Privatesector P U B L I C P O L I C Y F O R T H E Note No. 130 October 1997 Telecommunications Reform— How to Succeed Björn Wellenius Today, more than sixty emerging economies—twenty-five in Sub-Saharan Africa alone—are at some stage of transformation from state telecommunications monopolies to private-led, competitive markets. When well done, this reform can be a positive-sum game in which all stakeholders gain—customers, existing and new operators, employees, domestic and foreign investors, and the government. Faster growth, better and new services, lower costs, and, eventually, lower prices follow. This Note outlines the key ingredients of successful reform. Get support at the top expecting to use sale revenues to reduce budget deficits, financial advisers earning success fees Reform is most likely to succeed if it is led at tied to transaction prices—can steer reform off the highest level of political authority. This is this track. In particular, sale strategies that drive usually the head of government, who then al- up the prices paid for existing companies or locates responsibility for the reform to a single new licenses can hold down growth, reduce person with direct access to senior government the funding available to invest in these com- officials, freedom to cut red tape, and resources panies, or result in high tariffs. to assemble a small support team and hire the necessary experts. Such was the case in the For example, convinced that the six-year long- privatization of Mexico’s telecommunications distance monopoly granted to TELMEX in 1990 company, TELMEX. The president announced had led to high consumer prices and slower the reform in August 1989, appointed the min- growth than would have happened under com- ister of finance chairman of the board and gave petition, the government in 1996 chose to forgo him overall responsibility for the privatization, the high fees it could have obtained by tender- and handed over the chief executive’s job to ing one or two new licenses and instead opted an experienced public administrator with a clear for unrestricted entry. In India, exorbitant prices reform mandate. Privatization was completed bid for second fixed operator licenses in 1996 in December 1990. By contrast, Brazil’s attempts combined with modest revenue projections at reform from the early 1980s did not muster (from an overall low-income population) is mak- the necessary political muscle. Not until 1997 ing it difficult to raise debt financing for invest- has real progress been made. ment. In Brazil, the consortium that won the cellular license in São Paulo in 1997 with a Sort out conflicting objectives early US$2.5 billion bid—four times the government’s asking price and 60 percent more than the sec- The primary purpose of reform is to get ond-highest bid—is likely to pass on the cost to consumers more, better, new, and less costly customers through much higher tariffs than those services. Pressures from interest groups—in- proposed by rival bidders. By contrast, the cumbents who want ongoing protection, new government of Bolivia privatized ENTEL in 1996 entrants seeking special deals, treasury officials by issuing new shares for which the winning The World Bank Group ▪ Finance, Private Sector, and Infrastructure Network Telecommunications Reform—How to Succeed bidder paid US$600 million, immediately avail- main costs (equipment, capital) are determined able for investment in the company. in global markets and thus international bench- marks are relevant. As the market becomes Sale strategies that place less emphasis on cash more competitive, pricing can be increasingly up front can, moreover, yield substantially more left to the operators. cash to the government later. For example, awarding a cellular license to the bidder that The interconnection obligation of the dominant offers the largest build-out plan—rather than operators, the principles under which terms of the one offering the highest license fee—can interconnection will be negotiated, and the pro- increase tax revenue for years to come by cre- cess and timetable for a regulatory decision if ating more business. And initially selling only the parties fail to reach agreement must be the minimum number of government shares clearly spelled out. A new operator’s ability to needed for effective transfer of control of the reach (and be reached by) customers of the state company to the new owners (usually 20 existing operator and to use parts of existing to 30 percent) allows the government to float networks under reasonable technical and price the balance later and obtain much higher prices, terms rather than building complete new facili- once the company appreciates under private ties plays a big part in determining not only its management. In the privatization of TELMEX, own viability but also the economic efficiency for example, the government initially sold 20 of the sector overall. In Poland, failure to sort percent of the shares to a strategic investor in out interconnection with the incumbent meant 1990 for US$1.8 billion, then sold 31 percent that of some 200 licenses issued to indepen- more through public offerings in 1991 and 1992 dent operators since 1990, only about twelve for US$4.5 billion—70 percent more per share. were in use in 1996. Licensees cited the main impediments as unfavorable terms for sharing Set clear policies and procedures revenues