Turkey : IFC country impact review

4 F I N D I N G S Number IEG 35307 Turkey: IFC Country Impact Review 2006 About IEG investment outcomes of its projects, respectively, to derive lessons for future IFC's Independent Evaluation Group independently evaluates T his Country Impact Review examined IFC's operations in Turkey between 1994 and 2004 to evaluate IFC's country strategies, as well as development and Group strategies and operations. e review's findings are on balance positive. IFC's portfolio IFC's investment and technical in Turkey has performed well: it yielded better-than-average development impacts and assistance operations and reports earned the same profitability rate as the IFC portfolio average for the period under its findings to IFC's management review. IFC responded appropriately both to market opportunities and strategic Evaluation and Board of Directors. IEG is a imperatives necessitated by the economic and political crises in the country (Figure 1). resource for helping staff under- Figure 1: Turkey's economy has experienced significant volatility since 1990 stand what IFC has learned and how IFC can do better business in Independent the future. General election Financial Customs Union with Turkey declared a candidate Efforts to start EU produces a two-party crisis EU comes into force for EU accession accesion negotiations ruling coalition General election produces a Election produces a intensified coalition of two secular three-party ruling About Findings Inflation and center-right parties coalition 12% Political tensions interest rates 120% decrease IEG Findings helps inform trigger financial crisis sharply Kemal Dervis appointed IFC and Bank Group managers 10% Minister for Economy 100% and staff about new evaluation 8% 80% findings and recommendations. 6% 60% Findings is also available to the htworg 4% 40% public. e views expressed here are those of IEG and should not 2% 20% noitaflnifo be attributed to IFC or its affili- etaR 0% 0% ated organizations. PDGraey-no-raeY-2% 0991 1991 2991 3991 4991 5991 6991 7991 8991 9991 0002 1002 2002 3002 4002 Online access -4% http://www.ifc.org/ieg -6% Corporation Coalition falls apart, an -8% Islamist-led coalition Early election in November 2002 government comes into Devastating produces the first single-party power for the first time earthquake occurrs (AKP) government in 16 years in Turkey's history in August 1999 New stand-by agreement with IMF Finance Foreign investment in Turkey has tween 1994 and 2001, Turkey had three separate been constrained by a weak financial crises, causing 5 to 7 percent contractions business climate... in GDP on each occasion (Figure 1). e persi- International From an investor's perspective, Turkey has three stence of chronic inflation and high current natural advantages: 1) large domestic market; 2) account deficits throughout the period, as well as favorable geographic location in between the Euro- considerable uncertainty in economic and regula- pean Union (EU), the former Soviet Union, and the tory policy, all pushed up the risk of investing in the International Finance Middle East; and 3) competitive and highly-skilled country. Furthermore, investors have encountered Corporation labor market. Yet, it has remained at the margins as a high administrative barriers and resistance to the World Bank Group destination for foreign direct investment (FDI). Be- involvement of foreign investors in the ownership,  TURKEY: IFC COUNTRY IMPACT REVIEW corporate governance, and management of their businesses by many Judged against its strategic objectives, IFC has of the families that own and/or control Turkey's companies. is has achieved some important successes... limited the avenues for FDI in privatizations and start-up enterprises Supporting financial markets growth. Since 1994, IFC's gross com- in newly liberalized sectors of the economy. mitments in the financial markets sector have totaled US$1.3 billion, or 44 percent of total IFC investments in Turkey, a much higher con- ...but Turkey's business climate is responding to centration than in other countries up until 2003. recent economic stability Providing critical long-term lending. IFC has successfully differenti- e Turkish economy has rebounded since the 2001 economic crisis ated itself from other lenders by providing virtually the only source of with an annual GDP growth averaging over 7.6 percent between 2002 long-term financing for Turkish private sector borrowers, helping them and 2004. is was achieved with reforms aimed at economic harmoni- avoid liquidity problems during economic crises. e majority of IFC zation with the EU. Prospects of better macroeconomic and fiscal man- financing has been through its A- and B-loans, with equity accounting agement have also contributed to an improvement in external country for only about 1 percent of IFC investments over the period (Figure risk indicators since 2002. Turkey's country risk rating has risen steadily 3). e low level of IFC equity investment has limited potential gains since its low point in 2001 but still remains below those of a peer group (and losses), bringing the overall profitability rate of the IFC portfolio of countries including recent EU entrants and current candidates for in Turkey to 2.8 percent of the average outstanding amount in line membership (Figure 2). with the IFC average over the period. Figure 2: Turkey's business climate is responding positively to improving macroeconomic conditions Removing key administrative and legal barriers to FDI. Since 2001, FIAS has helped the GoT to remove a range of barriers to FDI, includ- 100 ing time-consuming company registration procedures, pre-approval of 90 Very Low Risk FDI, and lack of currency convertibility (Box 1). 