Colombia - Second Telecommunications Project

RESTRICTED Report No. PU - 57a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF THE SECOND TELECOMMUNICATIONS PROJECT OF THE EMPRESA NACIONAL DE TELECOMUNICACIONES COLOMBIA March 10, 1971 Public Utilities Projects Department  Currency Equivalents Measures Equivalents Currency Unit Peso khz 5 kilohertz US$1.00 = Col$18.50 mhz = megahertz US$1 million = Col$18,500,000 1 kilcueter (kIn) = 0.621 statute Col$1.00 US$0.05 mile Col$1 million = US$54,054 Fiscal Year Calendar year L15T OF ABBREVIATIONS, AC)NMS AND DEFINITIONS IN THE REPORT CAR - Corporacion Autonoma Regional de la Sabana de Bogota y de los Valles de Ubate y Chiquinquira. Carrier - A system of providing a number of circuits (channels) through one transmission mode. Chanel - One circuit of a carrier systen carrying speech or telegraph signals. FNA - Fondo Nacional de Ahorro HF - High Frequency (3,000-30,000 khz) INTELSAT - International Telecumunications Satellite Corporation iTEC - Instituto Tecnologico de Electronica y Comunicaciones LINCCY4PEX - An electronic unit to overcome same of the inherent disabilities of providing telephone service using HF Microwave - Radio system working at frequencies above 300 mhz but normally applied to systems working at frequencies above 1,000 mhz Multiplex - The equipment to provide many telecommunication channels through one transmission mode. PIANEACION - Departamento Nacional de Planeacion STD - Subscriber Trunk Dialling Telex - Teleprinter Exchange Service VHF - Very High Frequency 30-300 mhz  COLOMBIA EMPRESA NACIONAL DE TELECCFUNICACIONES (TELECCM) APPRAISAL OF THE SECOND TELECyRJUNICATIONS, PROJECT TABLE OF CONTENTS ~~-- ~~~Page No STM4ARY AND CONCLUSIONS i 1. INTRODUCTION 1 2. THE ECONCMY AND THE SECTOR 2 The Economic Background 2 The Telecommunication Sector 2 3. THE BORROWER 4 Organization and Management 4 Recruitment and Training 4 Accounting and Audit 4 Existing Telecommunication Facilities 5 Tariffs 6 Past Financial Performance 6 Present Financial Position 7 4. THE PROGRAM AND THE PROJECT 10 1971-1974 Program 10 Other Investment 10 The Project 10 Cost of the Project 11 Amount of Proposed Bank Loan 12 Procurement 12 Disbursement 13 Project Execution 13 5. JUSTIFICATION 14 Demand 14 Least-Cost Solution 15 Internal Financial Rate of Return 15 6. FINANCING PLAN AND FINANCIAL OUTLOOK 16 Financing Plan 16 Future Operating Results 18 Forecast Financial Position 19 7. RECOMMENDATIONS 20 This report is based on the findings of a Bank mission consisting of Messrs. A. X. Minton, J. G. Davis and J. Balkind who visited Colombia in June 1970 and a subsequent mission consisting of the same members and Mr. P. Bassole from July 26 to August 12, 1970.  LIST OF AiTNEXES 1. Organization Chart 2. Existing Telecommunications Facilities 3. Estimated Subscribers' Development to 1975 4. Long Distance & International Traffic Statistics 1965-1969 5. Tariffs 6. Actual and Forecast Income Statements 1967-1975 (including notes) 7. Actual and Forecast Balance Sheets 1967-1975 (including notes) 8. Actual and Forecast Sources and Uses of Funds Statements 1967-1975 9. Sensitivity Analysis of Cash Flow and Financial Rate of Return 10. Formula for Computation of Financial Rate of Return 11. The Project 12. Estimated Schedule of Disbursements of the Proposed IBRD Loan 13. Internal Financial Rate of Return Analysis 14. 1967-1970 Program 15. Construction Schedules Maps 1. Colombia Main Microwave Network (Geographical) - IBRD-3142 2. Colombia Main VHF Radio NIetwork after Redeployment - IBRD-3191  COI.CMBIA EMPRESA NALCIONAL DE TELECCIUNICACIONES (TELECCM) APPRAISAL OF THE S3COND TELECaOIVMUNICATIONS PROJECT SUMMARY AND CONCLUSIONS i. This report covers the appraisal of a project which forms about 83% of the 1971-1974 Telecommunications Expansion Program of Empresa Nacional de Telecomunicaciones Colombia (TELECOM). A Bank loan of US$15 million is proposed. ii. The project costing US$32 million equivalent will provide for an additional 42,000 local service lines in areas of Colombia where little or no local service exists and for the expansion of the long distance net- work to alleviate present congestion and cover estimated demand until 1975. The estimated Intenaal Financial Return on the project would be about 29%. iii. All items in the project to be financed by the Bank would be imported and procured through international competitive bidding. A small amount of long distance equipment and some telex equipment would be prooured from existing suppliers for reasons of standardization, and cable and local network materials would be from domestic manufacturers; these items are outside Bank financing. iv. The proposed loan is the second lending operation in the Colombian telecommunications sector. The first, Loan 499-CO, was made in 1967 to provide the basic long distance network, some local service, and to improve international service. Owing to delays in building construction and late deliveries of equipment, the closing date of the loan has been postponed one year to December 31, 1971. The full amount of the loan which was for US$16 million has now been committed. The project is expected to be satisfactorily ccmpleted and the loan fully disbursed by the new closing date. V. After initial weaknesses TELECOM's organization is showing rapid improvement and the entity is capable of carrying out the proposed program. vi. TELECOM's financial position is satisfactory. TELECOM will provide from its internal cash generation about 36% of its approved investment re- quirements during the period 1971 through 1974. The annual rate of return on net fixed assets in operation during that period would be satisfactory. vii. The proposed project is a suitable basis for a loan of US$15 million, for a term of 20 years including a grace period of four years.  COLOMBIA EMPRESA NACIONAL DE TELECOMUNICACIONES (TELECOM) APPRAISAL OF THE SECOND TELECOMMUNICATIONS PROJECT 1 INTRODUCTION 1.01 The Government of Colombia has requested Bank assistance in financing the 1971-1974 program of expansion to be carried out by Empresa Nacional de Telecomunicaciones (TELECOM). The main object of the program is to provide local telephone service in some areas of Colombia where service is limited or non-existent, and to expand long distance communica- tion facilities. The cost of the program is estimated at about US$39.5 million equivalent. 