a reasonable prospect that a better relationship between railway prices and long-term costs can be achieved in the future, as lower costs will result from increased railways efficiency. Regarding other measures, the Government seems strongly committed to continuation and expansion of the highway safety program and vehicle emission inspection program. Replicability of the Approach to Deregulation 3.26 The approach to deregulation employed in Mexico appears to be replicable in other countries where the trucking industry is highly regulated. The Mexican government's action in soliciting the cooperation of the affected industry prior to deregulation was a good strategic 34 move of general applicability. The regulatory scheme in Mexico prior to July 1989 was a particularly extreme form of governmental control with a high degree of interference by government in the industry. For this reason, the Government prudently accomplished the deregulation in two steps rather than in a single action, and such a staged approach might well be adopted by others. Deregulation could probably be effectively accomplished in other countries where Government is truly committed to the goal of achieving greater reliance on the forces of competition in road transport. Such a sectoral program has a higher probability of success if, as in Mexico, it is undertaken within the context of general structural reform rather than as an isolated action. 3.27 Not only has the Federal Government deregulated trucking operations within its interstate jurisdiction, but it has also encouraged state Governments to take similar action within their respective jurisdictions. SCT entered into agreements with all of the states toward that end. Intrastate transport is far less important than interstate transport, but nevertheless deregulation at the state level is rightly seen in SCT as an advisable action. Progress in this program has been slow although some states, such as Chiapas, have deregulated the trucking industry. 3.28 Replicability of the complementary measures undertaken in the sector is somewhat less clear than in the case of deregulation. With regard to highway finance, other countries could well follow the practices of Mexico's increased funding of highway maintenance and increased cost recovery from road users; the structure of user charges, however, varies considerably from country to country, reflecting special circumstances. The development of a highway safety program in Mexico is in an early stage but represents a sound approach that could be a suitable guide for others. The program of vehicle emission inspections is well advanced and probably could serve as a model for other countries facing serious air pollution problems. 35 4. Lessons Learned Telecommunications Sector 4.1 The Mexican experience demonstrates the feasibility as well as the desirability of privatizing state-owned telecom monopolies in developing countries. A Bank study of telecom privatization in Mexico and two other countries has separately confirmed that the policy produced a net economic gain for the countries involved; with the exception of certain consumer groups, all others, including employees, workers, and investors, seem to have been net winners of the policy.2 An implication for the Bank is the need to rethink its historical role in the sector, which a recent OED study characterized as the "traditional public utility model,"" and to ask how the Bank can promote privatization and deregulation of the sector in addition to marginal improvements in capacity, efficiency and institutional capabilities through project lending. 4.2 In terms of privatization, the Mexican experience suggests several "do's and don'ts" for other countries.'" The Mexican experience shows the value of: * A clever and comprehensive concession agreement, which can go a long way towards disciplining the privatized firm and easing the regulatory task after privatization. * Opening up as many segments of the sector to competition as is technically or economically feasible; this may call for the framing of comprehensive sector regulations in conjunction with privatization. Ultimately, competition, rather than privatization or regulation, is the best method to prod the monopoly telecom firm to become efficient and improve customer service. * Raising and rebalancing rates before rather than after privatization as this reduces one source of risk for prospective buyers and enhances the value of the firm. * Selling the firm's shares to both local and foreign investors, selling only for cash to make a clean break with the firm, and selling the government's shares in tranches to maximize the government's proceeds. * Gaining worker support for privatization; given the pent up demand for telecom services, a "no layoff" policy carries a relatively small cost so long as the union agrees to simplify work rules; offering workers a stake in the company can help win their support. 12. Galal et al [1992]. 13. World Bank (OED) [1993], p. ii. 14. For a more extensive discussion of the policy lessons from the telecom privatizations of Mexico and other countries, see Ramamurti [1994]. On the regulatory aspects, in particular, see Levy and Spiller [1993]. 36 Encouraging the supervising ministry to shed any operating functions that it may have performed historically and to concentrate on regulation. Also important are measures to strengthen the financing, autonomy, and staffing of the regulatory agency. To the extent possible, place the burden of conducting background studies and reports on firms in the industry, encouraging them to serve as checks and balances on each others' conclusions and recommendations. If necessary, after intra-industry debate and hearings, use national or international consultants to assist in making final policy choices. 