RESTRICTED FILE COPY Report No. P-81 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE ISLAMIC REPUBLIC OF PAKISTAN FOR THE SECOND TELECOMMUNICATIONS PROJECT May 5, 1970 INTERNATIONAL DEVEWIPMENT ASSOCIATION REPORT AND RECOGu1ENDATICN OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE ISLAMIC REPUBLIC OF PAKISTAN FUR THE SECOND TELECOM?UNICATIONS PROJECT 1. I submit the following report and recommendation on a pro- posed credit in an amount in various currencies equivalent to US $15 million to the Islamic Republic of Pakistan to finance the foreign exchange costs of priority items required for the fiscal years 1968/69- 1971/72 expansion program of the Telegraph and Telephone Department of the Government of Pakistan (T & T). PART I - HISTORICAL 2. Early in 1969, the Association made its first credit for telecommunications in Pakistan (No. 145-PAK) in an amount of US $16 million. This credit was to assist in financing (i) the addition of about 125,000 new lines to the subscribers'distribution network, (ii) micro- wave and coaxial cable systems as well as open wire lines in East and West Palistan, (iii) high frequency radio system improvements for the interwing and international network, and (iv) management consultants to T & T. Initial difficulties in starting the execution of the pro- ject have now been remedied and orders totalling about US $6.6 million equivalent are being placed. Tenders for further items totalling about US $8 million equivalent have also been issued, with orders to be placed by December of this year. The management consultants have already started their worlc. It is expected that the project will be completed on time and the credit fully disbursed by the agreed Closing Date, December 31, 1972. 3. The proposed project was appraised in November/December 1969. Negotiations were held in Washington from April 20 to 27, 1970. Messrs. A.R. Bashir, Economic Minister, and Mr. A.M.A. Muhith, Economic Counselor to the Embassy of Pakistan in Washington represented the Government of Pa.cistan. Messrs. S.A. Sathar, T & T's Chiet Engineer, Operations and Maintenance, and A.Q. Farooqi, Deputy Chief Engineer, Coordination, re- presented T & T. 4. The Association has made twenty-nine development credits to Pakistan totalling US $399.2 million, net of cancellations. Ten credits are already fully disbursed. The Bank has made thirty loans in Palcistan totallino US :p61L.3 xnitlion, net of cancellations, of which eighteen are fully disbursed. The following is a summary statement of Banlc loans and IDA credits to Pakistan, as of March 31, 1970: Loan Amount (US $ million) Credit Year Borrower Purpose less cancellations No. Bank IDA Undis- bursed 266 1960 Pakistan Indus (Multipurpose) 90.0 24.7 22 1962 Pakistan Khairpur Ground Water 18.0 4.3 LO 1963 Pakistan Chandpur Irrigation 5.2 0.1 41 1963 Pakistan Dacca Water Supply 13.2 10.7 42 1963 Pakistan Chittagong Water Supply 7.0 4.6 376 1964 Karachi Port Port Development 17.0 8.4 49 1964 Pakistan EP Education 4.5 1.2 50 1964 Pakistan WP Education 8.5 4.4 53 1964 Pakistan EP Highways 22.5 20.1 54 1964 Pakistan WP Highways 17.0 3.3 56 1964 Pakistan Eastern Railway 10.0 0.1 421 1965 PICIC Industrial Development 30.0 0.7 83 1966 Pakistan Foodgrain Storage 19.2 3.7 87 1966 Pakistan EP Education II 13.0 11.6 S-1 1966 Pakistan WP Highway Engineering 1.0 0.2 488 1967 KESC Karachi Electric Sup. 21.5 5.9 106 1967 Pakistan Lahore Water Supply 1.8 1.0 496 1967 Pakistan Western Railway 13.5 2.4 509 1967 PICIC Industrial Development 35.0 6.2 548 1968 Pakistan Tarbela (Multipurpose) 25.0 25.0 117 1968 Pakistan Agricultural Bank II 10.0 2.2 549 1968 Dawood Hercules Fertilizer 32.0 23.1 578 1968 Pakistan WP Highways II 35.0 34.6 136 1969 Pakistan Geii. Cons. (EPWAPDA) 2.0 1.4 590 1969 PICIC Industrial Development 40.0 25.0 145 1969 Pakistan Telecommunications 16.0 15.9 597 1969 SNGPL Sui Northern Gas II 8.0 7.2 621 1969 Pakistan Western Railway 14.5 14.5 157 1969 Pakistan Agricultural Bank III 30.0 29.7 S-8 1969 Pakistan Dacca S.W. Irrig. Eng- 0.8 0.8 177 1970 Pakistan Ind. Development (IDBP)I/ 20.0 20.0 Loans/Credits fully disbursed 252.8 179.5 Total 1 399.2 of which has been repaid 138.1 0.2 Total now outstanding 476.2 399.0 Amount sold 21.9 of which has been repaid 18.8 3.1 Total now held by Bank and IDA 473.1 399.0 Total undisbursed 177.7 135.3 313.0 1/ Uot vet effective - 3 - 5. In my recent report on the Chandpur II Irrigation Project in Eazt Pakistan (dated April 2, 1970; circulated to the Executive Directors as IDA/R70-12) I have referred to the slow rate of disbursement of some of the Bank Group's loans and credits in Pakistan and actions we are taking to deal with this situation. 