1.02 The proposed project, which foims about 83% of the program, pro- vides for new local networks and the extension of long distance facilities, additional telex and miscellaneous equipment. The cost of the project is estimated at US$32.4 million equivalent, the foreign exchange content would be US$18.2 million of which the proposed Bank loan would be US$15.0 million. 1.03 An application for the loan together with TELECOM's expansion plan was received in April 1970. During June 1970 an appraisal mission comprising Messrs. A. M. Minton, J. G. Davis, J. Balkind visited Colombia to evaluate the Project. The mission together with Mr. P. Bassole sub- sequently visited Colombia again in July-August 1970 to complete the appraisal. 1.04 The telecommunication project would be the second in Colombia. The first one, financed by Loan 499-CO (US$16 million) and signed in June 1967, provided for the establishment oL a modern long distance network and for the expansion and improvement of local and international tele- phone, telegraph, and telex services. Owing to delays in building construction and late equipment deliveries there has been some delay in the original construction timetable and in the disbursement of the loan. The closing date of the loan has been postponed from December 31, 1970 to December 31, 1971. The full amount of the loan has been committed and both disbursement and construction are expected to be completed by the new closing date. The loan now proposed will enable TELECOM, to maintain continuity of development for which procurement action has to be initiated in early 1971. 1.05 TELECO1g's management showed considerable weakness in the early stages of the project under Loan 499-CO but in the past year with the experience gained and with the aid of local and foreign consultants it has shown rapid progress.  2. THE ECONOMY AND THE SECTOR The Economic Background 2.01 Colombia is a country of about 22 million people distributed in a number of distinct regions defined principally by mountain ranges. In the north and west, high mountain chains, in some places reaching heights of 5,000 meters, isolate the densely populated districts of the central region from the coast; the south eastern portion of the country is sparse:ly populated and extends into the Amazon jungle area. Half the population is urban, living in the centers of more than 10,000 people. Nearly a quarter live in the four leading cities of Bogota (2.1 million), Medellin (1 million), Cali (1 million), and Barranquilla (0.7 million), all of which are importarnt manufacturing centers. Population is growing very rapidly (3.3%) and urban population is growing 60-70% faster than the national average. Per capita income, at US$300, is still relatively low but in recent years has shown accelerating growth in the face of a national economic performance over the past decade which has been somewhat better than expected. The growth of GNP ifhich rose from around 5% in the early 1960's to over 7% by the end of the decade has been broadly based. Non-traditional exports (i.e. agri- cultural products other than coffee, plus manufacturing) have shown growth rates roughly three times that of the GNP. The encouraging growth of commodity production, internal trade, and non-traditional exports has been heavily dependent on the government's large and effective program of infra- structure investment, much of which has been directed towards tying together economic activities carried on in relatively self-contained regions. National integration, for example, has been a major objective in the Bank's own sup- port for the road transport, electricity, and telecommunications sectors in recent years. 2.02 The provision of adequate telecommunication services is an obvious requirement for an expanding economy, which requires a large volume of rapid, reliable communications to operate effectively. In comparison with trans- port and power, the telecommunication sector is relatively undeveloped, in the sense that it will require a period of relatively heavy "catching-up" investment, and of institution-building, over the next few years. The Telecommunication Sector 2.03 The telecommunication sector is under the control of the Ministry of Communications. Investment in the sector is coordinatsd within the national economic development plan by the National Planning Department (PLANiEACION). The responsibility for providing telecommunication services in Colombia is divided among many entities. Although the Government-owned TELECO[ exclusively provides domestic telegraphy, telex and long distance telephone services together with international services, no less than 60 entities, including TELECOM, are providing local telephone service. At the end of 1969, TELECOM had 21,000 local telephones in operation; this represented about 3% of the total for the country. Under the terms of its license TELECOM is allowed to operate local services and does so, with the approval of the Ministry of Communications, in areas where the municipality is unable to give service and requests TELECOM to provide the facilities.  2.04 At the present time Colombia has about 600,000 local telephone lines. Over 90% are automatic and one-third are located in Bogota. National long distance connections are provided over about 3,900 circuits of which one-half are operated automatically. International services are conducted over direct links by satellite, HF and VHF radio. A countrywide telegraph service is provided through 1,424 public offices, and a modern telex net- work provides service for about 2,500 subscribers. Details of existing facilities together with planned expansion targets to 1975 are given in Annexes 2 and 3. 2.05 The major problem of the telecommunication sector in Colombia is the fragmentation of the local telephone service. While a few large munici- palities, which have created separate telephone entities, operate efficiently and give good service there are many others which oring to the small scale of operations cannot operate their services efficiently, let alone develop them. The proliferation of small entities results in the duplication of planning and in the complication of the technical integration and inter- connection of the sector. Without adequate technical and financial backing operations are not effective. Furthenmore, the purchase of costly imported plant and equipment in small quantities results in higher prices and con- sequently, greater demand on the country's foreign exchange resources. If progress is therefore to be made in the sector further fragmentation must be prevented and action should be directed to achieving a reasonable degree of consolidation. 