Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No: 25052

IMPLEMENTATION COMPLETION REPORT(CPL-39040; SCL-39046)

ONA

LOAN

IN THE AMOUNT OF US$325 MILLION EQUIVALENT

TO THE

REPUBLIC OF INDONESIA

FOR

TELECOMMUNICATIONS SECTOR MODERNIZATION PROJECT

December 18, 2002

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective as of June 30, 2002)

Currency Unit = Indonesia RupiahRp. 100 = US$ 0.012

US$ 1.00 = Rp. 9795

FISCAL YEARGovernment of IndonesiaJanuary 1 - December 31

PT TelkomJanuary 1 - December 31

ABBREVIATIONS AND ACRONYMS

AAA Analytical and Advisory ServicesCAGR Compound Annual Growth RateCML Connected Main LinesCoF CofinanciersDGPT Directorate General of Posts and TelecommunicationsDLD Domestic Long DistanceEBIT Eamings Before Interests and TaxesEBITDA Eamings Before Interest, Tax, Depreciation and AmortizationERR Economic Rate of ReturnGOI Government of IndonesiaICB International Competitive BiddingIDD Intemational Direct DialingIFC International Finance CorporationIMF Intemational Monetary FundIndosat PT IndosatITU International Telecommunication UnionJOS Joint Operation SchemeKSO Keija Sama OperasiLIS Lines in ServiceMTPT Ministry of Tourism, Post and TelecommunicationsMOU Memorandum of UnderstandingNBF Not Bank FinancedNCB National Competitive BiddingOEG Operations Evaluation GroupPIU Project Implementation UnutPLDT Philippine Long Distance Telephone CompanyPPI Private Participation i InfrastructureSDH Synchronous Digital HierarchyTA Technical AssistanceTelkom PT Telekomunikasi IndonesiaTelkomsel PT Telekomunikasi Seluler

Vice President: Jemal-ud-din KassumCountry Manager/Diiector: Andrew Steer

Sector Manager/Director: Pierre GuislainTask Team Leader/Task Manager: Rajesh Pra4han

INDONESIATELECOMMUNICATIONS SECTOR MODERNIZATION PROJECT

CONTENTS

Page No.1. Project Data 12 Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 35. Major Factors Affecting Implementation and Outcome 116. Sustainability 137. Bank and Borrower Performance 138. Lessons Leamed 159. Partner Comments 1610. Additional Information 17Annex 1. Key Performance Indicators/Log Frame Matrix 19Annex 2. Project Costs and Financing 20Annex 3. Economic Costs and Benefits 22Annex 4. Bank Inputs 24Annex 5. Ratings for Achievement of Objectives/Outputs of Components 26Annex 6. Ratings of Bank and Borrower Performance 27Annex 7. List of Supporting Documents 28

Project ID: P004001 Project Name: Indonesia - Telecom SectorModernization

Team Leader: Rajesh B. Pradhan TL Unit: CITPO

ICR Type: Core ICR IReport Date: December 26, 2002

1. Project Data

Name: Indonesia - Telecom Sector Modernization LC/ITF Number: CPL-39040;SCL-39046

Country/Department: INDONESIA Region: East Asia and PacificRegion

Sector/subsector: Telecommunications (97%); Central govemmentadministration (3%)

KEY DATESOriginal Revised/Actual

PCD: 09/20/1994 Effective: 06/15/1995 06/15/1995Appraisal. 12/09/1994 MTR:Approval: 11/07/1995 Closing: 06/30/2001 06/30/2002

Borrower/Implementing Agency: GOIlMTPT; GOI/TelkomOther Partners: France, Gerrnany (KfW), Japan EXIM, Japan OECF, US EXIM

STAFF Current At AppraisalVice President: Jemal-ud-dm Kassum Gautam S. KajiCountry Manager: Andrew D. Steer M. HaugSector Manager: Pierre A. Guislain Peter R. SchererTeam Leader at ICR: Rajesh B. Pradhan A. ShanmugarajahICR PrimaryAuthor: Peter L. Smith; Rajesh B.

Pradhan; A. Shanrnugarajah;Kashmira Daruwalla; Carlos R.Gomez

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L-Likely, UN=Urdikely, HUN=HighlyUnlikely, HU=Hlghly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: M

Bank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S S

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:

3.1.1. Until the early 1990s, the role of the private sector in the Indonesian telecommunications sectorwas mainly limited to participation in revenue sharing schemes (with no management control over businessoperations) or joint ventures with one of the two state-owned telecommunications operators. There waslittle competition in the main telecommunications services. Furthermore, by 1994 there were only about3.5 million telephone lines for a population of about 190 million, the equivalent of 1.8 lines per 100 people.One of the thrusts of the project was to expand the role of private investors in the sector in ways thatbrought international private management expertise to the sector and promoted competition in line with thelegal framework that existed at that time. This framework required all investment in the sector to be incooperation with, or by, one of the two designated state telecommunications operators, Telkom or Indosat.

3.1.2. The main objective of the project was to assist the Government of Indonesia (GOI) in theimplementation of the long-termi development program for the telecommunications sector aimed atenhancing its international competitiveness through: (a) the formulation and implementation of a sectorallegal and regulatory framework and (b) modernization of Indonesia's telecommunications services andnetwork. The project supported a reform program for the sector based on three key elements: (a) entry ofworld-class operators; (b) competition in all market segments; and (c) reorganization of Telkom, theincumbent domestic operator.

3.1.3. The project objectives reflected the priorities identified in the 1995 Bank's Country AssistanceStrategy (CAS) for Indonesia, which called for tailoring "public investment projects to eliminate criticalinfrastructure bottlenecks while increasing the role of the private sector". The objectives were alsoconsistent with the Government's policy initiatives, which included the award of a second national cellularlicense, implementation of large-scale joint operating schemes, reorganization of Telkom, review of thelegal environment, and the initial public offering of shares in Telkom, as well as its target of bringing anadditional 5 million telephone lines into service by 1999.

3.2 Revised Objective:

3.2.1. The original objectives were not revised.

3.3 Original Components:

3.3.1. The project was designed to achieve its objectives through three components: (a) a policycomponent of advisory services and capacity building for the Ministry of Tourism, Posts andTelecommunications (MITPT); (b) an investment component for Telkom; and (c) a technical assistancecomponent for Telkom.

3.3.2. The Policy component included support and capacity building for: (a) reviewing and developing,as appropriate, the telecommunications legal and regulatory environment to ensure effective entry of privateinvestors and operators; (b) strengthening MTPT's capacity to manage regulatory issues in the emergingmultioperator environment; (c) reviewing management and allocation of radio frequency spectrum; and (d)developing plans for the provision of rural telephone services on a commercial basis.

3.3.3. The Investment component supported improvements in Telkom's quantity and quality of service,and network modernization through: (a) the installation of local and interexchange networks to useeffectively an additional 1 million lines of switching capacity in Jakarta and Surabaya; (b) the installation

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of a second fiber optical backbone system between Jakarta and Surabaya; (c) the installation of submarinefiber optical systems to upgrade transmission facilities to Kalimantan and Sulawesi; and (d) theenhancement of information systems to improve Telkom's business processes.

