Document(s) 21 of 21

WHAT ARE SMART SUBSIDIES AND WHERE HAVE THEY BEEN DONE?

The supply of telephony has traditionally been skewed towards the urban affluent as opposed to the rural poor. The literature describes this bias as having been caused by a 'market efficiency gap' and an 'access gap' (see Figure 8.1).¹ The market efficiency gap is the difference between what markets achieve under existing conditions and what they can achieve if barriers are removed. This gap can be bridged through effective competition, private provision of services, and market-oriented policies and regulations that create a level playing field for new entrants. The access gap refers to people and places that remain beyond the limits of the market due to inadequate income levels or its skewed distribution. Bridging this gap needs subsidies to encourage service providers to enter these areas.

Figure 8.1
Market Efficiency and Access Gaps

Source: Navas-Sabater, Dymond and Juntunen (2002).

Closing the 'access gap' is not a straightforward task. A number of policy and regulatory complexities have to be considered. While there is debate on the ideal sequence of implementation of policy to bridge the two gaps, it is best to address the market efficiency gap prior to the access gap. Besides the policy and regulatory complexities are the geographic and socio-economic factors that have to be taken into account before designing access-gap-bridging policies. Primarily these are the size and terrain of a country; population densities of the settlements; the income level and its distribution among the population.

Subsidies can be distributed in various ways. Based on the criteria of targeting, market distortion and efficiency incentives, least-cost subsidy (LCS) auctions are considered to be the best method and are thus described as 'smart subsidies'. In LCS auctions, bidders are forced to consider the most cost-effective technology and other cost-saving options to bid for the lowest required subsidy, if at all. LCS auctions are very different from the provision of subsidy using a comparative evaluation scheme, which is known as a 'beauty contest' where the award is determined on a merit-based assessment of the applicant's ability to fulfill a given set of requirements. In countries with poor governance frameworks, it is always safer to use the smart subsidy approach, where only a single dollar figure is evaluated, than one that allows discretion to the tender board that evaluates bids.

LCS auctions for bridging access gaps in rural telecommunication services were introduced in the mid-1990s in Latin America. Chile was the first to do so, in 1995–1997, when a subsidy of USD 10.2 million was disbursed by Fondo de Desarrollo de las Telecomunicaciones to roll-out telecom services in some 4,500 rural locations. Other countries in the region used LCS to encourage regional telecommunications services. Some were more successful than others. Table 8.1 gives a summary of smart subsidy projects implemented in Latin America.

SMART SUBSIDIES IN NEPAL

Nepal is country with some of the most rugged and beautiful terrain in the world, and home to some of the world's poorest people. On the one hand, the incumbent Nepal Telecommunications Corporation (NTC) had failed to bridge the access gap in rural areas of Nepal and, on the other, hardly any private operator activity was afoot. Thus began the discussions between His Majesty's Government (HMG) of Nepal through the Nepal Telecommunications Authority (NTA) and the World Bank to consider alternative mechanisms to service these areas. Taking into consideration the difficulties of attracting private investments to Nepal, it was decided to carve out one administration region and implement a private sector led regional telecommunication service program through the provision of a subsidy as a pilot project.²

Table 8.1
Latin American Smart Subsidy Projects

Source: Dymond and Oestmann (July 2002).

Notes: *Implementation delay due to disqualification of subsidy winner; second bidder awarded.

**Network not implemented due to operator failure.

The beautiful Eastern Development Region (EDR) of Nepal, home to Mount Everest was selected for this pilot project. Because the Regional Telecommunications Development Fund (RTDF) was not yet in operation, the World Bank agreed to provide funds for regional telecommunication services under a long-term credit to HMG.

Based on the lessons of Latin America, the NTA, and the World Bank agreed to call for international competitive bidding. The winner would be the bidder requesting the lowest one-time capital grant. This was to be the first LCS auction in this part of the world.

Design and Implementation Plan: Expectations

The salient features of the license design and implementation plan, developed jointly by the NTA along with their Consultants and the Word Bank³ are discussed in this sub-section. The area of coverage was 534 Village Development Councils (VDCs) in the Eastern Development Region (out of a total of 893 VDCs) with a rural population of 4 million.

The license was to be issued on a non-exclusive basis to serve the EDR. However, HMG through the NTA agreed not to authorize NTC or grant any new licenses to any existing or new operators to provide services in the identified VDCs for a period of five years after the license. The logic of the five-year exclusivity seems to lie in the view that the five-year duration would help the licensee build its own network and broaden its customer base prior to competition setting in. The licensee was to install, activate, and operate at least two separate public access lines as Public Call Offices (PCOs) in two separate wards of each VDC. In terms of technology, NTA and the Bank chose to let the applicants decide on the basis of the existing infrastructure and geo-demographic and socio-economic conditions in the EDR. The Request for Applications (RFA) stated 'The Licensee may utilize any appropriate wireless or wire-line technologies in the provision of the regional telecommunication services in the Regional Service Area.' The technology had to meet minimum eligibility requirements and service-quality criteria.