2.06 The ideal solution for the problems of the sector, which must be a long term objective, would be the consolidation of the many local operating entities into a single national telecommunication body. Present indications are that over the short period any sectoral rationalization will mainly be brought about by TELECOM since the large financially viable local operating entities are reluctant to merge with the smaller entities; furthermore with local and regional political influences still very strong any form of merger through legislation would in all probability be resisted. 2.07 On the assumption that sectoral integration will only be achieved through the purchase of the smaller local operating entities, it is es- timated that between US$30 and 35 million would be required as compensation. TELECOM has included US$2.2 million in the 1971-74 program for such ac- quisitions. More recently, however, the Government, in approving increases in TELECOM's long distance telephone tariffs, specified that a part of the expected additional revenue (estimated at about US$3 million for the four years 1971 through 1974) should be set aside and used exclusively for local expansion including the purchase of local entities. TELECOM will also probably use a part of the remaining additional funds arising out of the tariff increase, estimated at about US$10 million, to acquire local entities. It would therefore appear that a significant start in sectoral reorganization will be seen during the next few years.  - 4 - 3. THE BORROWER Organization and Management 3.01 TELECOM is an autonomous entity which was established in 1947. It is governed by a Board of Directors comprising four members and four alternates. The Minister of Comnunications is ex-oficio Chadrman of the Board. The President of the Republic appoints all members of the Board and also the president of TELECOM, who is the entity's chief executive officer responsible for day-to-day operations. TELECOM's organization is divided into four divisions: Engineering, Operations, Financial, and Industrial Relations, each of which is headed by a vice-president who reports directly to the president. An organization chart is given in Annex 1. 3.02 Until recently TELECOM's organization and administration was weak in both technical and financial services but it is now showing rapid improvement. In 1968, TELECOM engaged financial consultants to improve general accounting, financial control, inventories, purchasing, credit collection and data processing. The first phase, partly financed by Loan 499-CO, is progressing satisfactorily and will be completed at the end of 1971. TELECOM proposes to continue with a second phase and the proposed loan provides for the financing of the necessary consulting services (see para. 4.02, ii). In 1970 TELECOM engaged technical consultants to improve the organization of its oporations division. This work, which is being financed by TELECOM, is still in its early stages. Recruitment and Training 3.03 TELECOMI has no difficulty in recruiting professional staff who come mainly from the universities. Technical and administrative staff are obtained chiefly from the Technical Institute of Electronics and Communications (ITEC) in Bogota. ITEC is a UNDP assisted vocational training institute for electronics and communications. Its courses on telecommunications, given by an international team of instructors, are made available to all entities dealing with telecommunications, including railways and meteorological services. 3.04 TELECOM's technical and operational staff are sent to ITEC for basic and refresher courses. The facilities are adequate to meet TELECOM's needs for the forthcoming expansion program. In addition, supervisory staff are sent abroad for training under arrangements made with suppliers and under bilateral assistance. Accounting and Audit 3.05 A number of serious accounting deficiencies were brought out in the audit of the 1967 accounts, the first to be submitted to independent audit. A subsequent in-depth investigation was carried out at the Bank's request under the direction of the auditors and was satisfactorily completed in May 1970. The 1968 and 1969 accounts have been audited and found correct.  - 5 - 3.06 The existing auditing arrangements which are satisfactory conform with the undertaking in loan 499-CO. Assurances have been obtained that the accounts lill continue to be audited by an independent auditor accept- able to the Bank. Existing Telecmmunication Facilities 3.07 A brief description of TELECOM's facilities at the end of 1969 is given below. Additional information is provided in Annex 2 and Maps 1 and 2. (a) Local Service As of December 31, 1969 TELECOM provided local exchange facilities in 373 tor-ans and smaller localities utilizing 13 automatic and 360 manual telephone exchanges with total capacities of 15,825 and 6,000 lines respectively. (b) Long Distance Service The domestic long distance service comprised of:- (i) Modern microwave systems (1,200 channel capacity) between the principal regional centers of Bogota, Cali, Medellin, Pereira and Bucaramanga (see Map 1). The number of cur- rently installed channels on each of these routes is sufficient to meet traffic until early 1973. (ii) VHF routes linking other important centers. Many of these routes are congested, in particular the Medellin/ Barranquilla, Barranquilla/Cartagena, Bucaramanga/Cucuta links urgently require additional capacity. (iii) Open wire lines and HF connections operating between small localities. The service is poor and requires upgrading with modern systems. (c) Long Distance Switching At the end of 1969 TELECOM had 35 automatic long distance switching exchanges in operation. Orders have been placed under Loan 499-CO for a further 10 automatic and 80 manual exchanges, which will be installed by the end of 1971. (d) Telex and Telegraph Service TELECOM's fairly well developed domestic telex network, which was established in 1954, is of modern design, with dialling for both local and long distance calls. At the end of 1969 the 2,310 telex subscribers had access to 650 national and 45 international circuits through 39 automatic exchanges.  - 6 - The present total telex exchange capacity is 2,550 lines. TELECOM also operates an extensive domestic telegraph service through 1,424 public offices, many of which are located in small villages. 