3.3.4. The Technical Assistance component supported: (a) the strengthening the projectimplementation, marketing, customer services, and managerial capacities of Telkom through the provisionof specialized marketing and managerial services; and (b) improving Telkom's managerial capacity throughthe implementation of its restructuring program.

3.4 Revised Components:

3.4.1. The components noted above were not revised.

3.5 Quality at Entry:

3.5.1. The project was not reviewed by the Quality Assurance Group. Quality at entry was considered tohave been satisfactory. The project was designed taking into account lessons learned from previoustelecommunications projects in Indonesia. The potential risks identified for the project fell into twocategories: (a) delays in procurement and (b) a shortfall in Telkom institutional capacity to implement theproject To avoid delays in procurement, engineering and site identification were coompleted before theproject launch, advance procurement actions were required by Telkom and the terms of reference for allconsultancy requirements were completed during project preparation. To address the shortfall in Telkom'sinstitutional capacity to implement the project, technical assistance was provided to Telkom's projectimplementation unit for the project management, implementation, and the procurement process. However,at the time of appraisal, the financial crisis of 1997 and subsequent political turmoil that hit Indonesia werenot foreseen and delayed project completion by one year.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:

4.1.2. Objective 1: Fornnuation and implementation of a sectoral legal and regulatory frameworlkThe achievement of this objective is assessed as satisfactory in respect of the following aspects of theIndonesian telecommunications sector: (a) private investment, (b) competition, and (c) legal and regulatoryframework.

(a) Private investrnent. During the course of the project there were three main channels for privateinvestment in the sector large-scale build-operate-transfer (BOT) schemes - commonly referred toby their Indonesian acronym as KSOs - with Telkom for local telephone networks; cellular mobileoperators; and partial privadzation of Telkom and Indosat.

(i) KSOs. Starting in 1995, following an international competitive bidding process, the KSOsoperated and developed the local telephone network in five out of seven Telkom's operatingregions (i.e., all of Indonesia except Telkom's Jakarta and Surabaya operating regions.) EachKSO investor consortium consisted of one or two major international telecommunicationsoperators together with intemational and local investors. They agreed to specific localtelephone line installation targets totaling about 2 million lines, and revenue sharing withTelkom according to a specified formula. Unlike other build/transfer schemes often seen inother sectors and countries, the KSOs did not provide for state guarantees of financial

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outcomes, so that all commercial risks were bome by the private investors. The otherdistinction of KSOs was their control over the entire assets-existing Telkom as well as newinfrastructure-during the period of the contract. The consortia were granted limitedauthorization for the provision of fixed local telephone services in their region. Separateauthorization was required to provide other services. The government's intention with theKSO scheme was to mobilize private capital, and technical and managerial expertise to thetelecommunications sector. The ownership structure of each of the five regional KSOinvestment consortiurs is listed in Table 1. IFC provided financing for the Pramindo KSO,which operated in Sumatra.

Table 1: Private Investors in KSO RegionsSumatra West Java Central Java Kalimantan East Indonesia

KSO Investor Pramindo Aria West M.G.T.I. Mitratel Bukaka MalindoConsortium Ikat

Foreign Telecom France Cable MediaOne Telstra Global Cable & SingaporeParticipant & Radio (AT&T) (20%) Wireless Telecom

(Equity Share) (35%) (35%) NTT (15 %) (25%) (40%)

Local and Other 65% 65% 65% 75% 60%Participants

(Equity Share)

By December 1999, in less than four years, the KSOs had invested about $1.6 billion and installedabout 1.3 million local telephone lines, representing at that time about 24 percent of all fixed telephonelines in Indonesia. By the end of 2001, the KSOs had connected 2.08 million lines, the equivalent of43 percent of the total additional connected lines in Indonesia during that period (see Chart 1.)

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Chart 1: Total and KSO-constructed Fxed Telephone Lines inService, 1995-2001

8,000,0007,000,000 -6,000,000 -5,000,0004,000,0003,000,0002,000,0001,000,000

1995 1996 1997 1998 1999 2000 2001

v Total fixed lines in service * KSO-constructed lines in service

Source: Telkom

Despite the significant KSO investment and fixed-line connections, the previously agreedtargets were not met for March 1999 -end of the build-out commitment period. The sharpdevaluation of the Rupiah in 1997 sparked a chain of events that placed most of the KSOsunder severe financial strain. In June 1998, Telkom and the KSO operators signed amemorandum of understanding (MOU) that was intended to assist the sustainability of theKSOs in the dramatically changed market environment. Thus, the MOU provided forareduction in the KSO build-out requirement from 2 million to 1.268 million lines together witha temporary reduction (until 1999) of Telkom's revenue share from the KSOs. Nevertheless,in spite of the MOU, most of the KSOs were unable to fulfill their revenue sharing andnetwork build-out obligations. After the crisis, partly as a result of the increased power ofparliament in the post-Suharto era, the KSOs continued to face difficulties primarily due totheir inability to obtain Govemment approval to raise tariffs. Of the five KSOs, Telkom hasbought out the operations in two regions: Kalimantan (in 2001) and Sumatra (in 2002). TheKSO in Eastem Indonesia, partnered with Singapore Telecom is expected to continue undernew arrangements. Negotiations for Telkom to buy out the KSOs in West Java and CentralJava are incomplete.

Although the KSOs attracted participation by major international telecommunicationscorporations as well as large-scale private investment, the KSO structure inherently hadimportant drawbacks compared to conventional business structures, as it (a) reduced flexibilityof business response in the face of changed political and market conditions; (b) made effectivemanagement and motivation of staff (who generally remained employees of Telkom) moredifficult; and (c) complicated downstream new entry because of contractual terms regardingexclusivity.

During the appraisal, it was envisaged that the dynamics of this initiative would lead to more

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competition and operators in the future. Within five years, there was the potential for theregional KSO arrangements to be converted into autonomous regional operating companies,each with the participation of a highly qualified foreign operator, providing not only localservice, but prospectively also long distance service within their operating region incompetition with Telkom and Indosat.

(ii) Cellular mobile operators. Opening the cellular mobile market to competition and privateinvestment was one of the major themes of the Bank's dialogue with the Government duringthe preparation and implementation of this project. Thus, the Bank arranged for a consultancy(funded under the Japan Grant Fund) to assess policy options to optimize the cellular marketsegment. Subsequently, the Bank emphasized the importance of ending cross-ownership byTelkom and Indosat of cellular operators (see section b).

The number of cellular mobile subscribers in Indonesia has increased from 210,000 in 1995, toabout 8.6 million projected for the end of 2002, representing an investment of $5 billion andexceeding the 7.4 million fixed-lines in service projected for 2002. The market is dominated bythree major national services: Excelcomindo, Satelindo, and Telkomsel. Each of theseoperators has had high levels of private investment Singapore Telecom holds 35 percentequity in Telkomsel - the remaining 65 percent is held by Telkom. Until recently, DeutscheTelekom owned 25 percent of Satelindo, but now is a 100 percent subsidiary of Indosat, whichis expected to reduce its Govemment control and ownership from 57 percent to 15 percent byDecember 2002. In the case of Excelcomindo, the company is majority privately owned by thelocal company Telekomindo, and Nynex (a subsidiary of Verizon), both holding 60 and 23.1percent of the equity, respectively. Thus, during 1995 to 2002, the cellular mobile sector hasgone from representing a small part of the total telephone market, to one that exceeds thenumber of fixed-lines and has very large amounts of private investment. Approximateestimates of recent and projected investment by cellular operators in Indonesia range from$700 million in 2000, to more than $1 billion in 2002.