4.3 At the same time, the Mexican experience points to some potential traps that other countries might want to avoid: * Avoid giving the privatized firm too many privileges in order to ensure a quick and successful sale. In Mexico, the government's prestige seemed to be riding on a successful TELMEX privatization, leading to a sale package that in hindsight looks excessively generous to the buyers: high tariffs, exclusivity in long-distance for six years, a national license for cellular service, and few restrictions on diversification. * The period for which countries are granting privatized firms a monopoly in long- distance service has been coming down: in the recent telephone privatization in Peru, it was only five years. While a period of exclusivity may be unavoidable, the goal should be to keep it as short as possible. The greatest gains in Mexico are likely to be realized with the onset of competition. * Establish some linkages (albeit partial) between price increases and quality improvements, especially for residential users who lack the clout to fight the privatized firm, and consider setting explicit goals for modernization." If possible, begin building the systems to measure quality of service before privatization is implemented. * Consider setting up the regulatory agency as an autonomous entity, funded by a levy on the industry, staffed with well-paid and well-trained experts. * If a higher selling price is desired for the firm, consider selling control to foreign investors, although the government may have greater control over a local investor group. " 15. Clearly, however, there will be cases where price distonions are extreme, where prices will need to be increased to finance and attract investment necessary for quality improvements to occur, and where other sanctions, with respect to poor quality performance may be more appropriate. 16. Mexican officials interviewed observed consistently that local investors understand better the government's compulsions. have a greater commitment to the long-term welfare of the firm, are more amenable to government influence because of other investments in the country, and are more likely to reinvest in Mexico the profits earned from telecommunications. 37 In setting the price-cap formula (RPI-X) in LDCs, take into account that the scope for productivity improvements is likely to be much higher (perhaps 10 percent to 20 percent a year) than in developed countries. In retrospect, the RPI-O formula used in Mexico may thus prove to have been somewhat on the generous side, when compared to the RP1-3 or even RPl-4 used in developed countries. 4.4 The Mexican experience raises at least two policy issues on which the Bank might wish to conduct additional studies. First, what is the optimal rate at which competition should be introduced into the sector? In other words, given technological and economic trends, how important is it to preserve and improve the sunk investments in the state-owned telecom firm versus permitting free entry into the sector from the outset? Second, should governments be urged to create autonomous regulatory institutions for each sector, as the Bank advised with respect to telecoms in Mexico, or is the Mexican approach of creating one, high-powered anti-trust commission a more realistic and efficient alternative? 4.5 Finally, the Mexican experience demonstrates clearly the importance of borrower ownership for the success of a sectoral adjustment operation, a point that has been emphasized in at least two recent OED studies."' In the telecom sector in Mexico, the Bank seems not to have been the "engine" of change but a very important catalyst and behind-the-scenes technical adviser; for instance, the Bank seems to have played a critical role in drafting the new concession agreement and the sector regulations, and in nudging the Government towards the (RPI-X) system rather than the rate-of-return method of regulation. To persuade other countries to consider similar reforms, perhaps the most useful measure the Bank can take is to disseminate widely the Mexican strategy and results. Transport Sector 4.6 In the numerous projects which the Bank has financed in the highway and highway transport subsector, the focus has been almost entirely on the construction and maintenance of highways and related institutional development; there has been little direct involvement in the improvement of road transport services and rates. The basic reason for non-involvement of the Bank in road transport is that it has been assumed that private sector commercial transport can adequately carry out its functions without governmental assistance. One of the lessons learned in the transport component of the project under review is that substantial economic benefits can be derived from a Bank project in which the focus is on deregulation of the trucking industry, thus reducing the cost of transport and improving the quality of transport services provided to the general public. 4.7 Another lesson learned is that transport deregulation causes profound changes in the sectoral institution of Government that had responsibility for the regulation. Therefore a project aimed at trucking deregulation should include a technical assistance component designed to assist the organization in making the transition to post regulatory conditions, assisting with such tasks as defining the organization's new role, reorganizing its structure and 17. See, in particular the recent OED review of the Bank's privatization experience (World Bank, OED, 1994) and the paper by Johnson & Wasty (1993). 