6. IFC has made eleven commitments in Pakistan totalling about US $21.6 million, net of cancellations. The value of outstanding commit- ments, net of repayments, cancellations and sales of loans, is about US $16.5 million. IFC is presently considering applications for invest- ments in a large engineering conppny and in a project for fertilizer production. 7. On April 14, 1970 the Executive Directors approved a US $13 million credit for the Chandpur II Irrigation Project, and on April 21, 1970 a US $1 million credit for the Karachi Port Trust Engineering Project; both are expected to be signed shortly. An engineering credit for the Karnaphuli and Muhuri irrigation projects (US $2.5 million equivalent) has been negotiated, with the final amount of the credit subject to adjuBhaent on the basis of a firm price proposal from the consultant yet to be selected. Recommendations for the following three projects on which negotiations have been substantially completed or are underwqy, will be submitted to the Executive Directors shortly: Small Industries in Eaat Pakistan (US $3 million); West Pakistan Power Transmission and Distribution (US $22.4 million) and West Pakistan Engineering Education (US $8 million). Two other projects are also expected to be negotiated soon: Tubewells in East Pakistan (US $23 million total financing Jointly with the Swedish International Devel- opment Agency and the Canadian International Dsvelopment Agency) and Sui Northern Gas Pipelines (US $19.2 million). - 4 - PART II - DESCRIPTION OF THE PROPOSED CREDIT 8. Borrower: The Islamic Republic of Pakistan. Beneficiary: Telegraph and Telephone Department of the Government of Pakistan (T & T). Amount: The equivalent in various currencies of US $15 million. Purpose: To help finance the foreign exchange costs of priority items under T & T's expansion program for fiscal years 1968/69-1971/72. Amortization: In 50 years including ten years grace, through semi-annual installments of i of 1% from August 1, 1980 through February 1, 1990, and 1I½ frcm August 1, 1990 through February 1, 2020. Service Charge: 3/4 of 1% per annum. Relending Terms: The Islamic Republic of Pakistan will relend the proceeds of the Credit to T & T for a period of 24 years including four years grace at an interest rate of 6E6 per annum on the principal amount outstanding from time to time. PART III - THE PROJECT 9. A report entitled "Appraisal of the Second Telecommunications Project - Pakistan" (No. PU-34a), dated April 30, 1970, is attached. 10. At the time of Independence in 1947, the telecommunications sector of Pakistan was rudimentary. In the meantime, the country has undertaken substantial efforts to develop this sector and since 1955, when the First Five-Year Plan was introduced, telephone density has increased at an average rate of over 12 percent per annum. Neverthe- less, telecommunications development is still lagging behind the rest of the economy and is at present still quite under-developed among major developing countries, with 1.4 telephones for 1000 persons and a waiting list of 72,000 as compared with 135,000 connected subscribers. The huge unsatisfied demand has led to high calling rates and substantial traffic overflows. 11. The need for better telecommunications facilities in Paicistan is intensified by the geographical situation of the country, with its two wings separated by over 1,000 miles of foreign territory. In West Pakistan the main population and industrial centers are hundreds of miles apart; in East Pakistan where distances are shorter, the numerous rivers are a major barrier in the path of fast and easy communications required for the development of the Province. 12. The 1968/69-1971/72 program of telecommunications expansion presently being carried out (of which both last year's and the proposed projects form part) is the maximum program which can be achieved with the existing human and material resources in Pakistan. With estimated total costs of about US $200 million equivalent (out of which about US $82 million is required in foreign exchange) it will provide the country with high quality international and interwing telecommunications facili- ties, a high capacity trunk network and 175,000 additional telephones. If the proposed Credit is approved, a total of aboat US $72 million equivalent of the foreign exchange required will have been secured from the Association and various bilateral sources; the Government of Pakistan is now negotiating to secure the rinaining US $10 million from other bilat- eral sources or through suppliers' credits. 