The implementation plan also called for 50 percent of the VDCs listed to be served within nine months of the effective date of the license and 100 percent served within 18 months. Failure to meet network roll-out requirements were to result in the loss of eligibility for the regional telecommunication service subsidy, forfeiture of the performance guarantee, termination of the license, imposition of fines, and even the forfeiture of all equipment, land, and other assets related to the regional telecommunication service. However, given the security situation, the RFA stated that these penalties would not be applied if the roll-out delay resulted from force majeure. In that event, the RFA stated, NTA would modify the locations.

The RFA specified that the licensee has to provide basic public telephone service consisting local, domestic long distance, and international long distance as mandatory services. Once the above requirements were fulfilled, the licensee was to be authorized to provide additional individual or public telephone access services in any location in the EDR. In addition to the mandatory services, offering Internet access, e-mail, prepaid calling card services, data communication services, and so on, were also authorized in all of the identified VDCs as well as the entire EDR once the roll-out obligations were met.

The license provided that from January 1, 2004, the licensee would have the right to obtain a separate non-exclusive license to provide national long-distance services, and a national license to provide international services using its own international gateway. The conditions for the two licenses were to be the same as any others that would be issued.

The design included a service-quality component that obliged the licensee to meet minimum quality and availability-of-service standards. The licensee was also bound by a number of service-availability criteria. The key availability criterion was that each PCO had to be open during reasonable daytime and afternoon hours (suggested 0900 to 1700 hours), totaling a minimum of eight hours, every day of the week. Where a PCO did not have access to the electrical power grid, the licensee was to provide an alternative source of power.

The Regulatory Framework: Promised

The World Bank was concerned that the many shortcomings in the telecom regulatory environment in Nepal would hinder the success of the project. In order to ensure that regulation would not be detrimental to the proposed project, NTA and the World Bank undertook a number of precautionary measures.

The initial term of the license was set at 10 years, with the licensee enjoying exclusivity in service provision for the first five years. NTA was expected to grant the license renewals, provided that there were no material breaches of the license. The license fee was set at a very low level of NPR 100,000 (approximately USD 1,250) for the initial 10 year period. The licensee was exempted from almost all other fees and levies until the first renewal.

Given the technology neutrality of the design, the licensee was free to use any wireless technology and/or satellite services in providing the services as long as they met stated technical requirements and service quality criteria. The RFA noted that the eventual licensee was required to pay fees on an annual basis for any spectrum license calculated on the same basis and payable on the same conditions as the fees in NTC's spectrum license. However, the licensee was to be exempted from paying spectrum fees as long as NTC was exempted from paying them. The RFA also noted that the licensee would have rights of access to public and private lands and also the rights of inspection and entry set out in the Telecoms Act.

The process of interconnection between the licensee's network and other licensed telecommunications networks in Nepal, including NTC, was to be governed by the Telecom Act's Guidelines for Interconnection.

The tariffs charged by the licensee were to be subject to regulation by the NTA in accordance with the Telecom Act. Except with the prior approval of the NTA, the licensee was not authorized to charge tariffs higher than those set out by 'Regional Telecommunication Service Maximum Tariffs and Default Interconnection Rates' in the RFA (see Appendix 2, Table A2.1).

The RFA stated that the NTA would regulate NTC to ensure that it does not unfairly discriminate against the licensee and does not grant anti-competitive preferences to or cross-subsidize its own regional service operations. The RFA further elaborated that any regional telecom service operations of NTC will be regulated by the NTA so as to ensure that NTC does not abuse its dominant position. It also undertook to ensure that any authorization granted to NTC in the regional service area of the licensee will contain terms and conditions equivalent to those applicable to the licensee.

The above guarantees gave a level of comfort to the bidders in terms of licenses, access to spectrum, tariffs, and possible anti-competitive behavior of the incumbent.

Eligibility, Selection, and Implementation

It is evident that the consultants to the World Bank and NTA intended to maximize the number of potential players that would become eligible to bid at the auction by setting eligibility conditions which were not overly restrictive. The key conditions were that the bidder must become registered as a company in Nepal prior to the license being issued; must have Nepalese investors with a minimum of 20 percent equity; must satisfy the NTA of financing capacity to complete roll-out of the network in accordance with the terms of the license; must provide evidence of operating either a telecommunications network with over 250,000 subscribers, or a telecommunications network with over 500 public telephone access lines in rural areas; and must furnish a bid security of USD 100,000.

The RFA was very clear in how the selection process was to be conducted using a single round LCS auction. It said 'The NTA plans to issue the License and the [regional telecommunication service] Subsidy to the Licensee proposed by the Qualified Applicant that proposes the lowest [regional telecommunication service] Subsidy.'⁴ It is important to note that no maximum subsidy amount was announced, taking the position that 'market knows best' and also guarding against bids converging at the maximum allowable subsidy.

