REPORT NO. 27671

COMPETITION IN INTERNATIONAL VOICE COMMUNICATIONS

POLICY DIVISION GLOBAL ICT DEPARTMENT JANUARY 2004

ABBREVIATIONS AND ACRONYMS

EAP East Asia and Pacific ECA Eastern and Central Europe EU European Union FCC (US) Federal Communications Commission FDI Foreign direct investment GATS General Agreement on Trade in Services GDP Gross domestic product HHI Herfindalh-Hirschman index ICT Information communication technologies IP Internet protocol ITU International Telecommunications Union LAC Latin America and Caribbean MNA Middle East and North Africa OECD Organization of Economic Cooperation and Development PAT Profit after tax PSTN Public switched telephone network RBOC Regional Bell operating companies SSA Sub-Saharan Africa UK United Kingdom UNDP United Nations Development Programme US United States VoIP Voice over Internet protocol WTO World Trade Organization YC Year that competition was completed

Vice President: Nemat Talaat Shafik Director: Mohsen A. Khalil Manager: Pierre A. Guislain Task Manager: Carlo Maria Rossotto

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CONTENTS ABBREVIATIONS AND ACRONYMS...................................................................................... i FOREWARD ......................................................................................................................... iv ACKNOWLEDGEMENTS .......................................................................................................v EXECUTIVE SUMMARY ...................................................................................................... vi CHAPTER 1. GLOBAL TRENDS IN INTERNATIONAL VOICE COMMUNICATIONS Volumes, Prices, and Revenues................................................................................. 1 The Dynamics of Full Competition: Market Shares, and Degree of Concentration ................................................................................... 4 Competition in International Voice Communications: Regional and Global Differences............................................................................. 7 CHAPTER 2. THE PUSH FOR COMPETITION The Benefits of Full Competition ............................................................................. 13 Driving Forces .......................................................................................................... 14 Worldwide Experiences of Market Opening ............................................................ 18 CHAPTER 3. THE RESISTANCE TO COMPETITION Lack of Institutional Capacity .................................................................................. 20 Fear of Undermining the Incumbent Operator ......................................................... 21 Fear of Losing Fiscal Revenues and Control............................................................ 24 Political Economy Reasons .......................................................................................25 Corruption and Nepotism ......................................................................................... 35 CHAPTER 4. FULL COMPETITION: REQUIREMENTS FOR SUCCESS Interconnection and International Accounts ............................................................. 33 Tariff Rebalancing and Universal Service................................................................ 36 BIBLIOGRAPHY.................................................................................................................. 64 LIST OF ANNEXES 1. Competition by Region and Income Level .................................................................. 40 2. Control of Corruption and Competition....................................................................... 43 3. Worldwide Experiences of Market Opening ............................................................... 45 4. The Success of El Salvador’s Regulatory Reform....................................................... 49 5. Fiscal Impact Scenarios ............................................................................................... 53 LIST OF BOXES 1. British Telecom and Telekom Malaysia: The Effect of Competition on Financial Results........................................................................... 21 2. Telekom Malaysia: Adapting to a Competitive Environment ................................. 27

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LIST OF FIGURES 1. Growth of International Service Revenues................................................................ 2 2. Forecasted Decline of International Telecommunications Revenues........................ 3 3. Introduction of Competition in Major Markets Coincides with Rapid Growth .................................................................................................. 8 4. LAC Leads in Competition........................................................................................ 9 5. Three-quarters of Developing Countries Maintain Restrictions on Market Access ............................................................................... 10 6. Competition Means Substantially Lower Prices....................................................... 11 7. Chile: Incoming and Outgoing Traffic Booms with the Introduction of Competition ..................................................................... 12 8. Partial Competition Offers Partial Results in Price Drop ......................................... 13 9. Driving Forces and Sector Change ........................................................................... 14 10. Higher Transmission Capacity at Lower Cost.......................................................... 16 11. Growth of International Traffic Through IP ............................................................. 17 12. Reasons for Resistance to Competition .................................................................... 20 13 Countries with Limited Economic Freedom Face More Obstacles to the Introduction of Competition......................................................... 13 14. Controlling Corruption and Reforming International Long-distance ......................................................................................................... 30 15. World Bank Group’sRole in Telecom and Governance Sector Reform......................................................................................................... 49 A1.1. Geography and Income Levels........................................................................... 42 A2.1. Top 20 Countries in Control of Corruption........................................................ 43 A2.2. Bottom 20 Countries in Control of Corruption .................................................. 44 LIST OF TABLES 1. International Communications Draws Closer to a Perfectly Competitive Market........................................................................... 5 2. Degree of Concentration in the International Communications Market ......................................................................................... 6 3. Three-quarters of Global Outgoing Traffic Originates from Competitive Markets....................................................................................... 7 4. Main Regulatory Features of Full Competition, Partial Competition, Monopoly................................................................................................................ 19 5. Pro-reform Actors Need a Stronger Political Voice ................................................. 27 6. Imbalanced Telephone Tariffs Before Competition ................................................. 37 7. Net Cost of Universal Telephone Service in Selected Countries ............................. 39 A4.1. Regulatory Structure for the Provision of International Long-distance Service...................................................................................... 52 A5.1. Example of Positive Fiscal Impact in the Short-term ........................................ 53 A5.2. Example of Negative Fiscal Impact in the Short-term....................................... 54

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FOREWORD Competition in international voice communications is a global phenomenon. Virtually all high income countries and selected developing countries have adopted a model based on low barriers to entry, multiple technological options, and competition. As a result, prices dropped dramatically and volumes increased, to the full benefit of the consumer. Moreover, low cost international communications proved to be a key enabler of economic competitiveness. International communications has been regarded increasingly as a key determinant of industrial location, job creation, trade facilitation, and trade integration. Some developing countries, for example, Chile and El Salvador have introduced and sustained full competition in international communications, which has resulted in spectacular successes. Despite these encouraging examples, about 74 percent of developing countries have retained barriers to entry in the international communications business, and about 85 countries still maintain monopolies. If the benefits of competition are so evident, and there are spectacular successes from selected developing countries, then what are the reasons for resisting competition? This paper was prepared by a team from the Policy Division of the Global Information and Communications Technologies Department of the World Bank explores some possible reasons. It draws on the team’s experience in covering an active policy dialogue on telecommunications reform in some 60 countries. The paper explores the emergence of full competition in international communications as a global phenomenon, assesses arguments and reasons commonly brought by governments to resist the introduction of competition; and illustrates some regulatory requirements to implement full competition. While part of the world makes international calls at a price of a few cents a minute, other very poor countries pay exorbitant prices for international calls. The paper explores some of the reasons for this divide; and the findings are interesting and relevant to economic development. Pierre Guislain Manager Policy Division Global Information and Communication Technologies Department

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ACKNOWLEDGEMENTS This report was written by a team composed by: Carlo Maria Rossotto (Regulatory Economist, Task Team Leader), Bjorn Wellenius (consultant), Anat Lewin (Knowledge Sharing Analyst) and Carlos R. Gomez (Junior Professional Associate), from the Policy Division of the Global Information and Communications Technology Department of the World Bank. The editorial assistance of Andrea M. Ruiz-Esparza is hereby acknowledged. The team expresses gratitude for the input provided by the reviewers: Agostino Appendino, Mark Jamison, Charles Kenny, Gareth Locksley, Massimo Mastruzzi, Christine Zhen-Wei Qiang, and Roberto Saracco. The team thanks an additional reviewer, who has asked to remain anonymous, and who has provided outstanding contributions to the paper. The responsibility for mistakes and omissions remains solely with the authors.

EXECUTIVE SUMMARY This paper presents the case that opening international voice communication to competition plays a key role in reforming the telecommunications sector, is sustainable in developing countries, and results in major gains to consumers, business users, and the economy overall. It makes the case for opening developing country markets quickly rather than gradually, and identifies regulatory matters that need to be tackled in opening the markets to competition. Over the last 20 years full competition became a global phenomenon and brought substantial changes to the telecommunications industry. International call volumes increased, international call prices dropped, and international call revenues declined first relative to other revenues from communications services, then in absolute terms. The full competition market structure became a dominant attribute in virtually all high-income countries. Selected developing countries, especially in Latin America and the Caribbean region, successfully embraced full competition. When full liberalization (defined as removal of numeric and other entry barriers) occurs in both developing and developed countries, the market structure is more akin to a competitive services or goods industry than to a network utility. The incumbent operator may retain a dominant position for a number of years, but the erosion of its dominant position is inevitable. Competition is sustainable over time. Lastly, as firms enter and exit the market, the fragmentation of the market is inevitable. Three powerful forces were behind the spread of competition in international voice communications. First, globalization of economic activity increased demand for international telecommunications services and created pressures for manufacturing and services firms to reduce costs and increase services. Second, technological change in the telecommunications industry reduced network costs and increased capacity, allowing the provision of international voice services at a lower cost. Third, the international trade system, through the World Trade Organization (WTO) and regional trade initiatives, leveraged international telecommunications as a key enabler for trade and economic integration. Competition in international communications was included as a cornerstone of the trade agenda. Now over 80 percent of global voice traffic originates in fully competitive markets. Resistance to full competition remains strong in several developing countries, where only 26 percent of the countries have introduced full competition; in particular a good number of African, Asian, and Middle Eastern countries retain considerable barriers to entry. In contrast, low- and medium-income countries, such as Chile and El Salvador, have demonstrated spectacular success in introducing and sustaining full competition. A spectrum of reasons for resistance to competition exist; some reasons are telecommunications sector-specific, and pertain to the absence of technical, regulatory, and business skills required in implementing competition, or the fear of bankrupting the incumbent operator. Other reasons are more systemic, such as: (a) the loss of fiscal

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revenues, (b) the lack of political influence by pressure groups in favor of competition, (c) corruption, and (d) restrictions on information flows. Competition in international communications is also a matter of economic freedom. The paper indicates that the countries in which the freedom of enterprises and consumers to voice their concerns is high, are also the countries with a higher level of competition in the international voice market segment. The transition from monopoly to the competitive provision of international services needs to be accompanied by improvements in regulatory reform, the performance of the incumbent operator, the licensing regime, and the interconnection regulatory framework. Attention needs also to be paid to fair competition conditions and to the creation of a core institutional capacity to monitor, investigate, and act against anticompetitive behavior. For social and developmental reasons, it is important to rebalance the incumbent’s tariffs to bring them closer to the industry cost structure, to regulate prices in noncompetitive areas, and to develop a strategy and finance mechanism to extend services. Finally, it is key in order to free the incumbent to adjust its business strategy and practices along fully commercial lines to face growing competition. This generally requires that the incumbent be established under company law and be strengthened by the participation of private capital and management.

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CHAPTER 1. GLOBAL TRENDS IN INTERNATIONAL VOICE COMMUNICATIONS Volumes, Prices, and Revenues Over the last 20 years, the international voice communications industry parameters of volume, price, and revenue experienced dramatic changes. International call volumes increased, while the international call prices dropped dramatically. International call revenues declined first relative to other revenues from communications services, then in absolute terms. These changes in the industry parameters were made possible by the adoption of new technologies1 in a competitive environment. Technology change and regulatory reform led to a new market structure based on lower entry and competition, affected the business model of firms in the telecommunications industry, and created pressures to modify the settlements system—a century-old set of bilateral agreements that ruled international communications. International call volume increased from less than 20 billion minutes in 1984 to over 144 billion minutes in 2001, a 13 percent annual growth rate.2 International outgoing traffic per subscriber also increased from less than 60 minutes in 1990, to about 120 minutes in 2001, a 6 percent annual growth rate—a higher pace than the global economy’s annual growth rate, 2.7 percent, during the same period. The price of international retail calls fell. TeleGeography estimates that the average retail price per minute of an international call dropped from $1.57 in 1983, to $0.42 in 2001. The impact of price in competitive routes, such as New York/London, was even more dramatic. In 1997, a call from the United States (US) to the United Kingdom (UK) cost $0.30, while that call is now priced at $0.04. Another competitive route is Santiago/Miami. In 1997, a phone call from Chile to the US was priced at $1.60 per minute,3 while in 2003 the price was closer to $0.15 per minute.4 International wholesale prices have also fallen even more sharply. For example, the wholesale price of a call from the US to Chile or the UK is around $0.015 per minute. Industry revenues experienced modest growth, and recently, a decline. Competition has stimulated volume and reduced prices. But price reduction had a substantial impact on revenues, causing stagnation and decline. During 1992 to 2001, revenues from international communications grew at a rate of 2.8 percent annually, close to global gross domestic product (GDP) growth. The global international communications industry generated $70 billion in 2000, its peak year, decreasing to just over $60 billion in 2001 (-14 percent). This decline can probably be related to worsening global economic conditions in 2001 and 2002. Good economic conditions may have contributed in part of

1 Key technological improvements occurred in the international voice communications market since 1980. Progress in fiber optic technology and the emergence of Internet protocol (IP) personal computer (PC)-based distributed telephone technology lowered entry barriers into the international communications market. 2 TeleGeography. 3 Published ENTEL retail tariff. Source: SUBTEL 4 The price $0.15 is probably the lowest available in the Chilean market. The incumbent price is $0.97.

