Results and challenges of economic regulation in fixed telephony of Brazil

1.  INTRODUCTION

The present document provides a summary of the main results obtained from Switched Fixed Telephone Service (Serviço Telefônico Fixo Conmutado—SFTC) concession contracts in Brazil, as well as some of the challenges that have currently emerged for regulation.

Two contract periods were adopted in Brazilian fixed telephony.  The first contract period ended on December 31, 2005 and refers to contracts that were taken up by private-sector enterprises substituting the former state operation by buying up the shares that were offered in a bidding process conducted in June 1998.  The second contract period, in follow-up to the first, accepted by the Union and the same private-sector players, started up on January 1, 2006 and shall extend until December 31, 2025. At present, fixed telephony in Brazil is completely operated by private-sector enterprises.[1] Part of the results achieved in the first contract period can be observed in the following table.

Although the progress achieved in the first contract period cannot be denied, the regulatory agency is addressing major changes, especially those involving quality, user rights, and the lowering of both retail and wholesale rates, as well as those services installed as a result of technological convergence.

2.  REGULATORY FRAMEWORK FOR RETAIL AND WHOLESALE RATES

The following table summarizes the regulatory frameworks currently in force in Brazilian telecommunications for the first and second contract periods.

Until 2005, after a period of rate readjustment, prior to divestiture of the state-owned monopoly, the rates were in line with the Price Cap Regime.  Both consumer rates (retail) and corporate interconnection rates (wholesale) were readjusted by the General Price Index – Domestic Availability of the Getulio Vargas foundation, inferred from pre-established productivity indices for local, domestic and international long distance telephony services.

In the second contract period, regulatory changes were introduced, among which the following are noteworthy.

2.1        Cost Model

Decree No. 4.733 of June 10, 2003, which defined new policies for Brazil’s telecommunications sector, introduced interconnection rating based on a long-run incremental cost model.  The concession contracts, signed in 2005, provided for the application of interconnection rates calculated on the basis of a long-run incremental cost model that is being developed by ANATEL. The rules for submitting the information needed to structure the model were specified in Resolution 396 of March 31, 2005, which adopted the Account Separation and Allocation Regulation (Regulamento de Separação e Alocação de Contas) and provided that an Account Separation and Allocation Document (Documento de Separação e Alocação de Contas—DSAC) would be submitted by the fixed telephony concession holders and by the Groups that hold Significant Market Power for the supply of fixed network interconnection, in addition to the supply of Industrial Exploration of Dedicated Line (Exploração Industrial de Linha Dedicada—EILD) (circuit rental).

Until interconnection rate calculations can be made on the basis of the proposed long-run incremental cost model, which is scheduled for 2008, percentages of retail rates (minute conversation value) were adopted for the wholesale rates (for example, the Local Network Use Rates – Tarifas de Uso de Rede Local—TU–RL).  The percentages set in the contract, 50% for 2006 and 40% for 2007 (hereinafter), were estimated to bring rates close to the values based on the LRIC model and promote diversity and competition in Brazil’s telecommunication services (below we have the evolution curve of TU–RL in real terms per minute).[2]

In the current phase of the development of ANATEL’s cost model, the fixed telephony concession holders sent the first DSAC on April 30, 2006, referring to financial year 2005 and confined to the Accounting data in Historical Bases[3] and their allocation to elements of the network and to products provided in accordance with the Fully Allocated Cost Model (FAC).

On April 30, 2007, the second delivery of DSAC by fixed telephony concession holders is expected, with respect to financial years 2005 (once again) and 2006, also referring to the data of the Accounting of Historical Bases. The delivery of data in Current Bases and LRIC is also planned for that year.

2.2        Telecommunication Service Index (Índice de Serviços de Telecomunicações–IST)

Among other innovations introduced in the renewal of concession contracts, the substitution of the General Price Index for the Telecommunication Service Index (IST) and the substitution of the pre-established productivity for a dynamically calculated productivity are noteworthy.

The IST is an index applied to telecommunication services in general and is comprised of a basket of other public indices of the Brazilian economy.  Thus, the IST is calculated on the basis of the multiplication of expense weighting factors of all the companies observed by the related price indices.[4]

As for the behavior of the IST, in the first 12 months of calculation (between January and December 2006), it recorded a variation that was lower than the general indices ordinarily used in Brazil.  Whereas the General Price Index – Domestic Availability, which previously indexed telecommunication rates, accumulated a 5.06% rise, the IST recorded a variation of 3.22% over the same period.  This result not only accounted for a smaller variation than that of the general index (in addition to showing less variance) but also, for the first time in the recent history of Brazilian telecommunications, led to a deflation in rates.

2.3        X Productivity Factor

Regarding Productivity, the new concession contracts provided for the application, in 2006 and 2007, which is the transition period, of the calculation based on the dynamic methodology, which considers the physical and economic data referring to the products (for example, monthly subscription and minute of use) and to factors or inputs (for example, number of employees and other resources consumed).  These data are obtained annually for the preceding financial year and are used to calculate the gain in efficiency on the basis of the Total Factor Productivity (TFP) method.

The gain in efficiency is divided between the concession holder and the users (50% each) and finally converted into a rate reduction factor, establishing what is internationally called the X Factor.  For a more concrete notion, consider that the average national X Factor calculated for financial year 2006 amounted to 1.136%, which, combined with the other contract indices, led to the reduction of local rates by about 1% in the readjustment authorized in July 2006.

As of January 1, 2008, productivity shall be calculated on the basis of a methodology that considers service delivery cost optimization in terms that shall be defined by the regulations.  This methodology is being developed and shall shortly be submitted to the public for consultation.

3.   CHALLENGES AND OUTLOOK

It is well known that regulation is a building task, and in Brazil it is no different.  The new fixed telephony concession contracts shall be reviewed in 2010, 2015, and 2020, bearing in mind the context of the services delivery in Brazil.  Some of the issues that are open for discussion and that merit thought by ANATEL, among others, focus on the following:

• How to minimize the imbalance of information that occurs in each productivity and cost evaluation calculation cycle;

• How to establish a capital cost calculation methodology that upholds citizen rights (fair rates, quality, inclusive), promotes efficient service delivery, and provides domestic and foreign investors with a fair return;

• How to regulate the economic aspects of a service provided on the basis of a public structure, with obligations to ensure universalization and continuity, in an environment of technological convergence with other services delivered under a private-sector regime, for example, mobile telephony, data and image communication, etc.;

• What are the implications for cost allocation, which must consider not only the accounts (backward looking) but also the obligations of service delivery (forward looking) and opportunities to adopt new technologies (NGN, IP...) substituting the traditional circuit-switched technologies.

Considering that the previous matters are to some extent part of the concerns that are common to various regulatory players of Latin America, it is suggested that a permanent query mechanism be installed for the exchange of information in the framework of the Inter-American Telecommunication Commission (CITEL).

Gerência Geral de Competição
Superintendência de Serviços Públicos - Anatel