The implementation plan of the LCS determined by the winning bid of the auction was straightforward. The RFA stated that the one-time grant was to be payable in four tranches: first tranche of 40 percent once the 534 access lines have been activated and are in operation; second tranche of 40 percent once 1,068 access lines have been activated and are in operation; third tranche of 10 percent as soon as possible after the end of the first year after the activation of services in all identified VDCs; and the fourth tranche of 10 percent was to be paid at the end of the second year after the activation of services in all identified VDCs provided that quality of service standards were maintained.⁵

NEPAL LCS AUCTION OUTCOME

The NTA commenced the auction process that decided on the present Licensee in February 2003. However, this was the second attempt of the LCS auction. The first attempt was in September 2000. At the 2000 auction, NTA received two bids and the applicant with the lowest subsidy signed a letter of intent to undertake the project. However, with the massacre of the King's family and rising Maoist violence, the winning party withdrew, forfeiting its bid bond. In this context, HMG and the World Bank undertook a total review of the program and weighed the options of suspending the project versus improving the attractiveness of the offer by including conditions that mitigated the risks involved and enhancing the financial attractiveness. It was decided to go ahead with a modified auction.

The RFA documents were made available for purchase in February 2003; a prebid conference with six potential bidders was held in April 2003; and applications for the regional telecommunication service license were received in June 2003. During the bidding process, some potential applicants raised additional concerns related to the financial, regulatory, and security risks. To mitigate some of the concerns, additional changes were made to the proposed regional telecommunication service license.

One of the major concerns addressed was the need for revising the scheduling of payments. If the licensee utilized the Very Small Aperture Terminal (VSAT) technology, 20 percent of the total subsidy was to be paid upon activation of the VSAT network hub station, which had to be based in Nepal. The other payments would be 20 percent of the subsidy upon activation of lines to 20 percent of VDCs; another 50 percent of the subsidy upon activation of 50 percent of the VDCs (for a cumulative total of 70 percent); and a further 20 percent (total of 90 percent) upon activation of all lines. The last 10 percent was to be paid at the end of 24 months of awarding the license. If the independent consultant were to certify that the licensee was prevented from serving some of the VDCs due to force majeure, the NTA was to approve a list of alternative locations within which PCOs could be installed.

However, even after all the above changes were effected, the LCS auction process attracted only two bids. One was disqualified on technical grounds.⁶ The incumbent NTC was not allowed to bid.⁷ Therefore, based on the only bid received, the regional telecommunication service license was awarded in November 2003 after ensuring compliance with licensing requirements, filing of consortium shareholder agreement and registration with Department of Industry, and receipt of the performance guarantee.

Details of the LCS Auction Award

In hindsight, several things could have been done differently, particularly in light of the lessons from Latin America. However, there was the overarching security problem.

At the time of commencing implementation, Nepal was undergoing a serious security threat from Maoist rebels who had been waging an armed campaign against the state since 1996 as a result of which some 11,500 people had been killed. It was not uncommon for hartals to shut down entire cities and villages. Sometimes main traffic arteries were shut down for days. In certain areas, the entire administration was run by the Maoists with no reference to government rules. The security situation was non-conducive from the initial stages of the regional telecommunication service project and it was known to all. It is, therefore, most likely that risk premiums that had to be borne in terms of additional costs would have been included in the bid.

Even though the Maoists created some problems in the initial stages of the roll-out, progress was on schedule until mid-January 2005 when 542 PCOs in 271 VDCs were completed. However, the conflict took a different turn when His Majesty assumed direct rule and took over executive powers on February 1, 2005. The king sacked the Prime Minister, dismissed his government and declared a state of emergency. Using emergency powers, HMG ordered STM to shut down all 542 PCO locations.⁸ Subsequently, HMG permitted STM to reopen 25 out of the 542 locations and by end August 2005, when this study was done, HMG had allowed STM to operate 197 PCO locations in total. In the meantime, STM was unaware of the condition of their equipment in the remaining 345 locations as it had not been possible to even visit these sites due to the numerous restrictions placed on them. However, NTA continued to complain that STM were not interested in relocating these PCOs to other 'safe' areas because they had already collected payments (subsidy) for their installation. In late August 2005, HMG granted permission to STM to restart its implementation program and provided a list of 177 new locations. However, it was alleged that these new locations had been decided by the Army without any thought to their viability given that NTC was already present in them.

From the point of view of the success of the project, there is no doubt that a more conducive security environment would have helped. However, in reality, the ground situation was such that all stakeholders needed to have factored in the unpredictable nature of the situation in Nepal. It is in this context that non-security related issues, particularly those related to ensuring a regulatory environment, within which STM could successfully implement and sustain the regional telecommunication service, are discussed.

DID NEPAL LEARN ANYTHING FROM THE LATIN AMERICAN EXPERIENCE?

A number of studies have evaluated the design and implementation issues of the Latin American LCS projects and arrived at similar conclusions (for example, Dymond and Oestmann, 2002; Guislain, 2004; Navas-Sabater, Dymond and Juntunen, 2002; Samarajiva, 2002; Wellenius, 2002; World Bank, 2003). The most important criteria for the successes was found to be the favorable telecom regulatory environments. Key regulatory aspects were pricing and interconnection. The discussion below considers the Nepali case in light of the past lessons.