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the superior growth experienced in the 1990s. Figure 1 illustrates international service revenues between 1983 and 2001 (TeleGeography, 2003).

Figure 1. Growth of International Service Revenues: International Service Revenues Increase by 10.9 percent from 1983-1992, and 2.8 percent from 1992-2001

0

10

20

30

40

50

60

70

80

1983 1986 1989 1992 1995 1998 2000 2001Inte

rnat

iona

l Ser

vice

Rev

enue

(US$

bn

)

GlobalRevenues

Source: TeleGeography Global Traffic Statistics and Commentary 2003, ITU, pp. 12,33. Missing years are estimated. This radical transformation in the international telecommunications market has had an impact on the overall telecommunications industry revenue mix. Revenue growth from international communications has been lower than the growth in two other market segments: mobile and data communications.5 The relative decline of international revenues is expected to continue. Other sources (IDC 2002, IntelSat) have forecasted that international revenues will decrease in the near future by 1.6 percent per year. In contrast, IP/Packet data has been forecasted to grow by 21.1 percent per year, and mobile voice by 9.3 percent per year. As a consequence, long-distance and international voice services, accounting for 18 percent in 2001 of overall sector revenues, are expected to decline to 12 percent in 2005.

5 Siemens research presents global revenue growth by market segment. Growth rates show that international communications grew by only a 12 percent in 1996-2000. In the same period, mobile communications revenues boomed by 127 percent. Over the five years data communications revenues doubled.

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Figure 2. Forecasted Decline of International Telecommunications Revenues

31%

19%

32%

18%

194 191 188 186 181

343 354 367 382 397

84 90 95 100 106117 143 174 211 251298

338376

398425

3242

5677

96

2001 2002 2003 2004 2005

-1.6%

5.8%

21.1%

9.3%

Telecom Revenues, 2001-2005

3.7%

31.6%

2001

2005

LD/Intl Voice

Data

Source: IDC 2002, Intelsat

Intl/LD Voice

Private Line Data

IP/Packet Data

Local voice

Mobile Voice

Mobile Data

CAGR

1,0681,158

1,2561,354

1,456 8.1%

Voice Access

Wireless

36%

25%

27%

12%

LD/Intl Voice

Voice Access

Data

Wireless

31%

19%

32%

18%

194 191 188 186 181

343 354 367 382 397

84 90 95 100 106117 143 174 211 251298

338376

398425

3242

5677

96

2001 2002 2003 2004 2005

-1.6%

5.8%

21.1%

9.3%

Telecom Revenues, 2001-2005

3.7%

31.6%

2001

2005

LD/Intl Voice

Data

Source: IDC 2002, Intelsat

Intl/LD Voice

Private Line Data

IP/Packet Data

Local voice

Mobile Voice

Mobile Data

CAGR

1,0681,158

1,2561,354

1,456 8.1%

Voice Access

Wireless

36%

25%

27%

12%

LD/Intl Voice

Voice Access

Data

Wireless

The decline of international revenues had an impact on the business model of market players. Incumbent operators were affected by these changes. For example, in Hong Kong the incumbent operator witnessed a decline in international service revenues over total corporate revenues from 53 percent to 21 percent in five years. Similarly, SingTel’s international wholesale revenues went from 40 percent of total revenues in 1997, to 15 percent of total revenues in 2001. Telmex international revenues (originating only) over total revenues dropped from 19 percent to 8 percent in the same period (TeleGeography, 2003). Other changes in the business model and practices involved the need for frequent (monthly or fewer) updates of international call prices, and the need to enchance the billing system. As a consequence of the relative decline in international revenues, some incumbents have diversified their business activities, entering into new lines of business. For example, a large number of incumbent operators have focused on the development of mobile operations and data (e.g., Telecom Italia Mobile and Telekom Malaysia). Other operators have changed their business model, and have expanded their operations abroad (e.g., BT). A common change in the business model consisted in changes to the tariff structure (tariff rebalancing). Tariff rebalancing was implemented by incumbent operators to reduce their dependence on revenues from international communications. In some cases, rebalancing was a business choice of the operator. In other cases, rebalancing was mandated by regulation, to prepare the incumbent operator for competition. The impact of rates rebalancing on network development has been positive. In Latin America (and elsewhere) rebalancing generated new revenues which allowed for an expansion of the local network, as shown by Ros and Banerjee, 2000, Gutierrez and Berg, 2000; Wallsten 1999. Changes in international communications affected the business model of nonincumbent operators as well. New mobile operators (e.g., MediTelecom in Morocco, and Tunisiana in Tunisia) profited from the introduction of competition in the international

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communications market, developing their own competitive gateways. Mobile competition is important to the development of competition in international communications. In many cases mobile is the only legal competition and is a powerful force as the penetration of mobile to fixed-line is now reversed in most developing nations (Wellenius, B. and Rossotto, C.M., 1999). This rapid transformation of the industry created pressures to modify the “settlement system,”6 the set of bilateral agreements, initially established in the late nineteenth century to administer payments between national monopoly providers of international telegraph and telephone services. An increasingly high quota of the global traffic moved away from these bilateral administrative agreements, and was settled using market-based systems. In particular, the factors that contributed to the changes of the settlements system were: (a) the growth of alternative ways to bypass the system, such as callback, refile and VoIP termination;7 (b) the growth in the number of full competitive markets, with several players negotiating termination charges; and (c) pressures from regulatory agencies such as the US Federal Communications Commission and international organizations such as the International Telecommunications Union (ITU).8 In addition to these forces, global corporate data networks were increasingly used to carry voice, and contributed to drive traffic out of incumbent operators. The incumbents themselves contributed to undermining the settlement system, as they received termination income from new worldwide, competitive carriers with whom they had agreements outside of the settlement agreements.9 As a result of these pressures, two changes occurred: accounting rates became more cost-oriented, and an increasingly higher percentage of traffic was carried outside the settlement system. The Dynamics of Full Competition: Market Share and Degree of Concentration When regulatory barriers to entry are removed, the market structure for international voice communications shows most of the features of a competitive market: many suppliers, low barriers to entry, and stiff competition or price. This contrasts with other parts of the telecommunications industry, such as mobile or fixed local loop access, in which the market structure resulting from competition tends to be, respectively, an oligopoly, or a market characterized by a dominant firm with fringe competition (Rossotto and others, 1999). This difference is due to the lower initial capital requirement to be a competitor in the international communications market. Table 1 presents the market share of selected countries’ incumbent operators three, five, and 10 years after competition is introduced. The year in which competition is

6 Kelly, 1997. 7 Artificially high termination rates created and strengthened the gray market through incentives for entrepreneurs to make quick and substantial gains. Most of the gray marketers were local companies, officials of ministries in developing countries, or employees within the incumbent’s own infrastructure. 8 Kelly, 1997. 9 Incumbents also rerouted calls using new competitive carriers to remove excess traffic for which they would otherwise have to pay high rates to their settlement partner. In other cases, incumbents with insufficient traffic to fulfill their side of the settlement agreement received traffic destined for the settlement partner’s hub that originated in a different part of the world.

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introduced is indicated as YC. YC+3, YC+5 and YC+10 refer, respectively, to three, five and 10 years after competition is introduced. Table 1 also indicates an index of market concentration, the Herfindahl-Hirschman index (HHI), three and five years after competition is introduced, and the number of suppliers in 2002. HHI is the sum of the squared market shares of different competitors. An HHI of 10,000 indicates a perfect monopoly; HHI values between 2,000 and 5,000 are an indication of an oligopoly. Values close to or lower than 2,000 indicate features closer to a competitive market.

Table 1. International Communications Draws Closer to a Perfectly Competitive Market (market shares as a percentage of outgoing minutes)

Country (incumbent)

Incumbent market share at

YC+3 (%)

Number of competitors

at YC+3

Incumbent market share at

YC+5 (%)

Number of competitors

at YC+5

Incumbent market share at

YC+10 (%)

HHI at YC+3

HHI at YC+5

Number of Suppliers in

2002

Chile (ENTEL Chile)

40 7 37.3 9 32.5 3008.2 2394.1 34

Finland (Sonera)

66 8 54.7 8 n.a. 5019 3920 32

The Philippines (PLDT)

69 9 79 12 49.9 5295 6238 11

México (Telmex)

68 16 66.6 21 n.a. 4974.8 4836.7 21

Malaysia (Telekom Malaysia)

77 5 61.1 10 n.a. 6112 4177 16

UK (BT) 67.7 100 54.9 215 33.3 5291 4039 500 Sweden (Telia)

76 13 66 60 43.4 6226 4984 120

Dominican Rep. (CODETEL)

77 3 72.2 4 n.a. 6176 5604 5

Average 67.6 61.4 39.77 5262 4524 Source: World Bank calculations, based on TeleGeography 2003 data. The data indicates that when full competition is introduced in the international communications markets, the result draw closer to a tight oligopoly with increasing competition. When full liberalization occurs, the incumbent operator may retain a dominant position for a number of years, but the erosion of its dominant position is inevitable. In all four cases (Chile, the Philippines, Sweden, and the UK) for which data are available, the market share of the incumbent decreases to less than 50 percent, 10 years after full competition is introduced. Other more recent liberalization experiences (Germany and Israel, for example), for which 10 years data are not yet available, suggest that the erosion of market shares of the incumbent might happen in a shorter period of time. The market share of Deutsche Telekom in the German international market went from 100 percent in 1998, to 48.7 percent in 2001. Bezeq’s market share in the Israeli international communications market fell from 100 percent in 1996, to 41.1 percent in 2001 (TeleGeography, 2003).

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Competition in the international communications market is sustainable over time. In seven out of the eight cases there was a drop in HHI from YC+3 to YC+5, indicating decrease of market concentration.10 New entrants established at the time of liberalization were able to retain and increase market shares. New entrants, possibly exploiting technological advancements, entered the market and thus contributed to its fragmentation. In markets where data are available there is evidence that the drop in industry concentration continues after YC+5. For example, in the UK, the HHI for 2003 (YC+10) is 2026, a drop of over 2,000 points with respect to YC+5. Where full competition is introduced, a high number of firms will operate in the market segment. The Dominican Republic’s small market sustains five competitors; Chile’s 34; the UK’s 500. In addition to the data presented in the Table 1, it is interesting to note the trend has continued even during the financial crisis for the sector in the 2000 to 2001. The number of suppliers in the UK market grew from 306 in July 2000, to 500 in July 2002. In the same period, the number of suppliers in Malaysia grew from five to 12, and in Argentina from four to 66 (TeleGeography, 2003). The market structure of a liberalized international communications market is more closer to a competitive services industry, or goods industry, than it is to a network utility. Even in cases where the entire telecommunications sector was fully liberalized, the international communications segment was more competitive than other market segments, such as cellular and local fixed-line services. Looking at measures of concentration alone, the international communications market has values closer to a large, competitive distribution market—like the chocolate market—than to the local fixed-line access market (Table 2).

Table 2. Degree of Concentration in the International Communications Market

Market Segment HHI (2003)

UK international voice 2026 UK cellular 2600 UK fixed-line domestic voice Over 7000 Chile international voice 2386 Sweden international voice 2523 US international 2218 US chocolate (2000) 2149 Mexico international óbice 4886 Mexico chocolate11 1875-2220

Sources: TeleGeography, Mexico FCC, Business Rankings Annual 2003

10 The exception is the Philippines where, however, carriers do extensive price fixing among themselves so as to prevent new operators from coming in, and to keep prices higher. 11 Mexico Federal Competition Commission, Annual Report 1994-1995. Http://www.natlaw.com/pubs/spmxat3a.htm. The Mexico FCC assessed the impact of certain mergers in the Mexico chocolate market, concluding that the HI value emerging from those mergers, 2220, would not hinder competition.

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Competition in International Voice Communications: Regional and Global Differences Major national markets, accounting for about 75 percent of global traffic, are now open to competition (ITU, 2002). However, most developing countries did not follow this trend, and retained entry restrictions. This “policy divide” has implications on sector performance. Measured by volume, competition has become a global phenomenon. In 1998, 74 percent of global outgoing traffic originated from markets opent to competiton, compared to 35 percent in 1990 (ITU, 2002). After the liberalization of international communications was introduced from the 1980s to the mid-1990s in Australia, the European Union (EU), Japan, the UK, and in the US, all major international communications routes were open to competition. In addition, competition has been established in several emerging markets, including Argentina, Bolivia, Brazil, Chile, Dominican Republic, El Salvador, Guatemala, India, Mexico, Malaysia, and the Philippines. However, the 25 percent of outgoing traffic that is not open to competition originates almost exclusively from developing countries.

