Turkey - Tenth Industrial Development Bank (TSKB) Project

CIRCULATING COPY TO BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1150 REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED TENTH LOAN TO TURKIYE SINAI KALKINMA BANKASI A.S. WITH GUARANTEE OF THE REPUBLIC OF TURKEY December 7, 1972 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit Turkish Lira (TL) US$ 1 = TL 14.00 TL 1 US$ 0.07 TL 1,000 = US. 71.4c0 TL 1,000,000 US$ 71,429 Turkish Fiscal Year - March 1 to February 2d  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED TENTH LOAN TO TURKIYE SINAI KALKINMA BANKASI A. S. WITH GUARANTEE OF THE REPUBLIC OF TURKEY 1 . I submit the following Report and Recommendation of a proposed loan to Turkiye Sinai Kalkinma Bankasi A. S. (TSKB) with the Guarantee of the Republic of Turkey for the equivalent of US$40 million to help finance lending for industry and tourism. Amortization would conform substantially to the aggregate of the amortization schedules applicable to the specific investment projects financed out of the proceeds of the loan. The interest rate would be 7.25% per annum. PART I - THE ECONOMY 2. A report entitled "Current Economic Developments and Prospects of Turkey" dated September 18, 1972 was distributed to the Executive Directors on October 25, 1972 (R72-236). A country data sheet is attached as Annex I. 3. Following a long period of stability, internal political tensions have appeared in the last two years. Student disturbances and unrest among workers occurred in 1970 and early 1971, and the armed forces called in March 1971 for the resignation of the Demirel cabinet and for the implementation of the land, tax, educational, administrative and other reforms prescribed by the 1961 Constitution. An "above-party and reformist" government was formed under Prime Minister Erim, and martial law was introduced. In its eight months in office, the Government largely re- established law and order, and introduced some administrative changes. It also raised prices charged by several State Economic Enterprises and presented several reform bills to Parliament. However, it was not able to translate its long-range economic policies into detailed measures and decrees. Growing opposition from Parliament to some of the administrative changes and reform proposals brought about the resignation of a large group of ministers in December 1971, and a new coalition government, headed again by Prime Minister Erim, was then formed. The second Erim government had greater political party representation, but its attempt to push through modified reform measures, again met with opposition in Parliament. A mining reform bill and a moderate land reform bill were introduced in Parliament, but little was done to further educational reform or to reorganize the State Economic Enterprises. Prime Minister Erim resigned in mid-April after his request for "government by decree", intended to speed up the process of reforms, was turned down by the political parties. A new government drawn from three parties and non-parliamentarians and headed by Prime Minister Melen was formed in May 1972. It declared its aim to pursue the reform measures and prepare for the national election in the fall of 1973.  -2- 4. While long-term economic policy issues have recently become a cause of political tensions, growth in Gross National Product in the last decade has been high and continuous, averaging about 6.8 percent per year in the period 1962-1971. In the same period, gross investment increased substantially, with its share in GNP rising from 15 to 21 percent. Although total consumption increased considerably, gross national savings increased at a much faster rate, their share in GNP rising from 11 to 20 percent. However, in the last two years, in spite of a big jump in workers' remittances, the share of investment and gross national savings has not risen substantially due to relatively poor public savings. 5. The main growth sectors in the last decade have been industry, power and construction. This reflected the development strategy during the first and second five-year plans (1962-67, 1968-72), which gave highest priority to industrialization. Industrial output grew bv about 10 percent per annum with textiles, machinery and equipment, steel and chemicals providing the main impetus. But this rapid growth, mainly to meet domestic demand and replace imports, was insulated from foreign competition. Other rapidly growing sectors were transport, trade and financial services. The impact of large investments in agriculture was slow, however, and agricultural production had a trend growth rate of about 3 percent per annum, with large fluctuations from year to year depending on weather conditions. As a result of the relative growth rates, the shares of industry and trade in GDP rose to 23 and 10 percent respectively, and that of agriculture dropped to 27 percent. In 1971 GNP increased by 9 per- cent in real terms, thanks largely to an excellent harvest, a continued indus- trial growth and a sharp rise in emigrant worker remittances, and output in 1972 promises also to be above average. 6. The balance of payments situation was characterized in 1967-70 by increasing trade deficits, and a strict system of import controls leading to delays and shortages of essential imports and, consequently, to underutiliza- tion of production capacity. The overvalued official exchange rate was changed in August 1970 (from TL 9 to TL 15 per US$) and revised to TL 14 in December 1971. This, together with associated stabilization measures and a rapid rise in workers' remittances helped to improve the situation dramatically. Workers' remittances increased sharply, from about $140 million in 1969 to $470 million in 1971. Commodity exports and tourism receipts also increased markedly. Net foreign assets, which were negative in 1966-68, rose to about $400 million in June 1972, the equivalent of four months' imports. These improvements have led to better availability of essential imports of investment goods, raw materials and parts, and to rebuilding of stocks. The improvement in the balance of payments has continued in 1972; in the first six months, exports were 53 percent higher than in the corresponding period in 1971 due primarily to increased exports of tobacco, cotton, textiles and food and beverages; imports were 16 percent higher; and workers' renittances had already reached $550 million by the end of September, compared with $470 million during the whole of 1971. The overall result has been a substantial rise in gross foreign exchange reserves, which stood at $1,134 million at the end of September 1972.  - 3 - 7. The budgetary situation has been dominated in the last decade by the need to control the rapid growth of public expenditures. Tax revenues have grown faster than GNP, their share rising from 12.9 percent in 1962 to 17.6 percent of GNP in 1971, but the increases in tax revenues have been more than offset by the rise in current expenditures and transfers. The overall budget deficit has grown since 1968 and was particularly large in 1971 when the full impact on current expenditures of public salary increases under the 1970 Personnel Reform Law was felt. The Treasury had to have growing recourse to the Central Bank for short-term advances and to other short-term borrowing. The difficulties facing public mobilization of resources led to public invest- ment expenditures falling short of targets, and to an actual decline in public fixed investment in real terms in 1971. The pressure on public resources is likely to continue in 1972, and the growth of public development expenditure will probably suffer as a result. 8. The financial results of the State Economic Enterprises (SEE's) have been consistently poor. Although the SEE's now account for over 10 percent of the value added and about 20 percent of the fixed investment in the economy, the rate of return on investment in the 28 major producing SEE's as a whole has been less than 3 percent in the last few years. The low profits of the SEE's have necessitated increasing budgetary transfers, which amounted to TL 3.5 billion in 1971. The profitability varies among different SEE's, with railways and the Coal Corporation, incurring heavy losses. 9. In the period 1967-70, while available resources increased, a more rapid growth of expenditures led to inflationary pressures in the economy, resulting in an average increase in wholesale prices of about 6 percent per annum. Inflationary pressure became particularly strong in 1971 when whole- sale prices rose 16 percent and cost of living by 20 percent. The pressures came mainly from the demand side due to substantial increases in public salaries and industrial wages, higher remittances from abroad and larger agricultural incomes in a year of record output. At the same time controlled prices of public industrial enterprises and support prices of major agricul- tural products were also raised, and prices of imported goods increased sharp- ly as a result of both devaluation and the rise in world export prices. The pressure on prices has continued in 1972, fueled by a continued rise in receipts from remittances and exports, as well as by the resumed growth of investment, both private and public. Wholesale prices rose by 10.5 percent in the first nine months of 1972. In these circumstances, better mobiliza- tion of resources by the public sector, a balance between the claims of the public and private sectors on investment funds, further liberalization of imports and avoidance of short term borrowing by the Treasury from the Central Bank are needed, among other measures, to contain the inflationary pressure. 10. For the longer term, the continued political uncertainties have meant that the planned reforms, e.g. administrative, tax, educational and land reforms, and reorganization of SEE's have on the whole not progressed very far. In July 1972, a "preliminary measures law" for land reform was passed which provided for preparatory measures, but the land reform bill has  - 4 - yet to be passed by Parliament. Administrative reform of the SEE's and upgrading their executive and labor skills have still to be achieved. This is particularly important to prepare Turkish industry for competition that will arise from association with the EEC. In agriculture, although sub- stantial irrigation investments have been made in the past and the government rightly gives high priority to completing on-going projects, several long-term problems remain. The Anatolian plateau and the eastern part of Turkey are considerably less developed than the coastal regions and land tenure problems are serious in some regions. Surplus stocks of tobacco, tea and hazelnuts have accumulated and there is need to modify price support and other policies to divert resources from these surplus crops. Some progress has already been made in shifting land from sugarbeets to sunflower, feedgrains and other crops. 11. The problem of domestic resource mobilization by the public sector will remain a major constraint and will restrain the real growth of public investment in the Third Plan period (1973-77), especially if the savings strategy continues to be heavily dependent on public savings. The draft Third Plan targets imply excessively high marginal savings rates. If sub- stantial increases in public savings are to be realized, then planned changes in the tax structure should be implemented at an early stage and the failure of State Economic Enterprises to generate sufficient surpluses should be a major concern of economic policy. In addition, it is essential to develop a capital market in Turkey to supplement the existing sources of long-term domestic borrowing. Proposals for a capital market bill are now being considered. 