Colombia - Third Telecommunications Project

FILE COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1550-CO REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO EMPRESA NACIONAL DE TELECOMUNICACIONES WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A THIRD TELECOMMUNICATIONS PROJECT December 31, 1974 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS (as of December 5, 1974) Currency Unit - Colombian Peso (Col$) US$1 Col$28 Col$1 - US$0.0357 Col$1 million - US$35,700  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS CN A PROPOSED LOAN TO EMPRESA NACIONAL DE TELECOMUNICACIONES WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A THIRD TELECOMMUNICATIONS PROJECT 1. I submit the following report and recommendation on a proposed loan to the Empresa Nacional de Telecomunicaciones (TELECOM), with the guarantee of the Republic of Colombia, for the equivalent of US$15 million to help finance a third telecommunications project. The loan would have a term of 20 years, including five years of grace, with interest at 8 percent per annum. PART I: THE ECONOMY 2. The Bank's most recent economic report (Economic Position and Pros- pects of Colombia, 138-CO) was distributed to the Executive Directors on May 18, 1973. A note on major developments in the economy since that time is included in Annex I. 3. The Colombian economy has shown impressive gains in the recent past. The rate of economic growth has accelerated to more than 7 percent per annum, and the expansion of non-traditional exports has been remarkable. Such improvements are very much needed in order to accelerate employment generation and to raise gross national product per capita, currently US$400, one of the lowest in Latin America, to a more acceptable level. Colombia also needs to spread the benefits from growth more widely in order to surmount problems of poverty and population pressures in both rural and urban areas. Concentration of land ownership, technical backwardness, and under-employment characterize most rural areas. In urban areas, pressures of population growth, compounded by heavy migration from the countryside, have generated serious unemployment and a severe housing deficit. Prospects for coping with these problems seem brighter as a result of the accelerated growth upon which the Colombian economy has embarked in the past several years. 4. Recent Government administrations have reacted to rural poverty and urban unemployment in a more systematic fashion than in the past, but much remains to be done. In spite of the passage of an Agrarian Reform Law and the creation of the Agrarian Reform Institute (INCORA) in 1961, only modest results have been achieved in alleviating rural poverty. Additional legislation has been enacted which lays a better basis for land reform but much remains to be done to raise income in rural areas. In recognition of the problems of urban concentration and unemployment, Colombia's previous Government placed greater emphasis on urban development, particularly in the housing field, but despite such action unemployment continued to increase in most of Colombia's major urban centers. Preliminary indications suggest that the new Government, which  took office in August 1974, will strive to sustain a high rate of economic growth while simultaneously attempting to achieve a more equitable distribution of its benefits, inter alia, through expansion of employment opportunities and increased investment in education, health and agriculture. There is likely to be more emphasis on the development of agriculture and industry, and less reliance on the urban construction sector to provide a stimulus to economic growth. Export diversification will continue to be a major component of development strategy and the Government is currently rationalizing the export promotion system. These development programs have necessitated and will continue to require a strengthening of the fiscal effort. 5. At the latest Consultative Group Meeting held in June 1973, members of the Group expressed the view that growing needs for public investment and other public expenditures called for increases in domestic fiscal efforts. While the Government then expressed the intention to further increase revenues by new tax measures and by increasing the savings of public enter- prises, little progress was achieved, and the fiscal situation remained weak. To overcome these problems, Colombia's new Government has institutedc comp~- hensive structural reform of the fiscal system which includes major modifica- tions of the sales and income taxes, and a strengthening of the fiscal con- tribution of decentralized public enterprises. Discussions between the Government and the Bpnk on fiscal issues are continuing. 6. Colombia's efforts to expand exports have been amply rewarded in recent years. Merchandise exports amounted to US$1,334 million in 1973, of which over half came from non-coffee items. Allowing for price increases, this represents a fourfold increase (representing an average annual real growth of 24 percent) in non-traditional exports since 1965-67. Flowers, clothing, emeralds, cotton thread and cloth, chemical and pharmaceutical products, sawwood, and wood products enjoyed particularly large gains, although raw cotton, sugar, meat, and other agricultural products continued to account for the greatest absolute amounts. Coffee receipts were up largely as a result of high international prices as the volume of coffee exports has increased relatively little in recent years. 