13. The part of the expansion program which would be ftinanced under the proposed Credit consists of the installation ol a microwave system, local and junction cables and air-conditioning equipment. The microwave system consists of two links, with ancillary equipment, between Karachi and Multan, with one link branching off to Rawalpindi, the other to Lyallpur. The foreign exchange cost of this part (including related surveys, studies, supervision and training), is estimated at US $6.8 million. The proposed system will add another miode to the existing main coaxial trunkline of West Pakistan, thus increasing the reliability of the network, by providing an alternative mode should one fail. 14. Local and junction exchange cables will also be financed under the proposed Credit to enable installation of about 50,000 new telephones, which form part of the telephone network expansion planned under the 1968/69- 1971/72 program. At the time of appraisal of the first project it was expected that these cables would be supplied-5j ^a local cable factory. The factory is not yet finished; production is expected to start later this year. In any case, it will not be producing junction exchange cables and will not reach full capacity until mid 1972. The timely completion of T & T's expansion program therefore requires the import of junction and local exchange cables, at a foreign exchange cost of US $5.7 million. 15. Telecommnications equipment does not perform satisfactorily unless operated in a dust-free atmosphere at optimal temperature and hu- midity. This is of particular importance under the climatic conditions in many parts of Pakcistan. It is therefore proposed to include US $1.5 million under the Credit to finance the foreign exchange cost o.C provid- ing air-conditioning for equipment rooms. Contingencies on the items de- scribed in the foregoing paragraphs would add a final US $1 million. - 6 - 16. Total costs of the project are estimated at about US $35.3 million. T & T will finance the local costs out of its own operating revenues. Completion of the installation of the new telephones and of the air-conditioning equipment is expected by June 30, 1972, and of the microwave part by June 30, 1973. 17. The project is expected to have a substantial and favorable impact on telecommunications and consequently on the economy of Pakistan. The Appraisal Report (Annex 13, IV) estimates that for many years after completion of the project 80-90 percent of all direct exchange lines will still be used by business and government. The economic benefits of the project are reflected in the unusually high rates of return; for instance in the case of the microwave system the minimum economic rate of return is estimated at 37 percent. 18. All items to be financed from the proposed Credit will be procured on the basis of international competitive bidding. A local factory, Telephone Industries of Pakistan (TIP), about 80 percent govern- ment owned (through T & T) is qualified and expected to bid on a part of the microwave system, the multiplex channeling equipment, the total costs of which are estimated at about US $500,000 or less than 1.5 per- cent of total project costs. In evaluating bids, TIP would be granted a margin of preference of 15 percent, or the prevailing customs duties, whichever is lower. 19. The Appraisal Report describes T & T in detail (para. 3.01 to 3.07) and points out certain organizational shortcomings and weaknesses. Both the Government of Pakistan and T & T are aware of the need to give the agency more autonorm and an integrated financial management. The management consultants financed under Credit No. 145-PAK are already studying these problems. Their recommendations are expected to be sub- mitted soon to the Government and the Association for approval, and T & T has already indicated its willingness to implement them as soon as approved. In the meantime, T & T is already taking various steps to improve its efficiency and under the proposed draft Credit Agreement will continue to do so. The consultants are also designing and will assist in introducing by the end of fiscal year 1972 a suitably staffed modern accounting system. 