Table 3. Three-quarters of Global Outgoing Traffic Originates from Competitive Markets

Year Global outgoing traffic open to competition (%)

1990 35 1995 46 1998 74 2005 85 (forecast)

Data: International Telecommunications Union The introduction of competition in major markets coincided with rapid volumes of growth. In 1990 to 1998, the size of the market open to competition has doubled, and the volume of the outgoing traffic grew by 450 percent (ITU, 2002). Figure 3 shows rapid growth in traffic that has originated in countries open to competition.

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Figure 3. Introduction of Competition in Major Markets Coincides with Rapid Growth

Introduction of Competition in Major Markets

Coincides with Rapid Growth in Volumes

0 20 40 60 80

100 120 140 160

1990 1995 1998 2001 2005

Global Ougoing Traffic (billions of

minutes)

Global Outgoing Traffic Generated in non-Competitive Markets

Global Outgoing Traffic Open to Competition

(forecast)Source: ITU

Globally 88 countries have a monopoly, 33 have introduced “partial competition,” and 65 have full competition in international voice communications. The Organization of Economic Cooperation and Development’s (OECD) high-income countries have full competition. Non-OECD high-income countries (such as Andorra and Malta), and high-income countries in the Middle East (such as Bahrain and Kuwait), retain a monopoly. Annex 1 provides further data on regional and income-level introduction of full competition. About 26 percent of developing countries (37 out of 156) have adopted full competition. Most of the countries that now offer competition were monopolies five to 10 years ago. Figure 4 shows that 37 of the 156 developing countries (as classified by the World Bank) have adopted full competition. And 33 developing countries are classified as having “partial competition” in international communications. These countries introduced some degree of competition, but have also retained certain restrictions.12

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12 “Partial competition” occurs where there is a numeric restriction on the number of international carriers, or where competition is limited to resale, or is otherwise constrained.

Figure 4. Latin America is a Leader in Competition Among Developing Regions, Africa and the Middle East Lag Behind

ource: World Bank updates to ITU, World Telecommunications Regulatory Database, 2002.

utside of the OECD region, where full competition is the norm, the majority of etition

,

y

tion

S Ocountries in the Latin America and Caribbean (LAC) region introduced full comp(among them, Argentina, Bolivia, Chile, Colombia, El Salvador, Guatemala, Peru, and Venezuela). A few countries in the Eastern Europe and Central Asia (ECA) region haveintroduced competition (among them, Estonia, Hungary, and Ukraine). A majority of African countries retain a monopoly. The Asia-Pacific region presents a mixed picturewith fully competitive countries such as Malaysia and the Philippines; countries with partial competition such as Cambodia, China, and India; and countries with a monopolsuch as Myanmar, the Pacific Islands, and Vietnam. The Middle East North Africa (MNA) region’s predominant market structure is the monopoly, with partial competiemerging in North Africa. There is no country in the MNA region with full competition. Further details about regional introduction to competition can be found in Data Annex 1.

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Figure 5. Three-quarters of Developing Countries Maintain Restrictions on Market Access

Developing Countries

26%

23%

51%

Full competition

Partial Competition

Monopoly

Source: World Bank updates to ITU, World Telecommunications Regulatory Database, 2002. What are the implications of this policy divide? Developing countries that restrict entry to the international communications market face three consequences: higher prices, lower outgoing volume, and reduced network investments. The prices for international communications are higher, with negative consequences for consumers and domestic enterprises. Figure 6 shows the price of a three-minute phone call to the US from different regions. Africa has the highest price, over $5.00, where only 17 percent of the countries have full competition. East Asia and the Pacific (EAP) region also pays a high price, where only 13 percent of its countries have adopted full competition. The two regions with the lowest international communications prices are LAC and ECA where 45 percent and 29 percent, respectfully, of the countries have full competition.

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Figure 6. Competition Means Substantially Lower Prices

ECA and LAC Offer Lowest Prices, AFR the Highest

17%

13%

38%

45%

29%

0

1

2

3

4

5

6

Sub-SaharanAfrica

East Asia &Pacific

South Asia Latin America& Caribbean*

Europe &Central Asia

Cos

t of 3

Min

Cal

l to

US

(US$

)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Cost of 3 MinCall to US (US$)(2000)

% countries withfull competition

Source: Wor ld Development Indic ator s 2003, World Bank, ci ting International Telecommunications Union data.* LAC data are for 1999. MNA data were unavailable. Ther e ar e no countr ies in the MNA r egion wi th ful l competition.

There are no comprehensive and comparable data for MNA, the only region where no country has adopted full competition. Only four out of 16 countries have adopted partial competition, while the remaining countries maintain monopolies. As an indication, an average tariff calculated on a sample of 12 MNA countries indicates a high price of $5.42 for a three-minute call to the US.13 This price is higher than the average for Africa—the region with the second highest price which also maintains a high number of monopolies14. Call volumes will be lower. Consumers will call less, and will try to bypass the system. The impact of competition on volume in selected full competition developing countries is meaningful, as the introduction of the multicarrier system coincided with a rapid growth of incoming and outgoing traffic. Several examples, including Chile, support this evidence.15

13 WDI data, citing ITU data, 2003. Data are from 2000. 14 The price reduction experienced in fully competitive markets not only mean significant increases in competitiveness for businesses, but also the possibility for the more disadvantaged groups in the society to call their relatives living abroad. The international long-distance prices in developing countries with fully competitive markets, like El Salvador, match the price of a local call. 15 First, the dynamics of incoming and outgoing traffic depend on income, on the degree of competition among two countries, on trade patterns and other factors which are difficult to capture in a statistical model. Second, official statistics often do not capture the growth of unlicensed carriers which use various means of bypass for both incoming and outgoing calls. Some examples are call-back, refile, “directs” , leased corporate WANs. These methods use both TDM and VoIP technologies and often elude official statistics, posing additional measurement issues. Third, there is a time lag between the introduction of competition and the impact on volumes, due to cross country differences in demand elasticity, lack of capital available for the newly licensed competitors, or obstructive behavior from the incumbent operator. Fourth, the introduction of “full competition” has several characteristics that differ among countries (such as the presence or not of carrier selection), that might influence the services demand.

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Figure 7. Chile: Incoming and Outgoing Traffic Booms with the Introduction of Competition

0

50

100

150

200

250

300

350

400

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002*

Chile: Increase in international trafficTotal minutes (in millions)

Incoming

Outgoing

Source: Subtel * Estimate

Multicarrier system

0

50

100

150

200

250

300

350

400

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002*

Chile: Increase in international trafficTotal minutes (in millions)

Incoming

Outgoing

Source: Subtel * Estimate

Multicarrier system

Countries that retain a monopoly will attract less network investment and be excluded from the development of international backbone networks. In terms of investment, the share of new investment from competitors over total investment in telecommunications is increasing. Countries that are opening their markets to competition are attracting more investment (Hausman and others, 2003). Introducing competition is a better way to integrate the country with the development of regional high bandwidth networks. This has been the case in the EU, where a common liberalized framework allowed the development of pan-European networks. Thanks to a common, pro-competitive regulatory framework peripheral and lower income regions of Europe have been reached by high-bandwidth, pan-European networks, such as in Estonia, Hungary, and Poland. Liberalization benefited peripheral regions of Europe (Berben and Clemens,1995) and led to higher transparency and better governance. This is due to the fact that when other carriers or investors buy into an incumbent at privatization, they demand increased accountability and transparency. The implementation of a common regulatory framework, allowing for full competition, for the accession countries in Eastern Europe allowed operators of pan-European networks to extend their presence in Estonia, Hungary, and Poland and to reach these countries with high bandwidth networks. Liberalization contributed to the growth of local operators.16

16 An important example of this development is the growth of the operator Tiscali, now one of the strongest ISPs and alternative network operator in Europe, which originated from a peripheral region of Europe (the island of Sardinia), and developed as a Pan-European operator, including networks points of presence in Hungary and the Czech Republic. Another example is the operator Telia International Carrier which has a 22,000 km. Network linking 25 cities in Western Europe, with PoPs in the Baltic countries, Czech Republic, Hungary, Poland, and Russia. GTS has a network of over 22,000 km covering all major Western European cities, with PoPs in the Czech Republic, Hungary, Poland, Romania, Russia, and Ukraine. (IDATE, 2001)

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CHAPTER 2. THE PUSH FOR COMPETITION The Benefits of Full Competition Compared with gradual liberalization, full competition results in lower prices and related welfare gains. Figure 8 illustrates that international call charges in fully competitive markets can be as low as one-third the prices in partially competitive markets.

he average consumer in Texas saved 23 percent on her long-distance bill as a result of

50

same

addition, full competition requires less regulatory intervention than partial competition,

he

st, in

$5.15

$2.33$1.78

$0 $1 $2 $3 $4 $5 $6

Partially competitive markets

Fully competitivemarkets (developing

countries)

Fully competitivemarkets (all available

countries)

Average price of 3 minute call to USby market structure (in US$), 2001

Source: ITU

Figure 8. Partial C ompetition O ffers Partial Results in Price Drop

Tincreased competition (Hausman, et al.,2002). Similar results are obtained in developingcountries. In Chile, following full opening of international services to competition in 1994, the weighted average call charges to major destinations by 1998 had declined bypercent, compared with a similar basket in 1991, under limited competition. Traffic also increased fourfold to 215 million minutes. This resulted in an estimated consumer surplus of about 125,000 million pesos ($275 million) in 1994 to1998. This is approximately 2.7 percent of total revenues from the major operators during theperiod. Inreducing the administrative burden for the government and operators, and limiting the opportunities for corruption. The partial competition model is based on regulatory barriers to entry. Examples of these barriers to entry are the presence of numeric restrictions on the operators in the market and the asymmetric treatment between tincumbent operator and competitors. For example, in a partial competition environment, the government needs to spend time and resources to decide when to further open the market and when to allow carrier preselection. Operators need to spend resources lobbying the government to maintain or remove regulatory entry barriers. In contraa fully competitive environment all operators meeting standard, objective criteria, are

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allowed. This reduces all costs considerably. It also reduces the opportunities for corruption, especially in environments with weak governance. Driving Forces Competition in international communications has been driven by globalization of economic activity, technological change, and international trade (see Figure 9). Figure 9. Driving Forces and Sector Change

Sector policy reform

Many more players

Increased competition

Less distinction between users and

providers

Aggressive search for new business

Development of worldwide market

Source: Adapted from Wellenius and others (1989)

Globalisation of economic activity Globalisation of economic activity progress

Technological

Many more players

Increased competition

Less distinction between users and

providers

Aggressive search for new business

Development of worldwide market

International Trade System

- Driving Forces and Change Sector

Growth in the movement of goods, people, and capital across national borders has increased the demand for low-cost, high-quality international communications. Key technological progress occurred at the same time in the telecommunications industry, notably the emergence of Internet protocol (IP) telephony, which enabled the provision of international communications at a much lower cost. Also, reducing barriers to trade in goods and services increased integration of economic activity. In this context, telecommunications services became fundamental enablers of trade, and a crucial input for export oriented companies. They became more prominent in the overall global trade agenda. International institutions such as the WTO and the World Bank, and other relevant players like the EU and the (US) Federal Communications Commission have promoted market-based reform to the provision of telecommunication services. Globalization of economic activity. Globalization of economic activity increased the demand of international telecommunications services. Trade in goods increased from 33 percent to 40 percent of world GDP from 1990 to 2001 (World Bank, 2003b.). Mobility of people increased as well. From 1995 to 2000, about 11.6 million people migrated

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from developing to developed countries (UNPD, 2002). Foreign labor in the US increased from 19.7 million people in 1990, to 28.4 million people in 2001 (World Bank, 2003b.). Movement of labor increased demand for international calls, especially by poor migrants from developing countries. The last decade also saw an increase in cross-country financial transactions. On a global scale, foreign direct investment (FDI) grew from $203 billion in 1990, to $746 billion in 2001, with FDI of middle income countries increasing from $21 billion to $162 billion gross, as a percentage of GDP increased from 2.7 percent to 5.1 percent (World Bank, 2003b). Globalization requires high-quality and low-cost communications, to promote better access to markets, to increase economic integration and global competitiveness. For example, in Lithuania, the high international charges are identified as a bottleneck to the development of a knowledge economy, and as a constraint for regional and international integration (World Bank 2003). Tunisia’s high charges are also identified as a disadvantage to developing export-led telecommunications intensive services, such as call centers and electronic delivery of software (World Bank, 2002). Low-cost, high-quality international communications networks are a prerequisite for the development of high-growth, information communication technologies-related (ICT) services (World Bank, 2002) are also considered key to the success of national trade facilitation policies (Schware, R. and Kimberly, P., 1995), and for the development of electronic commerce (Schware, R. and Kimberly, P., 2000). High quality-low costs communications could only be effectively provided in competitive markets. Several studies (Dökmeci, V. and Berköz, 1996; Rossotto, C.M., Sekkat K. and Varoudakis, A., 2003) found that the introduction of competition in international communications lowers the input costs for firms (lower cost of international calls, access to global data networks), and spurs productivity gains (better integration in the client-supplier chain). These two factors improve the competitiveness of export-oriented firms and stimulate economic growth. Therefore, firms in their search to expand globally, have pushed for competition in international communications around the world. Technological change. Technological change reduced network costs and increased their capacity. Until the beginning of the 1980s, the cost of transmitting a telephone call was particularly sensitive to the distance and to traffic volume. With the advent of digital technology, the capacity of existing wire networks was substantially increased. The introduction of optical fiber enabled transmission capacity to increase 100-fold in the period 1955 to 1985 (Figure 10). Capacity is expected to increase by a factor of 1,000 before 2005. At the same time, major intercontinental submarine cables reduced the cost of a single circuit by a factor of 10,000 since 1995 (Saracco and others, 2000). Progress on transmission side was coupled with switching improvements, a multiplicity of technological options for reaching end customers, and the emergence of IP-based networks. The development of IP-based services over increasingly broadband wireless connection to customers is expected to further revolutionize cost structures and business models.