(iii) Privatization of Telkom and Indosat. Both Telkom and Indosat are listed on the Jakarta,London, and New York stock exchanges. As a result of initial public offerings as well as othertransactions, the percentage of Indosat and Telkom respectively that are owned by privateinvestors has increased significantly (see Tables 2 and 3.)

Table 2: Indosat - Ownership and Privatization TransactionsYear Private (%) GOI (%)

Priorto 1994 0 1001994 35 652001 43 57Dec. 2002 (expected) 85 15

Table 3: Telkom - Ownership and Privatization TransactionsYear Private (°) GOI (%)

Priorto 1995 0 1001995 34 662001 46 54

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(b) Competition. Between 1995 and 2002, important achievements were made in increasingcompetition in the Indonesian telecommunications markets. Particularly notable are the followingdevelopments:

(i) In 1995, cellular service in Indonesia was in its infancy and was limited to small regionaloperators and two national operators, all partly owned by Telkom and/or Indosat. Currently,vigorous competition occurs between three national cellular operators with estimated 2002market shares as follows: Excelcornindo (17 percent), Satelindo/Indosat (30 percent), andTelkomsel (51 percent). About 2 percent of the market share is with small regional andanalogue operators.

(ii) Telkom's monopoly ended in August 2002, and Indosat was awarded a license to operate in thefixed-line market. However, real competition for fixed-local telephone service comes fromcellular. With about 8.6 million cellular subscribers projected at the end of 2002 comparedwith 7.4 million fixed lines in service, there are now more cellular than fixed-lines in Indonesia.

(iii) After the financial crisis of 1997, there was considerable sustained pressure to merge Telkomand Indosat into one company. Nevertheless, in line with the Bank's recommendation and theGovernment's commitments to the IMEF as set out in the letters of intent, the GOI decided topromote competition by implementing a two full service-operator policy, whereby over a shorttime both Telkom and Indosat are authorized to provide a full range of domestic andintemational telecommunications services (see Table 4).

(iv) The effectiveness of competition has also been increased by the significant reduction ofcross-ownership in the sector. In a set of transactions in May 2001, Indosat gave up its largeminority share in Telkomsel and acquired Telkom's large minority share in Satelindo. As aresult, both Telkom and Indosat respectively have control of a major cellular operator withoutcross-ownership from the other. In addition to promoting competition, these actions allowoptimal development of the businesses and increase shareholder value. The combined valuesof Telkom and Indosat represent about 16 percent of total capitalized value of finns listed onthe Jakarta Stock Exchange.

Table 4: Telkom and Indosat Expanded Service AuthorizationsMarket seement Before Auest 2002 Au ust 2002 Augst 2003

VALelkonI Indosat Telkom | ndosat Telkom I ndoRnstLocalfixed Yes No Yes i Yes Yes YesDonmestic LnDitce Ye$ No Yes No Yes Yeslniternational Direct Dialinz No yes No I Yes Yes Yes

(c) Legal and regulatory framework The project sought to develop the legal and regulatoryenvironment for the telecommunications sector in order to promote competition and large-scaleprivate investmnent. The scope of the project did not include the establishment of an independentregulatory body for the sector since that option was not available at that time under the Suhartoregime. In addition to policy dialogue under the project, additional funds were provided by theCountry Management Unit under a policy dialogue AAA activity, to enhance, broaden, andadvance the sector policy agenda. This effort was very effective as the Bank prepared a"Telecommunications Development Priority Action Plan" under the request of the coordinating

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Minister of the Economy, which affiliated serious consideration of establishing a nonministerialregulatory agency, actions on competition in basic service, and resolution of cross ownershipbetween Telkom and Indosat.

4.1.3. As a result of the Bank's policy dialogue, there were significant achievements as indicated by thesize of private investment in the Indonesian telecom sector over the period 1996 to 2002. These projectachievements include:

* Proclamation (as a result of dialogue with the Bank in respect of preparation of this project) of adecree that created the possibility of large-scale private investment through the joint operatingschemes.

* Establishment (until 1997) of a price-cap type formula to determine tariff changes for maintelephone services. The price cap formula was developed with assistance from a project-fundedconsultancy.

* Passage of a new telecommunications law in 1999, which ended the requirement that alltelecommunications services be provided by or in cooperation with Telkom or Indosat. This majorchange reflected dialogue with the Bank during the project and was supported by a project-fundedconsultancy.

* Preparation and publication in 1999 of the "blueprint" sector policy document which provided forincreased competition under the two full-service provider policies. This policy also reflecteddialogue with the Bank and helped avoid an anticompetitive merger of Telkom and Indosat.

* Early termination of the exclusivity rights held by Telkom on local and national long-distanceservices (2002), and by Indosat and Satelindo on international services (announced for 2003.) Thisgovernment decision also reflected dialogue with the Bank during project supervision.

4.1.4. Nevertheless, the telecommunications regulatory development agenda in Indonesia is incomplete.Progress still needs to made in the areas of: (a) establishing a non-ministerial regulatory body; (b)improving transparency of process; (c) effectively implementing an appropriate interconnection policy; and(d) establishing an appropriate tariff regime that both protects customer interests and gives confidence toinvestors. Dialogue between the govemment and the Bank on these policy and regulatory issues iscontinuing under a AAA budget. Additional assistance in these areas is planned under a technicalassistance project on infrastructure policy.

4.1.5. In two other areas, the project made limited progress. With respect to rural communicationsservices, partial progress was achieved through the "universal service" obligations of the KSOs.Furthermore, business model approaches for accelerated provision of rural service on a commercial basiswere developed under the project, but never implemented (in a contemplated pilot project) because of theseverity of the economic crisis that started in 1997. With respect to radio frequency management, theproject supported plans for development of more modem approaches, but these were not implemented (in acontemplated follow-on project) because of changed priorities after the financial and economic crisis.

4.1.6. Objective 2: Modernization of telecommunications services and networks. The achievementof this objective is assessed as satisfactory. It was attained by the installation and commissioning ofmodem technology in Telkom's local access, interexchange and long distance networks, as well as by theimproved operation and management of the networks. Telkom has an advanced network that is fullydigitalized. In spite of adverse economic and political situation, total fixed-lines grew at 16.6 percentCAGR during the project period raising the penetration rate for fixed telephone lines from 1.3 percent in1994 to 3.25 percent at the end of 2001. Telkom also greatly increased the number of telephone kiosks(payphones) to serve primarily poorer parts of the population that could not afford fixed phone service. The

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growth of telephone lines in service over the period 1990 to 2001 is shown in Chart 2.