with the dominant state operator, lim- ited access to its network, slow negotiation of The business offered to investors must be interconnection agreements, and a prohibition clearly defined in the laws, regulations, and on setting up their own transmission facilities. main transaction documents (licenses, contracts of sale). The most critical policy issues relate Reforms should follow clearly defined processes to pricing, competition, and interconnection. that are open to participation and review by all In pricing, governments must bite the bullet interested parties. The public should be kept early and rebalance tariffs. The price an op- informed. Market mechanisms, not individual erator is allowed to charge its customers is the negotiations, should be used to select partners most important determinant of profitability and and determine the right sale prices. And the ability to finance growth. Existing tariffs are award of licenses and contracts should strictly often way out of line with costs. Including re- adhere to the evaluation criteria announced at balancing plans in the licenses or contracts has the outset. Once a window of political opportu- tended to delay further reforms, as the new nity for reform opens, time is of the essence— owners avoid the public fallout from raising but should not be used as an excuse to cut some prices yet later expect the licensing of corners or strike deals behind closed doors. competitors to be delayed because tariffs re- main unbalanced. To set new tariff structures, Clear rules and processes must also apply to though, calculating the actual costs of each the regulatory function. The locus and functions operator is seldom a viable method. Rather, of regulatory authority as well as the basic pro- tariffs observed in competitive markets prob- cedures that will govern its relationships with ably offer the best guidance on efficient prices. operators and customers must be defined, pref- Although some cost elements (labor, land, erably by law. That does not mean that a full taxes) vary considerably among countries, the regulatory capability must be in place before TABLE 1 FASTER GROWTH IN OPEN, PRIVATIZED MARKETS Annual percentage growth in main telephone lines major reform steps can be undertaken. Initial 1984–89 1989–94 regulatory decisions can be written into licenses and contracts of sale. A core decisionmaking Brazil, Colombia, 7.0 7.8 capability in the form of a commission, say, and Ecuador, Peru, Uruguay a secretariat with processing capability, sup- Argentina, Mexico, Venezuela 6.7 11.3 ported by outsourcing of expertise, can deal with whatever is essential in the first two or three Chile 6.6 20.5 years, such as issuing licenses, managing con- flicting demands on the radio spectrum, and resolving interconnection disagreements. Other state monopolies areas of competence can be gradually devel- privatized monopolies oped as needed. Chances are that successive privatized open markets Source: Pyramid Research (1996) and World Bank. problems will arise, peak, and then decline to a low simmer so that a permanent, comprehen- sive in-house capability may never be needed. Moreover, in most emerging economies, any- national operator and three other cellular com- thing beyond a minimalistic regulatory institu- panies were already in place—and the price tion is not feasible. per line was similar to that paid for the mo- nopoly in neighboring Côte d’Ivoire. But lack Open all markets to competition of clarity regarding competition policy does drive investors away. Partial privatization in Without competition, the benefits from increased 1996 of Svyazinvest, the Russian holding of 85 private participation will not be fully realized. regional telecommunications companies, failed In Latin America, for example, countries that shortly before closing when the winning bid- granted monopoly privileges of six to ten years der realized the government did not intend to to the privatized state enterprises saw connec- grant Svyazinvest a license to build its own tions grow at 1.5 times the rate achieved under long-distance network. state monopolies but only half the rate in Chile, where the government retained the right to is- Enhance credibility and stability sue competing licenses at any time (table 1). Rural areas, too, can become an attractive busi- Even if a government gets all the policies, rules, ness under liberal entry and pricing policies. In and procedures right, operators and investors Chile, government subsidies equivalent to less will come and stay only if they believe that the than 0.5 percent of total telecommunications government will stay the course. Governments revenue, allocated through competitive bidding can do several things to enhance credibility in 1995, mobilized twenty times as much pri- and stability. To safeguard reforms against poli- vate investment to extend basic telephone access tical changes, governments should develop to rural areas. The program brought service to them with the support of major stakeholders— about a third of the rural population lacking it. various branches of government, public and private sector users, chambers of commerce, Contrary to views often expressed by financial consumer groups, large enterprises (including advisers, investors are not opposed to com- state-owned firms) that could become alterna- petition—as long as they are not also burdened