Kenya Telecom Reform: A Good Story Gone Bad?

UNCLAS SECTION 01 OF 04 NAIROBI 001488

SIPDIS

DEPARTMENT FOR AF/E, AF/EPS, EB/CIP

TREASURY FOR ANN ALIKONIS

E.O. 12958: N/A
TAGS: ECPS ECON KCOR KE
SUBJECT: Kenya Telecom Reform: A Good Story Gone Bad?

(U) Sensitive-but-unclassified. Not for release outside USG
channels.


1. (SBU) Summary: After years of stagnation under a
government-mandated monopoly, Kenya's telecom and ICT
sectors looked set to grow rapidly in 2005 following the
adoption late in 2004 of bold reforms aimed at opening the
market to all comers. These prospects are now in doubt,
however, following the surprise decision on March 7 by the
government to dismiss the board and the director general of
the Communications Commission of Kenya, the regulatory
agency leading the reform effort. The abrupt, arbitrary
move has put licensing and policy decisions on hold, and
generated unwanted uncertainty in a market craving greater
predictability. In the absence of more information and
transparency from the government, it's hard not to conclude
the dismissals were motivated by a desire to protect both
former monopoly service provider Telkom Kenya from increased
competition, and perhaps to also protect corrupt officials
and businessmen who have long exploited Telkom's privileged
status for personal gain. End Summary.

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The Sad State of Telephony and ICT in Kenya
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2. (U) Until recently, Kenya has been in many respects a
case study in how not to develop the telecom and information
and communications technology (ICT) sectors, and this
failure has been both a cause and effect of Kenya's more
general economic stagnation over the past decade. A few
statistics speak volumes. Despite its privileged position
as a regional services hub, Kenya had only 327,000 landline
phone connections in 2002 in a population of over 31
million. The number of landline connections actually
decreased by mid-2004 to just under 300,000. This equates
to a teledensity rate of just over one percent - 23rd in
Africa, and one tenth the rate in South Africa. Kenya does
relatively better in Africa in terms of internet penetration
with 1.4 million reported users, but 95% of these are
located in urban areas, leaving most of the country unwired
in the information age.


3. (SBU) The stagnation of Kenya's telecom sector stems
fundamentally from bad policies put in place and maintained
by the Government of Kenya (GOK) over the years. Telecom
reform began too late, and until recently has been too
incremental. In 1997, the GOK adopted a plan to gradually
liberalize the telecommunications sector. Under the Kenya
Communications Act of 1998, the state-run Kenya Posts and
Telecommunications Corporation was divided into three
entities: the Postal Corporation of Kenya, monopoly phone
service provider Telkom Kenya Limited (TKL),and a new
independent regulator, the Communications Commission of
Kenya (CCK). The 1998 Act introduced very limited
competition in the sector, and gave (TKL) a virtual monopoly
in all key market segments until June, 2004, including land
line services, international gateway services, and internet
backbone.


4. (U) TKL was thus given five years of monopoly status to
reorganize itself, pay off large debts, and prepare itself
for eventual privatization. As part of this, and as a stand-
alone policy goal, it was also tasked by government to
expand the country's phone network, to include especially
extending network infrastructure into Kenya's vastly
underserved rural areas. To no one's surprise, CCK's latest
annual report notes TKL's utter failure to translate its
monopoly status into improved services and infrastructure.
TKL's switching capacity has grown only incrementally since
the late 1990s, and as noted above, the number of landline
connections actually decreased in 2004. Every year since
1999, the number of Kenyans waiting for fixed line phone
connections has hovered around 100,000. Nearly all Kenyans
can recount anecdotes which together paint a picture of an
inefficient, badly managed company widely seen as more a
platform for political patronage and corruption than a
genuine service provider.