Chart 2: Total Telephone Lines (Fixed and Cellular), 1990-2001

18,000,000 -

16,000,000 -

14,000,000 - 2 i

12,000,000 - . f

10,000,000- _

8,000,000- A

6,000,000-

4,000,000- -

2,000,0000

o - N X Nt U) tD r- Go C) 0 C-a) 0) a) a) 0) CD 0) a) a) 0) 0 0 oCDaCDC) a) ax 0) o) 0) CD aw a v'

-- +-Total telephone lines Fixed lines in -service Cellular subscribers

Source: Telkom

4.2 Outputs by components:

Policy Component

4.2.1. The project satisfactorily completed most components as stated in the Staff Appraisal Report(SAR).

4.2.2. Consultant advisory services, supported by continuous dialogue by the Bank's supervision team,were provided in all areas indicated in the SAR. As indicated earlier, the component supported theemergence of competition and private investment in the sector, the monitoring of the KSO performance, andhelped to address important policy, legislative, and regulatory issues with respect to tariff adjustment,network interconnection, rural telecommunications services, and radio spectrum management.

4.2.3. The list of policy and regulatory consultancies supported under the project is shown in Section 10.This component also provided significant training support to the Ministry and DGPT staff to exposeofficials to best international practices and to upgrade professional skills. Nevertheless, due to a number ofchanges in the institutional set-up and leadership of the DGPT, as well as availability of grant funds frombilateral sources (which were used instead of project funds), only 70 percent of funds allocated under thiscomponent were used. This comnponent was closed on the originally planned closing date of June 30, 2001.

Investment Component

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4.2.4. Telkom's investment program (1994 to 1998) was supported by both Bank and cofinanciers(OECF Japan, EXIM Japan, KfW, France and EXIM USA). The Bank assistance focused on areas suchas outside plant network rehabilitation, expansion and capacity utilization, given that these components arethe least attractive to the donors. Over 2.7 million digital line units of telephone switching capacity wereinstalled in about 878 locations. Outside plant facilities and the junction network in Jakarta and Surabayawere upgraded and expanded to achieve increased capacity utilization. Modem high-capacity optical fiberand submarine cable transmission systems, were installed for the Surabaya-Ujungpandang-Banjaarmasinand Pangkal Pinang-Pontianak routes. Transmission systems were expanded in about 420 locations tocarry the growing traffic. Fifteen outside Plant Maintenance Centers were established to improve technicaloperation and management of the local access networks. Enhanced information infrastructure andimproved training facilities were provided. The project also enabled Telkom to address Y2K audit andcorrection on its networks and management systems. This component contributed to the increase in the totalnetwork capacity (including KSO divisions) from 1994 to 2001, which grew from 3.9 to 8.8 million lines,and the increase in capacity utilization from 63 percent to 82 percent for the same period (see Annex 1.)Additionally, quality of service as measured by local and long distance call completion rates increased from53 percent and 43 percent to 74 percent and 66 percent respectively, from 1994 to 2001, however, theseachievements were below the appraisal targets due to significant reductions in capital expenditure in thelast three years following the economic crisis in 1997. To improve access to telecommunications facilitiesto those who cannot afford to own a telephone line, telephone kiosks and payphones increased from100,000 to 383,000 during 1994 to 2001.

Technical Assistance Component

4.2.5. The project supported capacity building for Telkom, in planning and implementing projects toexploit the most modem and cost effective technologies, and provide improved customer service. Telkom'smanagerial capacity to succeed in an increasingly competitive market has been significantly improved. Thisperfornance is reflected in Standard & Poor's recent (June 2002) B+ credit rating for Telkom. Thecomponent also provided assistance to Telkom to modernize its training facilities and delivery of training.Accordingly, assistance was provided to update curricula and training modules to effectively managemodem information and communications technologies. Training of instructors for a range of courses tofamiliarize themselves with developments in the regional training institutions was supported. Telkom'starget is to provide 10 training days per staff, thus ensuring a well-trained staff providing good qualityservice. Partly as a result of these initiatives, staff productivity has improved to 5 staff per 1,000 lines in2001 from 13 in 1995, exceeding the appraisal target of 7. This result is in line with intemational trendsand will be improved with the deployment of wireless technologies in the access networks. Consultantservices were provided in the areas of activity-based costing and interconnection management therebystrengthening Telkom's management capacity in a competitive multioperator environment.

4.3 Net Present Value/Economic rate of return:

4.3.1 At appraisal, the economic rate of return (ERR) was calculated at 33 percent, based on overallinvestments expected to be made by Telkorn. This estimate did not take into account the benefits thatwould be accrued due to the impact of the other elements of the overall reform components of the project,such as the increase in numbers of lines due to private investment and participation through the KSOs,increased cellular access, and new employment opportunities generated through the development of newservices. Using the same methodology and assumptions at the time of appraisal, the actual ERR ofTelkom's investments is estimated at 32 percent, which is comparable to the ERR estimated at appraisal.

4.4 Financial rate of return:

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4.4.1. Telkom's prudent financial management helped minimize the negative impact of the financial crisisin Indonesia on its performance since 1997. Telkom was also shielded from the full impact of Rupiahdevaluation, as the KSOs faced the investment risk for the expansion and management of the networkoutside of Jakarta and Surabaya, and Telkom continued to receive minimum revenues from the KSOs(essentially lease payments in respect of Telkom's assets operated and managed by KSOs.) Telkom'sfinancial performance indicators are provided in Annex 3. While Telkom's financial returns were affecteddue to the downturn in the economy, Telkom met both its debt service coverage and internal cashgeneration covenants. Throughout the project period, Telkom's debt service coverage and internal cashgeneration ratios were well above the 1.5 times the debt service requirements and 50 percent of its averageannual capital expenditures over current and following years, respectively.

4.4.2. As of December 31, 2001, both the liquidity and financial position of Telkom have deteriorated dueto the action being taken by Telkom to resolve cross-ownerships and KSOs buyout. Telkom's liquiditystood at 0.7 as compared to 2.7 on December 31, 2000. This drop in current ratio was due mainly topayment due to Indosat for the purchase of 35 percent shares of Telkomsel and buyout of the KSOs. Inaddition, on December 31, 2001, the long-term debt to total capitalization stood at 70 percent as comparedto 53 percent as of December 31, 2000. With the consolidation of Telkomsel's account (majority Telkomowned cellular operator) with Telkom's account starting fiscal 2002, the liquidity and financial positionshave improved to 0.9 and 18 percent, respectively, as of September 30, 2002.

4.5 Instititional development impact:

4.5.1. The project's institutional development impact was modest. The partial privatization of Telkomthrough listings on stock exchanges, required it to strengthen its accounting and financial functions,contributing to increase the professionalism of Telkom's management and ability to make effective use ofits human and financial resources. Telkom's staff received on-the-job training to develop in-housecapabilities in all aspects of operations and thus reduce reliance on foreign expertise. The staffproductivity increased from 10 to 5 workers per 1,000 lines in service, exceeding the established target.Additionally, with technical assistance from the Bank, MTPT was able to develop an agenda for regulatoryactivities, assess, recommend, and implement regulatory action on priority matters. MTPT was also ableto review proposals for tariff revisions and recommend an appropriate tariff rebalancing mechanism, whichwas implemented until the disruption of the Rupiah collapse and economic crisis. In spite of theseachievements, we note that DGPT's ability to apply intemational best practice in addressing regulatoryissues remained weak at the end of the project

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control ofgovernment or implementing agency:

5.1.2. The major extemal factor affecting the project was the severity of the unforeseen financial andeconomic crisis that began in 1997. This factor, coupled with difficulty in obtaining authorizations forincreased tariffs (see below) were the key factors in ending the commercial viability of the KSOs. Inaddition, the economic crisis contributed to the delay in the implementation of the investment and technicalassistance components of the project by one year, and accordingly the closing date of the loan was extendedto June 30, 2002, from its original date of June 30, 2001.