38 facilitating the redeployment of staff. Some of the agency staff involved in the eliminated functions can be given appropriate training for the continuing functions of the agency and thus retained in useful positions while others should be released in an orderly manner. 4.8 An important additional lesson is that project timing for a project with the primary objective of deregulating road transport should be carefully considered in relation to certain circumstances. In the late 1980s, transport regulation in Mexico was viewed with growing skepticism, particularly as a result of studies documenting the high economic costs associated with the regulatory system; at the same time, the Government undertook a general program of structural reform. These conditions were very favorable for undertaking deregulation of the trucking industry. 4.9 A lesson learned was that programs of highway safety, control of vehicle weights and dimensions and inspections of vehicle emissions were introduced rather late. Had they been implemented about the same time, or nearly so, as the deregulation actions of 1989 and 1990 there could have been a smoother transition from the regulatory regime prior to July 1989 to the post regulatory regime prevailing in 1994. Such scheduling would have resulted in much better utilization of SCT resources. Overall Project Assessment 4.10 Essentially, all of the project objectives have been achieved, and for some even exceeded (e.g. sector expansion, investments, pricing). The audit thus assesses overall project outcome as highly satisfactory (versus satisfactory in the PCR). All main loan covenants were complied with (with minor delays in some cases) and project implementation by the Borrower must be regarded as excellent, considering the obstacles along the way and the time available. The Bank played a very useful catalytic and advisory role and its performance is assessed as fully satisfactory - although, in hindsight, it could have paid more attention to the planning of SCT's activities in the road sector following deregulation. All applicable Operations Manual Statements (OMS), Operational Policy Notes (OPN) and Bank guidelines were observed and followed. Institutional development is considered substantial: the project's major institutional goals (trucking deregulation and greater private sector involvement in telecommunications) were achieved although the strengthening of SCT to adjust to its new regulatory functions in both sectors has been somewhat slower than expected. The above ratings are in accordance with those of the PCR. 39 References Galal, Ahmed, Leroy Jones, Pankaj Tandon, and Ingo Vogelsang. "The Welfare Consequences of Selling Public Enterprises: Case Studies in Chile, Malaysia, Mexico, and the U.K. ", Washington D.C.: The World Bank, 1992. Goldman Sachs & Co. et al. 1992. "Prospectus for Tel9fonos de Mexico, S.A. de C. V.," May 1992. Levy Brian and Pablo Spiller. 1993. "Regulation, Institutions, and Commitment in Telecommunications: Comparative Analysis of Five Countries," Paper presented at the Annual Bank Conference on Development Economics. Washington D.C.: The World Bank, May 1993. Ramamurti, Ravi. 1993. "Tel9fonos de Mexico: The Privatization Decision (A) and (B)," Case Research Journal, Spring 1993, pp. 43-67. "Telephone Privatization in a Large Country: Mexico." In Ravi Ramamurti (ed.) Privatizing Monopolies: Lessons from the Telecom and Transport Sectors in Latin America. Baltimore, MD: The Johns Hopkins Press, forthcoming. Smith Peter and Bjorn Wellenius. 1992. "Mexico Telecommunications: One Year (Plus) After the Reform Program. " Informal study, April 1992, ASTIF. Tandon, Pankaj. 1992. "Tel9fonos de Mexico. " Presented at the World Bank Conference on the "Welfare Consequences of Selling Public Enterprises. Case Studies from Chile, Malaysia, Mexico, and the U.K. June 11-12, 1992. Washington D.C. TELMEX. Annual Report. Various Years, 1987-1993. World Bank. 1993. Operations Evaluation Department. "The Bank's Experience in the Telecommunications Sector: An OED Review." Washington D.C.: The World Bank, November 1993. 40 Annex A BANOBRAS National Bank for Public Works and Services Mexico City International Financial Agencies Department GOFI/146/95 January 17, 1995 Mr. Yves Albouy Chief, Infrastructure and Energy Division Operations Evaluations Department The World Bank Dear Mr. Albouy: With reference to the Performance Audit Report for the Road Transport and Telecommunications Sector Adjustment Loan (Loan 3207-ME) prepared by the World Bank's Operations Evaluation Department and submitted to BANOBRAS for comment, as a follow-up to our letter GOFI/018/95, in which we convey our comments on that report, I attach a copy of letter 393.111.3.-010 of January 17, 1995, in which the Secretariat of Finance and Public Credit indicates its point of view with regard to the evaluation made by the World Bank. I trust that those considerations will be taken into account. Cordially, /s/ Ismael Diaz Aguilera cc: (see original) 41 Annex A United Mexican States Secretariat of Finance and Public Credit Directorate of Public Credit International Financial Agencies Department Productive and Infrastructure Projects Section Ref. No: 393.111.3.