12. The employment situation is also a matter of growing concern. Despite rapid industrialization and with the levelling off in agricultural employment, Turkey has not been able to absorb the increasing labor supply in the last decade. The labor force grew by about 420,000 a year between 1965 and 1970, of whom about 57,000 emigrated and 240,000 found employment on the domestic market, mostly in services and industry, leaving about 124,000 more unemployed each year. In the medium term, labor supply is expected to con- tinue growing by about 2.8 percent per year while demand outside agriculture is projected to about half the increase only. Speedy implementation of land reform would help to reduce the migration from rural to urban areas. In addition, labor-intensive projects need special emphasis in the choice of industrial projects. However, even with continued emigration, urban unemploy- ment is likely to grow. 13. If the country remains politically stable and if the government effectively carries out structural reforms in the areas mentioned above and promotes exports, Turkey may be able to maintain or even exceed a growth rate of 7 percent per annum. However, in spite of the recently improved balance of payments and exchange reserve positions, Turkey will continue to need substantial amounts of external assistance to be able to maintain a high level of investment as well as meet its financial obligations. The growth of foreign exchange reserves is unlikely to continue at the same rate, par- ticularly as short-term debts are repaid. Reserves are also needed to cushion any sudden drop in workers' remittances which are vulnerable to  -5- changes in economic conditions in the host countries, and to support further import liberalization. Larger project assistance will also be needed to offset the decline in program assistance. In these circumstances, it would seem advisable for Turkey to continue for the time being its restraint in using suppliers' credits. 14. Total debt outstanding and disbursed was $2.2 billion at the end of 1971, of which all but 2 percent is public or publicly guaranteed. The average terms have been hardening in recent years and this trend is expected to continue. Of the total gross official external assistance of about $400 million in 1971, the Consortium members provided about $300 million. Of this, about $90 million came from the United States, $52 million from the European Fund, $26 million from the European Investment Bank and $37 million from the World Bank Group. The USSR disbursed $40 million. As a result of successive debt reschedulings and arrangements for debt relief together with substantially increased workers' remittances, the debt service ratio fell considerably after 1965, reaching 19.4 percent of exports of goods and non factor services and 12.9 percent of total foreign exchange earnings (including workers' remittances) in 1971. However, since the improvements in the balance of payments have oc- curred relatively recently and are based to a considerable extent on external factors, Turkey should continue to seek a part of its external aid on conces- sionary terms. PART II - BANK GROUP OPERATIONS IN TURKEY 15. During the lengthy period of chronic balance of payments difficulties before the 1970 stabilization program, and devaluation of the Turkish lira, Bank lending was only intermittent. Since then, the rapid improvement in the balance of payments and in creditworthiness stimulated by these actions has made possible a large increase and a new continuity in Bank/IDA lending, which in FY 1971 and FY 1972 amounted to $114 million and $173.3 million respectively. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of October 31, 1972, and notes on the execution of on-going projects. 16. Bank Group lending since 1970 has generally been aimed at assisting Turkey in the following broad development tasks: (a) the continued build-up of creditworthiness; (b) the external orientation and liberalization of the economy to improve external and domestic competitiveness; (c) improved orien- tation of public investments with a view to ensuring the efficiency of invest- ments and bringing about a better balance between growth and employment and between the sectors and regions where development has reached a momentum of its own and those where it is lagging and (d) institution-building in the public sector and especially among SEE's, where resource mobilization should and can be greatly improved.  - 6 - 17. In the pursuit of these aims, a pattern of concentration in lending is evolving along sector and to some extent along geographic lines. In two sectors, agriculture and industry (including mining and development finance companies), past and planned lending is on a large scale and fairly broad in coverage of subsectors. In transportation, power and urban development, substantial lending focused on a few projects, particularly SEE's, will be continued or started. Geographical concentration has been designed to obtain mutually reinforcing benefits in related sectors and institutions and to support the objective of better rural-urban balance. Thus far, concentration has occurred mainly in the Istanbul region, with emphasis on urban develop- ment and industrial finance, and in the Cukurova region around Adana on the southern coast, with emphasis on power, irrigation and fruit and vegetables. A start has recently also been made on a complementary effort to provide rural inhabitants with an alternative to urban migration by lending for employment - creating projects such as the Second Livestock Credit wnich focuses on breeding, raising and fattening in Eastern and Central Turkey and by preparing, with the assistance of the IBRD/FAO cooperative program, an integrated rural development project in rainfed areas of Central Turkey. 