40% of the service is operated with tele- printers, the remainder by hand key. (e) International Service International telephone, telegraph and telex services are provided through an earth satellite station inaugurated in I'arch 1970 or by means of HF radio. The satellite system pro- vides high quality service through direct links k27 circuits in all) to Argentine, Brazil, Chile, Panama, Mexico, USA, West Germany and Spain. The HF radio stations which are located near Bogota have direct circuits to various cities in Europe, North and South America. The service via HF facilities has recently been improved by additional technical equipment. Tariffs 3.08 Details of TELECOM's principal tariffs are given in Annex 5. Telephone installation fees, monthly rentals, and call charges are reason- able. In addition to a guarantee deposit of US$42 equivalent, new local subscribers are required to pay an investment deposit which varies between US$27 and US$64 equivalent per line. Investment deposits were introduced in 1969 to help finance the urgently needed local development. Both deposits are refundable when service is terminated. TELECOM's telex charges are reasonable. 3.09 Domestic tariffs are set by the Board of TELECOM subject to the approval of the Minister of Communications. Tariffs for international telephone, telex, and telegraph traffic and the related participations are established in agreements between TELECOM and foreign entities. The equivalent Colombian peso charges for international traffic, which are settled in dollars or gold francs are at present being reviewed bi-monthly and revised to take into account currency changes. This arrangement is satisfactory. Past Financial Performance 3.10 Statements of sources and application of funds for the period 1967-1970 are given in Annex 8. During that period it is estimated that TELECOM will have increased its gross plant in operation from about Col$366 million to Col$911 million. 35% of newly constructed works will have been financed from internal sources, 39% from suppliers' credits, and 26% from IBRD Loan 499-CO. 3.11 TELECOM's audited income statements for the years 1967 through 1969 with estimated figures for 1970 and relative notes are given in Annex 6. Between 1967 and 1969 TELECOM's overall revenues increased by  - 7 - 76% to Co1$497 (US$26.9) million; part of the additional revenue arising from a 13% telephone tariff increase in August 1968. During the same period, mainly due to successive wage awards and higher social charges, operating expenses increased by 61% to Col$426 (US$23.0) million. Despite a slight improvement, the operating ratio was still poor, at 86, in 1969, reflecting in part the operation of the heavily staffed telegraph service taken over in 1965 at Government request. 3.12 Loan 499-C0 requires TELECOM to limit the net annual increases in staff during the present program to a maximum of 5% of the number of employees at the beginning of each year. This provision, which was satisfactorily complied with, will, with the agreement of TELECOM, be continued for the construction period of the new program. 3.13 Loan 499-CO requires TELECOM to achieve an annual rate of return of at least 9% on the net value of fixed assets in operation calculated on the current peso equivalent of the dollar value of the assets with a 10. rate of depreciation (see Annex 10). During the period 1967 through 1969 the annual average value of the Colombian peso to the dollar declined from 14.5 in 1967 to 17.3 in 1969. The tariff increase of August 1968 was im- plemented too late to prevent the annual rate of return falling slightly below 9% in 1968. The rates of return for 1967 and 1969 slightly exceeded 13% and 10% respectively. 3.14 TELECOM's debt service coverage by internal cash generation has ranged between 1.9 times and 1.5 times during the past four years. Present Financial Position 3.15 TELECOM's audited balance sheets for the years 1967 through 1969 with estimated figures for 1970 and relative notes are given in Annex 7. TELECOM's financial position as of December 31, 1969, was generally satisfactory. Current ratio was 1.1:1, cash position was adequate. Net assets, valued at historical cost, totalled Col$838 (US$45) million and consisted of net fixed assets in service Col$499 million, other fixed assets (mainly work in progress) Col$259 million non-current assets and investments Col$61 million and net current assets of Col$19 million. For rate making purposes TELECOM is required to value its net assets in service at their dollar value (see Annex 10). On this basis net fixed assets in service as of December 31, 1969, would have been Col$718 million, with a corresponding increase in the total equity figure.  3.16 TELECOM's capitalization as of December 31, 1969, was as follows: Col$ Col$ (million) (million) Equity and surplus 373.6 Provisions Pensions 36.9 Other 4.7 41.6 Subscribers' deposits 12.9 Long-term debt:- Bank loans 38.9 Suppliers' credit 111.2 IBRD Loan 499-CO 136.0 Fondo Nacional de Ahorro 123.7 h09.8 837.9 Debt/equity ratio was 52/48. Salient features of the capitalization are given below. 3.17 Under a 1968 law dealing with severance pay, public entities such as TELECOM were required to pay to the Fondo Nacional de Ahorro (FNA), the new acdministering authority for severance pay, an assessed liability for the past service of their employees. As of December 31, 1969 TELECOM had a liability to FNA for employees severance pay totalling Col$123.7 million. TELECOM has been allowed by ministerial arrangement to retain the funds together with the contributions for 1969, 1970, and 1971 and an interest charge of 9% per annum until December 31, 1971 after which it must repay tne sum then due (estimated at Col$194 million) by seven equal annual instalments. 3.18 TELECOM has a non-contributory pension scheme for its employees. In the past TELECOM has adopted the practice of charging to operational expenses only the actual payments for pension allowances rather than an annual charge related to the salaries of the employees, covering a pro- vision for their future retirement allowances. It has now been agreed that TELECOM will have an actuarialvaluation made of its pension liabili- ties by June 30, 1972 following which satisfactory arrangements will be made to provide for the ascertained liability. In the meantime a sum of Col$36.9 million has been provisionally set aside to meet the liability as at December 31, 1969. Provisions for future pensions will be retained within TELECOM and used for internal investment until such time as they are required.  - 9 - 3.19 At the end of 1969 TELECCM's current receivables totalled Col$127.0 million, equivalent to about four months revenue. In an effort to improve this position, TELECCM is following the consultants' recommendations and is accelerating billing; where there are direct contacts with the subscribers, collection procedures are being improved. However, the bulk of unpaid accounts relates to the Government, official bodies and local connecting entities, and Government action is required. 3.20 In 1969, the Government, with the concurrence of the Bank, agreed to settle its old arrears with TELECCM in four instalments terminating in January 1972. This arrangement is being carried out, however, there has been delay in the settlement of current accounts by a few Government departments. As of December 31, 1970 the National Post Office owed TELECOM an estimated Col$31 (US$1.7) million for services rendered in district offices operated jointly by the two entities during the three-year period 1968 through 1970. The Government agreed during negotiations that the arrears of the Post Office would be settled in accordance with arrangements satisfactory to the Bank and that future bills of the Post Office and other Government agencies would be maintained on a current basis. 3.21 A number of national connecting entities have not been promptly transferring to TELECOM the sums collected on the latter's behalf and in two extreme cases TELECOM had to set up its own collection organization in the areas concerned. During negotiations the Government agreed to use its best efforts to ensure that telephone operating entities make punctual payment of their debts to TELECOM.  - 10 - 4. THE PROGRAM AND THE PROJECT 4.01 In addition to the completion of the remaining works of the 1967- 1970 program, which includes construction financed by Loan 499-Co and some complementary items (see Annex 14), TELECCK has drawn up a further program of expansion for execution during the four-year period 1971 through 1974. 1971-1974 Program 4.02 The new program, the total estimated cost of which is Col$731.6 (US$39.5) million, provides for:- (i) the expansion of the local telephone service, the provision of additional long distance facilities, and the extension of the telex network (see para. 4.04 for details); (ii) the Improvement to budgeting, costing and plant accounting through the employment of accounting consultants; (i;i) the acquisition in 1974 of about 8,000 lines being provided in various localities on the plain, north of Bogota. The regional development authority for the area, Corporacion Autonoma de la Sabana de Bogota (CAR), in accordance with its statutes, will carry out the construction works and then transfer the plant, at cost, to TELECUM for operation; (iv) the commencement of construction in 1974 of a microwave link between Colombia and Ecuador, and a national data transmission network. Other Investhment 4.03 During the period 1971 through 1974 TELECOM also expects:- (i) to purchase some small local systems from operating entities, which, because of financial difficulties, wish to sell their undertakings; (ii) to increase investment in INTELSAT as required for continuing participation; and (iii) to further develop its staff housing scheme under which loans for housing are made available to the staff at low rates of interest. The Project 4.04 The project for Bank financing comprises items 4.02 (i) and (ii) in TEIECOM's 1971-1974 program of expansion. The full details of the project and the annual expenditure are given in Annex 11. A brief outline of the project is set out below. *Includes Co147.9 (us$0.4) million incurred in 1970.  (i) Local systems (a) the installation of about 42,000 lines of local exchange equipment, cable networks and subscribers' plant; (ii) Logdistance network (a) the construction of new microwave links on the Medellin/ Barranquilla/Cartagena and Bucaramanga/Cucuta/San Cristobal routes, presently served by VHF systems (see map 1); the expansion of the Bogota/La Cruz route by the addition of a microwave radio frequency channel; the establishment of 16 new VHF routes presently served by open wire lines (see map 2); the provision of about 620 supplementary voice frequency channels on the existing principal microwave and VHF routes; (b) the replacement of existing maritime radio plant at Buenaventura and Barranquilla with modern equipment, the installation of carrier equipment on open wire lines to give an additional 1,000 channels and of technical equipment on HF routes to improve transmission quality and facilities-, (c) the installation of three new trunk switching exchanges at Bogota, Cali and Medellin and the provision of toll ticketing facilities at Bucaramanga, Barrancabermeja, Bogota, Buenaventura, Cali, Cucuta, Ibague, l4anizales, liedellin and Pereira. (iii) Telex network The provision of 1,000 additional lines in the Bogota telex exchange and 1,000 new teleprinters. Cost of the Project 4.05 The costs of the project, totalling Col$599.1 (US$32.4) million are sunmarized below. % of total Col$ million US$ million Expend- Local Foreign Total Local Foreign Total iturfe Local telephone service 79.25 106.66 185.91 4.28 5.76 l0.o4 31 Long distance netwfork Transmission equipment 24.31 112.74 137.05 1.31 6.10 7.41 23 Switching equipment 16.04 57.13 73.17 0.87 3.09 3.96 12 Telex 1.37 44.8o 46.17 0.07 2.42 2.49 c Buildings 74.o0 - 74.oO 4.0o - 4.00 12 Sub-total 194F97 321.33516.3-0 10.33 17.37 27.90 -6i Accounting consultants - 5.55 5.55 - 0.30 0.30 1 Contingencies:- for design changes 5.60 9.81 15.41 0.30 0.53 0,83 for price changes 61.51 - 61.81 3.34 3.34 10 Total 262.38 33 9599.o7 lh.17 18.20 39.37 100  - 12 - 4.o6 The cost estimates are reasonable and adequate and are based on recent experience in Colombia. The costs of local and long distance switch- ing plant, microwave and other radio links, and toll ticketing equipment have been estimated having regard to the prices included in recent contracts signed by the larger local operating entities and TELECCK with suppliers. 4.07 As telecormunication equipment costs are showing a downward trend, the contingency provision on foreign supplied equipment has been restricted to 3% to cover unforeseen design and engineering modifications. The local costs of the project have been based on current prices with a 3% contingency for design and engineering modifications and an annual 10% contingency for wage and price escalation; the latter is in line with the 1966-69 average price increases for labor and materials of the type to be used in the project. Amount of proposed Bazk loan 4.08 A loan of US$15 million is proposed for the financing of the items, all to be procured through international competitive bidding, listed below: US$ million Local systems exchange equipment 5.30 telephone sets 0.46 5.76 Long distance network microwave links 2.23 multiplex, VHF & other equipment 3.18 5.41 trunk exchanges 1.08 toll ticketing equipment 2.01 3.09 Accounting Consultants 0.30 Contingencies 0.44 Total 15.00 Procurement 4.09 Items financed by the Bank loan will be procured by international competitive bidding. The additional radio channel on the existing Bogota/ La Cruz microwave route and the additional Lincompex and telex equipment are being procured from existing suppliers for standardization reasons; the cost of these items which is in line with interrational prices will be financed through suppliers' credit.  - 13 - 4.10 Certain goods such as cable ducts, poles, fittings which are manufactured locally will be procured by local bidding. Cables will be procured from the domestic manufacturers. These items are included in local currency costs and are outside Bank financing. Disbursement 4.11 The proposed Bank loan would be disbursed against CIF costs of imported equipment and the foreign costs of the consultants. Estimates of disbursements have been made according to the construction schedule and are shown in Annex 12. 4.12 Any unused balance of the loan should, after consultation with the Bank, be made available for the purchase of additional goods similar to those already procured under the loan. Project Execution 4.13 The construction schedule for the main items of the project are shown in Annex 15. No assistance from technical consultants will be required. Construction of the project will be carried out as follows:- (i) New microwave links, trunk switching plant, toll ticketing equipment, the large and meditum sized local exchanges, telex exchange extensions and the maritime radio plant will be installed by the suppliers with the help of TELECCI's staff. (ii) Additional microwave channel, multiplex equipment, HF equipment, construction of new VHF routes and redeployment of VHF radio equipment, carrier equipment on overhead lines, installation of small local exchanges, local cable works, subscribers telephone and telex plant will be installed by TELECCM since it already has experience in this work. (iii) Buildings, routes and ductwork will be constructed by local contractors under TELECOMts supervision.  - 14 - 5. JUSTIFICATIONi 5.01 The project aims at meeting the demand for local exchange and long distance facilities in TELECOM's area of operations. It provides for the development of local services by expanding present exchanges and ex- tending service to new areas, and the expansion of long distance and telex facilities. The components of the project are balanced and accord with correct development priorities in the sector. The project would make an important contribution to the economic development of Colombia by increas- ing the efficiency of operations in administrative, industrial and commer- cial activities. Demand (i) Local Telephone Service 5.o2 Of the 42,000 lines to be installed under the project about 24,000 lines have been allocated to some of the areas where TELECCI4 is already providing local service. The remaining 18,000 lines are to be installed in towns where there is no local service. 5.03 TELECCH had about 21,000 connected lines at the end of 1969. Since then it has carried out further local expansion and has also purchased t-he local networks of the North Santander Telephone Company, bringing the total number of connected lines to about 31,400. Unsatisfied waiting applications are about 3,500. In planning an increase of 24,000 lines up to the end of 1974, TELECCEI is providing for an annual growth rate of 12.3%; this is in line with the average growth rate of the automatic connected lines for the whole country (13%). 5.04 TELECOIIs plans for the extension of its local systems to new areas of service have been guided by the population and economic importance of the areas concerned. NJew; telephone exchanges are being provided in about 200 localities having populations of between 5,000 and 30,000 with a total population of over two million. The capacities of exchanges for the new localities have been based on TELECQCIEs experience in towns of similar population and economic background in the country. Out of the 109 centers listed in Annex 3 the present density is, with the exceptions of 12 localities, higher than one telephone line per hundred of the population, without taking into account the planned expansion. The capacity planned by TELECQI for the new exchanges totals 18,000 lines, which will provide a density of less than one per hundred of population. Planned expansion is therefore conservative. (ii) Long Distance Service 5.05 Long distance traffic has been increasing at the rate of 25% per annum. This high rate of growth is expected to continue during the period of the program in part due to the high growth of local telephone  - 15 - installations throughout the country and to the expected increase in subscriber dialling of long distance calls following the introduction of toll ticketing. The number of circuits has been worked out on a route-by-route examination of traffic trends. (iii) Telex 5.o6 The telex service is used mainly by large coamercial and industrial firms. The number of telex subscribers has been increasing at the rate of 8-9% per annum. International telex service has recently Improved with the additional facilities offered by the earth satellite station and this would stimulate the demand for telex facilities. In providing an additional 1,000 lines the project allows for an annual growrth of 10% in subscribers over the period 1971-1974. Least-Cost Solution 5.07 TELECCMVs local exchange program consists of a large number of separate small works covering the conversion to automatic working of existing manual exchanges, the expansion of capacity in a large number of existing exchanges and the provision of automatic exchanges in new local- ities. The choice of automatic working for providing local service and for handling long distance telephone traffic provides a better service and represents the least-cost solution. For the expansion and extension of local exchanges, the least-cost solution depends entirely on correct ergineering design of the exchange systems. TELECcM is handling these satisfactorily. Internal Financial Rate of Return 5.o8 The internal financial rate of return on the project is estimated to be 29% (see Annex 13) at current tariffs. This gives a minimum measure of the project's substantial benefits to transportation and industry by way of increased efficiency. The rate of return was determined by equal- izing the present values of expenditures and the incremental operating cash flows attributable to the project.  - 16 - 6. FINANCIqG PLAN AND FMIACCTA OUTLOOK Financing Plan 6.01 The capital investment and additional capital requirements for the four-year period 1971-1974 and the sources from which they would be met are summarized below. Forecast statements of sources and application of funds are given in Annex 8. Col$ US$ % - millions)--- Requirements 1971-74 Program 723.7 39.1 60 1967-70 " (balance) 311.4 16.8 26 Local networks - purchase 40.0 2.2 3 INTELSAT investment 10.9 0.6 1 Employees' housing scheme 23.8 1.3 2 Provision for exchange depreciation 67.0 3.6 6 Increase in working capital 27.4 1.5 2 Total requirements l,204.2 65.1 100 Sources Internal Cash generation 1,2h0.2 Less:- debt 564.8 675.4 - uncommitted funds 245.2 430.2 23.3 36 Pension and severance pay funds 57.0 3.1 5 Collection of past due accounts 27.3 1.5 2 Subscribers' deposits 64.8 3.5 5 Borrowings: - IBRD - Loan 499-CO (balance) 96.2 5.2 8 - proposed loan 277.5 15.0 23 C.A.R. - local loan 59.8 3.2 5 Suppliers and other financing 191.4 10.3 16 Total sources 1,204.2 65.1 100 6.02 In estimating the requirements for the construction works, provision has been made for price escalation in the local costs of the program (para. 4.07); escalation of operating costs during the period of the program has also been covered (para. 6.12). The foreign costs of the program and of debt service have been based on the rate of exchange as at  - 17 - the time of appraisal (Col$18.5=U3$l), and no account has been taken in those figures of exchange depreciation, which since 1968, has been about 5-6% per annum. However, the financing plan includes a reasonable provision of Col$67 million as cover for any additional payments of debt service and foreign equipment should exchange depreciation continue at the present annual rate of 5-6/o A brief analysis of the sensitivity of TRIECCH's cash flcw to currency variation is given in Annex 9. 6.03 The recent tariff increases are expected to provide TELECOM with not less than Col$245 (US$13) million over and above that required from internal cash generation for the approved requirements of the four-year period 1971 through 1974. Since the decision to increase tariffs was only taken in December 1970 plans for the utilization of the new funds have not been finalized, nevertheless it is known that TELECC4 will now be able to acquire sooner than expected several of the larger local operating entities at present in financial difficulties and requesting take-over. To ensure that no interference is suffered by the Bank-financed project, detailed procedural arrangements for the take-over of local entities, including adequate consultation with the Bank, were agreed during negotiations. It was furthermore agreed that TELECOM would obtain the approval of the Bank before undertaking any capital expenditure additional to that included in the 1971-1974 program if such additional capital expenditure during any one year would exceed Us$50O,0OO0 or 5 of the previous year's capital expenditure, whichever is the greater. 6.04 In November 1970, after consulting with the Bank, TELECOI agreed to purchase, at a cost of US$1.2 million the local networks of the Departmental entity of Norte Santander. Under the agreement TELECCM will repay the amount due to the entity and to suppliers (US$0.9 million) over the five-year period 1971-1975. 6.05 TELECOIM has agreed to take over the CAR network in 1974 at cost (see para. 4.02, iii). The terms of the purchase provide for TELECOM to take up from CAR a five-year 12% local currency loan of US$3.2 million equivalent for the cost of outside network and to assume the liability for the suppliers' credits on the exchange equipment estimated at US$1.5 million equivalent. 6.o6 TELECOM is arranging US$2.9 million by way of suppliers' credits towards the cost of the supplementary Bogota/La Cruz microwave channel, Lincompex HF equiprment and telex plant included in the 1971-1974 program (see para. 4.04, (ii a & b and (iii)). A further US$ 3.2 million of suppliers' credit, most of which has already been contracted, will be usedi to finance the remaining works of the 1967-1970 program (see para. 4.01 and Annex 14). 6.07 Execution of a microwave link between Colombia and Ecuador and the national data transmission network (see para. 4.02, iv) is expected to  - 18 - cormmence in 1974. As no detailed studies are yet available for these items they have not been considered at this time for Bank financing; however it has been assumed that TELECCI will arrange financing for US$1.8 million of the cost. Delay in the execution of this work would not interfere with the Bank-financed project. 6.08 The financing plan takes into account an estimated US$3.5 million equivalent from subscribers' deposits and an estimated US$4.6 million equivalent which would become available for internal investment from severance pay and pension funds (see paras. 3.17 and 3.18) and from the settlement of past due receivables. 6.09 Suppliers' credits have been included in the forecast at 8% per annum repayable over five years, these being the current terms obtainable by TEL3CoMI at the time of the appraisal. Future Operating Results 6.10 Forecast income statements to 1975 are given in Annex 6. Fore- cast operating results for the period of the program 1971-19774 are summarized as follows:- 1971 1972 I972 1974 -(in millions of Col$)---- Total Operating Revenues 781.2 921.5 1,112.5 11352-5 Total Operating Ecpenses 589.1 712.8 863.8 1,058.3 Net Income 192.1 208.7 248.7 294.2 Operating Ratio 75 77 78 78 Rate of Return 18.8% 17.6% 18.8%o 19.9% 6.11 It is estimated that with the new tariffs and the introduction of the additional facilities which TELE'CQH is at present installing and those which will come into operation before the end of the program the overall revenue should more than double between 1970 and 1974. Telephone revenues which should increase by about 37% in 1971 are expected to show an average annual increase of 20-25% over the three remaining years of the program. With the increase in telephone facilities domestic telegraph revenue is expected to remain relatively static or even decline; provision has however been made for an annual 8% increase in international telegraph revenue. Telex revenue, which has been growing annually at between 20% and 24% durirg the past three years is forecast to show a 17% average annual increase. 