5.2 Factors generally subject to government control:

5.2.1. Following the Rupiah collapse and the end of the Suharto regime, the government repeatedlydelayed authorizing tariff increases for the main telephone service that would have reflected the published

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tariff adjustment formula. Public antipathy to all PPI deals was a contributory factor to GOI reluctance inadjusting the tarifis. Consequently, investment in fixed telephone networks was discouraged and theviability of the KSOs business scheme was damaged. While this approach was under government control,it also reflected the political crisis and much increased power of parliament in the post-Suharto era.

5.3 Factors generally subject to implementing agency control:

5.3.1. Telkom successfully managed the complex and intricate activities related to: (a) developingexceptionally large investment programs, (b) implementation of these programs by connecting a very largenumber of new subscribers, and (c) simultaneously establishing effective operation and maintenancesystems for the network. This effort resulted in substantial improvement in the quality and the efficiency ofthe services. All this is attributable largely to the setting-up of a Project Implementation Unit (PIU), whichfunctioned efficiently and effectively in liaison with the project planning and management department. Inaddition, Telkom employed consultants for implementation of each project component in liaison with theproject planning and management department. Consultants were employed by Telkom in particular for: (a)its corporate planning process, (b) program/project management, (c) construction supervision, (d) technicalaspects of capacity utilization, and (e) interconnection tariff setting arrangements. These tasks andactivities were satisfactorily performed and completed. GOI and Telkom evaluated the perfornance ofconsultants as satisfactory.

5.4 Costs andfinancing:

5.4.1. The total cost of the project was $1,090.70 million as compared to the appraisal estimate of$1,412.70 million. Details of the project cost and financing are available in Annex 2. The Bank financed$215.0 million of the total project cost as compared to the original Bank loan of $325 million. As part ofthe Bank dialogue with GOI on portfolio restructuring after the financial crisis in 1997, $96.7 million wascancelled at the request of the Government to reduce the amount of overall borrowing by the country. Asavings of $13.3 million will be cancelled effective end-October 2002, as this is the balance remainingunused after payments on the withdrawal applications received by the Bank by October 31, 2002, havebeen made.

5.4.2. Given the economic and financial situation of 1997, and its effect on demand for service, Telkommanagement controlled its investment expenditures to align with the reduction to reduced demand. Inaddition, Telkom wanted to minimize its exposure to foreign exchange risk. The main component affectedby this decision was the outside plant network expansion, which was funded through Bank funds andTelkom's internal resources. The Bank supported Telkom's disciplined approach with respect to scrutinyon capital expenditures on fixed-line build-out as well as on equipment needed for improving quality ofservice. Telkom focused on improving the utilization of its network capacity and thus reached anutilization rate of over 80 percent, much higher than TelecomAsia in Thailand and PLDT in Philippines.These two companies over-built capacity and now have utilization rates of near 70 percent and both nowsuffer financially. Consequently, the total project cost was lower than the appraisal estimates. In addition,significant cost savings in both the optical fiber and SDH transmission equipment between appraisalestimates in 1994 and the tendering period in 1996 contributed to lower the project cost.

5.4.3. The cancellation of the loan arnount and the reduction in overall capital expenditure did affectnegatively the achievement of the physical performance indicators as agreed at project appraisal (Annex 1.)Nevertheless, the total lines in service in the sector as a whole, has been augmented by the significantgrowth in the number of cellular lines which now exceeds the number of fixed-lines. Telkom expectscellular growth to accelerate and fixed-line growth to stagnate as the cellular substitution effect kicks in.

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6. Sustainability

6.1 Rationalefor sustainability rating:

6.1.1. Sustainability of the project's results has been rated as "likely" for the following reasons:

* The role of the private sector in Indonesian telecommunications appears to be irreversible andcontinues to grow.

* The existence of market competition and private investment creates strong incentives for continuedperformance improvement. Thus, the managerial capacity of Telkom will continue to improvebecause of competitive incentives, learming from competitors, involvement of foreign partners suchas Singapore Telecommunications, and the obligations of the reporting requirements to the NewYork Stock Exchange.

* The networks installed by both the KSOs and Telkom continue to be maintained and used.

6.2 Transition arrangement to regular operations:

6.2.1. At Telkom, the transition to regular operations was successfully completed with the disbanding ofthe project management unit (PMU) in mid-2002.

6.2.2. With respect to the overall Indonesian telecommunications sector, although real progress has beenmade which has transformed the structure and performance of the sector, several important areas of thepolicy and regulatory framework need to be addressed. These include: establishment of an effectivenon-ministerial telecommunications regulatory agency, placement of a nonarbitrary price regulationmechanism; adoption of an improved wireless licensing mechanisms; and the establishment of moreeffective universal service mechanism. Dialogue between the GOI and the Bank on these policy andregulatory issues is underway with AAA budget. Additional assistance on these areas is planned under atechnical assistance project on infrastructure policy.

7. Bank and Borrower Performance

Bank7.1 Lending:

7.1.1. The overall performance was satisfactory. The project was consistent with the GOI's desire toundertake a comprehensive telecommunications sector reform and with the Bank's CAS for Indonesia.Active participation and commitment of all stakeholders during project identification, preparation andappraisal led to successful outcomes in institutional reform. The project team built on the relationshipdeveloped between the Bank and GOI during the previous telecommunications projects implemented inIndonesia.

7.1.2. Since the beginning, the Bank made extensive efforts to involve the GOI, Telkom, Indosat anddonors in an interactive process of sector restructuring and development. This resulted in broad consensusamong all parties on the main elements of reform and the specifics of implementation. During all stages ofthe project, the Bank maintained close dialogue with the GOI and Telkom to ensure that the projectobjectives were directly in line with the client's goals for the sector, especially during the period of thefinancial crisis. The staff mix and its continuity during preparation, appraisal, and supervision wereappropriate and satisfactory.

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7.2 Supervision:

7.2.1. GOI and Telkom have emphasized the extent of the harmonious and fruitful working relationship,which the Bank maintained with all the parties under the project. The resulting positive contributions tosector and institutional developments and Telkom operations were particularly recognized and appreciated.

7.2.2. The overall supervision of the project was satisfactory. Regular supervision missions were carriedout and documentation on the project is adequate. The Bank team ensured that DGPT and Telkomfollowed the Bank procurement guidelines. When deemed necessary, DGPT and Telkom were requested toprovide additional infonnation or explanation for their award recommendations. DGPT and Telkomprovided the infonnation requested in a timely manner. The Bank team reassessed in detail Telkom'saward recommendation on a procurement case, which was brought to the attention of the Bank'sInvestigation Unit. Telkom provided all information and documents necessary to carry out the Bank'sreview. Based on the information provided, the Bank team concluded that Telkom had followed Bankprocurement guidelines.