18. Several specific projects financed by the Bank Group in recent years or presently under discussion may be mentioned to illustrate the effort to support the objectives discussed above. For instance, emphasis was placed on export-oriented sub-projects in the last loan (713-TU) made to the Industrial Development Bank of Turkey (TSKB) which has made a start in this direction, and in the loan and credit (762/257-TU) for the Fruit and Vegetable Export Project. Other projects for which lending is contemplated in coming years, especially for livestock, forestry and irrigation, are expected to enhance Turkey's ability to earn foreign exchange as well as spread development in rural areas. On the other hand, attempts to assist the expansion of tourism have not borne fruit, indicating some Government hesitation as to the importance to be given to tourism in Turkey's development strategy; as a result tourism projects suitable for Bank consideration have not yet been put in shape, al- though an IFC investment in the sector is likely to be presented soon to the Executive Directors. The objective of institution building has been pursued chiefly in agriculture (including agricultural credit), power and in trans- portation where a recently negotiated loan for railways is expected to pave the way for substantial organizational and financial improvements. In pre- paration of this, the Bank has already acted as executing agency for UNDP technical assistance studies on transport coordination and on a railway investment program. The Bank has furthermore been instrumental in bringing about a comprehensive reorganization of the power sector culminating in the establishment of the Turkish Electricity Authority (TEK) to which a loan (763-TU) was made in 1971. 19. In addition to the proposed Loan for TSKB, three other Bank/IDA operations are planned for FY 1973: a $47 mil.ion loan to help finance a project for the financial rehabilitation a-nd the technical and administrative modernization of the railways; a loan of about $10 million for power develop- ment as part of Istanbul's urban development; and a $44 million loan and $30 million credit for the irrigation multipurpose and power Ceyhan Aslantas project.  -7- 20. IFC has been active in Turkey, having participated in industrial investments in nylon yarn, pulp and paper, glass and aluminum. Total commit- ments so far amount to about $30 million. IFC is currently investigating new investment opportunities in various sectors including special steel and tourism. PART III - INDUSTRY IN TURKEY 21. Turkish manufacturing output grew by about 10 percent per year in the 1960's with industries like machinery and equipment, steel and chemicals providing much of the impetus for growth, and others like aluminium, motor vehicles, durable consumer goods, synthetic fibres and major chemical inter- mediates contributing to the sophistication and diversity of the sector. However, industrial expansion was largely oriented towards import substitu- tion, which was developed behind high tariff barriers and quantitative re- strictions even when competitive cost production was not possible. In 1970, industrial growth slowed down sharply to 2 percent, mainly due to shortages of foreign exchange, leading to curtailed imports of raw materials and spare parts, which resulted in under-utilization of industrial capacity. With the devaluation in August, 1970, and the clearing of the backlog of import ap- plications, industrial growth recovered in 1971, showing an increase of 10 percent. 22. Manufacturing industry, mining and power, contributed in 1972 about 23 percent of GDP and employed about 10 percent of the active labor force. Manufacturing accounts for about 86 percent of the value added in the sector. Although modern industries have developed fast and represent now about 50 percent of the value added in manufacturing, traditional consumer goods in- dustries are still very important with food, beverages and tobacco processing accounting for about 25 percent of value added and textile and clothing about 20 percent. Exports still represent only a small part (2-3 percent) of the value of manufacturing production, but they have increased at an average an- nual rate of nearly 16 percent during the last four years, reaching $145 mil- lion in 1971. Apart from processed foods, exports of manufactures consist essentially of textiles (mainly cotton yarns), leather, wood products and chemicals (pharmaceuticals, oils, borax and boric acid). 23. Mining, which accounts for 8 percent of value added in the sector and belongs mostly to the public sector, has grown comparatively more slowly than manufacturing. Despite high investments, due to delays in starting new projects, value added increased by only 4 percent per annum in recent years. Production of basic minerals for domestic use, except lignite, has shown little growth recently, with the production of coal, iron ore and crude oil being stagnant for the last three years. On the other hand, production of minerals for export has grown rapidly, with mineral exports increasing from $20 million in 1967 to $40 million in 1971.  -8- 24. The main problems in industrial development in the past have been shortages of imported raw materials and spare parts resulting in underutil- ization of capacity, which, together with the uneconomic size of plants, has led to uncompetitive costs of production; in addition, the sector has suffered from shortage of skilled labor and insufficient: emphasis on labor-intensive industries and industrial development in less developed regions. With the easier foreign exchange position and a more liberal policy towards imports, capacity utilization should improve. The importance of minimum economic plant size is now well appreciated by Turkish planners who aim at larger plants and rely on exports to absorb the surplus over domestic demand. On the other hand, the shortage of skilled labor is aggravated by the migration of workers to Europe and the supply of skilled managers is surpassed by the rapid expansion of industry. In the public sector in particular, competent cadres tend to shift to the private sector due to higher salaries. Greater emphasis on labor-intensive industries is required because they are poten- tially more competitive in view of the prevailing wage structure and can help in solving the problems of unemployment and regional imbalances. 