Decision to Proceed with the Auction

The Latin American successes were based on competition, both for the market and for the allocation of subsidies. Each LCS auction winner was selected on the basis of competitive bids. Sometimes incumbents were allowed, at other times they were not. Incumbents, whenever permitted, sought to defend their territories from possible new entrants and new entrants, on the other hand, sought to gain footholds in the demarcated license territories. This competition reduced subsidies at the outset. In Chile, the subsidy given out in some cases was only a sixth of the benchmark.

In this context it is worth revisiting the selection of the Licensee where the Nepalese incumbent was not allowed to bid. An issue that has generated strong opposing views is the decision to continue with the LCS auction despite there being only one eligible bidder—STM. While some, including the NTA and the World Bank, see no reason why the auction process should have been suspended, others argue that going ahead with just one eligible bid was perhaps a significant error in judgment. The consultants to the World Bank are said to have approached more than 100 potential international entities with the regional telecommunication service opportunity and reported that there seemed to be 'sufficient interest from serious bidders to run an auction.'⁹

License Region and Exclusivity

Another success factor in Latin America was selecting the 'right' areas using bottom-up approaches. In Chile, local authorities, community organizations, and telecom companies together submitted lists that were later short-listed by regional authorities. Comprehensive market research was undertaken by the regulator and was shared with bidders. Division of license territories into smaller units and allowing bids for multiple licenses was another factor. This process allowed bidders to assemble territorial blocks according to their corporate interests.

In Nepal, how were these VDC areas in the EDR selected? The question is whether sufficient information on the EDR along with demand forecasts was provided to potential bidders by the NTA. The NTA and the World Bank assert that the input from their rural economic consultants (not those who helped design the regional telecommunication service) was based on extensive ground work and the feedback on the draft RFA provided sufficient information for bidders to formulate their plans. Even though the tender did not require a business plan be submitted for evaluation along with the LCS amount, it is obvious that a business plan had to be prepared to calculate the amount. The question is whether the assumptions in these plans were accurate. The NTA revealed that they did not commission a survey to estimate the potential demand for regional telecommunication service in the EDR prior to preparing the RFA.

The primary lesson from Latin America was the importance of a conducive regulatory environment. Because the World Bank and NTA had taken pains (on paper at least) to ensure such an environment would prevail in Nepal, it is worthwhile assessing the outcome.

The license guaranteed exclusivity to STM for the first five years. No new service provider was to be given licenses, nor was NTC to be allowed to provide any service in those VDCs. This decision was rooted in estimates of the economic activity and, hence, the traffic in these areas. Introduction of competition prior to STM building its network and consolidating its customer base was not seen as advisable given the available demand. However, from the date of selecting STM and the time this research ended (November 2003–November 2005), NTC entered more than 100 of the 534 VDCs exclusively earmarked for the STM. The unauthorized entry of NTC to the areas earmarked for STM was a clear violation of the license condition. However, even after numerous complaints from STM and reminders from the World Bank to stick to the agreed rules of the game, NTA failed to stop this continuing abuse.

Adding to the issue of exclusivity violations is the pending implementation of a Code Division Multiple Access (CDMA) license already issued to NTC. The incumbent is planning to install one million lines in the next five years across Nepal including in the EDR. Technical experts are of the view that the CDMA signal will cover almost all VDCs in the Terai region and many of those in the Hill region, which would result in telephone services at a much lower tariff than the existing STM tariffs.¹⁰ Be that as it may, the general view is that the CDMA roll-out has been talked about for a number of years without any concrete results.¹¹ If and when the CDMA roll-out takes place, STM's ability to operate their VSAT PCOs at a profit will be seriously compromised.

Interconnection and Tariffs

Interconnection has a very significant impact on new entry, which puts tremendous pressure on the regulator to establish clear and fair interconnection rules for the success of new entrants. The existence of substantial externalities due to incoming traffic towards rural networks, as well as of different incremental operating costs between urban and rural networks, makes a cost-based interconnection regime essential. There is a strong case for asymmetric interconnection favoring the rural operator.

For instance in Chile, tariffs were regulated minimally; all tariffs except call charges within the primary calling area were left for the operators to set under a ceiling. Implementation of a cost-based asymmetric interconnection regime was critical to the viability of the projects. The ability of the regulator to get the operators, particularly the incumbent, to abide by an access charge that reflected the higher cost of operating a network in the rural and sparsely populated license territories was critical. It cost 18.7 times more to terminate a call on a rural network than on an urban network in Chile.¹² This gave an opportunity for the winning operators to build a business case that included revenue from incoming calls. Sixty percent of the revenue of the largest rural operator in Chile was generated by the positive interconnection balance with urban operators in 2002. The large variations in the subsidy per location, for instance, between the first Chilean and Peruvian auctions; USD 2,250 vs. USD 18,800 indicate that the Peruvians relied on the subsidy much more than the Chileans. In Chile, each dollar of smart subsidy resulted in six private dollars, while it was only two private dollars per subsidy dollar in Peru. The existence of a cost-based asymmetric interconnection regime in Chile, and not in Peru, it has been suggested, explains the difference.¹³ Colombia and Peru are now moving towards asymmetric interconnection regimes.