7.2.3 Modifications in the project, including extension of closing dates were processed by Bank's staff inan efficient manner in order to respond to the Borrower's needs.

7.3 Overall Bank performance:

7.3.1. Overall Bank performance was "satisfactory" under the project. The closing of this project is aculmination of 16 years of cooperation with the GOI in the development of the telecommunications sectorin Indonesia, by far the largest recipient of Bank lending in this sector. As a result, many leadinginvestment banks and consulting companies have offered their services in telecommunications deregulationand privatization to the govemment The Bank's involvement in the sector has helped the govemment toreorganize the sector, has created openings for private investors and operators in basic services, hasintroduced competition in various segments of the sector, and has reorganized the corporatized Telkom andits management process.

Borrower74 Preparation:

7.4.1. The Borrower participated actively and satisfactorily in the preparation of the project. Thisvery-positive position on the Borrower's part promoted from the beginning, consensus on the elements ofreform and the methodology of implementation. The PIJ within Telkom, responsible for projectmanagement of the Telkom's investment component and technical assistance, was identified and appointedbefore appraisal. Prior to negotiations, the Borrower had developed a detailed project implementation plan.The quality of the Borrower's commitment and contributions to the preparation of the project are notable.

7.5 Government implementation performance:

7.5.1. The project made major contributions to the government implementation performance in severalways: (a) timely expert advice was made available through consultancies, (b) dialogue with the Banksupervision team was influential and reinforced by the size of the project financing in the sector, and (c)training exposed officials to international best practice. Partly as a result of the project, major steps weretaken toward sector reform, institutional improvements, and continued evolution toward sectorliberalization. Given the overall progress made on sector reform during the project period with the issue ofthe blueprint document, the new telecommunications law, and the separation between the regulator andoperator, the govemment's performance can be considered satisfactory.

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7.6 Implementing Agency:

7.6.1. DGPT was the implementing agency for the policy and regulatory component (Part A of the loanagreement) of the project. Due to a number of changes in the institutional set-up and leadership of theDGPT, there were delays in the use of funds. This was compounded by the availability of grant funds frombilateral sources (which were used instead of project funds). For the policy component, only 70 percent ofthe funds were allocated and it was closed as originally planned on June 30, 2001, even though severalpriority agenda items were not fully resolved. The Bank has reminded DGPT that it has not submittedaudited project accounts for fiscal year 2001, which were due by June 31, 2002, as required under the loanagreement.

7.6.2. Telkom was the implementing agency for the managerial strengthening and improvement of thetelecommunications network (Part B and C of the loan agreement) of the project Drawing on the bestbenefits from the technical assistance, consultancy and training services financed under previous Bankoperations, Telkom efficiently managed the complex and challenging tasks by initiating importantorganizational restructuring and successfully planning and implementing its rapid development Telkomalso maintained accurate and detailed financial records at the PMU level and submitted timely, auditedcorporate and project finance accounts. Telkom met all its covenants under the project agreement.

7.6.3. The partial opening of Telkom's ownership to the international capital market provided additionalresources for ongoing and future development. Telkom has confronted the same challenges such asprivatization, liberalization, new technologies and services, as other world operators and has undergonevast organizational and cultural transition. Nevertheless, Telkom unlike other major operators in Europeand North America did not embark on building network capacity. In fact, Telkom cancelled Bank's loansand other foreign denominated loans in the context of slowing demand for fixed telephone service. On theother hand, many first-class global operators such as British Telecom, Deutsch Telekom, and FranceTelecom, which are also partially privatized, did launch an ambitious domestic and intemational networkexpansion and are now carrying heavy debts in the order of $35, $40, and $30 billion, respectively.Telkom has transformed itself from being completely dependent on government for financing capitalexpenditure, to a market and customer-driven company responsible to its shareholders and capable ofacquiring funds for its own investments.

7.7 Overall Borrower performance:

7.7.1. As in the previous projects, the government performance continued to be satisfactory and theirrelationship with the Bank was good and fruitful throughout the implementation of the project OverallBorrower perfornance and participation in both project preparation and implementation is ratedsatisfactory.

8. Lessons Learned

(a) In the telecommunications sector, where technological advances occur rapidly, it is necessary tobuild flexibility into projects. In Indonesia, this approach allowed for project realignment whennecessary, thus accommodating the redefinition of needs that helped drive down the costs ofproviding services.

(b) The provision of adequate technical assistance at the beginning to build good project managementand implementation capacity at Telkom, greatly contributed to the success and sustainability of the

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project.

(c) Emphasis on promoting competition in the telecommunications services sector, which createsmultiple channels for investment, accelerates the diffusion of best practices and changes theincentives for improved performance. Promoting competition was a key factor in the transformedperformance of the Indonesian telecommunications sector, and is a key contributor to thesustainability of the outcomes.

(d) The KSO investment structure was clearly not the first choice for bringing large scale privateinvestment coupled with management expertise into the sector. The government selected thismechanism because it was more politically acceptable than the altematives. Because of theinherent drawbacks of KSO or other concession-type business structures in accelerating privateinvestment, their advantages need to be balanced carefully in comparison with alternativeinvestment mechanisms. Furthermore, clarity of role for investors in making business decisionsand managing employees is very important. In addition, vigilance is necessary to avoidcommercially attractive contract terms, which can subsequently hinder market opening. Theconclusion is that the KSO scheme is not the best vehicle for private participation. IFC's OEG andGICT's Credit and Portfolio Division jointly reached this conclusion with respect to IFC'sinvestment in one of the KSOs.

(e) To the extent that sector development involves major restructuring of infrastructure or otherimportant economic sectors, the engagement and involvement of economic ministries as well assector ministries can play a critically important role in maintaining focus on the economic policyaspects of sector reform.

(f) In major reformns where private participation and sector restructuring are involved, building astrong constituency for reform is important to minimize resistance to change. Bank interventionsshould support preparation of plans and allocation of resources to address management, employeeand public perceptions and concerns. With respect to the telecommunications sector developmentin the post-Suharto era in Indonesia, this approach needs to be extended to provide members ofparliament with balanced information on the nature of the economic policy choices related to theenabling environment for large scale private investment in the sector.

(g) Continuity in the supervision team is absolutely critical for satisfactory project implementation.The size and skill mix of the team should remain relevant to provide concise, well-analyzed, anddecision-oriented briefings on policy, strategy and complex project issues.

(h) The provision of AAA budget to supplement the policy dialogue under the project improves thechannel of communication with the government and helps advance the reform agenda.

9. Partner Comments

(a) Borrower/implementing agency:

9.1.1. Telkom has provided the Bank its Implementation Completion Report (ICR) for the project, datedOctober 2002. A summary of this report is provided below.

9.1.2. The Telecommunications Sector Modernization Project supported the development of thetelecommunication facilities in Indonesia from 1995 to 2000. The aims of the project were to add about1.2 million new customers, in addition to improving govemment's capability in policymaking andregulatory oversight, and Telkom's capacity for effective operation and maintenance of existing modemnetwork facilities. The project's investment was funded by six international funding agencies that includedFrance, Germany, Japan EXIM, USA EXIM, OECF, and the World Bank.