25. The First and Second Five Year Plans aimed at rapid industrializa- tion as the basis for sustained economic growth, to absorb surplus manpower and to reduce the need for foreign aid. The investment priorities in the Second Plan were chemicals and petroleum refining, steel and other metals, mechanical and electrical equipment and consumer goods. In the draft Third Plan, the emphasis on industrialization is continued, with a comparatively greater emphasis on investment goods. The long, term aim is to reach a highly diversified industrial sector before full association with the EEC is achieved in 1992. 26. About 40 percent of the value added in manufacturing industry and about 80 percent in mining comes from the public sector. The public sector has a virtual monopoly in steel, petroleum refining, fertilizers, petro- chemicals, pulp and paper. It has also accounted for about 57 percent of industrial investment during 1967-71. Although some state economic enter- prises have shown good operational results, the overall financial performance has been poor. In the private sector, high rates of protection coupled with investment incentives have encouraged investments in industry, particularly in food, textiles, chemicals, cement, non-metallic products, metals, machin- ery and vehicles. In 1971, private fixed investment in manufacturing rep- resented 53 percent of the total. With the incentives announced in early 1972 for duty-free imports of investment goods and general prospects of sustained growth, business confidence seems to be high and the prospects for private investment in 1972 seem to be good. 27. Of the total private fixed investment in manufacturing of TL 12 billion in the 1969-71 period, about 65 percent was financed by internally generated funds of the companies and new share capital, 10 percent from tax credits, five percent from bond issues and the remaining 20 percent from fi- nancial institutions including the Industrial Development Bank (TSKB). TSKB's disbursements during the period amounted to $85.7 million, corresponding to about eight percent of the total investment.  - 9- 28. The capital market in Turkey is extremely limited with a stock exchange only in Istanbul. There are few negotiable securities available for investors and fewer still which represent means for private industry to raise funds through intermediary channels. There is a market for Government bonds, confined largely to social security organizations and financial insti- tutions, which are required to hold them. Until 1967 when TSKB started to guarantee such issues, there were no bonds issued by private enterprises. It is widely recognized that to mobilize long term capital the capital market should be developed and a capital market bill is currently being considered. However, the evolution of such a market can only be gradual. PART IV - THE PROJECT 29. A report entitled "Appraisal of Turkiye Sinai Kalkinma Bankasi, A.S., Turkey"(15a-TU dated December 7, 1972) is being circulated separately. A loan and project Summary is attached as Annex III. 30. General. The relationship between TSKB and the Bank spans more than twenty-two years, originating with the founding of TSKB in 1950. TSKB was the first development bank established with the assistance of the Bank and it was one of the first clients of IFC. TSKB has grown with the Turkish economy, its net worth, originally TL 12.5 million reached TL 271 million ($19 million) on June 30, 1972. Between its founding and September 30, 1972, TSKB had raised about TL 3,700 million ($260 million) for Turkish industry, of which $200 million was in foreign exchange. Five Bank Loans and four IDA Credits contributed $128 million or 64 percent of this foreign exchange. 31. TSKB continues to be the major institutional source of long term finance for private industry in Turkey. The other main source is Sinai Yatirim ve Kredi Bankasi A.S. (SYKB) founded in 1963 by six major commercial banks. It is about one-third the size of TSKB, but while TSKB has been a main source of long-term foreign exchange financing in Turkey, the bulk of SYKB's lending to industry has been in local currency. In early 1972 the Central Bank began to require commercial banks to allocate every year ten percent of their total commercial credits to medium term loans; some of these funds may be invested either through or with the assistance of TSKB. 32. TSKB's lending reflects the pattern of private industry in Turkey and is well diversified. After a slowdown in commitments, due to the un- certainties besetting the private sector in the periods preceding the August 1970 devaluation and stabilization program, and following the March 1971 change in Government, TSKB experienced an upsurge in early 1972 and looks for a substantial increase in its lending in the coming two years. 33. Since the previous Bank loan of $40 million in 1970, TSKB on the Bank's urging, has increased considerably the geographical dispersion of in- vestments previously concentrated in the Marmara Sea region; in 1971, 46 per- cent of TSKB's lending was outside this area. TSKB is also planning to become  - 10 - more active in Eastern Turkey where private industry has so far not develo. !c, despite an adequate natural resource base and where both investors and. - nancial institutions need to be encouraged. A similar situation prevails for tourism which, despite Turkey's great potential based on natural anrd historic assets, is growing much more slowly than in other mediterranean countries; TSKB is now planning to start lending for tourism. At the time of the previous Bank loan to TSKB, concern was expressed over the small num- ber of export-oriented projects financed by TSKB and the large number o0 small loans to relatively large companies for essentially replacement needs; the situation is now markedly improved in both respects. 