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Figure 10. Higher Transmission Capacity at Lower Cost

Source: Saracco and others (2003)Source: Saracco and others (2003)

Telephony through IP-based networks17 contributes to competition, through lower investment and operating costs, and by opening alternatives to traditional technical and commercial solutions, often outside the traditional accounting rate system.18 Prices for wholesale international long-distance calls through IP networks cost 30 to 50 percent less than using traditional networks and commercial arrangements. Most of the major international carriers have announced plans to increase their international voice traffic through IP networks. IP has increased dramatically since its adoption. As shown in Figure 11, if the current traffic growth trend continues, by 2005, about 45 percent of the total traffic could be carried through IP-based networks (Telegeography). 17 The development of Internet technologies and the increase in bandwidth capacity permits the transport voice communications in a more effective and reliable manner. Voice traffic is converted into coded small data packets that travel through the Internet network to a specific destination, where it is converted into voice stream. Although it is usually difficult to notice if a call is being carried by IP or by traditional switched-networks, some countries have allowed IP-based international traffic with the condition that it does not cross a quality threshold that is near to the quality of a circuit-switched voice call. 18 The “accounting rate” regime is a commercial arrangement among companies jointly providing international services. The providers negotiate with each other a nominal rate of call charges, unrelated to cost and usually well above it, which is generally divided equally among the participating providers. This arrangement worked reasonably well when services were provides by monopoly providers in each country, but is increasingly out of favor in competitive markets. Despite successive modernization attempts, the accounting rate regime still results in user prices which are well in excess of cost. Carriers using IP telephony do not usually follow accounting rate regime, thereby substantially reducing cost.

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Figure 11. Growth of International Traffic Through IP

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

1997 1998 1999 2000 2001 2002* 2003F 2004F 2005F

International traffic through IP is growingInternational minutes (in millions)

Source: Forecast using Telegeography data * estimate F forecast

IP

PSTN

The largest share of IP voice traffic terminates in developing countries, where the cost of switched-networks is relatively higher. For example, from the total traffic originated from the US, only four of the top 10 traffic destinations are developing countries; whereas nine from the 10 top IP voice traffic destinations are developing countries. In 2001, East Asia, Eastern Europe, and Latin America were the primary destinations of global IP voice termination (Telegeography). The international trade system. The establishment of an international trade system promoting increased economic integration was a major driver for the introduction of competition in international communications. The WTO framework has played a key role in pushing for competition in international long-distance as a way to increase trade in services (Sherman, 1998 and Blouin, 2000). This has unfolded along three directions. First, through negotiations under the WTO, countries that have liberalized—such as the US and the UK—pushed for liberalization of the market in other countries. Early reformers have sought the deregulation of the telecommunications sector of their commercial partners.19 Second, once countries commit to open their markets under the WTO framework, the have a legally binding obligation that has precedence over national law, strengthening the credibility of their commitment, as showed by several authors (Sherman, 1998; Schwartz and Satola, 2000; Blouin, 2000; Intven, 2000). Third, in the process of accession to the WTO in telecommunications, countries commit to adhere to the General Agreement on Trade in Services (GATS) fundamental principles

- 17 -

19 The US also promoted the inclusion of services in the Uruguay Round under the GATS, which contains a special annex dedicated to telecommunication services.

(nondiscrimination, transparency, and reasonable regulation and competition safeguards) and, often also adopt the Reference Paper of the Negotiating Group on Basic Telecommunications (24 April 1996). These principles introduce regulatory requirement that are important to implement full competition, as indicated in Chapter 4 (Schwartz and Satola, 2000; Intven, 2000; Rossotto, 2003). In the WTO framework international communications is not considered a market segment per se, but it is implicitly included in the services sectoral classification list, which constitutes the basis for countries to formulate telecommunications commitments. Under the WTO framework, introduction of competition means both “facilities based,” and “services” competition. Countries that commit to introducing competition in telecommunications services within the WTO framework accept to introduce competition at network operator level and not simply resale (unless specified in the offer). Countries negotiate specific commitments to liberalise the sector. Some of the countries that have partial competition in international communications have included certain restrictions to their schedules of commitments. There are countries (e.g., Morocco) that have committed to open their international market to competition under the WTO agreement, but then limited the number of operators to two. Other countries had restrictions to competition in international communications in their WTO telecommunications offer (for instance, Hong Kong, China), but then opted for full competition. The importance of the WTO framework to introduce competition is also supported by the fact that the only dispute case in the telecommunications sector (US vs. Mexico), relates to the provision of international services. At a regional level, the EU also recognized the importance of telecommunications reform as a driver for increased economic integration and free movement of goods, services, and people. The EU introduced competition in international communications among its member states, and requires the introduction of competition as a condition for EU accession countries. In this way, European countries were exposed to an institutional model based on free entry and competition. Worldwide Experiences of Market Opening The push for competition has led policy-makers in the US, Europe, and in selected developing countries, to establish principles and rules of an open and competitive market for international voice communications. The US as a precursor of sector regulatory reform, and one of the biggest markets for international communications, is one of the most influential proponents of sector reform. The EU has also played a key role by fully liberalizing its international voice communications market in 1998, and requiring new accession countries to open their markets as a prerequisite to gain membership. One notable case among developing countries is Chile—now considered one of the best examples of how to introduce full competition effectively and reap the full benefits of reform.

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Following these early liberalization efforts, many countries have introduced competition. In their process to open the market, some countries have retained regulatory restrictions to market entry. As a result, with respect to international communications, regulatory frameworks can be broadly included in three groups: full competition, partial competition and protection of the monopoly. Table 4 shows the main regulatory features of full competition, partial competition and monopoly. Annex 3 discusses the experience of the EU, US, and selected developing countries.

Table 4. Main Regulatory Features of Full Competition, Partial Competition, Monopoly in International Voice Communications

Full Competition Partial Competition Protection of the

Monopoly Restrictions on the number operators in the market

No restriction The government determines how many operators are allowed in the market

Only one operator

Nature of the license(s)

Class license or authorization

Individual license License protecting the incumbent operator

Competition at network operator or service provision level

Competition at both levels, network operator and service provision

Competition limited to resale (service provision level) or to “own customers”20

No competition at either level

Investment requirements

None Investment obligations in addition to the international gateway

Not applicable

Fair competition thresholds

Regulatory asymmetry in favor of new entrants

Regulatory asymmetry in favor of the incumbent

Not applicable

Carrier selection Yes No Not applicable Technological neutrality and VoIP

Technologically neutral licenses; VoIP allowed or not regulated

Technology specific licenses; VoIP often prohibited

VoIP prohibited; government efforts in enforcing prohibition

Limits on foreign ownership of international communications operators

None Yes Not Applicable

Interconnection Clearly defined in the regulatory framework, transparent, non-discriminatory, cost-oriented

Flaws in the interconnection regime

Not applicable

20 For example, in Morocco, the second GSM operator has the right to offer international services to its own final clients. It cannot terminate international traffic originated in other networks.

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CHAPTER 3. THE RESISTANCE TO COMPETITION Notwithstanding the benefits and track records of developing countries that have successfully implemented full competition in international voice communications, policy makers in some developing countries resist the introduction of competition. Annex 1 shows the geographic and income-level characteristics of countries resistant to full competition. Policy makers opposed to full competition present the following arguments: the lack of institutional capacity to implement reform, the fear of undermining the sustainability of the incumbent operator, and the fear of losing fiscal revenues and control. In addition to these three sector arguments, liberalization is constrained by political economy reasons and by corruption, and nepotism.

Figure 12. Reasons for Resistance to Competition

Lack of Institutional Capacity A minimum legal and regulatory framework and institutions need to be in place to support sector reform. Chapter 4 shows the key regulatory requirements to enable the introduction of competition. Developing countries maintain, and private sector investors confirm, that developing countries often lack the technical, legal, business practice, and regulatory capacity to enable reform. Furthermore, full liberalization poses a lighter burden than gradual opening. Lack of institutional capacity should not be an excuse to postpone competition. There is ample experience, including from some of the poorest developing countries, that confirms that these minimum requirements can be met at an

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early stage. Some of the regulatory rules and decisions, for example, can be embedded in operating licenses and contracts.21 Fear of Undermining the Sustainability of the Incumbent Operator A common reason for hesitating to introduce competition in international voice communications is the desire to protect the incumbent operator. The opposition to introducing competition is usually supported by officials (who are concerned about continuity of service) of the ministry in charge of telecommunications, and by the managers of the incumbent operator. Staff are concerned about possible threats to continuity of employment, and levels of remuneration. The argument is that a rapid shift to a fully competitive market would reduce drastically the revenues and profits of the incumbent operator, compromising its financial viability. A related concern is that, in this event, subsequent privatization would be more difficult. However, international experience shows that that incumbent operators can successfully adapt to the changing conditions in the telecommunications market following the introduction of competition in international voice communications. None of the 65 countries in where full competition has been introduced has seen a bankruptcy of the incumbent operator. Competition in international voice communications, through the radical changes it provokes, does change the revenue structure of the industry. It forces the incumbent operator to operate with higher efficiency and transparency, and implement a new pricing structure that is aligned to real costs. Furthermore, competition induces major changes in the business model of telecommunications operators. Boxes 1 and 2 show how BT and Telekom Malaysia (successful incumbent operators in a liberalized environment) have implemented changes to adapt to the new market environments.

21 Smith and Wellenius, 1999.

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Box 1. BT: Effect of Competition on Financial Results A good example of the effect of competition on the on the financials of an incumbent operator is the case of BT. Until the mid-1980s, BT was a monopoly. Revenues from international accounted for 40 percent of total BT revenues. When limited competition was introduced, revenues from international declined to represent 14 percent of BT revenues. In the same period, the market share of BT fell to 67 percent. When full competition was introduced in 1996, the international revenues fell to represent 8 percent of BT’s revenues, and BT’s market share fell further to about 40 percent. This forced BT to change. While BT’s international revenues were declining in relative and absolute terms, BT was able to increase its turnover in higher growth activities, such as mobile communications, which grew from 5 percent to 8 percent of overall turnover, and business services, such as data and corporate solutions. BT also increased its foreign presence. Business services and revenues from foreign acquisitions represented around 20 percent of BT’s revenues in 1999. Interconnection revenues from competitors grew to 4 percent of turnover. As a result of the success of BT in changing its revenue structure and business model to face competition, overall revenues grew by 31 percent, and the Profit After Tax (PAT) went from £1,736 million to £3,002 million, a 73 percent increase. The ratio PAT/sales improved from 12.5 percent to 16.5percent. Far from provoking the incumbent operator into bankruptcy, competition in international voice communications stimulated change and forced the enterprise to react to the new market forces.

Pre-

competition Post-

competition

Pounds m. 1995 Revenue Share

(%) 1999 Revenue Share (%)Inland calls 4,941 36 5,178 28 International calls 1,935 14 1,501 8 Subscription 2,534 18 3,337 18 Private circuits 1,024 7 1,165 6 Interconnection 0 645 4 CPE supply 1,041 7 870 5 Mobile 657 5 1,400 8 Directories 371 3 491 3 Other (business services + foreign) 1,390 10 3,636 20 Total 13,893 18,223 Markets share in international (%) 67.7 39.7 Stock price (pence) 352 1,459 Profit after tax 1,736 3,002 Profit after tax/sales (%) 12.5 16.5

Source: Analysis of data adapted from www.bt.co.uk

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Box 2. Telekom Malaysia: Adapting to a Competitive Environment

A good example from a developing country is the introduction of competition by Telekom Malaysia in 1996. In 1997, the market share of Telekom Malaysia on the international voice communications market was 80 percent. In five years it decreased to 54.7 percent. In 1997, Telekom Malaysia was enjoying monopoly profits. In that year, it realised RM1786.4 of PAT, on a turnover of RM 6796, a 26 percent profit/sales ratio. Also in this case, competition in international voice communications forced the operators to change. Telekom Malaysia successfully diversified its revenue sources. In particular, the development of data and Internet services, a high growth segment, contributed to sustained revenues. I n 2001, five years after introduction of competition in the international voice communications market, Telekom Malaysia’s turnover increased to RM 7909. Also in this case, the incumbent operator was far from bankrupt, achieving RM 858.6 PAT, in a difficult year for telecommunications and technology companies worldwide. Its PAT/sales ratio decreased to 11percent, a value more in line with telecommunications companies operating in a competitive environment.