The NTA failed to create an environment conducive to the successful implementation of the project in the related areas of interconnection and tariff regulation. Interconnection between the licensee's network and that of the NTC was to be governed by the Telecom Act's Guidelines for Interconnection. However, the RFA did not specify an interconnection charge between the regional telecommunication service licensee and NTC, but indicated a maximum retail tariff of NPR 9 per minute for local calls in the RFA annex on maximum tariffs and default interconnection rates.

An interconnection charge was set eventually. What was agreed between STM and the incumbent NTC was 55 percent of NTC's own 'VSAT tariff.' With the NTC 'VSAT tariff' set at NPR 9 per minute, the interconnection rate between STM and NTC was then set at NPR 4.95 per minute for calls originating on the STM network and terminating on the NTC network. STM, therefore, set its own tariff at the maximum allowable rate of NPR 9 per minute. On the other hand, calls originating on NTC's network and terminating on STM licensee's network were to entail a NPR 0.30 payment from NTC to STM.

At the outset, a local call from STM's network to that of its own network or to NTC cost NPR 9 per minute. This was in contrast to NPR 1 per 2 minutes from NTC to NTC non-VSAT calls, making an STM call 18 times more expensive than a call on NTC (note that NTC had VSAT phones in only 7 out of 464 VDCs it covered in the EDR). Realizing that it was not at all possible to sustain such high tariffs, STM eventually reduced its local tariff to NPR 3 per minute at a loss of NPR 1.95 per minute (still 6 times NTC rates) and reduced long-distance charges to NPR 5 per minute with an operational profit of just NPR 0.25 per minute. After numerous rounds of lobbying and directives by NTA under pressure from the World Bank, NTC finally reduced the interconnection rate charged from STM to NPR 2.75 per minute for calls originating on STM and terminating on NTC and continued paying NPR 0.30 per minute for calls originating on NTC and terminating on STM.

The original interconnection charge was excessive. This obviously led to the unsustainable NPR 9 tariff, which then had to be brought down to a loss-making tariff. Internal World Bank communications indicate that the interconnection problem was present from the very beginning. STM had requested NTA to facilitate the interconnection agreement with NTC to which it received a positive response. However, NTC had insisted that they could interconnect STM along the same lines as United Telecom Limited (UTL, Nepal) (the fixed Wireless Local Loop [WLL] operator) which meant STM paying for 16 E1 lines even though their requirement was for just a single E1 line. Furthermore, NTC had objected to providing interconnection at two locations (Kathmandu and Biratnagar) even though the license condition had provided this facility to STM, which was anyway key to reducing back-haul costs to make the operation sustainable. In an early letter to the World Bank, STM called this issue a 'show stopper.'

The independent certification consultant identified a number of interconnection problems that STM was facing. Based on discussions among NTA, STM, and NTC, the regulator had agreed that NTA would immediately mediate between STM and NTC in order to negotiate a fairer interconnection and revenue sharing agreement, and hold regular meetings with STM and NTC to ensure that technical interconnection issues are resolved in a timely manner. They had further agreed to hire a consultant to assist NTA develop an interconnection, pricing, and tariff regime to solve the problems faced by STM and NTC. But, there were no concrete results.

A decision that warrants some attention is why the NTA and the Consultants to the Bank agreed to the maximum rates proposed in the RFA (NPR 9 per minute) as 'reasonable.'¹⁴ The consultants had mentioned that since neither they nor the NTA had NTC's actual costs and interconnection rates, the proposed tariffs had been 'benchmarked adequately and should provide some comfort to potential applicants.' However they had noted that the problem was going to arise with NTC's reaction to interconnection. In order to deal with this impending issue, they had suggested that NTA be provided with 'convincing arguments to support the proposed tariff levels'.

It is clear that NTA had been unable or unwilling to prevent NTC from imposing unfair and potentially detrimental interconnection charges on STM. This resulted in a negligible volume of calls being originated on the STM network and a minimal termination of 'local' calls to the network. Even after the reduction in call rates (to levels that were six times that of NTC), STM reported that during July–August 2005, the average use per day among its 174 operational sites was only 0.36 minutes per day. NTA must take major responsibility for letting the interconnection and tariff issues drag on for so long without finding a solution.¹⁵

The real question is why, after all the evidence from Latin America, did the NTA and the World Bank not pursue a cost-based asymmetric interconnection agreement favoring the regional telecommunication service operator in Nepal? The Latin American evidence is that it is only through such an interconnection agreement that a significantly high incoming revenue structure for rural networks has been made possible thereby making them sustainable.

Technology and Network Roll-out Requirements

The Latin American successes hinged upon complete freedom to use any technology of choice as long as the quality and service parameters were met. A salient feature in almost all LCS auctions in Latin America was the association of the winning bidder with suppliers of specialized rural telecommunications technology, particularly VSAT technology. While this was a success from the point of implementation, sustainability was becoming an issue with evidence emerging that these new entrants were motivated by creating a new market for their principals' equipment. The evidence suggested that many of these operators lacked adequate knowledge in the business of supplying telecommunications services.