34. On the whole, TSKB is an efficient development finance company which has no internal problems affecting its long-established good standing as a borrower of Bank funds. Its competent appraisal staff gives balanced consideration to both the financial and economic aspects of projects. The key challenges in TSKB's immediate future are the raising of enough domest. and foreign resources to meet the expanding needs of Turkish private indust---, the further geographical diversification of its lending and the extension e lending to tourism projects. 35. Capital Structure and Resources. TSKB's unaudited June 30, 1972 balance sheet shows total assets of TL 2,207 million ($158 million) includ- ing TL 1,346 million ($93 million) in foreign currency debt. Of total as- sets, the loan portfolio represents 80 percent, the equity portfolio 6 per- cent and liquid funds 7 percent. Of liabilities, 62 percent of the total comes from foreign loans, 26 percent from local borrowings and 12 percent from equity. The Government is the primary source of local funds, having provided TL 368 million or 17 percent of total assets in a subordinated loan. Share capital is privately owned; 81 Turkish shareholders own 76 per- cent of the shares, another 13 percent is foreign owned with IFC the largest foreign shareholder. The ownership is broadly representative of the Turkish financial community: the major commercial bank, Turkiye Is Bankasi, is the largest shareholder holding 20.8 percent of the shares and 11 other Turkish private institutions own an additional 42.5 percent. Besides the IBRD, which accounts for 36 percent of TSKB's debt, foreign funds have been provided bv the European Investment Bank, which holds 16 percent,Kreditanstalt fur Wiederaufbau (7 percent), and USAID (3 percent). 36. Management and Organization. TSKB's management and staff are capable and experienced; the staff totals 224, including 104 professionals. Following the resignation in 1971 of Mr. Yazici, TSKB's Managing Director, Mr. Egeli became TSKB's Chief Executive. Mr. Egeli has been associated with TSKB since its founding. In January 1971 TSKB i?.-roved its organization, integrating the various aspects of the appraisal work previously done inde- pendently. TSKB's technical staff have the expertise and experience to assist project sponsors to revise and improve proposed projects and have done so in many cases. TSKB's Board of Directors consists of 9 members, all Turkish. Mr. Ferid Basmaci, General Manager of Turkiya Is Bankasi, has been Chairman of the Board since 1969, and there have been but two changes in the Board composition since the last Bank loan. The Board is active; it meets twice  - 11 - a month and considers all applications above US$50,000 equivalent. The Board in the past has been conservative and was not always ready to take the rislks implied by a more aggressive developmental orientation. There are indications that this posture is changing and that TSKB's Board is becoming more aware than before of TSKB's development role in Turkey's backward regions. Thus TSKB's Regional Development and Promotion Department has been working since 1971 on a systematic promotion program in Anatolia; it has identified about 20 new industrial projects and is seeking sponsors and investors for them. A mature and sound institution, TSKB can play a larger role in promoting de- velopment in Turkey and the Bank has encouraged TSKB to make more moves in this direction. 37. Role and Importance. Undoubtedly TSKB's major contribution in Turkey has been to serve as a vehicle through which funds could be channeled to Turkish industry on the basis of a particularly well developed appraisal process. Currently over 700 individual companies have received TSKB's as- sistance and the number of projects reviewed over its 22-year history is several times greater. TSKB has made a significant contribution in Turkey in terms of project selection and its overall performance, including periods of recession as well as expansion, has been commendable. 38. Operating Policies and Procedures. Until its recent decision to finance tourism,TSKB's activities were devoted exclusively to industry, fol- lowing policy guidelines last revised in 1967. These guidelines provide limits for exposure in its loans and investments, restrict the use of foreign exchange to imports, and provide for economic tests of the merits of projects. Since 1968, TSKB has been making an explicit assessment of the economic impact of its projects and since 1970 it has been employing effective rate of protection calculations. Despite a number of protective and incentive features in Turkey, TSKB's projects have only rarely shown an effective rate of protection exceed- ing 15 percent. In general, as the increased geographical dispersion of its investments, promotion activities, exploration of tourism and emphasis on economic analysis demonstrate, TSKB is moving towards a more active devel- opmental role than heretofore. 39. Financial Results. Both foreign currency and lira loans are lent at the maximum legal rate of 12 percent net after a 25% tax, which means that after tax TSKB's borrowers pay 15 percent. Borrowers also assume the foreign exchange risk on foreign currency loans. Average terms are about 6-7 years on lira loans and 9-12 years on foreign currency loans. Following the 1970 devaluation, arrears on TSKB's loans increased sharply because of liquidity difficulties faced by borrowers; loans affected by arrears in excess of three months totaled TL 240.7 million on December 31, 1970, about 15 percent of the loan portfolio, and the payments in arrears totalled TL 48.9 million. In spite of intensive efforts at collection, arrears in excess of three months have increased to TL 77.7 million as of June 30, 1972, although the percentage of the portfolio affected has dropped to 10.3 percent. However, TSKB's port- folio is considered sound as loans in arrears are well covered by collateral and provisions for losses are adequate. Profits are good; they reached 18 percent of net worth after taxes and provisions for losses in 1971 and TSKB  - 12 - has maintained its historical 12 percent dividend involving in 1971 a 38 per- cent distribution of earnings. The yield on market prices is a nominally low 7 percent but average yields over time are estimat:ed around 12 percent due to bonus shares and rights issues. 