Pre-reform Post-reform

RM 1997 2001Turnover 6796 7909* of which Internet and data 208.5 1152PAT 1786.4 858.6PAT/sales 26% 11% Market share in international 67.7% 54.7%Source: Telekom Malaysia annual reports, available at: http://www.telekom.com.my/corporate/intro.php

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The examples of Telekom Malaysia and BT have common features. Competition in international voice communications stimulated change in the incumbent operator. The key to this chance was flexibility and diversification. Competitive pressures in the international voice communications segment created incentives for the incumbent operator to launch new services. This benefited the consumer as well as the financial health of the company and the country. Both operators were able to maintain financial profitability, and the state was able to collect additional revenue. While flexibility and diversification were keys to the success of BT and Telekom Malaysia, there are also incumbent operators that rely solely on revenues from international termination services for stable revenues. Examples are UTEL in Ukraine and FINTEL in Fiji. For these companies, the immediate impact of competition in international voice communications will be stronger. When full competition is introduced, a steep decline in turnover and profitability is to be expected as rates fall to the level of the global competitive market. A decrease in revenues from international call termination is already taking place, even if the monopoly is de jure maintained. Refile, “country direct services,” reorigination, call-back, and other means of bypass are gradually eroding revenues. In the case of diversified incumbent operators, and of incumbent operators that specialize in international voice communications, the fear of a financial upset is not a reason to hold the sector hostage to outdated business models and pricing structures. It is good practice, however, to ensure that incumbent operators have the tools to react, if change is the key to adapting to the introduction of competition. Both in the case of BT and Telekom Malaysia, operators had the chance to diversify and adapt their business. It is crucial that this opportunity be used by incumbent operators in developing countries. Capacity building in revenue diversification, setting and adapting to changes in the pricing structure and training in competitive, open business practices might facilitate the transition to an open and competitive market. Fear of Losing Fiscal Revenues and Control In countries with a state-owned incumbent operator, competition reduces government control over a major source of fiscal revenues. Under monopoly conditions, the incumbent operator bills customers for international calls; these revenues go the state budget through the dividend policy in place with the incumbent operator (if corporatized), or directly to the state if telecommunications operations are run through a government department. In cases where the country is a net recipient of international accounting rates settlements, the operator collects settlements revenues. This is often a substantial source of foreign currency. The introduction of competition brings changes to both channels of revenue collection. First, the introduction of competition brings new private operators into the market. The state has an indirect control over the revenue collected by the new operators, typically through sales taxation. Second, the new operators (both in the originating and in the

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destination country) bypass the traditional settlement rates system, therefore reducing the amount of revenues received from the state. The net effect of these changes depends on a series of parameters, including: the dividend policy before competition, the rate of value-added tax, the market share of the incumbent in a liberalized market, the settlement rate, the fees from the award of new licenses, and the elasticity of demand. If international voice communications competition is isolated from the rest of sector reforms, there may be cases in which the impact of competition on revenue collection are negative in the short-term. The introduction of competition, however, does not necessarily or sufficiently lead to loss of revenues. As illustrated in the examples of BT and Malaysia Telecom, when reform is undertaken, appropriately and with flexibility, revenue channels are redistributed and total revenues remain comparable or may increase. It is unlikely that the government could, in any case, continue to collect monopoly rents as bypass, even if illegal, is eroding the revenue base. High charges for international voice communications provide an incentive to bypass the system, through call-back, cyber cafes, refile or “directs” using VoIP and public switched telephone network (PSTN) technology. The revenues originated from these operators are more difficult to tax. Therefore, this causes a natural erosion of the tax base. High international voice communications charges provide incentives to originate the call outside the country. Since the FCC decision to apply lower benchmarks on settlement rates, the use of settlement rates as a fiscal instrument is constrained, and has thus driven down the settlement prices. This will harm countries that still rely on settlement revenues as a source of hard currency. For example, in Myanmar settlement revenues are estimated to constitute between 7 percent and 13 percent of government budget revenues. The introduction of competition opens the market to all players, thus capturing more transparent revenues for taxation. In most cases, the reluctance to lose control is not justified and originates from a short-term view of fiscal contributions. Telecommunications reform, in some cases may actually increase fiscal revenues. Annex 5 shows scenarios where fiscal revenues grow as a consequence of competition, and scenarios in which they decrease. Countries with a state-owned monopoly operator have high international charges and low telecommunications investment per capita. The monopoly rent, therefore, is used mainly to satisfy fiscal needs. For example, in Myanmar a three-minutes call to the US costs more than $23.00, and the investment per capita is 0.1$. In contrast, countries with full competition in international communications have cheaper international charges, and a high investment per capita. For example, in El Salvador, under full competition, the cost of a three-minute call to the US is $1.23, and the investment per capita is in excess of $25.00.22 22 Other countries researched, such as Costa Rica, Gabon, and Lebanon have noncorporatized incumbent operators and a high surplus in minutes per capita. Other data required for this analysis were not available.

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Political Economy Reasons The configuration of interest groups in given political structures influences whether a country privatizes and liberalizes its telecommunications sector (Li and Xu). Policies arise either as a result of competition among interest groups in a democratic society or as a result of politicians pursuing their private interests subject to institutional constraints. More democratic countries with stronger presence of pro-reform interest groups, such as the financial sector and urban consumers, are more likely to privatize or liberalize the telecommunications sector. Less democratic countries are more likely to retain higher state ownership when such a governance mode yields a higher payoff for the governments, for example, when their fiscal deficits are high. Furthermore, in the more democratic countries, the voices of interest groups appear to affect the pace of telecommunications reforms (Li and Xu). In some countries, powerful political forces are opposed to reform. Table 5 provides examples of the beneficiaries of reform and those of the status quo. The beneficiaries of the status quo are few and therefore benefits are concentrated. The beneficiaries of the status quo, such as the incumbent operator, are a well-organized political constituency, often capable of capturing the ministry responsible for telecommunications and the ministry of finance.23 On the other hand, the beneficiaries of reform are many; they comprise a large consumer and enterprises base, thus, the benefits are diffused. The beneficiaries of competition in international voice communications, such as consumers and enterprises, usually do not find an adequate way to voice their interests. As many studies indicate, where benefits are diffused among many beneficiaries, those beneficiaries find it more difficult to organize themselves into pressure groups.24 Therefore, in monopoly situations, there is often no organized constituency, or a weak one, working towards introducing competition in international voice communications.25.

23 Smith, P. L., 1995. 24 Olson, 1971. 25 In some cases, the independent telecommunications regulator and the trade ministry can act as a catalyst for reform, and counterbalance the power of the incumbent telecommunications operator.

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Table 5. Pro-reform Actors Need a Stronger Political Voice

Pro-reform Actors (demand side of reform) Status Quo Actors • Consumers, often underrepresented • Urban consumers who may cross-subsidize

rural access • Rural consumers who may benefit from post-

competitive rural rollout • Enterprises, often not organized in pressure

groups • Small operators, without lobbying means

Private sector competitors e.g., VoIP and call-back operators

• Independent regulators, often with inadequate means

• Ministries of trade, to comply with WTO commitments and facilitate trade and exports

• Politicians facing a debt crisis and looking for benefit of ownership shares and licenses

• World Bank, WTO, EU, US FCC, IMF, to foster economic development and reduce poverty

• Incumbent operators • Risk or change-averse staff in fear of losing

employment and salaries • Political leadership • Trade unions • Major global carriers that enjoy exclusivity

in international voice communications in the market

• Sector ministries, in fear of losing political power

• Ministries of finance, for fear of harming fiscal revenues, especially in countries where there are difficulties in raising sufficient taxes from other sources

• Low income consumers who may lose subsidies after tariff rebalancing

• Politicians able to extract rents in status quo regime

The resistance to competition in international communications is higher than the resistance to reform in other segments of the telecommunications market. This can in part be ascribed to international voice communications licenses not being associated with large “price tags,” unlike licenses in the cellular segment. In the case of privatizations and sale of cellular licenses, an expectation of large proceeds provides incentive to respond to beneficiaries of the reform process, e.g., potential competitive operators, officials in the ministry of finance. The prospect of privatizations and sale of licenses is also a catalyst for international investors to enter the arena, a group that is able to add pressure to implement reform. Small- and medium-sized operators, beneficiaries of the introduction of competition in international communications, normally do not have the means to exert political pressure.26 Some exceptions exist, for instance, in India, competition in the international voice communications market was introduced due to the pressures of software and information technology export-oriented companies, whose management complained about the high cost of international voice communications. In this case, reform was linked to the organized lobbying effort of users groups pointing to the high cost and inadequate quality of international voice communications as a constraint to growth and development. High communications costs were hindering the capability to provide real-time IT assistance and electronic delivery of software (EDS).

26 Competition in international communications is usually introduced after the general sector reform process has started. For example, competition in international voice communications in Africa and the Maghreb followed the introduction of cellular market competition. Newly established cellular operators exercised political pressure to obtain an own international gateway.

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In the absence of strong, politically organized local advocates of competition, proponents of competition in international voice communications are often organizations outside of the domestic political system.27 Unless the stakes go beyond telecommunications (e.g., when reform is needed for accession to the EU or to the WTO), it is unlikely that external political pressure alone brings reform. Since change is a political process, good regulatory governance and economic freedom are increasingly identified as a key factors for the success of sector reform.28 In the paper and database “Governance Matters: Governance Indicators for 1996-2002”, Kaufmann, Kraay, and Mastruzzi rank countries on the basis of several governance indicators.29 One of them is voice and accountability, in itself a composite governance index showing how local enterprises can publicly express concerns and have a voice in the political process in different countries. The voice of the enterprise is one of the indicators considered; others include an assessment of civil liberties and freedom of the press. Out of a sample of 20 countries (10 with a monopoly in international voice communications and 10 with competition) the countries that ranked highest in terms of voice and accountability offer competition in international voice communications. The eight countries that ranked lowest—those that constrain the political rights of enterprises and others—retain a monopoly in international voice communications. Of the 10 best performing countries in terms of voice and accountability, nine have competition in international voice communications.30 All of these are ranked higher than the world average.

27 For example, the EU exercised positive pressure in introducing competition in the ECA region, especially for accession countries. Eastern Europe has seen several countries introducing competition in international voice communications, with the price of international services decreasing dramatically. The US FCC 1997 Benchmarking Order determined a price cap on settlement rates that US operators should pay to foreign operators for terminating US traffic. According to the FCC and several authors, this decision also acted as a stimulus for developing countries to reduce their costs of international voice communications and implement reform (Stanley, K. 2000; for a different perspective, see also Melody, W. H., 2000). The reduction of settlement rates forces a change in the domestic telecommunications sector, reducing the reliance of the incumbent operator, and of fiscal authorities, on settlement revenues. In other cases, the proponents of reform have been international organizations, such as the World Bank and the WTO. 28 Gutierrez, L. H., and Berg, S., 2000; Varoudakis A. and Rossotto C. M., 2003 29 The authors (Kaufmann et al) recognize that there are margins of errors and therefore the rankings can be subject to a certain variation. Another corruption index, published by Transparency International, is available at http://www.transparency.org/cpi/index.html#cpi, while another index discussing corruption and the voice of the enterprise, the Global Economic Competitiveness Index published by the World Economic Forum/Harvard University, can be found at http://www.weforum.org. 30 Malysia is the only country outside the top 10 that has full competition in international voice communications, which, however, has an overall good ranking, being ranked number 12 in the sample. See also Gutierrez, L. H., and Berg, S., 2000.

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Figure 13. Countries with Limited Economic Freedom Face More Obstacles to the Introduction of Competition

orruption and Nepotism

he rent associated to a monopoly in international communications results in the d Xu’s

, their

,

or oligopoly status. This phenomenon has been described as “state capture.”32

Voice of Constituencies and Reforming International Long Distance

Competition

Competition

Competition

Competition

Competition

Competition

Competition

Monopoly

Compet itio n

Compet itio n

Monopoly

Compet itio n

Monopoly

Monopoly

Monopoly

Monopoly

Monopoly

Monopoly

Monopoly

Monopoly

C Tconcentration of large sums of cash, often in foreign currency, in few hands. Li anstudy mentioned above elaborates that if ruling politicians in less democratic societies face less political competition, they enjoy more discretion to choose policies that maximize rents or corruption proceeds, or further their private interests. Howeverability to extract rents may be limited if there are conflicts of interest among different groups of politicians, for example the ministry of finance and the telecommunications ministry, which create a more competitive environment for policy-making. In this casethe configuration of these groups of politicians may affect telecommunications policies inways that are similar to the interest-group politics in more democratic societies.31 On the other hand, while corruption in the typical sense involves paying a government official for personal gain, a form of corruption involves individuals, groups, or firms both in thepublic and private sector illicitly providing private benefits to public officials and therebyinfluencing the formation of laws, regulations, decrees, and other government policies to their own advantage. Powerful local interest groups, such as incumbent operators or private sector companies, may offer funds for legislation that benefits their monopoly

- 29 -

31 Li and Xu, p. 443

s, D. Kaufmann, and M. Schankerman (2000), p. xv 32 J. Hellman, G. Jone

Figure 14.