7. Rapidly expanding exports accompanied by more slowly rising imports, despite progressive removal of import restrictions, have created substantial balance of payments surpluses. Net foreign exchange reserves of the Banco de la Republica reached at the end of February 1974 nearly US$600 million, or the equivalent of about five months' imports of goods and non-factor services at the 1973 rate. This compares favorably with the US$345 million and US$170 million held at the end of 1972 and 1971, respectively, and to the deficit positions that were common prior to 1968. Since February, accelerated import payments resulting from liberalization of import restrictions and lengthening of the lag between export registrations and exchange surrender together with lower world prices for coffee, moved the current account of the balance of payments from a surplus position in 1973 to a deficit for the first eight months of last year. Sharply reduced external borrowing by the Government has further lowered the inflow of foreign exchange, and reserves  -3- probably declined by about US$120 million during 1974. Care will have to be exercised in foreign exchange reserve management since world coffee prices may remain weak for some time and prices of several of Colombia's non-traditional agricultural exports appear to have peaked, while those of imports are expected to continue to rise. The new Government is aware of the possibility of some weakening in the balance of payments, and since taking office in mid-August has more than doubled the rate of depreciation of the peso, ahead of domestic price increases, in an effort to hold down the rapid growth of imports and sustain adequate incentives to exporters. A longer-term problem is that, unless appropriate action is taken, Colombia will become a sizeable net importer of crude petroleum near the end of the decade, and the pressure on the balance of payments from petroleum imports, should they become necessary, could be considerable. A high-level Energy Cowncil is studying exploration incentives, taxation and foreign-exchange arrangements, product pricing, and other aspects of this problem. 8. The rapid growth of Colombia's GDP in 1972-73 was accompanied by a sharply accelerated rate of price inflation. Consumer prices jumped 22 per- cent in 1973, as compared with 14 percent in 1972, 12 percent in 1971, and an average of 7 percent yearly in 1967-70. Food prices, which have a weight of about 50 percent in the cost of living index, increased by 30 percent in 1973. The authorities have taken a number of ileasures to dampen price pressures, including liberalization of import controls, reduction of tariffs, and tighter controls on public expenditure, but given the weak state of public finances, inflation continued being a problem throughout 1974 and is expected to have reached 25 percent by year end. To deal with this situation, the new Government invoked emergency economic powers and is moving forcefully to implement a comprehensive fiscal and monetary reform aimed at strengthening public finances and at producing a more balanced flow of resources through Colombia's financial system and at providing the authorities with greater monetary control. 9. Colombia's public external debt repayable in foreign currency amounted to US$2.6 billion at the end of 1973, or US$1.9 billion excluding undisbursed commitments. The Bank's share of this external debt (disbursed only) as of end 1973 was about 28 percent, but this share is expected to decline to 25 percent in 1978 as Colombia relies to a greater extent on other external borrowing. Service on this debt is modest (12 percent of foreign exchange earn- ings in 1973) relative to other developing countries. Since exports have risen  -4 - more rapidly than debt service in recent years, there has been a decrease in the debt service ratio at a time when economic growth has accelerated. The debt service ratio is expected to rise moderately and peak in the mid-1980s at about 18 percent as a result of greater capital inflows associated with a high growth rate. The Bank's share of total debt service is expected to peak at about 28 percent in 1975 and is likely to decline thereafter. Should economic growth continue at a rapid pace, which appears feasible, and should that growth be accompanied by a further strong expansion of non-coffee exports and the maintenance of sound economic and financial policies, Colombia should find it possible to secure the amounts of external capital it needs and to service the indebtedness that this borrowing would generate. PART II: BANK GROUP OPERATIDNS IN COLONBIA 10. The proposed loan 2/--the fifty-ninth to be made to Colombia--would bring the total amount of Bank loans to Colombia to US$1,127.8 million (net of cancellations). Of the foregoing amount, US$854.6 is now held by the Bank. IDA has made one credit of US$19.5 million for highways in Colombia in 1961. 