tive network providers, local investors and with regulatory uncertainty, unrealistic service banks, and the staff and management of exist- obligations, and rigid tariffs and employment ing operating companies. rules. This is true even in small, low-income markets. Ghana Telecom was successfully In emerging economies, most with strong privatized in late 1996 at the same time that a growth potential, the concerns of labor can in license was awarded for a second full-service fact be readily accommodated. Most workers Telecommunications Reform—How to Succeed stand to gain from higher salaries, improved Investors, operators, and customers will be re- career prospects, and new opportunities as assured by a telecommunications law that es- employees or entrepreneurs in a rapidly ex- tablishes broad principles and rules governing panding market. Growth allows major gains in the sector. A law with a narrower objective, labor productivity with little reduction in per- however, such as establishing a regulatory au- sonnel. As Ghana Telecom prepared to priva- thority, may suffice. The timing of amending tize in 1996, some 500 workers (14 percent of or replacing a dated law must weigh the po- the combined telecommunications and postal tential delays and political cost. workforce) agreed to leave with severance pack- ages that cost the government less than 3 per- Anchoring key elements of reform in interna- cent of the initial proceeds from privatization. tional frameworks also adds credibility. World After privatization, potential labor problems Trade Organization (WTO) member countries largely disappeared following management that subscribe to the telecommunications agree- commitment that there would be no forced re- ment of 1997 enter a binding international com- dundancies, introduction of training programs, mitment to implement aspects of their own and expected growth. By contrast, labor unions reform targets, abide by a common set of regu- whose concerns—and political clout—had been latory principles, and recognize the WTO as ignored brought to a halt Sri Lanka’s reform an instance of intergovernmental appeal. All program in the mid-1980s. In the restructuring this is likely to provide comfort to investors of state telecommunications enterprises in Latin worried about regulatory risk. Similarly, loans, Viewpoint is an open forum intended to America, an additional enticement has been of- credits, and guarantees from multilateral agen- encourage dissemina- fered—employee stock option plans that trans- cies such as the World Bank Group involve tion of and debate on fer about 5 percent of shares to employees on government obligations that can be tailored to ideas, innovations, and best practices for ex- favorable terms. help offset risks such as failure of the govern- panding the private ment to abide by the terms of licenses (on pric- sector. The views pub- Essential for reducing investor risk is limiting ing, for example) or ensure access to foreign lished are those of the authors and should not the opportunity for discretionary government exchange for debt service or dividend pay- be attributed to the or regulatory intervention in business, espe- ments. A US$90 million investment by the Inter- World Bank or any of cially in the early years. In Uganda, initial de- national Finance Corporation and the European its affiliated organiza- tions. Nor do any of the cisions on tariffs, service obligations, and Bank for Reconstruction and Development in conclusions represent default interconnection terms are being writ- 1993 in the Hungarian state telecommunica- official policy of the ten into licenses and contracts (as was also done tions company mobilized US$1.2 billion in for- World Bank or of its Executive Directors in Ghana). Numbers that will remain firm for, eign funds at the time of privatization. or the countries they say, five years—subject if necessary to auto- represent. matic adjustment, based on simple formulas, Conclusion To order additional for inflation, foreign exchange, or other fac- copies please call tors—are more effective at reducing risk than Major transactions such as a privatization or the 202-458-1111 or contact are rules for calculating these numbers. issuance of new licenses tend to drive the re- Suzanne Smith, editor, Room F6P-188, form agenda, but change continues well beyond The World Bank, Telecommunications reforms gain credibility these transactions. Following the rules and hon- 1818 H Street, NW, when coupled with broader programs in which oring commitments helps consolidate an envi- Washington, D.C. 20433, or Internet address the government has a large stake. The privati- ronment for sustainable growth. Also critical is ssmith7@worldbank.org. zation of ENTel in Argentina was the flagship to build a regulatory capability to suit changing The series is also of President Menem’s multisectoral public en- needs, take every opportunity to enhance com- available on-line (www.worldbank.org/ terprise reform program in the early 1990s, and petition, and address any persistent gaps be- html/fpd/notes/ everyone knew that a failure by the govern- tween development and commercial objectives. notelist.html). ment to stick to the rules it had set for tele- Printed on recycled communications would have undermined the Björn Wellenius, Telecommunications Adviser, paper. whole program. Telecommunications and Informatics Division