In the Nepali case, the RFA was technology-neutral to the extent that it let the applicants decide on 'any appropriate wireless or wire-line technologies in the provision of the regional telecommunication service.' In terms of network roll-out, the RFA gave the freedom of choice to STM to prioritize the VDCs in a manner that was most suitable to them. The RFA simply mentioned that 50 percent of the VDCs were to be covered within nine months and 100 percent within 18 months. NTA and the World Bank did not require any order in which the VDCs or districts should be covered. The outcome of the above two conditions was that STM proposed a VSAT solution, on which it was selected as the lowest subsidy bidder and it started the roll-out with the easiest, or most accessible, VDCs in the beginning and left the difficult ones for later.¹⁶ It must be noted here that STM is a large VSAT manufacturer based in the US. At the time STM applied for the smart subsidy, it had wide experience in manufacturing and installing VSAT networks. It had supplied and installed equipment in Bolivia, Argentina, Venezuela, Mexico, Brazil and Thailand as well as Nepal.¹⁷

In this context several questions have been raised. One is whether STM selected the best technology solution. There is more than one answer to this question. As far as the ease of installation and quick deployment is concerned, VSAT technology seems to be the most suitable for the difficult mountain terrain of the EDR, and perhaps even for some of the more difficult hills where transportation is a problem. This is borne out by the fact that in just over a year STM completed the installation and commissioned regional telecom services in 542 sites in 271 VDCs. These installations, however, were concentrated in 10 out of the 16 districts in the Terai (109 out of 208; 52.4 percent) and the Hill region (162 out of 256; 63.3 percent) while the remaining six remote districts in the mountains were not touched (0 out of 70; 0 percent). However, STM's position is that had there been smooth operation of the project it would have completed its obligation of installing and operating 1,068 PCOs in the 534 VDCs on schedule.

Given delays in roll-out due to a variety of reasons, mostly beyond the control of STM, they are unable to maintain the network on a profitable basis. In this background, the issue is whether using a hybrid solution comprising a less expensive technology in the Terai and a VSAT solution in the more difficult hilly and mountainous districts would have been better (see Appendix 2, Table A2.2 for technology cost guidelines). STM asserts that prior to proposing a VSAT technology they studied in detail the exiting infrastructure, and geo-demographic and socio-economic conditions of the EDR and concluded that a pure VSAT solution was more economical than a hybrid solution. In interviews STM stated that they would have needed a subsidy amount twice that of the actual winning amount; that is, approximately USD 24 million. The argument was that the EDR was not large enough to sustain a multi-technology solution.

But there are opposing views. These become relevant in the context of the practical problems STM is facing on the ground. For instance, when 345 locations out of 542 are out of commission, a possible solution to sustain the operation would be to expand service within profitable VDCs by adding more PCOs in those areas. But research revealed that the VSAT equipment used by STM can only serve an area of 4–5 km and, thus, additional VSAT terminals need to be installed for new locations beyond this perimeter. Given the average cost of at least USD 11,000 per VSAT terminal (derived by dividing the USD 11.865 m subsidy by 1,068 locations), the expert view is that it is uneconomical to use this technology to expand within the VDC without any subsidy. The irony is that while STM is losing money because many of their PCOs have been closed down in 'unsafe' areas, they are unable to expand the service within the 'safe' areas due to high per line costs.¹⁸ Had STM used a hybrid WLL and VSAT solution, it may have had a greater chance of increasing revenues by expanding within 'safe' VDCs.¹⁹

If the objective of giving absolute freedom in the choice of technology was to motivate the licensee to use either one type of technology or a combination of best possible technologies to make the project the least expensive in capital layout as well as recurrent maintenance and operational costs, then the evidence does not suggest the outcome was optimal. In terms of coverage, if perhaps some priority areas were indicated—not necessarily in terms of particular VDCs, but even in terms of difficulty of access or districts within the EDR—it may have been possible to achieve a more balanced roll-out.

The Latin American licenses were designed in a way that winning bidders were able to provide additional unregulated services to strengthen their business case. In addition to the mandatory public payphones or call offices, most operators started provision of services to homes and businesses very early on. Some even added other data communication services. One operator who had obtained a license to provide 1,800 public payphones had expanded the network to over 18,000 lines. In Nepal, NTA and the World Bank relaxed midway the stringent license condition of restricting service provision outside of the identified 534 VDCs by amending sections of the license to allow STM to provide optional services to meet new demand outside of the listed VDCs. The World Bank clarified that this should be done with the understanding that it would not affect the meeting of roll-out milestones, and that no subsidy would be paid for the provision of extra services. However, STM is not keen in providing either more than the two mandatory lines or providing additional services in any significant number of VDCs either in the list or outside. It is possible that partly the reason for this is the VSAT technology they have deployed where adding terminals is expensive, and without the subsidy it is likely that STM is not convinced of sustaining more lines.