20. T & T's financial position is sound. To ensure that this situation is maintained, T & T has agreed not to reduce its tariffs until the introduction of the new accounting system without prior ap- proval of the Association. After the introduction of the new accounting system, a rate covenant will become effective, under which T & T is required to achieve a minimum annual rate of return of 10 percent. At the same time a debt covenant will come into effect, under which no new debts may be incurred by T & T (or for it) unless its maximum debt service requirement for any fiscal year is covered at least 1.5 times by its net revenues for the preceding twelve-month period. - 7 - PART IV - LEGAL INSTRUMENTS AND AUTHORITY 21. The draft Development Credit Agreement between the Islamic Republic of Pakistan and the Association, the Recommendation of' the Committee provided for in Article V, Section 1(d) of the Articles of Agreement, and the text of a draft Resolution approving the proposed. Development Credit are being distributed to the Executive Directors separately. The draft Development Credit Agreement follows the usual pattern of credit agreements for projects of' this type, and that of Development Credit Agreement No. 145-PAK. PART V - THE ECONaMY 22. In my report on the Chandpur II Irrigation Project, referred to in paragraph 5 above, recent economic developments in Pakistan were reviewed. Since then, an economic mission has returned from Pakistan and we expect to distribute its report in mid-June. 23. During the sixties, Pakistan's national product recorded sustained growth at a rate above 5.5 percent per annum. Such an achievement was attained despite substantial adverse developments arising from the Indo-Pakistan War of 1965 and the decrease in net transfers of foreigi assistance. 24. Despite this good performance in terms of the overall growth rate, Pakistan is now faced with a number of issues and difficulties. Some of these difficulties originated in the deliberate policy of the Government to maintain a high rate of growth despite shortfalls in internal and external resources. Income growth has been accompanied by an increasing disparity in personal and regional incomes. Over the Third Plan Period 1964/65-1969/70, income per capita is estimated to have grown in West Pakistan by 3.3 percent annually, whereas in East Pakistan the estimate is only 1.1 percent per annum. The need to improve income distribution will call for greater emphasis on social sectors, and in:.rastructural facilities that have somewhat lagged be- hind the development of production will also have to be expanded. 25. With this new orientation of capital expenditure, resource constraints may be felt more than ever. The Government is aware of the importance of raising national savings to meet investment require- ments and of improving the fiscal effort to finance operating and development spending. Government taxes currently account for only nine percent of the national product; but it is expected 'that this ratio will improve over the next few years with greater reliance on direct taxation. Increased tax revenues would also enable Pakistan to increase its capacity to absorb project aid, a capacity which has been somewhat limited in recent years by the shortage of domestic resources. - 8 - 26. In order to sustain the output growth required to meet the new challenges posed to Pakistan, an improvement in infrastructural invest- ment is needed, including the coimunication network. The geographical position of two wings, separated by more than 1,000 miles, the length of the axis between the adninistrative capital, Islamabad, and Karachi, the largest city and only port of West Pakistan, the natural obstacles put by numerous rivers in East Pakistan, are factors emphasizing the need to raise telecammunication facilities to international standards. 27. In view of Pakistan's rising debt service, which has now reached about 20 percent of foreign exchange earnings, the Consortium is considering how to maintain a net capital inflow at a level and on terms compatible with the development needs of Pakistan The relatively small deficit on external payments which is expected for 1969/70 results from a drastic curtailment of imports that cannot be continued without jeopardizing longer-term development. It will also be necessary for the Government to take action with respect to exports in order to put an end to the current stagnation and resume the rapid expansion demon- strated by exports in the sixties. 28. In these circumstances, and considering Pakistan's good record oI' economic management, continued assistance is justified on concessional terms. PART VI - COMPLIANCE WITH ARTICLES OF AGREFMENT 29. I am satisfied that the proposed Development Credit would comply with the Articles oi Agreement of the Association. PART VII - RECOMNENDATION 30. I recommend that the Executive Directors approve the proposed Development Credit. Robert S. McNamara Attachment President