Competition

Compet itio n

Monopoly

Monopoly

Competition

Competition

Monopoly

Monopoly

Compet itio n

Compet itio n

Monopoly

Monopoly

Monopoly

Compet itio n

Compet itio n

Compet itio n

Compet itio n

Monopoly

Monopoly

Controlling Corruption and Reforming International Long Distance

Monopoly

Controlling corruption and reforming international voice communications are important in goals. A second indicator of governance introduced by Kaufmann, Kraay, and

. ffer

ar

portant factor in alleviating corruption in the lecommunications sector. In Sri Lanka, for example, petty crime was reduced, arguably

ion in

twMastruzzi in their governance study addresses governments’ efforts to control corruptionIn this case, among the 20 countries with the highest anticorruption standards all 20 ofull competition in international voice communications. Of the 20 countries with the lowest anticorruption standards according to this data set, only five offer full competition (see Annex 2). In the chosen sample of countries, countries with competition in international communications tend to have an higher ranking in terms of anticorruption efforts. While a direct correlation is difficult to certify, private sector operators’ wstories provide anecdotal support. Introducing full competition is an imtesince competition caused the incumbent operator to tackle inefficiency, waste and corruption, or face losing its customers.33 However, competition alone is not sufficient in alleviating corruption. A study by Ibarguen shows that in Guatemala, full competitaddition to good licensing were complementary agents for increasing transparency and reducing corruption in the radio spectrum liberalization process.34

33 Samarajiva, 2001, p. 79, 81 34 Ibarguen, p. 543

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The World Bank Group has a role to play in all of these important concerns. For example, it offers policy advice in the following areas:

• Operating in a competitive telecom business model • Managing change of revenue composition • Investment climate issues

rruption/nepotism The re statistically significant influence of W r tate ownership

are and the study’s competition index in the telecommunications sector.35

• Civil society and organized consumer groups • Governmental transparency and fighting co

p viously mentioned study by Li and Xu found ao ld Bank telecommunications sector projects in raising the nons

sh

35 Li and Xu, p. 453

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CHAPTER 4. FULL COMPETITION: REQUIREMENTS FOR SUCCESS This paper has argued that opening international communication to competition plays a key role in reforming the telecommunications sector, is sustainable in developing countries, and results in major gains to consumers, business users, and the economy overall. It has made the case for opening these markets quickly rather than gradually. The transition from monopoly to competitive provision of international services, however, needs to be preceded or accompanied by actions along several related directions:

• Establish a licensing regime that allows new entry without quantitative limitations, subject only to general requirements applicable to all public telecommunications operators and commercial enterprises. A class license may facilitate, expedite, and enhance transparency of the process of authorizing new entrants.

• Implement a system where the user can select the international operating

company for each call. • Put into place the basic elements of a credible interconnection regime that is

consistent with internationally accepted principles. This includes elements of sector legislation, implementing regulations, default terms and conditions of interconnection, and a core institutional capacity to monitor, enforce, and adjudicate on interconnection rules and agreements.

• Establish the principles and rules for fair competition and a core institutional

capacity to monitor, investigate, and act against anticompetitive behavior. In countries where a general competition law and effective enforcement capability is not in place, these functions must be incorporated in the legal, regulatory, and institutional framework of the telecommunications sector.

• Rebalance the incumbent’s tariffs bringing them closer to the industry cost

structure, establish the means to regulate prices in areas where there is not enough competition, and develop a strategy and financing mechanism to extend services beyond the market when required for social or other development reasons.

• Free the incumbent to adjust its business strategy and practices along fully

commercial lines as needed to effectively face growing competition. This generally requires the incumbent to be established under company law and is enhanced by the participation of private capital and management, and by training staff in new technical and commercial skills (such as contracts, collection and billing practices).

This is a tall order, and it means that competition in international services is not a panacea. The conditions necessary for successful implementation are no less important

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than those required for overall sector reform. In Chapter 5 we examine in more detail the issues and options involved in creating some of these necessary conditions for effective competition in international communication. Interconnection and International Accounts Interconnection is the most important determinant of a successful transition from monopoly to competitive telecommunications markets. Internationally accepted principles for interconnection in competitive markets have been adopted at global and regional levels. Putting in place the basic elements of a credible interconnection regime that is consistent with these principles is a key precondition for effective competition in the provision of international services. The interconnection regime designed for competitive environments, coexists, however, with the remains of the accounting rate regime that was developed in the context of national monopolies and is still in use. Moving decisively to an interconnection regime for international communication is necessary for successful development of this market segment and to enhance its impact on sector reform and economic development overall. Interconnection enables new entrants to reach customers initially connected only to incumbent dominant operators. Interconnection also gives operators choices between developing their own infrastructures and facilities or paying to use those of others, thus reducing barriers to entry and enhancing overall network efficiency. Technical issues, such as the number and specification of the points where networks interconnect, tend to be resolved more readily than commercial issues, especially prices. The trend is for interconnection to be treated as a commercial matter between the interconnecting parties. It is often necessary, however, for the regulatory authority to provide guidelines for such negotiations, intervene when the parties fail to agree, and require operators with market power to publish standard interconnection offers approved by the regulator that apply in the absence of agreement.36 In 1997, the WTO Agreement on Basic Telecommunications was the first widely recognized multilateral treaty to include binding rules for interconnection. Fifty-seven countries, accounting for at least 70 percent of international traffic, committed to the Reference Paper in which these rules are defined, and more countries have followed.37

36 An annotated selection of papers, case studies, and websites dealing with interconnection can be found at http://rru.worldbank.org/. 37 The Fourth Protocol of the General Agreement on Trade in Services (usually referred to as the Agreement on Basic Telecommunications), negotiated under the auspices of the WTO in February 1997 and signed by 69 countries, became effective on 1 January 1998. The Reference Paper is an informal text containing regulatory principles negotiated among WTO members, contained in an annex to the Fourth Protocol. The Reference Paper became legally binding on 57 WTO members that attached it as part of their ‘additional commitments’ in their GATS Schedule of Commitments on telecommunications market access. Six more committed to parts of the Reference Paper, and several other countries that did not commit formally have since reflected the principles of the Reference Paper in national legislation and regulations. See Intven, Hank (editor) 2000, Telecommunications Regulation Handbook, The World Bank, Washington, DC, module 3, “Interconnection”, and the Reference Paper in Annex 1.

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Regional organizations in Asia, Europe, and Latin America have established similar directives for interconnection.38 The WTO Reference Paper establishes basic principles for interconnection, with special attention to operators that control essential infrastructures or have dominant market position. Interconnection to such major suppliers must be ensured at any technically feasible point of the network, in a timely manner, on nondiscriminatory and transparent terms, at cost-oriented prices, and sufficiently unbundled to avoid charges for unnecessary components. The procedures for interconnection, as well as interconnection agreements or model interconnection offers of major suppliers, must be made public. Putting in place the basic elements of a credible interconnection regime that is consistent with the WTO principles is a key precondition for effective competition in international telecommunications services. Specific initial measures are the following:

• Sector legislation that establishes the right and obligation to interconnect, the basic principles of interconnection (including nondiscrimination, transparency, and cost orientation), the role of the regulator in enforcing these principles, and the procedures for requesting interconnection and handling disputes.39

• Interconnection regulations that flesh out how the principles and procedures

established in the law will operate in practice.

• A reference interconnection offer by the incumbent approved by the regulator that establishes default technical and financial terms and conditions applicable to any other operator requesting interconnection.

• A core institutional capacity and authority to monitor and enforce interconnection

rules and agreements, including the means to outsource technical expertise as needed to address specific problems.

The credibility of the interconnection regime can be enhanced by reflecting the main rules and procedures in contracts and operating licenses, undertaking binding commitments with international and regional organizations, vesting regulatory authority on an entity that is separate from the operators and reasonably free from day-to-day interference by the government and the political system, and other measures.40 Accounting rates. The interconnection regime, designed for competitive environments and increasingly applied to the provision of international communication, coexists with the accounting rate regime.

38 Some of these regional frameworks are binding on member countries (European Union), while others are of an advisory nature (CITEL and Andean Pact in Latin America, APEC in Asia-Pacific). All point roughly in the same directions as the WTO agreement and Reference Paper. 39 Schwarz and Satola, 2000. 40 Smith and Wellenius, 1999.

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International telecommunications services were traditionally supplied jointly by two (or more) operating companies in different countries. Under this arrangement, each company has its own international gateway and a network (half-circuit) extending to a real or fictitious midpoint between both gateways where they connect. The companies jointly own, operate, and maintain some facilities used to provide international service, such as pairs or fibers in submarine cables and transponder capacity in satellite systems. Other equipment, such as local switches, transmission, and distribution networks, is owned, operated, and maintained in each country by the individual company.41 The correspondent relations between the companies are governed by bilateral operating agreements, including the financial arrangements to compensate each other for the costs incurred by one company to terminate calls originated and billed by the other company. The accounting rate per minute of traffic is negotiated bilaterally (mostly). The settlement rate between or among companies usually apportions the accounting rate equally between them, i.e., divided in halves between two companies or in thirds if traffic transits through another company. Settlement payments are made from time to time between companies for the net traffic exchanged between them. Accounting rates are meant to compensate for the costs incurred by each company to provide jointly the service, but in practice they are bargained between companies with little reference to costs, are influenced by the circumstances of individual negotiations, and thus vary widely among companies. The uniform settlement rate furthermore implies that the total costs are evenly divided between the joint providers. Although accounting rates have been declining, they are still generally much higher than the cost of handling and terminating minutes of international traffic in domestic networks. The accounting rate regime has thus contributed to maintaining high prices of international traffic despite dramatic cost reductions resulting from technological innovation and global market growth. The international accounting rate system has been under mounting pressure to align accounting rates with costs and, more broadly, phasing it out in favor of interconnection arrangements better suited to competitive markets.42 The pressure for change has come from international organizations (ITU, OECD) and some national regulators (FCC), but above all from changing market conditions worldwide. The opportunity for arbitrage between the accounting rates and the much lower underlying costs has led to an increasing proportion of international traffic being now carried by competitive providers bypassing the accounting rate regime. New modes of service provision have the potential

41 Stanley, Kenneth B., “International Settlements in a Changing Global Telecom Market”, in William H. Melody (editor) 1997, Telecom Reform: Principles, Policies and Regulatory Practices, Technical University of Denmark, Lyngby, chapter 25. 42 The international accounting rate regime was established initially some one hundred years ago for telegraph and then telephone services provided by a single monopoly operator in each country. Today it is still used extensively despite the advent of widespread competition and massive traffic growth.

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for determining the termination charges for international traffic by market forces rather than bilateral negotiation.43 The direction of change is clear, but is held back by delays in opening international services to full competition in many developing countries. High accounting rates, besides resulting in high prices, are also major contributors to large and growing settlement payments by some major operators (especially in the US) to some other countries.44 Large settlements discourage the receiving operators from negotiating lower accounting rates and their governments from increasing competition. A factor keeping the accounting rate regime alive is the dependence of some developing countries on international settlements as a source of foreign exchange and fiscal revenue.45 Fear of abuse of market power also keeps some governments from making the transition from accounting rates to interconnection for international services. In Mexico, for example, the law requires accounting rates applicable to all operators to be negotiated by the operator with the largest traffic over each route. By effectively ruling out price competition for the termination of incoming international calls, this has contributed, arguably, to Mexico having one of the highest prices for international communication in Latin America. Tariff Rebalancing and Universal Service A critical step towards competition in international services is to rebalance the incumbent’s retail tariffs so that they roughly reflect industry cost structures. This is necessary for reasons of economic efficiency as well as for the financial viability of incumbents and new entrants. Tariff rebalancing, however, requires regulatory intervention as the incumbent is likely to remain the sole or largest provider of connections to the end customers. Tariff rebalancing also raises concerns about maintaining or extending service beyond what operators are prepared to do on a commercial basis alone, especially in order to reach high-cost rural areas and low-income urban population groups. Thus tariff rebalancing, preceding or undertaken concurrently with the advent of international competition, must be coupled to a strategy to deal with universal service. Enough progress can be achieved fairly quickly on all these fronts to enable early introduction of international competition. At the beginning of the transition to competitive supply, retail prices are often highly distorted relative to costs. Under monopoly supply, telephone connections, monthly subscriptions, and local calls were typically priced below costs, and the resulting deficits were cross-subsidized by above-cost international and domestic long-distance call charges. While distorted tariffs have adverse economic efficiency effects (wrong signals to users to consume and to operators to invest), overall financial viability of the operator

43 These new modes include leased-line resale, refile, and related modes, international alliances, international points of presence, and Internet telephony. See Tyler, Michael and Carol Joy, 1997, 1.1.98 Telecommunications in the New Era: Competing in the Single Market, Multiplex Press, London, chapter 6 and Stanley, op. cit. 44 [Examples, especially US to Mexico and others]. 45 Braga, Forestier and Stern, 1999.