80 Figure 3: IFC's A- and B-loan program has dominated its instrument mix in Turkey Low Risk 70 Moderate Risk 60 gnitaR High Risk A-Loan US$1.8 billion 50 60% Key: 40 B-Loan Turkey 30 Equity US$1.2 billion EU Accession Very High Risk US$41 million 39% Peer Group 20 1% (Highest, Average, 500 25 Lowest) 10 B-Loans IFC Net Commitments 0 Number of Operations (RH-scale) 400 20 1994 1996 1998 2000 2002 2004 s Chart shows the composite International Country Risk Guide ratings (ICRG) snoilli 300 15 m $SU 200 10 IFC's strategy in Turkey has been closely iontarepOforeb muN aligned with its global corporate priorities 100 5 Turkey has significant strategic importance for IFC as its fifth largest 0 0 country investment portfolio and has made a positive contribution to 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Fiscal Year of Approval IFC's cumulative net income over the past decade. In line with the Total commitments by instrument FY94-05 (above) World Bank Group goal of correcting the policy and structural Annual commitments and number of investment operations (below) weaknesses in the country's economy as it moves towards EU accession, IFC's aim over the period has been to encourage sustainable ...but has not achieved some objectives private sector development by: i) concentrating on the high impact More support for second-tier companies. Although half of IFC's proj- sectors of financial markets, infrastructure, health, and education; ii) ects in Turkey have been sponsored by second-tier companies, by vol- widening its client base to include more second-tier companies and ume IFC has concentrated its investments in Turkey's large conglomer- SMEs; iii) supporting the Government of Turkey's (GoT's) privati- ates, with four groups making up over half of IFC's current exposure zation program; and iv) facilitating Turkey's financial sector reform. in the country. is was largely a market response by IFC, reflecting IFC's country strategy for Turkey has been well-aligned with its global the significant contribution that these companies have made to Turkey's corporate strategic priorities since 2000. GDP. IFC investments in second-tier companies in Turkey have been less successful, and finding viable projects with creditworthy sponsors in this segment of the market has been difficult.  TURKEY: IFC COUNTRY IMPACT REVIEW Box 1: FIAS has helped relieve some key constraints to FDI in Turkey FIAS carried out a diagnostic review of the foreign investment environment in Turkey in 2001. FIAS' study highlighted five areas of major concern for investors: (i) political and economic instability; (ii) time-consuming and costly administrative barriers, representing a hidden surtax of some 36 percent; (iii) an inefficient legal structure; (iv) weak policies on privatization and corporate taxation with serious distortions; and (v) lack of effective investment promotion. FIAS carried out a systematic program of follow-up work. After 2001, committees, FIAS'work has facilitated the following changes: FIAS carried out a series of follow-up reviews of administrative barriers to in- Administrative barriers: A new system of company registration reducing the vestment and the legal environment for FDI, in addition to a study on how time it takes to register from 79 days to nine days. Eliminated barriers such a new investment promotion agency might operate. e main recommenda- as minimum investment threshold and pre-approval of FDI. tions of FIAS' review were: Legal environment for FDI:A new FDI law that abolishes previously required Administrative barriers: Reduce excessive permits and duplications of approv- approvals for new FDI and includes guarantees of convertibility, expropriation als and inspections, and focus on facilitating rather than controlling new in- compensation, and international arbitration of disputes; and a new formal fo- vestments with some limited risk-based auditing. rum for public/private sector dialogue, the Investment Advisory Council for Legal environment for FDI:Update the existing 1954 FDI law and associated Turkey (none existed previously). regulations, with a view to simplify and modernize the FDI regime. Investment promotion: A new investment promotion agency withinTreasury Investment promotion: Establish a single agency dedicated to investment (a partial success, since FIAS recommended that the organization be indepen- promotion. dent of the GoT). Competition policy:Reduce regulatory overlap between the Competition Au- Some long-term treatment is still required. FIAS' remedies are help- thority and other agencies, especially in the electricity and telecommunications ing relieve some of the key FDI constraints.Some long-term treatment is sectors. still required: FIAS continues to push for deeper privatization, as well as tax FIAS' remedies are helping relieve some of the key FDI constraints. reforms (adoption of international accounting standards that deal effectively As an immediate step to implementing FIAS' recommendations on admin- with inflation and are in line with EU norms), better corporate governance (to istrative barriers, the GoT set up a Coordination Committee for Improving increase competitiveness and enable linkages between local and foreign firms), the Investment Climate with nine technical sub-committees. rough these and increased efficiency in court procedures. Diversification in its financial markets portfolio. IFC has pursued Figure 4: Projects in Turkey have yielded better outcomes financial market diversification, but it has been constrained by Turkey's economic and banking crises, slow policy reform, and limited financial market sophistication. IFC's financial market priorities have necessarily focused on restructuring of the commercial banking sector. 