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9.1.3. The outcome of the project has been rated successful despite the delay. While the Bank financedabout 22 percent of the total public sector investment in Telkom, it took the lead and was effective insecuring needed policy reforms and ensuring a balanced investment program by utilizing bilateral fundingfor the development of Telkom's switching and transmission networks.

(b) Cofinanciers:

9.1.4. The Bank maintained a close dialogue with the donors and financed only those investmentcomponents that were least attractive to donors. Dialogue with IFC was maintained in respect of privateentry into the telecommunications sector in Indonesia.

(c) Other partners (NVGOs/private sector):

10. Additional Information

10.1. This project is the last in a series of technical assistance and investment projects that started in thelate 1980s to address the acute and chronic shortage of telecommunications services and modernize thesector. Key performance measures for the sector are ability to meet demand, quality of service, efficiencyof service, and national availability of service. Looking at the development of Indonesia'stelecommunications sector over the last decade, the total number of lines in service has increased fromabout 450,000 in 1988 to about 16.8 million lines in late 2002, including telephone lines provided byTelkom, KSOs, and cellular mobile operators. This expansion has eliminated what used to be chronicshortages of telephone service. It has involved investments in the order of $11 billion to $12 billion, andhas only been possible, in terms of both finance and managerial implementation capacity, because thesector was opened to multiple channels of investment, including private participation. Furthermore, therapid growth in the cellular market partly reflects the stimulus that has been created by competition in themarket.

11. Consultancies and Training Financed Under the Project

MTPT/DGPT

* Project monitoring and management consultancy to assist DGPT in the monitoring progress ofKSO investors.

* Personnel communication services consultancy to assist in preparation of tender.* Radio frequency management consultancy to assist DGPT in spectrum management.* Revision of the telecommunication regulatory framework.* Telecommunication training course for DGPT staff.* Interconnection in multimedia consultancy.* Standardization methodology of "X' factor calculation for price cap of domestic

telecommunications tariffs.* Preparation of Y2K program.* Program for progressive English competency.

Telkom

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* Construction management consultancy to assist Telkom in the implementation of theTelecommunications Sector Modernization Project

* Activity based costing system.* Intercomnnection management.* Human resources improvement program for training center.

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Annex 1. Key Performance Indicators/Log Frame Matrix

Flscal Year Ending December 31 1994 1999 2001Actual SAR target Actual Actual

Exchange Capacity ('000)Total Telkom Divisions 3,887 5,214 4,449 4,745

Total Capacity, KSO Divisions 0 4,020 3,909 4,060Total Exchange Capacity 3,887 9,234 8,358 8,804

Lines in service ('000)Telkom 2,463 4,183 3,102 3,950

KSO 0 3,607 2,709 3,269Total 2,463 7,790 5,811 7,219

Main telephone lines per 100 Inhabitants 1.28 3.50 2.93 3.25

Quality of ServiceNumber of Faults per 100 subscribers per year 2.5 0.5 0.6 1.7

Successful Call Completion Rate (Average)Local (%) 52.7 90.0 70.1 73.9

National Long Distance (%) 42.7 80.0 62.3 65.7

Staff ProductivityEmployees per 1000 CML 17.0 7.0 6.2 5.2

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Annex 2. Project Costs and Financing

Proect Cost by Component in US$ mii ion equivalent)i IILat tqst. Percentage of

"iA."' Apprisal

Switching Equipment 333.70 545.00 163Outside Plant Equipment 384.10 167.80 44Transmission Network 315.20 215.40 68Junction Network 92.30 36.80 40Advanced Service Network 16.70 7.10 45Computer Support System 10.30 2.80 27Technical Assistance 29.70 17.00 57

Total Baseline Cost 1182.00 991.90Physical Contingencies 59.10 0.00Price Contingencies 47.80 0.00

Total Project Costs 1288.90 991.90Interest during construction 123.80 98.80 80.00

Total Financing Required 1412.70 1090.70 _

Project Costs by Procurement Arrangements Appraisal Estimate) (US$ million equivalent)

<~~~~~~~~~~~~~~~~~~~~~~~qa -z Cost1. Works 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)2. Goods 486.40 0.00 0.00 769.70 1256.10

(317.00) (.00) (0.00) (0.00) (317.00)3. Services 0.00 8.80 23.90 0.00 32.70

(0.00) (8.00) (0.00) (0.00) (8.00)4. Miscellaneous 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)5. Miscellaneous 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)6. Miscellaneous 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)Total 486.40 8.80 23.90 769.70 1288.80

(317.00) (8.00) (0.00) (0.00) (325.00)

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Project Costs by Procurement Arrangements (Actual/Latest Estimate) (US$ million equivalent)

Expe ICB ~~~~~~~~~~~N.B.F tP ~ dt

1. Works 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 211.61 0.00 763.29 974.90

(208.05) (0.00) 0 (0.00) (208.05)3. Services 0.00 0.00 7.59 9.41 17.00

(0.00) (0.00) (6.95) (0.00) (6.95)4. Miscellaneous 0.00' 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)5. Miscellaneous 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)6. Miscellaneous 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)Total 211.61 0.00 7.59 772.70 991.90

(208.05) (0.00) (6.95) (0.00) (215.00)

"Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies.

vIncludes civil works and goods to be procured through national shopping, consulting services, services of contracted staffof the project management office, training, technical assistance services, and incremental operating costs related to (i)managing the project, and (ii) re-lending project funds to local government units

Project Financing by Com onent (in US$ million equivalent)

';j~mponenti k- 2 ;i6 te NCe6 PaIP geoE 754 ICo;Aj k Fr'Co F.Switching Equipment 0.00 0.80 361.80 8.31 117.37 419.32 0.0 14671. 115.9

2Outside Plant Equipment 244.00 0.00 134.20 82.13 18.60 67.10 33.7 0.0 50.0Telecommunications 73.00 0.00 273.70 117.61 0.00 144.49 161.1 0.0 52.8Equipment and MaterialsTechnical Assistance 8.00 0.00 23.90 6.95 0.61 9.41 86.9 0.0 39.4

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Annex 3. Economic Costs and Benefits

Economic Rate of Return

Assumptions

1. The ERR estimate is based on the methodology used at the time of appraisal. The generalassumptions used in the calculation of the benefit and cost streams are provided below.

2. The capital expenditures are the actual Telkom's investment during 1996 to 2001. The incrementalrevenue and operating costs are calculated as the revenue and cost derived from the additional linesconnected in Telkom's Jakarta and Surabaya regions. The time horizon for the project cost and benefitstreams ranges from 1996 to 2010. At the end of this period, it is estimated that on average all equipmentprovided under the project would have completed its useful life.

3. Based on these assumptions, the economic rate of return is estimated at 32 percent. This is anunderestimate of the true ERR because it does not include: (a) improvements in the existing networkperformance due to the project, (b) estimates of consumer surplus, and (c) major productivity and qualityimprovements expected to follow from the KSO initiative. In addition to quantitative factors, the projectcontributes indirectly to poverty alleviation through general economic and social development linked to theimportant productivity improvements, and market access and information that arise from a modem andcompetitive telecommunications sector.