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can be achieved by setting aggregate tariff levels high enough, so there is little pressure to rebalance tariffs towards costs. Highly distorted tariffs are not sustainable under competition. The high margins of international service are quickly competed away and the incumbent is increasingly left with loss-making services. The case for tariff rebalancing thus becomes urgent not only for economic efficiency, but, primarily, for the incumbent’s financial survival, and to give the new entrants incentives to invest in a broad spectrum of networks and services, not only in the overpriced international segment. Table 6 shows distorted telephone tariffs prevailing in Latvia in 1996, compared to those in a basket of markets where prices were close to costs through a combination of effective competition and some regulation. The table illustrates the need for major increases in monthly telephone charges as the incumbent faced fierce competition from international call-back operators, as it also prepared to liberalize all market segments towards accession to the EU. Table 6. Imbalanced Telephone Tariffs Before Competition, Latvia 1996

US$ Tariff element Average of Five Competitive

Markets Latvia

Rental/month business 22 7 residential 14 1 Local call/min 0.03 0.03 Long-distance call/min Near 0.38 0.36 Far 0.71 1.91 Source: author’s compilation although a key element in moving from monopoly to competition, tariff rebalancing cannot be left entirely to the market. In the early years of reform, and probably for a long time thereafter, the incumbent will be the sole or main provider of connections to the end customers. Tariff rebalancing involves a mix of freeing competitive international call prices while regulating fixed and local call charges (and, as discussed later, interconnection prices between international and domestic operators). In early stages of development, the regulatory authority, itself, must be equipped to address these matters to prepare for international competition. Tariff rebalancing has a political cost. Although rebalancing typically decreases the overall cost of communication for all users and for almost each category among these, business users benefit the most. Rebalancing may increase the cost to low-income households for which fixed charges (e.g., monthly rental of phone lines) account for most of the bill.46 Rebalancing must thus be coupled with dealing with universal service, that

46 Fixed and local call charges are sometimes included in the retail price index, so raising them also may increase the measure of inflation which in turn can lead through indexing to other price increases (e.g. public sector wages).

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is, maintaining or extending service to localities and customers that are not commercially viable by themselves, or that are deemed by the government to deserve services below actual cost. Tariff rebalancing, therefore, requires addressing the consequences of ending cross-subsidies (among services, categories of users, or locations) that were implicit in the monopoly regime, or of replacing them by explicit subsidies that are sustainable in an increasingly competitive environment. Where a considerable number of low-income households have under-priced telephone service (for example, the former Soviet Union and Eastern Bloc countries, at the time of transition from centrally planned to market economies) the question is, what to do with those households already connected that cannot afford the higher cost-based prices. In Bulgaria and Latvia it was estimated in the mid-1990s that about one-third of all residential customers could not pay market prices for telephone service and were likely to be disconnected unless provided some support.47 In most developing countries, however, with less pervasive networks and where most customers are middle-income or business users, the traditional argument against rebalancing is rather that cross-subsidies from international service are necessary to rollout networks and reach high-cost localities especially in rural areas. Since most monopoly operating companies in practice were unable to meet demand even in prime urban markets, let alone in less profitable ones, this argument carries little force but the challenge of reaching unserved high-cost areas and low-income users remains. The level of service that should be universally available, how much it will cost, who pays for it, and how the monies are collected and distributed—all of these questions lie at the heart of all contemporary approaches to universal service.48 The market can be used to determine whether, and, how much subsidy is needed to reach a particular set of universal service targets, and who can provide the service at minimal cost. The subsidies can be funded from the government’s budget (e.g., Chile) or, more commonly though less economically efficient, from contributions by all or the largest telecommunications operators passed on to end customers through tariffs (e.g., Peru) or from other sources (e.g., proceeds of radio licenses in Guatemala). An unusual arrangement was recently adopted in Sri Lanka, where a temporary tax on incoming international calls (hence on foreign callers, many of them expatriate Sri Lankans) captures part of the price reduction resulting from introducing international competition and channels it to rolling out networks (including broadband) to provincial towns and rural areas. Despite the complexity of pricing, regulation, and universal service provision, rebalancing tariffs to the extent needed to introduce international competition can be done fairly quickly—typically in less than one year—once the political decision has been taken. In the absence of reliable cost accounts, roughly right levels for regulated prices can be prescribed readily from benchmarks derived from competitive markets, adjusted to reflect major country differences in factor costs (for example, labor, capital, land), or

47 One solution is to offer residential customers an optional package of minimal service at a low (subsidized) price, and let customers self-select what quality of service they can afford. 48 Wellenius, Björn, “Extending telecommunications beyond the market: toward universal service in competitive environments”, World Bank, Viewpoint Note No. 206, Washington, DC, 2000

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through simple network engineering models. Following tariff rebalancing and other measures to allow markets to work well, reasonable targets to extend service beyond the market can be reached at modest cost relative to total sector revenue (Table 7) and new services help reach the least privileged population groups.49

Table 7. Net Cost of Universal Telephone Service in Selected Countries50 Country Net Cost as a Percent of Sector Revenue Argentina 0.6-1.0 Australia 2.0 Chile 0.2 Colombia 4.3 France 3.0 Norway 2.0-2.4 Peru 1.0 Sweden 0.8-1.2 Switzerland 1.7-2.2 UK 0.2-0.3 US 5.0 Source: Wellenius, 2000.

49 Prepaid mobile phone service, typically available to 90 percent of the population only one or two years after competitive entry, further reduces the cost of universal service and shifts the issue from network extension to affordability of use. 50 The data are estimates or projections covering various periods from 1995 to 2004, collected in 1999. Net cost of universal phone service has further declined since then. Some countries, however, now aim at universal provision of Internet and other advanced communication and information services that cost more.

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ANNEX 1 Competition Region and Income Level

Geography and Income Levels Geography:51 Roughly half of developing countries have monopolies in international voice communications (Figure Annex1). Resistance to introducing competition in developing countries prevails in the Middle East and North Africa (MNA), Sub-Saharan Africa (SSA), and East Asia and Pacific (EAP) regions (Figure A1.1.). In MNA, 71 percent of developing countries have a monopoly in international voice communications. None of the region’s developing countries has yet introduced full competition, while a third of offer partial competition. In SSA, over half of the region’s countries have a monopoly in international long-distance, with close to a third offering partial competition. A similar pattern is reflected in the average for all low-income countries. In EAP, almost as many developing countries have monopolies as in the MNA region–68 percent. However, unlike in MNA, full competition is offered in a little over 10 percent of the countries, with roughly a fifth of countries offering partial competition. The unusual constellation of developing countries in EAP provides part of the explanation: the Pacific region includes several small island economies that continue to be monopolies.52 In ECA, nearly half of the region’s developing countries still operate monopolies, and a fifth offer partial competition, due in part to their difficult transition period from centralized economies to market-based economies. This pattern of competition is similar to that of the average of all developing countries (Figure Annex1). The number of countries adopting full competition in Eastern Europe is expected to increase substantially, however, in the upcoming years.53 In SAR, 43 percent of developing countries operate international long-distance monopolies—the same number as offer full competition in the region. In LAC, half of the region’s developing countries are fully competitive. As Figure A1.1. shows, this region leads the developing world in opening international long-distance markets. One-third of countries continue to operate monopolies, however, and similar to the ECA region, one-fifth offer partial competition.

51 NB: The regional classifications in this section include only developing countries. Further information about World Bank Group regional and income-level country classifications can be found at http://www.worldbank.org/data/countryclass/countryclass.html. 52 The World Bank Group has active telecom reform projects in the OECS region and Samoa, as well as policy dialogue and technical assistance activities in Cape Verde, Fiji, and Vanuatu. 53 TeleGeography, Global Traffic Statistics and Commentary2003, pp. 18-19

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Income levels. An analysis of resistance to competition along income levels shows that roughly 50 percent of both low income and middle income countries maintain monopolies. All high-income OECD countries offer fully competitive international long-distance markets. Interestingly, high-income non-OECD high income countries are still to 72 percent monopolies—similar to the pattern for MNA (Figure A1.1.).

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Total: middle income

29%

22%

49%

Full competition

PartialcompetitionMonopoly

Figure A1.1. Geography and Income Levels

High income: non-OECD22%

6%

72%

Full competition

PartialcompetitionMonopoly

Low income21%

26%

53%

Full competition

PartialcompetitionMonopoly

High income: OECD

100%

0%

0%

Full competition

PartialcompetitionMonopoly

Latin America & Caribbean

50%

20%

30% Full competition

PartialcompetitionMonopoly

East Asia and Pacific11%

21%

68%

Full competition

PartialcompetitionMonopoly

Middle East & North Africa0%

29%

71%

Full competition

PartialcompetitionMonopoly

Eastern Europe & Central Asia

32%

20%

48%

Full competition

PartialcompetitionMonopoly

South Asia

43%

14%

43%

Full competition

PartialcompetitionMonopoly

Sub-Saharan Africa17%

28%55%

Full competition

PartialcompetitionMonopoly

ANNEX 2 Control of Corruption and Competition in International Voice Communications

Top 20 Countries in Control of Corruption

Figure A2.1

All 20 countries have introduced full competition in international voice communications.

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Bottom 20 Countries in Control of Corruption . Figure A2.2

Of these 20 countries, five have introduced full competition in international voice communications.

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ANNEX 3

Worldwide Experiences of Market Opening Regulatory Reform in the US The following are key features of the present regulatory regime in the US: • “Free” entry of international carriers. Currently there are no restrictions on the

number of operators in the market. The international communications market segment was one of the first to be open to competition. In 1971, the Specialized Common Carrier Decision allowed AT&T's competitors to enter the common carriage market through microwave and satellite networks. This decision allowed MCI, the oldest competitor to AT&T, to establish its business. This position evolved into a model of unrestricted entry. The only test posed by the regulatory authorities in the US is that competitors in the long-distance and international market should not enjoy a monopoly position in the local market. In the US there are over 2,000 suppliers of international services.54

• Asymmetric treatment of local monopolies. The 1982 Modified Final Judgment

involved the creation of asymmetric treatment of local monopolies, the newly established Regional Bell Operating Companies (RBOCs). The RBOCs were not allowed to be competitors in the long-distance and international market. This position was modified by the 1996 Telecommunications Act that gave RBOCs access to the long-distance market (InterLATA market), provided that RBOCs allow sufficient competition in their local market. In 2001, an FCC decision authorized SBC Communications, the first RBOCs, to offer long-distance services.55

• The regulatory regime is technologically neutral. VoIP is allowed. An FCC decision

(September 2000) declared that Internet-based services should not be subject to the same regulatory obligations as basic telephone services.56

• There are extensive fair competition tests affecting regulations. Interconnection

charges have been regulated for a long time, but a FCC decision in May 1999 deregulated carrier-to-carrier interconnection charges for international communications. Interconnection between a local and a long-distance operator is still subject to extensive and detailed regulation.

54 TeleGeography, 2003. 55 Appeals in 1998–Court of Appeal in New Orleans confirms FCC clauses on local competition. 56 FCC Decision N. 00-185, adopted on September 28, 2000.

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Regulatory Reform in the European Union The regulatory regime for international communications in the EU has the following key features: • Free entry of international carriers. All entry barriers to the international

communications market have been removed in Europe, and in the largest countries there are over 100 suppliers of international services (500 in the UK). As in the US, this regime of free entry evolved over time. First, services were liberalized through the Services Directive 1990 (reviewed in 1992). The Green Paper on Infrastructure (1995) progressively liberalized infrastructure, starting with independent networks. The Minister of the Council of Telecommunications adopted the principle, designated 01/01/98 as the date to liberalize all network infrastructures. The Full Competition Directive (1996) mandated the removal of all entry barriers.

• Progressive liberalization towards a “big bang” date. Most countries followed a

progressive liberalization path, but with an agreed “big bang” date. For example, the UK implemented a Duopoly Policy from 1984 to1992; this policy was subject to review in 1992, and full competition was allowed in [1996]. In most other countries of the EU, a progressive timetable was implemented before full opening in 1998. It is important to note that while this progressive timetable was implemented, the operators and policy makers were certain that the end result would be full competition.