40. Projected Operations and Resources Required. Supported by an ex- panding economy but also by TSKB's determination to play a wider role in backward regions and tourism, TSKB expects its total commitments to triple in the next five years, reaching a total of TL 8.6 billion ($ 615 million) for the 1973-1977 period. To support this increase TSKB will need to borrow in the next two years alone $118 million in foreign exchange and TL 650 million ($46 million) in lira. TSKB expects to obtain foreign exchange loans aggregating $45 million equivalent from EIB and KfW. The Government has also agreed to permit TSKB for the first time to raise foreign resources from private financial institutions abroad on conventional terms. IFC is assisting TSKB in borrowing in foreign capital markets where there are good prospects for raising substantial amounts over the next two years. Together, these sources will not cover the foreign exchange requirements in their entirety; a Bank Loan of $40 million will help TSKB bridge its foreign exchange resource gap for about 2 years, but at the same time leave enough uncovered to induce it to continue its active search for funds from other sources. Moreover, if the above efforts are successful TSKB's reliance on the Bank will be further reduced: The Bank share of foreign exchange financing in the up- coming two years would be but 34 percent of the foreign funds supplied as compared with its 57 percent share of the foreign funds liabilities outstand- ing in the June 30, 1972 balance sheet and its 64 percent share of TSKB's foreign exchange borrowings since it was formed. 41. TSKB's lira funds have come thus far, although in increasingly insufficient amounts, from TSKB's share capital and internal cash generation, from quasi-equity and other loans provided by the Government and from counterpart funds of foreign lenders (AID and EIB). The major obstacle TSKB faces in tapping the domestic market is a 12 percent ceiling set by the Government on the net lending rate for lira loans, which is below the current effective cost of medium- and long-term funds in Turkey (at least 15 percent for TSKB's borrowers and prime borrowers). Under these conditions, lira borrowing produces a negative spread for TSKB. One possible solution to enable TSKB to increase its local resources would be to raise its before tax lending rate on lira funds from 12 percent to about 15 percent. The waiving of the expenditure tax for interbank lending (25 percent) would further ex- pand TSKB's ability to mobilize funds and to relend them at a competitive rate. Both these measures would require a Government decision which cannot be taken in isolation from the package of incentives the Government extends to industrial investments, nor without a study of the other adjustments in the Turkish interest rate structure which they may make necessary. While this matter has been discussed with Government, an early decision before the impact of the changes on the rate structure and the capital market have been tho- roughly studied cannot be expected.  - 13 - 42. Spread on Relending Borrowed Funds. Under current market condi- tions in Turkey, TSKB will relend Bank funds at 12%, resulting in a positive spread of as much as 4.75%, although since interest rates on foreign exchange loans are under pressure in Turkey, rates may well drop below the present level before TSKB has fully committed the proposed loan. TSKB also needs lira funds. As explained in paragraph 41 above, lira funds borrowed in the market would cost TSKB about 15%, but since the interest received on their relending would be only 12%, there would be a negative spread of about 3%. In these circumstances, TSKB has agreed to the principle of a blend of the foreign exchange borrowing from the Bank with lira borrowing from the local market over the next two years, the local borrowing to take the form of direct borrowing by TSKB of TL 200 million and TL 150 million in guarantees. More- over, TSKB has undertaken to set aside not less than the equivalent of 25% of the difference between the interest and commitment charge paid on the Bank loan and the interest and commitment charge received from relending to be used under a special program for the promotion of industrial (including small and medium projects) and tourism enterprises, especially in the less developed areas of Turkey. As a result of these arrangements TSKB's net spread will be in the range of 2 to 2.5 percent. 43. Financial Covenants. The proposed loan will have the usual terms for DFC operations including the standard commitment charge. In view of TSKB's upgrading of its project appraisal work, an increase in the free limit from $750,000 to $1 million is called for, with an aggregate free limit of $12 million. The debt/equity ratio (calculated using the definition in the Loan Agreement which treats the maturities on the subordinated Govern- ment loans exceeding the last maturity on the latest Bank loan as equity) is currently 3.0:1 as against the 4:1 maximum in the previous loan agreement. Share capital, TL 124 million as of June 30, 1972 is being increased to TL 193.4 million. By the end of the year when the new shares issued will have been fully paid up, TSKB's debt ratio will temporarily drop. However, because of its projected increase in volume, TSKB's debt/equity limit will exceed the present contractual limit of 4.0 to 1 sometime in 1973. Since the quality of TSKB's portfolio is sound and covered by good guarantees, with losses adequately provided for and its follow-up commendable; it is proposed that the present debt equity limit be increased to 5 to 1. Such a limit would require TSKB to add another TL 100 million to its net worth by 1975, which TSKB intends to do by increasing its share capital. 