6.12 It is envisaged that operating expenses (excluding depreciation) will show an overall annuial increase of about 20e. This would cover the cost of the annual wiage awards, (an increase of about 16% per annum during the last three years), higher social charges, additional staff requirements and other operating expenses arising out of expanded operations.  - 19 - 6.13 With a much higher total revenue TELECOM's operating ratio is expected to improve to about 75 in 1971. After 1971 a slight annual deterioration of the ratio to 78 in 1974 is anticipated, this being mainly due to the costs of additional operational staff required for the expansion of the networks. 6.14 The forecast of TELECCli s future performance as given in para. 6.10 has been drawn up using the rate of exchange as of August 1970 (Col$18.5=US$l). On this basis TELECCM is expected to have an average annual rate of return of about 18.8% during the period of the program. This would be highly satisfactory. However, a more realistic evaluation of TELECOM's performance for the period of the program should take into account possible currency depreciation (see para. 6.02); and a further calculation has therefore been made by following the rate of return formula, based on the dollar value of the assets, prescribed for Loan 499-co (see Annex 10), and, as agreed during negotiations, to be continued for the proposed loan. On this basis, assuming a 5.3% exchange depreciation, the rate of return would average about 15.1% per annum. A sensitivity analysis of TELECOMI s rate of return to currency variations using the covenant formula is given in Annex 9. Under Loan 499-Co TELECOM is required to have a rate of return of 9% per annum. However, this rate would be in- sufficient to generate the funds necessary for the new program and it was agreed during negotiations that a rate covenant of 11% per annum from 1971 would be required. Forecast Financial Position 6.15 Forecast balance sheets as of December 31, 1970 through 1975 and related notes are given in Annex 7. TELECCM's financial position is expected to remain satisfactory during the period of the program. Net plant in service should increase from Col$667 million in 1970 to Col$1,352 million in 197k. At the end of the program, debt/equity ratio would be 37/63. Cash position should be very satisfactory. 6.16 Under Loan 499-co TELECOM is required to obtain the approval of the Bank before undertaking any long-term debt unless its debt service in any future year is covered 1.7 times by the net revenues of the pre- ceding fiscal year or a later 12-month period prior to the incurrence of the debt. TELECCVils debt service has been considerably increased by recent local and long distance expansion, the earth satellite station and the new severance pay requirements (para. 3.18) and the entity has repeatedly had to consult with the Bank under the covenant. A reduction of the debt service covenant requirement to 1.5 times, which would provide adequate safeguard, would reduce frequent requests for Bank approval for the incurrence of new debt. This change was agreed during negotiations.  - 20 - 7. RECGIMETDATIONS 7.01 During loan negotiations agreement was reached on the following principal points:- a) annual increases in personnel will continue to be restricted (para. 3.12); b) an actuarial valuation of TELECOMts liability for employees' pensions will be carried out and satis- factory arrangements made to meet the ascertained liability (para. 3.18); c) the rate of return will continue to be computed on the average value of net fixed assets in operation calculated on the current Colombian peso equivalent of the dollar value of the assets with a 4W rate of depreciation (para. 6.14); d) tariffs wiU be maintained at such a level which will provide an annual rate of return of at least eleven percent (11%) on the average net value of fixed assets in operation (para. 6.14); e) approval of the Bank will be sought before undertaking new debt if the maximum annual future debt service is not covered 1.5 times by net revenues of a 12-month period prior to the incurrence of new debt (para. 6.16); f) the approval of the Bank will be obtained during the execution of the program before any additional major capital expenditure or investment is incurred (para. 6.03); g) satisfactory arrangements will be made for the settlement of receivables due fram the Government and its agencies (para. 3.20); h) the Government will use its best efforts to insure that telephone operating entities shall make due and punctual payment of their debts to TELECOM (para. 3.21). 7.02 The proposed project forms a suitable basis for a Bank loan of US$15 million for the term of 20 years including a four-year grace period. March 10, 1971  ANNEX 1 COLOMBIA ORGANIZATION OF EMPRESA NACIONAL DE TELECOMUNICACIONES (TELECOM) BOARD OF DIRECTORS PLUBLIC RELATIONS PRESIDENT LE GA L A DVI SOR DEPARTMENT GENERAL S ~~~~~~~ADMINISTRATIVE | GENERAL SECRETARY l | PLANNING OFFICE FIN LINDUSTRIAL RELATIONS ENGINEERING OPERATIONS 0 VICE-PRESIDENT | | VICE - PRESIDENT VICE-PRESIDENT VICE-PRESIDENT ACCOUNTING ADMINISTRATION ENING OERATIONS FINANCIAL INSPECTION INSTALLATIONS TELEGRAPH q TREASURY l q TRAINING ] PROCUREMENT ] COMMERCIAL ] ______SUPPLIES SOCIAL AFFAIRS MAINTENANCE | CREDIT AND ~STANDARDS OF CREDIT AND SERVICE AND WORKSHOPS COLLECTION ~PROMOTIONS SYSTEMATIZATION ] BO GOTA BU CARAMAN GA CAR L IBAGUE MANIZALES MEDELLIN IBRD - 5243  ANNEX 2 Page 1 of 4 pages COLOMBIA EIPRESA NACIONAL DE TELECOYiUNICACIONES (TELECOM) Existing Telecommunications Facilities A. EMPRESA NAACTONAL DE TELECOMUNICACIONES (TELECOM) At the end of 1969 TELECOM facilities consisted of: 1. Local Service Automatic exchanges in service 13 Manual exchanges in service 360 Capacity of exchanges: automatic 15,825 manual 6,000 Total line capacity 21,825 Connected direct exchange lines: automatic 15,034 manual 5,700 Total connected lines 20,734 2. Long distance service The main long distance routes in Colombia are shown in maps IBRD 3142 and 3191. Links between Bogota and the regional centers are micrawave and from the regional centers a VHF network and open wire lines connect zone, group and local centers. As of December 31, 1969 a total of 3,870 long distance circuits connected 35 automatic exchanges and numerous small manual exchanges. About 1,000 circuits were microwave; 1,100 VHF and the remainder open wire; 2,100 circuits were operated automatically. The total number of circuit-kilometers was about 450,000. The microwave network had a length of 950 km and works were in progress to extend this by 640 km. 3. International service Prior to Harch 1970, all