-010 Mexico City, January 17, 1995 Mr. Ismael Diaz Aguilera Manager, International Financial Agencies Department BANOBRAS Mexico City Dear Sir: I refer to the communication from the World Bank of last November 23, in which the Bank sent us a draft of the Performance Audit Report for the Road Transport and Telecommunications Sector Adjustment Loan (IBRD Loan 3207-ME). In that regard, it is the opinion of this Department that the report should stress the quality of the dialogue between the Government and the Bank during program preparation, as the Mexican authorities clearly articulated their goals for program implementation and Bank officials succeeded in serving as catalysts for those policy decisions. The result was the design of an undertaking consistent with Mexico's circumstances in a context of overall adjustment, without conditions being imposed by the Bank, and which ultimately compiled with the implementation timeframe, to the benefit of the project. We agree with the Bank that the SCT could have been more dynamic in changing its role in both sectors to one of supervision and regulation more appropriate for the new circumstances; nevertheless, it was foreseeable that this retooling of its institutional capacity would be done gradually in tandem with human resource training, the change in criteria and assimilation of the new context. These efforts will unquestionably have to be reinforced over the short run, so as to have more competent and sensitive authorities, especially given the fact that in August 1996 competition will be allowed for national and long-distance telephone services and, in particular, in order to avoid adverse pressures on the groups that would be affected by a return to former freight transport regulation schemes. Lastly, in the specific case of freight transportation, it is critically important that the Bank has accepted the Government's strategy for regulation iii three phases: first an agreement with the 42 Annex A sporters association, followed by elimination of access restrictions and ultimately the romulgation of the government decree deregulating rates. This made it possible for the Mexican authorities to assess the impact of the measures and would have facilitated the adoption of modifications in the event of reservations (reticencias). It will now be necessary to ensure that the desired competitiveness among transporters is maintained. I would be very grateful if you would incorporate these observations into the comments to be included in the final version of the report. Yours truly, /s/ Moises A. Pineda Padron Director, International Financial Agencies 43 Annex B Planning Directorate Operations Programming Department Secretariat of Communications and Transport Ref. No.: 112.203/95/004 Mexico City, January 10, 1995 Mr. Yves Albouy Chief, Infrastructure and Energy Division Operations Evaluation Department The World Bank Dear Mr. Albouy: This is in reference to your letter of November 23, with which you sent a copy of the Performance Audit Report for Loan 3207-ME, regarding the Road Transport and Telecommunications Sector Adjustment Loan. In that connection, I agree with the comments in the above-mentioned report to the effect that the general results of the project were highly satisfactory, inasmuch as the primary institutional goals targeting deregulation of federal public transport and an expanded role for the private sector in telecommunications were achieved. Yours truly, Is/ Jaime Luna Traill Director General 44 Annex C BANOBRAS National Bank for Public Works and Services Mexico City International Financial Agencies Department Ref. No.: GOFI/018/95 January 4, 1995 Mr. Yves Albouy Chief, Infrastructure and Energy Division Operations Evaluations Department The World Bank Dear Mr. Albouy: This is in reference to the Performance Audit Report for the Road Transport and Telecommunications Sector Adjustment Loan (Loan 3207-ME) prepared by the World Bank's Operations Evaluation Department and submitted to this institution for comments. In that regard, following our review, I would make the following comments: 1. In general, the report adequately reflects the development of the loan and its conclusions are appropriate. 2. The report uses figures without clearly referring to new pesos or pre-1993 pesos. We would suggest that the figures be standardized in their equivalents in United States dollars or that their reference be clearly indicated. 3. As some paragraphs contain minor errors, we would propose the following for the purposes of clarification: a. Replace the word "desreglamentar" with "desregular" throughout the body of the report and the Summary. b. Page i of the Evaluation Summary, para. 1, line I should read " the Federal Government began " or the " administration of President Miguel de la Madrid began." b. [sic] Page i of the Summary, para. 1, line 5 states "The refons were continued and 'le dio mayor vuelo' under the Salinas Government." Instead, it should read "The 45 Annex C reforms were continued and 'le dio mayor auge' under the Salinas Government." c. Page i of the Summary, para. 2, line 9 states "...good-quality trucking services nor low rates." Instead, it should read: "...good quality services, nor agreed rates." d. Page i of the Summary, para. 3, line 7 states "in the amount of US$20 million," instead of "US$22 million." e. Page i of the Summary, para. 4, line 2, which states "... labor contracts were restructured, the firm...", should read "TELMEX's labor contracts were restructured, the firm ..." f. Page 1 of the report, para. 1.01, line 3, which reads "... to overcome a serious crisis that was characterized, " should be changed to "to overcome a crisis that was characterized ..." g. Page 3 of the report, para. 2.05, line 3 reads "...labor contracts were restructured ," instead of "TELMEX's labor contracts were restructured ..." h. Page 20 of the report, para. 3.12., lines 8, 9 and 10 reads "All of the conditional measures related to the transport sector were implemented prior to the November 15, 1994 target date established for meeting the conditions ." In this connection, it is necessary to know whether that date is correct and, if not, when the conditions were actually met. Yours truly, /s/ Ismael Diaz Aguilera cc: (see original)   IMAGING Report No: 14400 Type: PPAR