5. (SBU) Kenya's political leadership has compounded the
problem by refusing to privatize TKL. In 2000, the GOK
offered 49% of the company for sale and received several
offers. But it rejected the highest bid of $305 million on
the grounds that it was too low. It was subsequently unable
to attract a higher price and terminated the process without
results in 2001. This decision takes on a tragic dimension
given TKL's current state. Minister of Finance David
Mwiraria told the Ambassador in December that TKL has 18,000
employees when it only needs 8,000. (Note: Private sector
analysts say an efficiently run TKL would only need 2-3,000
employees. End note). The GOK needs $100 million to pay
severance and retirement benefits to the 10,000 workers who
would need to be dismissed to make the company attractive
enough to sell. For the moment, according to Mwiraria,
there is currently little of value in TKL beyond its office
building.

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Enter the Wonders of Mobile Telephony
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6. (SBU) TKL's failure as a fixed line service provider
stands in stark contrast to the roaring growth of Kenya's
mobile phone industry - one of the country's rare economic
success stories. Mobile services were commercially launched
in 1993, but the market didn't start to take off until 1997,
when SafariCom, a wholly-owned subsidiary of TKL, was
established. In May 2000, TKL sold 40% of Safaricom to
Vodafone UK, which assumed management of the company.
Limited but genuine competition was introduced into the
market when a second service provider, KenCell (since
renamed Celtel) was licensed in 1999, prompting a drastic
reduction in connection charges and handset prices.


7. (U) With just this little bit of competition, the market
took off. Mobile network connections surpassed the number
of fixed lines in 2001 and by 2004, total subscribers
exceeded 2.8 million. Networks have been rolled out
quickly, and close to 60% of the population now has cellular
signal coverage. This rapid growth in mobile is both a
cause and a consequence of TKL's failure in the fixed line
market. Fixed line services as offered by TKL have simply
been outcompeted by mobile services, and the vast majority
of Kenyans now use mobile phones for all their basic phone
needs.


8. (U) Competition has also stimulated growth in internet
services. Fully liberalized only in 2004, internet services
have witnessed substantial growth. Currently there are 78
licensed Internet Service Providers (ISPs) in Kenya,
although fewer than half are operating. Until only very
recently, however, the market remained shackled by the high
costs associated with the fact that the country had only one
internet backbone, owned and operated as a monopoly by none
other than TKL.

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Monopoly Ends, CCK Moves to Fully Liberalize
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9. (SBU) By the time TKL's monopoly status ended on June
30, 2004, Kenya had a new government elected in large part
on a platform of market-based economic reforms, including
privatization. However, the GOK's initial plans for post-
monopoly telecom/ICT liberalization appeared half-baked,
restricted to the licensing of a second national landline
operator (SNO),a third mobile provider, and four additional
internet backbone providers, all through competitive
auctioning. Action on licensing an SNO ground to a halt in
July when Minister of Information and Communications Raphael
Tuju intervened at the 11th hour by canceling the tender
just as it was about to be awarded, without subsequent
explanation. The case remains in court. Similarly, the
licensing of a third mobile operator has been mired in
controversy. CCK awarded the license to Econet Wireless in
September, 2004, only to have Minister Tuju revoke it on the
grounds the company had not met the minimal capital
requirements. Econet challenged the action in court, won,and is in the process
now of rolling out its network.


10. (SBU) In light of these uncertainties, market actors
were pleasantly surprised when CCK announced in September
2004 a "Post-Exclusivity Regulatory Strategy" which provides
for a technology-neutral licensing regime which abolishes
auctioning in favor of a first-come first-served system
requiring applicants to merely demonstrate adequate
technical capabilities and pay a reasonable licensing fee.
In recognition of technological convergence, the strategy
consolidates previously segmented licensing categories,
allowing operators to provide a broader range of services.
For example, the new regime allows for:

-- Mobile operators to construct their own international
gateways. Previously, TKL controlled the country's only
gateway. In January, two companies were issued gateway
licenses.