11. Disbursements have been completed on 33 loans and the one IDA credit. IFC has made effective investments and underwriting commitments in 20 enterprises in Colombia, totalling about US$27 million of which IFC now holds US$13 million. Annex II contains a summary statement of Bank loans, the IDA credit, and IFC investments as of September 30, 1974, and notes on the execution of the 23 on-going projects. SECTORAL COMIOSITION OF BANK GROUP OPERATIONS TO SEPTEMBER 30, 1974 (Amounts in US$ millions) Sector Share of Total Sector Number of Loans Total Amount _ Agriculture 8 80.7 7.5 Telecommunications 2 31.0 2.9 Education 3 33.8 3.1 Industry 7 221.5 20.5 Power 18 344.1 31.9 Transportation 12 229.6 21.2 Water Supply 5 131.6 12.2 Pre-Investment 1 8.0 0.7 Total 56 1,080.3 100.0 j/ The proposed loan is presented simultaneously with two other proposed loans for a Small-Scale Industry Project and a Water Supply and Sewerage Project.  12. Since 1968, Bank lending in Colombia has become more diversified than in earlier years. All three loans in the education sector have been made since then as were one-half of the eight agricultural loans, four of the five loans in the water supply sector and four of the loans for industry. This compares with six loans during these past five years in the sectors where the Bank has been traditionally active, i.e., power and transport. Bank efforts have been focused on production-oriented activities and activities which carry social as well as economic benefits. Projects being developed will seek to combine the objectives of increasing output with maximum benefits in terms of employment and improving the income of the poor, particularly in rural areas. 13. We expect over the next several years to make an increasing contribution to the agricultural and industrial sectors, with particular emphasis on projects involving small and medium size farmholdings and industrial enterprises. The other major focus of our activities would be in such social sectors as education and water supply. We would con- tinue to support projects in the traditional sectors of Bank lending-- electric power and transportation--in those cases where support is required for necessary institutional development. Projects are currently in an advanced stage of preparation for rural settlement and irrigation rehabilitation. 14. The operations of external lenders in Colombia are shown in Annex I, pages 3-4. While IBRD, IDB, and AID provided about four-fifths of total external financing to Colombia in the 1961-72 period, their share has decreased since then. The IDB has assisted projects in low- cost housing, university education, agrarian reform, ports, electric power, water supply, transportation, and industry. AID has shifted the emphasis of its lending in recent years from program to sector loans, particularly for education, urban development, and agriculture. PART III: TELECOMMUNICATIONS IN COLOMBIA 15. The Ministry of Communications exercises governmental control of the sector, It is responsible for policy making, licensing and regulation of the various entities operating in the sector. Responsibility for providing telecommunications services in Colombia is shared by 54 entities, Operating as the sole government-owned entity, TELECOM has the exclusive license to provide national telegraph, telex and long distance services and all inter- national telecommunications services, Local telephone services are provided by TELECOM and the 53 other municipal entities. With prior mrinisterial approval, TELECOM is allowed to acquire the entities operating local telephone services. However atthis stage TELECOM only owns and operates about 5 percent of the  -6- local subscribers lines (35,000 out of 677,000). 16, The main problem of the telecommunication sector is the fragmented operation of local telephone service. The large number of entities complicates sector interworking with varying operating standards and often results in uncoordinated planning of facilities. Some large municipalities provide reasonably good service. In smaller cities and towns, however, the quality of the telephone service is unsatisfactory due to the small scale of operations (all except eight operate less than 10,000 equipment lines) and the insufficient attention paid to the extension and improvement of the telecommunication service. 17. The long term solution of the problem lies in consolidation of the several local operating entities by TELECOM into a single national telecommunication body. When approving increases in TELECOM's long distance tariffs in 1971, the Government specified that part of the expected additional revenue should be set aside and used exclusively by TELECOM for local expan- sion,including acquisition of local entities. TELECOM has taken over control of seven such entities during the last three years and plans during 1975-78 to take over 19 more entities. By 1981 TELECOM expectBto have taken over all local telephone entities, except the eight largest in the major cities. 