International License

Another serious issue is with STM's international license. By license condition, STM was restricted to use the international gateway and other international facilities of NTC until January 1, 2004. However, thereafter, upon application, STM was to have the right to obtain a national license to provide international services using its own international gateway upon payment of the license fee equal to that of NTC. According to STM it has not been granted the international license since its application in April 2004, which if granted would have helped them tide over the serious sustainability issues caused by the unstable security situation within Nepal. The World Bank on numerous occasions has requested NTA to comply with the license condition of providing STM with an international license. STM complained that its request has not been entertained while NTA claims that STM has not made the required payments. STM had requested an extended payment plan for the license fee because of the deteriorating security situation taking a tremendous toll on its bottom line.

It was the responsibility of the NTA to be more proactive in this situation and make necessary mid-course corrections. But it seems that NTA was only interested in sticking to the rules, irrespective of the changed circumstances.

Service Quality and Service Availability

Besides standard quality criteria, STM was bound by a number of service-availability criteria. The key availability criterion was that each PCO had to be open and available to make local, long-distance, and international calls during reasonable daytime and afternoon hours, for a minimum of eight hours, every day of the week. The monitoring of service quality and availability is something that the research found to be wanting. Discussions with independent evaluation consultant PlanetWorks revealed that the difficulty in fulfilling the requirements was particularly due to the security issues and the remoteness of sites.

Be that as it may, during a field visit to one of the sites at Bhaudaha in the Morang district, STM's PCO was closed because that day was a government holiday. Interviews with the local people revealed that the service quality and maintenance was not at all satisfactory. Local people were of the view that the STM PCO should be open from early morning hours because people leave home early to reach their work places which are usually far from their homes. However, the PCO opens only from 1000 to 1700 hours which does not serve that purpose, nor satisfy the license condition that the PCO should open for a minimum period of eight hours a day on all days of the week. In the case of the above example, the PCO is run by the VDC, a semi-government office which maintains office hours. It would have been better had the PCO operated from a private house or business where it would have been accessible to villagers outside 'office hours.' Discussions with PlanetWorks indicated that there are a number of technical issues that needed to be solved to make the service-quality monitoring more efficient. Among the recommendations were that NTA purchase a Geographic Information System (GIS) based system to assist in mapping of VDC sites, storing data, and undertaking analysis.

Was STM prudent in selecting its 'partners' to operate the PCOs and creating the right incentive structure to satisfy the service-quality and availability criteria? The selection of the partners could have been better. It appears that the normal practice is for a representative of STM to visit a village, shortlist a few potential candidates, and, thereafter, select a person to operate the PCO, all on the same day. It was also revealed that for a person to obtain the right to operate a PCO, STM requires them to deposit NPR 35,000 which would be refunded in three years time (NPR 15,000 forfeited if discontinued in 1 year; NPR 10,000 forfeited if discontinued after 2 years, and so on). Once the right to operate a PCO was obtained, these people have to make advance payments (prepaid cards) of NPR 7,500 through banks, which in some cases involves a two to three days walk from the VDC. Discussions revealed that many of these PCO operators were in dire financial difficulty because the PCOs were non-operational or yielded meager revenues.

Certain improvements in the design and a more conducive security environment would have helped STM keep to the implementation plan. However, the primary reason for the current problems which threaten the completion and sustenance of the program is the weak regulatory environment.

NTA's weaknesses were known. All stakeholders were aware of the capacity issues NTA was facing prior to going ahead with the regional telecommunication service. In this context, the World Bank had, in 2004, held extensive discussions on the performance of NTA in a multi-operator environment and recommended that NTA institute processes to improve its regulatory functions. However, even towards the latter part of 2005 the situation at NTA remained unchanged with serious lack of capacity. Interviews with its Chairman and senior officers revealed NTA was severely understaffed and ill-equipped. The regulator's decisions are not free from the influence of the Ministry;²⁰ there is a clear need to revise staff remuneration to attract the right kind of people for the senior and middle management positions that remain vacant. Even the vacancy for the fifth position of the NTA board, which made obtaining a quorum for meetings difficult, was only filled in August 2005 after much pressure from the World Bank.

CONCLUSION

While it is true that the Nepali smart subsidy project has been able to provide some rural communities with telecommunications services, the real question is whether the solution is optimal and whether the project can be sustained in the medium to long term. The answer is not straightforward, but inclined to the negative. This chapter shows that unless the right regulatory conditions are in place, particularly with respect to cost-based asymmetric interconnection agreements and effective regulation of incumbent's anti-competitive practices, success of the regional telecommunication service provider, who was empowered by almost USD 12 million of smart subsidies, is unlikely.

This conclusion leads to revisiting the wisdom of separating the 'access gap' and the 'market efficiency gap' in the literature, particularly in terms of sequencing smart subsidy projects and market liberalization programs. The findings indicate that perhaps it would be more useful to consider addressing rural connectivity issues from an integrated and continuous regulatory-subsidy angle instead of separate solutions for the two gaps.