44. Economic Benefits. In 1971 68 percent of TSKB's loans were extended to new companies or to existing clients for making new products, compared with 46 percent in 1970; 29 percent were for financing export oriented proj- ects. In the past three years an estimated 3,500 to 4,000 new jobs have been created each year by the projects financed by TSKB at an estimated capital investment of $15,000-20,000 equivalent per job. The Bank currently is under- taking with TSKB a special study of the developmental impact of TSKB's oper- ations. 45. Capital Market Activities. TSKB initiated private industrial-bond markets in Turkey in 1967 when it began to guarantee such issues. By September 1972 a total of 78 issues worth TL 922 million had been fLoated  - 14 - of which 17 percent were guaranteed by TSKB. Because most corporations are closely held family concerns, share issues by private corporations to outsiders in Turkey are very limited in number. In addition, information on firms is often inadequate. As a result the stock exchange in Istanbul plays a relatively insignificant role in raising local capital. In the face of these difficulties, TSKB has attempted to expand its direct investments but as of June 30, 1971 its equity portfolio consisted only of the shares of 31 firms at a cost of TL 133.5 million. TSKB's equity portfolio is thus only one-half of its net worth. In future, TSKB intends to intensify its efforts to promote equity investments and to raise its limit on equity investments from the present fixed level of TL 175 million to a limit based on a percent- age of net worth. 46. In summary, TSKB is an effective and important institution in Turkey, contributing substantially to the growth of the industrial sector. It has demonstrated its ability to use capital effectively and it is credit- worthy for the additional Bank financing proposed. PART V - LEGAL INSTRUMENTS AND AUTHORITY 47. The draft Loan Agreement between the Bank and Turkiye Sinai Kalkinma Bankasi A. S. (TSKB) and the draft Guarantee Agreement between the Republic of Turkey and the Bank, the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement and the text of a resolu- tion approving the proposed loan are being distributed to the Executive Directors separately. The draft agreements conform to the normal pattern for loans for development finance companies. 48. I am satisfied that the proposed wou:Ld comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 49. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments December 7, 1972  ANNEX I Page 1 of 2 COUNTRY DATA - TURKEY AREA POPULATION DENSITY 780,000 kl.2 37.2 million (mid-1972) 48 per km.2 Rate of Growth: 2-6% (from 1965to 1972) 140 per km2 of arable land POPULATION CHARACTERISTICS (1967) HEALTH (1967) Crude Birth Rate (per 1,000) 39.0 Population per physician 2,760 Crude Death Rate (per 1,000) 14.6 Population per hospital bed 560 Infant Mortality (per 1,000 live births) 153.0 INCOME DISTRIBUTION (1965-68, Istanbul) DISTRIBUTION OF LAND OWNERSHIP (1963) % of national income, lowest quintile 7 % owned by top 5% of owners 36 highest quintile 42 % owned by smallest 10% of owners 2 ACCESS TO PIPED WATER (% of population) ACCESS TO ELECTRICITY (1970) (% of population) % of population - urban-- % of population -urban ) - rural-- -rural ) NUTRITION (1964-66) EDUCATION Calorie intake as % of requirements 110 Adult literacy rate % 46 (1965) Per capita protein intake (grammes) 77,9 Primary school enrollment 7, 77 (1968) .1/ CNP PER CAPITA in 1971 : US $ 327 GROSS NATIONAL PRODUCT IN 197 1 ANNUAL RATE OF GROWTH (%, constant prices) US $ Mln. % 1962-65 1965-70 1971 GNP at Market Prices 11,939 100.0 5.0 7.1 8.9 Gross Domestic Investment 2,544 21.3 10.3 2/ 10.7 2/ 3.4 21 Gross National Saving 2,422 20.3 14.3 9.6 11.1 Current Account Balance 122 1.0 . D.8 Exports of Goods, NFS 853 7.1 .. 4.7 Imports of Goods, NFS 1,356 11i.4 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1971 Value Added Labor Force V. A. Per Worker US $Mln. % Mln. % US $ % Agriculture 3,083 26.6 9.8 66.2 Industry 2,710 23.4 1.5 10.1 1 .y0 2,1 Services 5,797 50.0 3.5 23.7 1 'H5. 211 Unallocated Total/Average 11,590 100.0 i4.8 100.0 (dj 100.-0 GOVERNMENT FINANCE CentralCovernment TL Bln.) % of GDP 1971 1971 1968-71 Current Receipts 36.6 21.1 19.8 Current Expenditure 353.2 19.1 15.8 Current Surplus 3-4 . 4.0 Capital Expenditures 14.2 8.2 8.6 External Assistance (net) i/ 0.8 0.5 1/ The Per Capita GNP estimate is at 1970 market prices, calculated by the same conversion technique as the 1972 World Atlas. All other conversions to dollars in this table are at the average exchange rate prevailing during the period covered. 1 Growth trends, which may differ from compounded average growth rates 31 Fixed investment ~j/ Including debt repayment and capital transfers 2/ _xcludes 1.8 3illion TL net borrowing by State Enterurises, guaranteed by Uovernment  AMiEX I ra ,e 2 of 2 COUNTRY DATA - TURKEY May MONEY, CREDIT and PRICES 1965 1969 1970 1971 1971 1972 (Million 'L outstanding end period) Money and Quasi Money 22,000 41,000 50,400 64,400 Bank Credit to Public Sector 5,518 10,156 11,297 Bank Credit to Private Sector 15,388 30,846 40,921* (Percentages or Index Numbers) Money and Quasi Money as % of GDP 39.7 34.0 156.5 357.2 General Price Index (1963 = 100) 109 137 14: 169 L 197 Annual percentage changes in: General Price Index 518 6.4 15-7 Bank credit to Public Sector 16.4 11 .4 Bank credit to Private Sector 19.0 135.15 BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1969-71) 196 9 197 0 1971 US $ Mln