18. While TELECOM's long distance service development is progressing satisfactorily, local telephone service planning and development by the other telephone entities is not able to keep up with demands. The local services entities do not have adequate financial resources for planned development. Two of the largest such entities (Bogota and Cali) would, beyond 1975 and 1976 when their present plans fructify, have serious problems in financing future development, and have requested the Government to organize and mobilize financial assistance from various sources including the Bank. The position of the other smaller entities is even worse, and their future development plans are based not on need, but on the quantum and timing of supplier credits which they hope to obtain. The Government is aware of these problems and requested the Bank to undertake a sector study and to assist the Government to assess the requirements of each entity over the next 5-10 years, establish priorities for investment, and consider possible sources of funds. The Sector Study has been completed and the report is in course of preparation. The sector mission's main conclusions are that present fragmentation of the sector has resulted in increased costs and lowered efficiency, as well as lack of coordination and rationalization in policy planning, investment programming and budgeting, procurement and regulatory control. Its chief recommendation is that the most appropriate solution to this problem lies in consolidation of the many separate entities into one; namely, TELECOM. Discussions with the Government on these recommenda- tions are continuing. PART IV: THE PROJECT 19. The project was appraised in November 1973 and loan negotiations were held in Bogota during October-December 197h. The Colombian delegation was led by Dr. CristiAn Mosquera. A loan and project summary is attached as Annex III to this report,and an Appraisal Report (605-CO) is being  -7- circulated separately to the Executive Directors. 20. The proDosed loan constitutes the Bank's third lending operation for telecommunications in Colombia. The first Loan to TEELECOM (L99-CU) of utS16 million was rmade in 1967 to help finance the establish2aent of a basic long distance network and for the expansion and improvement of national and international telecommunications services. The loan has been fully disbursed and the physical work; still outstanding should be completed by mid-1975. 'Tlhe second Loan to TELECOM, (740-CO) for US$15 million which was approved in 17i, assists in financing new local networks and extension of long distance facilities. The project will be completed by June 197b, one year behind schedule. TELECOM's performance has in general been satisfactory; however, iL has had organizational problems in recent years, and would engage technical and financial consultants to assist in improving its operational efficiency. Descriotion and Purpose of the Project 21. The project is estimated to cost Col41,609 million (US452.1 million) withi a foreign exchange component of US$33.5 million equivalent. The proposed Bank loan (US$15 million) would cover part of the foreign exchange costs, while the balance (US$1.5 million) would be financed with TELECOM's own resources. The Government is prepared to provide the necessary foreign exchange from the general foreign exchange reserves of the country. The Govern:;ient believed that, at least for the time being, potentially availabl'e foreign credits carry unacceptably onerous terms. The project is national in scope, and consists of installation of (a) about 18,000 additional lines of switching equipment, cables and subscribers plant, to connect about 16,000 additional subscribers; (b) long distance equipment for about 5,400 additional circuits; (c) telex equipment to connect 500 additional subscribers; and (d) call office telephone facilities in about 200 rural areas. A further important objective of the loan would be to enable the Bank to continue its institutionl- building effort in the telecommunications sector. Execution of the Project 22. lELECOM's staff will do engineering designs and, with the assistance o' tecimical consultants retained under Loan 740-CO, will prepare bid documents and technical specifications,. evaluate bids and draw up contracts for goods. TE'LECO'I will lay all distribution cables and will supervise construction of cable ducts and buildings constructed by local contractors. All telephone and transmission equipment in new locations will be installed by the suppliers with the assistance of TELECOk staff. Extensions to existing plant will be installed by TELECOIM1, which will also carry out acceptance tests of all installed equipment.  -8- Finances 2. From 1971 to 1973 TELECOM's overall revenues increased by 92 per- cent to Col$1,1L41 (US$43.9) million, partly as a result of tariff increases. During the same period, operating expenses increased by 91 percent to Col$1,022 (US$39.3) million, maimly due to increases in personnel expenses. The rate of return, on an annual basis, was 11.7 percent in 1971, 14i.9 per- cent in 1972 and 7.5 percent in 1973. Following a 12 percent tariff increase in January 1974 it is estimated that TELECOM's rate of return for 19714 will be sufficiently high to make up for the 1973 deficiency and provide for an 11 percent return. This accords with the rate of return covenant in Loan 740-CO, which requires TEIECOM to achieve an annual rate of return of at least 11 percent, but allows a shortfall or overrun to be carried forward to the next year. In computing the rate of return, assets are valued in terms of peso equivalents of their dollar values. 2). For the future, TELECOM has undertaken to maintain the 11 percent rate of return and to review on an annual basis (i) the need for a tariff increase prior to April 1, and (ii) to adjust its rates, if necessary, prior to July 1 each year (Section 5.05 of draft Loan Agreement). 