-- Additional licensing of internet backbone and gateway
operators, broadcast signal distributors, and commercial
VSAT operators.
-- Operators to carry all forms of multimedia traffic over
their networks, including voice over internet protocol
(VoIP).

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Communications Minister Jolts the Market
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11. (SBU) Kenya's telecom and ICT sectors, whose growth had
been restricted largely to the mobile market in recent
years, looked set to boom in 2005 under CCK's new licensing
system. CCK was reportedly reviewing a series of new
license applications, some of which appeared on track for
approval, when the market was jolted on March 7 by Minister
Tuju's sudden and unexplained dissolution of the CCK board,
and the suspension of Director General Sammy Kirui on
compulsory leave. Tuju's announcement provoked howls of
protest from industry groups like the Telecommunications
Service Providers Association of Kenya (Tespok),whose
president said the move had "created a vacuum" in the
sector.

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Motivations Behind Tuju's Actions Uncertain, But...
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12. (SBU) The motivations for Minister Tuju's precipitous
dissolution of the CCK board are, and probably will remain,
unclear. Speaking with Econ Counselor March 17, James Rege,
the Permanent Secretary in Tuju's Information and
Communications Industry, professed ignorance, saying only
that he understood that Tuju had simply acted on orders from
above in both firing the CCK board, and in earlier revoking
the Econet Wireless license.


13. (SBU) While a small minority of contacts credit Tuju
for taking bold action in dismissing a corrupt CCK board,
many in the industry believe just the opposite, i.e. that
Tuju's actions indicate an attempt by senior GOK insiders to
halt or at least delay liberalization. The motivations for
doing so are to either protect TKL as greater competition
starts to bite, to protect cabals in and out of government
who continue to benefit illegally from the legacy of TKL's
monopoly status, or both.


14. (SBU) Market players note in particular that the
legalization of VoIP is already undermining one of TKL's
cherished cash cows - its de facto monopoly in international
gateway services. As such, VoIP would also be eating away
at the ill-gotten gains of illegal call termination
operations, in which companies physically connect to TKL's
international gateway and sell international call
termination services at a fraction of the cost charged by
TKL itself. The profits are then shared by the operators,
complicit TKL officials, and probably senior officials
within the GOK itself. While some of these activities are
reportedly being investigated by the Kenya Anti-Corruption
Commission, it is unclear in the absence of greater
transparency where the investigations stand.

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Licenses on Hold, Policy Direction Uncertain
--------------


15. (SBU) GOK sources, including Permanent Secretary James
Rege, have told the Embassy that the GOK will move quickly
to name a new board at CCK, and that liberalization will
stay on track. Rege even told Econ Counselor that CCK
Director General Sam Kirui will be reinstated shortly. In
the meantime, however, the industry is "a complete mess"
according to an American ISP owner, with the licensing
process having "ground to a standstill" as CCK staff await
guidance and policy direction from above. This has injected
another poisonous dose of uncertainty into a market which
badly needs greater regulatory stability if it is to
continue to generate new investment, with all the positive
multipliers this implies for the growth and development of
the broader economy.


16. (SBU) Further, even after a new board is constituted,
it remains to be seen whether new CCK leadership will
continue to aggressively liberalize, or act on behalf of TKL
and those profiting from it by trying to roll back recent
reforms. The good news is that the newly licensed internet
backbone companies are up and running and already offering
lower cost services to a number of economically important
companies. With these benefits already in place, many are
counting on pressure from the business community to ensure
against backsliding.

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Comment
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17. (SBU) Along with the cancellation of the SNO tender and
the attempted revocation of the Econet Wireless license last
year, this marks the third time in less than a year that
Minister Tuju has jolted the market by arbitrarily
exercising self-proclaimed powers and interfering in what
are in theory processes independent of his authority.
Whatever his motivations, this highhandedness, and the lack
of transparency involved in the decisions, have greatly
undermined confidence in what was only weeks ago one of
Kenya's rare economic success stories.

BELLAMY