• Interconnection is still regulated. In 1998 the transition to full competition, including international communications, a precise set of rules was established to discipline interconnection, and this is illustrated by the two parts of the Interconnection Directive.

• VoIP is considered a value-added service and, therefore, not subject to the telecommunications regulations in the EU.

Regulatory Reform in Developing Countries Developing countries followed three regulatory reform models with respect to the international communications segment: full competition, partial competition, and protection of the monopoly. The full competition model has been adopted by some countries, especially in Latin America and Eastern Europe. The Chilean model is well known as it represents the case for full competition, where immediate entry was allowed without restrictions or obligations to entry. Operators that acquire a license are allowed to offer all services, including international long-distance, without limitation to any specific technology. The market opening became effective in 1994, when Chile adopted the multicarrier system, meaning that before dialing consumers needed to decide which carrier to use. Approximately 40 operators have obtained authorization to provide international voice service.

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El Salvador also introduced a fully competitive market rapidly. Bolivia and Estonia have also followed a similar version of the full-competition model. The common result in these countries is a significant growth in international traffic and reduction in tariffs. Sri Lanka is are just starting to implement this model. Other countries, like Argentina and Brazil, had a transitional period of several years where the number of competitors was limited, before removing entry barriers and allowing entry without restrictions on the number of competitors. Countries that have adopted the full competition model have characteristics in part similar to those enumerated for the US and EU, namely:

• No restriction on the number of operators in the market; • Transparent licensing; • Interconnection clearly defined in the regulatory framework; • Technological neutrality (VoIP is accepted as a different way to provide service,

or unregulated); • Carrier selection (in most countries).

The partial competition model has been adopted in several countries. In certain cases, for example in Argentina and Brazil, there has been a transition of several years of partial competition before opening the market to full competition. In most countries, there is no plan to move from partial to full competition. There are several ways in which the introduction of competition is partial. The most common is the presence of restriction on the number of operators in the market, such as in Cambodia and Indonesia. There are other ways in which competition can be constrained. For example, Mexico allowed only limited foreign ownership for long-distance operators. It also adopted a presubscription system, meaning that consumers were to subscribe to a specific operator for all their international calls. The regulator (COFETEL) sent applications to subscribers to assigned them to their preferred carrier for international service. Those that did not respond were assigned, by default, to the incumbent TELMEX, benefiting the dominant operator. This is an example of asymmetry in the market access for different operators. Other examples of asymmetric market access are those countries that adopted a partial competition model through the award of competitive mobile licenses. In many of these countries, however, the cellular operator is allowed to offer international services only to its own clients. In other cases, the cellular operators have to purchase international long-distance from the incumbent, at higher prices than those that they would pay to other international carriers.57 In most countries where there is a partial competition model, VoIP is not allowed. However, Argentina, China, and Indonesia have adopted a duopoly strategy by constituting two full service providers, but allowed the use of VoIP, and many value-added service provides 57 In many cases competition has been introduced through granting competitive cellular operators the right to have their own international gateway. Cameroon, among others is one such case, as well as the Central African Republic, Egypt, Guinea, Mauritania, Morocco, and Tunisia. In most of these countries, however, the cellular operator is allowed to offer international services to their clients only.

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have taken advantage of that regulation to offer international voice communications at lower cost, contributing to the reduction in international tariffs. Carrier selection is usually not adopted. Common features of the partial competition approach are:

• Restriction on the number of operators in the market; • Competition limited to resale; • Asymmetry of license obligations between the incumbent operator and new

operators; • Limits on foreign ownership of international communications operators; • VoIP is usually not allowed; • No carrier selection.

Partial competition model may display some or all of the features indicated in the table. But it is enough that the regulatory framework displays one of the features of the partial competition model not to qualify as a fully competitive market. In countries that opt for protection of a monopoly the incumbent operator usually has a legal protection. This legal protection can assume several forms. In many countries specific legislation indicates that the incumbent operator is the sole provider of telecommunications services, including international. In other cases, the protection of the incumbent operator is guaranteed through the award of an exclusive license (for example, the license of MATAV in Hungary included an exclusivity clause), or through a shareholder agreement with no competition clauses (for example, TVL in Vanuatu). In countries that protect a monopoly, bypass is common. Therefore, a second (peculiar) feature of the regulatory framework is the prohibition of VoIP and other means of bypass. In addition, the government places efforts in banning VoIP and other illegal ways of bypassing the legal monopoly; the enforcement of these prohibitions is usually ineffective.

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ANNEX 4

The Success of El Salvador’s Regulatory Reform El Salvador’s Policy on International Long-distance Service The Government of El Salvador opened the sector by eliminating barriers to entry and deregulating tariffs. In 1996 the government approved a new telecommunications law that introduced competition in long distance services, and created the telecommunications regulator SIGET. In 1997, an amendment to the law was passed that reintroduced tariff regulation on all fixed-line services. The incumbent operator, CTE-Antel, was privatized in 1998. Although tariff deregulation was reversed in 1997, fierce competition has eliminated the need to regulate tariffs for international long-distance calls. Introducing Competition In 1997, El Salvador introduced competition by introducing the multicarrier system, after approval of the liberalization legislation. There was no period of transition, unlike the experience of other countries. The first set of codes was assigned in the early 1997, and the second in 1998. El Salvador decided to adopt the presubscription and the multicarrier modality and allowed local access operators to use carrier presubscription starting in October 1998. For the case of incoming traffic through the accounting rate system, a temporary clause dictated that 70 percent of the international settlement rate was to be reserved to the local access operator and 30 percent to the international carrier, until October 2000. The purpose of this arrangement was mainly to increase the market value of the local access carrier CTE-Antel that was in the process of being privatized. However, all operators are allowed to negotiate their own rates with other international carriers. Market Structure

0

5

10

15

20

25

30

1997 1998 1999 2000 2001 2002

Offer international service

Entry into the international marketNumber of telecommunications service operators

Source: SIGET

1

10 10 10 10

29

All telecommunication services are offered in a competitive environment and there are no restrictions to entry into the market. Operators that acquire a license are allowed to offer all services, including international long distance, without limitation to a specific technology or market. Up to 2002, there were 29 licensed telecommunications operators out of which 11 functioned as international service carriers. The main international long-distance operators in El Salvador are: CTE, Telefonica, and Telemovil. CTE is the former public company that inherited Antel conventional operations and a PCS license before its privatization in September 1998. The Estel Consortium - partly controlled by France Telecom—acquired 51 percent of shares for $275 million. The other shareholders are : the government with 42.1 percent, and employees with 6.9 percent. According to the privatization plan, the government had to sell its shares six months after the contract’s initiation, however it has failed to do so, arguing that the international market conditions were not

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adequate. Under the privatization contract, Estel is obligated to maintain its shares for five years until September 2003.

19%9%

43% 29%

Competition has split the marketMarket share (% total minutes)

CTE Telefonica

Telemovil

OthersSource: SIGET

The second main operator is Telefonica El Salvador, which was established, initially, as Intel (Internacional de Telecomunicaciones) by receiving the cellular operations of Antel. Telefonica International (TISA) acquired 51 percent of its shares and another license to provide telecommunication licenses for $41 million in 1998. Telefonica began offering international long-distance service in October 1998, and has built infrastructure to offer fixed-line business s

ervices.

he third operator is Telemovil, a subsidiary of Millicom Cellular International, which, in 1994,

ained

pact of Competition

ompetition has given more choices to the consumer for making international calls, in terms of

$0.80 per

e

Tbecame the first cellular operator in the country by acquiring a license. The company has installed a local network to offer fixed-line services. Other international operators are: El Salvador Telecom, with 3.4 percent of market share in 2002; El Salvador Network, with 2.22 percent of the market share; and Publitel with 1.4 percent of the market share. The market structure is evolving from a monopoly to a competitive market. In 1997 , CTE-Antel had a monopoly on international traffic, now it has 45 percent of the total traffic. Telefonica has gmarket participation and is now the second operator for the international long-distance market. Im Cprices and quality. Outgoing traffic has not increased as expected, mainly because the large population living in the US drives the calling pattern. In 1996, a few months before the Telecommunications Law was approved, SIGET lowered the tariff of a call to the US to minute,58 as an initial step to adjust the general tariff structure. Since then, the maximum tariff to the US is unchanged at $0.80, but the actual published tariff by CTE has decreased to $0.25. Currently, most carriers offer even lower tariffs to the US and Canada, some as low as the samprice of a local cellular call. As a consequence, international service revenues are decreasing.

58 The percentage of international outgoing traffic to the US was 50 percent in 1999 (Telegeography).

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0100200300400500600700800900

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002*

Increase in traffic (mainly incoming)Total number of minutes (in millions)

Incoming

Outgoing

Source: ITU, SIGET * Preliminary

0

10

20

30

40

50

60

70

80

1998 1999 2000 2001 2002

US$ M

illio

n

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

US$ p

er m

inut

e

Competition is driving revenues downRevenues from international long distance service

Source: Py ramid, Equilibrium

Telefonica

CTE

All carriers

0.00

0.25

0.50

0.75

1.00

1998 1999 2000 2001 2002 2003*

Reduction of international tariffsCost of call to the US (US cents per minute)

Source: SIGET *First quarter

CTE published tariff

Maximum approved tariff

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Table A4.1. Regulatory structure for the provision of ILD service Licensing • No obligations for providing international service

• Infrastructure development is allowed Interconnection • Interconnection is obligatory

• Operators are responsible for negotiating the interconnection rates, and only in case of dispute shall SIGET intervene59.

• The local access providers with more than 100,000 lines need to offer an unbundled interconnection tariff, and the lease of unbundled network elements, both of which have are to be negotiated among the respective parties.

Tariff setting • SIGET (regulator) regulates tariffs for public services; maximum tariffs are adjusted every year according to the CPI 60

• Network operators that control less than 10 percent of any specific market are allowed to establish their own maximum tariffs based on their costs.

Multicarrier system

• The Telecommunications Law established a multicarrier system in order to foster a competitive environment.

• SIGET assigned multcarrier codes by a multiphase bidding process, the first in early 1997 and the second in 1998. SIGET has assigned 29 codes and currently only 10 are in service.

• All access service operators that have more than 10,000 lines are required to give access to the mulicarrier system at no cost. In addition, all access service providers are allowed to offer pre-subscription service to their custumers, in addition to free access to the multi-carrier system.

VOIP • VoIP is allowed as long as it fulfills the numbering, the automatic identification of the user number, and the interconnection requirements.

59 The Telecommunications Law defined the interconnection rates at $0.011 for end-switches, $0.017 for tandem end-switches and $0.20 for international switches, until October 1998. After that period, CTE and other operators negotiated an interconnection rates agreement that continues unchanged up to now. 60 Starting in 2003, the readjustment will be according to an index composed by the IPC and the devaluation rate against the dollar.

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ANNEX 5 Fiscal Impact Scenarios

The following example presents a case in which competition is introduced at a time in which the incumbent operator is a corporatized enterprise with a 30 percent dividend policy (where 30 percent of net revenues go to the state in the form of dividends to the state). The example assumes that there is growth in the market. This growth cannot originate from international voice communications revenues alone; it is assumed that it is related to rates rebalancing, which allows higher revenues from local and long-distance services, to compensate for international revenues that are stagnant or slightly declining. The incumbent operator, as is often the case, is assumed to have retained about 40 percent of an enlarged telecommunications market. In this example, the net fiscal impact is positive, even without considering license fees that the operators are usually willing to pay to enter the market. In a case like this, some policy makers may not see the whole picture. They are conscious of the loss in direct taxation linked to the de-monopolization of international voice communications, but cannot see the medium-term fiscal benefits related to fiscal contributions from competitors, and to a rebalanced tariff structure.

Table A5.1. Example of Positive Fiscal Impact in the Short-run Case 1: Incumbent Operator is a Corporatized Enterprise

Before Competition After Competition Net revenues 100 200 Settlements 100 100 Dividend policy 30% 30% Sales tax 20% 20% Incumbent market share 100%61 40% Competition 0% 60% Fiscal revenues (30%*200) = 60 (30%*120+20%*180)=72

Using the same case data as the previous example, but under the assumption that the incumbent operator is a government department, the results are different. Since we can assume that a government department can transfer 100 percent of their net revenues to the state budget, the resulting impact of introducing competition is a reduction of fiscal revenues.

61 We assume here that the incumbent operator holds 100 percent of the market. However, due to bypass, the incumbent operator is likely to lose control over some market shares. The extent of the loss will depend on the market conditions. In full competition, illegal forms of bypass are normally eliminated as soon as new competitive legal entrants market their services.

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Table A5.2. Example of Negative Fiscal Impact in the Short-run Case 2: Incumbent Operator is a Government Department

Before Competition After Competition Net revenues 100 200 Settlements 100 100 Transfer to state budget 100% 100% Sales tax 20% 20% Incumbent market share 100%62 40% Competition 0% 60% Fiscal revenues (100%*200) = 200 (100%*120+20%*180)=156

62 Same as footnote 4.

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