The Nepali smart subsidy projects may fail without a favorable telecommunications regulatory environment. Another important conclusion is that such projects should have built-in mechanisms for dynamic mid-course corrections. The case of Nepal highlights this point very well where a debatably unexpected security problem has caused havoc in the implementation and sustainability of an already weak project.

Recent action by NTA, at the strong insistence of the World Bank, particularly with the new interconnection ruling and the awarding of the international license are perhaps the most positive steps taken to change the downward direction of the project thus far. It is hoped that the NTA will be encouraged in continuing its good work towards creating a more favorable regulatory environment which will ultimately decide the fate of this project to provide telecommunication services to the rural population of the EDR of Nepal.

NOTES

¹ The conceptual framework of the two gap dichotomy is developed in Navas-Sabater, Dymond and Juntunen (2002). There are others who refer to the same dichotomy with reference to a 'regulatory gap' and an 'affordability gap'.

² Dividing the country in to three terrain regions of mountains, hills, and terai was also considered. The key feature was the possibility of using different technologies in the three geographically different regions. However, that was abandoned in favor of the administrative regions.

³ As per the Request for Application. Consultants to the Bank were Canadian consultancy firm, McCarthy Tetrault Inc.

⁴ However, the RFA was not clear on how the selection would be made in case there was more than one identical lowest bid.

⁵ However, a somewhat revised plan was actually implemented.

⁶ Telecommunications Consultants India Limited (TCIL) from India.

⁷ In some of the Latin American projects, the incumbents were allowed to bid, but did not necessarily win the LCS auctions. However, in India the incumbent won the majority of LCS auctions, the reasons for which are discussed in Chapter 9.

⁸ All telecommunications facilities, including Internet services, were completely shut down for seven days. Mobile phone operations were suspended for three months and even then only select post-paid connections were reconnected. Prepaid connections were activated only after five months. Even at the time of the research, private FM radio stations were prevented from airing news; newspapers were prohibited from publishing news deemed to be anti-state or reporting anything about the Maoist insurgency.

⁹ Documentation at the World Bank showed that six potential bidders were present at the pre-bid conference.

¹⁰ STM tariff structure is discussed later in the chapter.

¹¹ NTC claims it is ready to commence the service. The commissioning of the service and the installation activities were stopped by a court order.

¹² Samarajiva (2002) explains the necessity for such a cost based asymmetric interconnection regimes as follows: 'Traditionally integrated monopolies that supplied voice telephony charged for the service of call origination and offered call termination as a bundled "free" service. Because each "free" call reception was accompanied by a revenue-generating call origination elsewhere on the network, this made sense in an integrated environment. However, the economic viability of connections tended to be measured solely in terms of origination revenues. Those who do not originate many calls (a group that includes most of the poor) appear "uneconomical" though they may be generating income for the overall network through the reception of calls. This perception may be changed through regulatory design that ensures the implementation of cost-oriented interconnection based on measured compensation, as opposed to the simpler sender-keeps-all regime. Because costs are higher in geographical areas where the network is less dense, cost orientation requires that termination rates in low-density parts of the network, such as rural areas, be higher than in high-density, urban areas.

¹³ Ibid.

¹⁴ Internal documentation of the World Bank.

¹⁵ After the research was completed, NTA reported that on October 18, 2005, it had given a directive to operators on the new interconnection rates, but implementation is awaited.

¹⁶ STM license was granted on November 21, 2003; roll-out of 50 percent of VDCs completed by January 14, 2005.

¹⁷ STM Telecom Sanchar Inc. is a consortium consisting of (a) STM Communication Services Inc., USA, (b) STM Network Inc., USA, (c) SAMART Communication Service Co. Ltd, Thailand, and (d) Apollo Investment Private Limited, Nepal.

¹⁸ Rural Telecommunications Service (RTS) in the EDR called for installation of 1,068 PCOs in 534 VDCs spread over 28,456 sq km. Not all VDCs are in the remote inaccessible areas. In fact, 416 PCO locations, that is, 39 percent of RTS areas are in the flat land or Terai region. Just to contrast, NTC's technology distribution in EDR is as follows: wire-line 102; radio and wire-line 108; VHF 245; and VSAT 7 for a total of 464 VDCs covered.

¹⁹ Given here is a rough estimate made available to us by local experts and presented here as relevant information. However, the authors do not take responsibility for the accuracy of same. All 416 locations in the Terai region can be easily covered by WLL technology. Even if only 10 percent of the remaining stations, that is, 65 (10 percent of 1068–416) stations are covered using WLL technology locations with an integrated technology would turn out as follows. Using the per line cost of USD 11,110 per VSAT terminal from the ongoing project and assuming a cost of USD 600 per line using WLL technology, the project cost could have come down to USD 6,810,170 which is USD 5,054,830 less than the actual subsidy awarded. If exchange cost is included this cost goes up by another USD 250,000.

Cost scenario with integrated WLL-VSAT technology (amounts in USD)

²⁰ It should be noted that the Chairman of NTC is, at the time of writing, the Secretary to the Ministry of Information & Communications; this is a clear conflict of interest.

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