2 1 2 1 Participation in infrastructure.Participation in infrastructure: IFC has e HGIH e 6% 61% HGIH 17% 42% been successful in supporting port projects. However, the infrastructure High development High development High development outcome High development outcome outcome High IFC return outcome High IFC return sectors together account for only 4 percent of IFC commitments in moctuOtne Low IFC return moctuOtne Low IFC return Turkey. Opportunities have been limited due to the slow pace of the 4 3 4 3 privatization program and of sector reform in general. Looking ahead, 14% 19% 34% 7% Low development Low development Low development Low development however, as Turkey further liberalizes its energy sector and privatizes its mpoleveD WOL outcome outcome outcome outcome Low IFC return High IFC return mpoleveD WOL Low IFC return High IFC return electricity distribution and generation assets, there will be an increasing LOW HIGH LOW HIGH role for IFC to provide direct investment and technical assistance. Investment Outcome Investment Outcome IFC's investments have achieved better-than- average outcomes... ...explained by four key results drivers Development and investment outcome success rates were significantly IEG's recent Annual Reviews have identified four key results drivers for better in Turkey than elsewhere (Figure 4), with 67 percent of projects IFC's overall portfolio performance. ese outcome drivers are also rel- inTurkey achieving high development outcomes, compared to a 59 per- evant for IFC's results inTurkey: cent average for the rest of the IFC. Moreover, 80 percent achieved IFC's work quality was consistently good across the project cycle high investment outcomes compared to 49 percent in other countries in 54 percent of cases in Turkey compared to 41 percent in all the other although the profitability rate of the Turkey portfolio is the same as that countries; of the IFC portfolio average. Not surprisingly, therefore, IFC achieved a To balance the significant economic and political risk in the much higher proportion of "win-win" projects inTurkey than elsewhere. country, IFC's project and instrument risk intensity was on average lower ese results hold true for both financial markets and real sector projects in Turkey than elsewhere (Figure 5). is resulted from IFC's repeat in- in the country. Environmental, social, health, and safety (ESHS) im- vestments with existing clients and a portfolio largely comprised of senior pacts were also largely positive, especially in the real sector where IFC has A- and B-loans; had long-term relationships with reputable sponsors who are therefore well-versed in IFC's ESHS requirements.  TURKEY: IFC COUNTRY IMPACT REVIEW Strategic choices have focused IFC on the financial markets Figure 5: On average, projects in Turkey have exhibited lower risk intensity than elsewhere in Turkey where development and investment outcomes have been 30% Turkey better; and Rest of IFC e business climate, which despite some serious remain- ing deficiencies, is improving and will be an important results-driver 20% going forward. stcejorPfo noitroporP10% 0% 0 1 2 3 4 5 6 7 8 Number of High-risk Factors C O N C L U S I O N S A N D R E C O M M E N D A T I O N S With Turkey now embarked on the road towards EU membership, investor sentiment in the country is improving. IFC's ex- isting client base is becoming well-served by the domestic and international financial markets. IFC, therefore, faces a new challenge ahead: how to redefine its role in a rapidly changing environment, seek out opportunities to support Turkey's successful emerging companies, and help sustain the country's momentum towards economic advancement. is is not a new challenge for IFC. It has faced the same challenge before in other middle-income countries in Latin America, Eastern Europe, and East Asia. IEG's recommendations take into account IFC's achievements and shortfalls against its past strategic priorities and the rapidly changing economic and business conditions in Turkey. In summary: Existing clients. IFC should seek ways to maintain a value-added role for its existing client base in Turkey, particularly the large industrial and financial groups. New clients. IFC should increase its efforts in identifying successful, creditworthy, emerging companies in Turkey and sup- port their growth through direct investment or technical assistance. Local capital markets. IFC should help develop the local capital markets in Turkey, and use its guarantee, risk manage- ment and structured finance instruments to help mobilize local currency funds for clients. Instrument mix. Where prudently possible, IFC should increase its use of quasi-equity instruments. Learning from experience. IFC should learn from its experiences in other countries that have improved their business climates in developing its going-forward strategy for Turkey. IEG-IFC is an independent unit directly accountable to IFC's Board of Directors through the Director-General, Independent EvaluationoftheWorldBankGroup. eviewsexpressed here are those of IEG-IFC and should not be attributed to IFC or its affiliated organizations. Resources For further information: Acting Director, IEG-IFC: Head of Knowledge Building and IEG-IFC Help Desk: Nicholas Burke Denis Carpio Dissemination, IEG-IFC: (202) 458-2299 Task Manager (202) 473-1013 Sid Edelmann IEG@ifc.org (202) 473-7069 dcarpio@ifc.org (202) 458-4738 nburke@ifc.org sedelmann@ifc.org