Economic Rate of Retum (Rupiah Billion)

Fiscal Year Ending December 31 1996 1997 1998 1999 2000 2001

Deflator 1.00 1.09 2.20 2.43 2.73 3.12

Project Capital Expenditure for TELKOM 529 710 2,194 1,200 1,125 1,282VAT on Capital Expenditure 19 18 24 15 17 19

Additional LIS ('000) 810 742 354 244 282 340Cumulative LIS ('000) 810 1,552 1,906 2,150 2,432 2,772Rev. /Av Line 1.01 1.03 1.28 1.46 1.51 1.50Op. CostlAv line 0.47 0.51 0.60 0.73 0.77 0.81

Incremental Revenue 1,606 2,431 3,148 3,672 4,168Incremental Operating Cost 795 1,146 1,576 1,881 2,233

Net Incremental Benefit (510) 119 (886) 387 684 673Net Incremental Benefit (1996 terms) (510) 109 (403) 159 250 216

Economic Rate of Retum 32%

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Telkom - Key Financial Indicators

Fiscal Year Ending December 31 1996 1997 1998 1999 2000 2001Target Actual Target Actual Target Actual Target Actual Actual Actual

Profitability: (Rp. Billion)

Gross Operating Revenue (a) 4,918 5,076 5,419 5,090 6,046 6,600 6,637 7,790 9,375 16,130

Less. Operating Expenses (b) 3,174 2,927 3,438 3,383 3,655 4,000 3,934 4,847 5,338 8,515

Net Operating Income 1,743 2,149 1,980 2,526 2,391 2,600 2,702 2,943 4,037 7,615

Net Profit (c) 1,069 1,503 1,023 1,152 1,274 1,169 1,397 2,172 2,539 4,250

Financial Ratios:

EBITDAtRev (Telkom network) (d) 61% 70% 62% 72% 61% 74% 59% 68% 65% 65%

Return on Average Equity (e) 15% 19% 22% 12% 24% 3% 23% 8% 19% 46%Net Intemal Cash Generation as %Av.

Cap. Inv. 55% 63% 88% 84% 95% 118% 90% 136% 228% 314%

Debt Service Coverage 4.70 4 30 4.20 4.80 3.40 3.70 3.40 2.90 6.81 2 90

Current Ratio 1.00 1.10 1.00 0.90 1.10 1.30 1.00 1.95 2 69 0.73

Debt/ (Debt + Equity) 0.52 0 33 0.48 0.36 0.42 0.45 0.37 0.43 0.53 0 70

(a) Gross operating revenue from 1996 onwards includes minimum Telkom revenue from its existing network managed byKSOs and revenue share paid by KSO based on the agreement.

(b) Operating expenses include depreciation for Telkom's existing network managed by KSO but do not include personnelexpenses for employees of KSO based on KSO agreements.(c) Net profit includes initial investor payment on an after-tax basis.(d) EBITDA = earnings before interest payment, taxes, depreciation and amortisation. Revenue from Telkom network includesthe minimum revenue from its network managed by KSOs.(e) The rate of return would be higher if straight line depreciation method is used.

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Annex 4. Bank Inputs

(a) Missions-Stage of Project Cycle No. of Persons and Specialty Performance Rating

(e.g. 2 Economists, 1 FMS, etc.) Implementation DevelopmentMonth/Year Count Specialty Progress Objective

Identification/Preparation08/06/1994 4 TELECOM ENGINEER (1); HS HS

TELECOM POLICY SPEC. (1);FINANCIAL ANALYST (1);MANAGEMENT SPEC. (1)

Appraisal/Negotiation11/10/1994 4 TELECOM ENGINEER (1); HS HS

TELECOM POLICY SPEC.(1); FINANCIALANALYST (1);MANAGEMENT SPEC. (1)

Supervision08/07/1995 2 TELECOM ENGINEER (1); HS HS

FINANCIAL ANALYST (1)02/09/1996 3 TELECOM ENGINEER (1); HS HS

TELECOM POLICY (1);FINANCIAL ANALYST (1)

10/26/1996 4 TELECOM ENGINEER (I); HS HSFINANCIAL ANALUST (1);TELECOM POLICY (1);FINANCIAL ANALYST (1)

04/10/1997 2 TELECOM ENGINEER (1); HS HSTELECOM POLICY SPEC. (1)

12/16/1997 4 TELECOM ENGINEER (1); HS HSTELECOM POLICY SPEC. (1);FINANCIAL ANALYST (1);COUNTRY OFFICER (1)

07/03/1998 3 TELECOM ENGINEER (1); HS HSTELECOM POLICY SPEC. (1);FINANCIAL ANALYST (1)

12/19/1998 4 FINANCIAL ANALYST (2); S HSTELECOM ENGINEER (1);TELECOM POLICY SPCLST(1)

12/20/1999 3 TELECOM POLICY SP. (1); S SFINANCIAL ANALYST (1);TELECOM ENGINEER (1)

02/10/2001 3 PR. TELECOM POLICY SP. S S(1); PR. TELECOM ENGINEER(1); SR. FINANCIALANALYST (1)

10/29/2001 3 LEAD FINANCIAL ANALYST S S(1); LEAD TELECOM SP. (1);PR. TELECOM ENGINEER (1)

05/29/2002 3 MISSION LEADER (1); S S

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CONSULTANT (1)

ICR08/15/2002 2 TELECOM ENGINEER S S

(1); TELECOM POLICYSPEC. (1) _ _ _ _ _ _ _ _ _ _ _

(b) Staff

Stage of Project Cycle ActualLatest Estimate,No. Staff weeks US$ (000)

Identification/Preparation 12 40Appraisal/Negotiation 45 140Supervision 150 215ICR 8 35Total 215 665

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Annex 5. Ratings for Achievement of Objectives/Outputs of Components

(H=High, SU=Substantial, M=Modest N=Negligible, NA=Not Applicable)Rating

3 Macro policies O H OSUOM O N * NAO Sector Policies O H OSUOM ON O NA

3 Physical O H OSU*M O N O NA3 Financial O H OSU*M O N O NA

Z Institutional Development O H O SU * M O N 0 NA3 Environmental O H OSUOM O N * NA

SocialF PovertyReduction OH OSUOM ON * NA0 Gender O H OSUOM O N * NArO Other (Please specify) O H OSUOM O N * NA

F Private sector development 0 H O SU O M 0 N 0 NAO Public sector management 0 H * SU O M 0 N 0 NAO Other (Please specify) O H OSUOM O N O NA

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Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bankperformance Rating

O Lending *HSOS OLU OHUO Supervision OHS OS O U O HUOl Overall O HS * S O U 0 HU

6.2 Borrowerperformance Rating

O Preparation *HS OS O U 0 HUO] Government implementation performance O HS OS 0 U 0 HULI Implementation agency performance O HS OS 0 U 0 HUL Overall OHS OS O U 0 HU

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Annex 7. List of Supporting Documents

1. Memorandum and Recommendation of the President of IBRD to Executive Directors2. Staff Appraisal Report (SAR)3. Project Aide Memoires4. Project Supervision Reports(PSR)5. All Back to Office Reports6. Information Memoranda prepared by Telkom. Borrower's ICR dated October 20027. Telkom Audited Financial Statements (1997 - 2001)

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Repor No.: 25052Type: ICR