25. TELECOMts debt service coverage by internal cash generation declined from 2.1 times in 1971 to 1.1 times in 1973, because of the continuous devaluation of the Colombian peso and the increasing amounts of foreign debts incurred. During this period TELECOM experienced difficulties with the collection of receivables from other telephone entities operating in Colombia,and from Government. TELECOM has informed the Bank of the steps it has taken and will take to improve this situation. It has just completed the collection of the Government debt in question. The Government will also use its good offices with municipalities, departments and the connecting local telephone enterprises to clear within a reasonable time their present arrears to TELECOM and to prevent future accumulation or arrears (Section 3.02 of draft Guarantee Agreement). 26. Domestic tariffs are set by the Board of TELECOM, subject to approval by the Minister of Communications and the National Tariff Board. In addition to the installation charge of about US$14.50 equivalent, and the guarantee deposit of about US$33, new local subscribers are required to pay a non interest-bearing deposit which varies between about US$20 and US$49 equivalent per line. Telephone monthly rentals of US$1 for residential and about US$1.40 for business subscribers, and the local telephone call charge of US$0o0oh (Col$0010),are very low compared with similar charges in other countries.  -9- 27. TELECOM's financial position is expected to improve during the project period. Its liquidity position would in every year be satisfactory and enable TELECOM to meet regularly its current debt service obligations. While total debt service payments are projected to increase from Col$183 mil- lion in 1974 to Col$372 million in 1978, the annual debt service coverage ratio is projected to improve from 1.1 times in 1973 to 2.0 times in 1978. Procurement 2c. All goods financed by the Bank loan will be procured through international competitive bidding, except the extensions to existing exchanges (valued at US$2.6 million) which were obtained through international competi- tive bidding under Loan 740, where the equipment is for reasons of standardization, being obtained from the original contractor at unit Prices cuoted under the earlier bid, and adjusted for inflation. 2ELEGOA will finance from; its own resources other imported goods which will be erocured by negotiatiorIs woita thie suppliers and through competitive bidding, and goods such as cables, cab_e ducts, poles and fittings which are manufactured locally and which will De nrocured through competitive bids fromi domestic suppliers. -. None of the Bank-financed goods are currently produced in Colombia; therefore, the issue of preference to domestic suppliers does not arise. Though Colombia is a member of the Latin American Free Trade Association (LAFTA) and the Andean Pact, TELECOM is exempt from import dutiesj hence, bid preference for LAFTA and the Andean Pact countries is not applicable. Disbursement Disbursement would be for the CIF costs of imported equipment and the foreign costs of its installation. Any unused balance of the loan would be used to finance additional equipment, similar to that already procured under the loan, after consultation with the Bank. Rate of Return and Justification The project's rate of return is about 27% if benefits are measured -el- by the incremental net revenues attributable to -he project. l'he incre- eonta:L revenues uwlderstate the benefits since the project costs include the `ull costs .f extending service to new areas even though the fu_l Denefit of such extension would be obtained only when additional potential subscribers o-re connected. A sensitivity analysis has been carried out showing Lhat th1e r2ate of -eturn would be 22 per cent for unfavorable variatio,ns of tn1e main ..a-aieters by 10-1i per cent. The project would iiiake an i;.,ipL.rtant indirect cont-ibusion to the economLic development of Colomibia by inc-easing operating efficiency ill atministrative, indusLrial card commercial activities.  - 10 - PART V: LEGAL INSTRUMENTS AND AUTHORITY 32Q The draft Loan Agreement between Empresa Nacional de Telecomunicaciones and the Bank, the draft Guarantee Agreement between the Bank and the Republic of Colombia as well as the Report of the Committee provided for in Article III, Section t (iii), of the Articles of Agreement and the text of-a draft Resolution approving the proposed loan, are being distributed to the Executive Directors separately. 33. The draft Agreements contain provisions to reflect the various arrangements described in part IV above and conform to the normal pattern for loans for telecommunications projects. 34. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI: RECOMMENDATION I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President MbyJ. Burke Knapp At tc.c!Lients Becembcr 3 , 1 '7L  Page 1 of 12 paes COUN4TRY DATA - COLOMBIA AREA POPULATIOYN mxSrny 1,139,000 a_2 25.0 reillio- (mid-1972) .. Pee teDs! arable land SOCIAL INDICATORS Reference Countries Turkey Brazil Mexico CliP PUB CAPITA uS) (ATLS BASIS) ~ .. ~ /a 1222 1222 15270 G" PZR CAnTA US4 (ATIAS BASIS) / 400_ 370 La 530 /a 750 /a DEICIGBAPHIC Cuebrhrate (par thousand) 39 Ai 45 /d 38/a-u 38 /d 43/ Crude death rate (Per thousand) 12 i ll 13 10 71 1o0 Wnfnt mortality rate (par thousad Uiv births) 100 70 15 1 110- 58As Life eXPrtanoY at birth (years) 57 59 i 55 iSa 61 /d hi4 Oross reProduction rate 12 3.2 3.2 /d 2.6/