Turkey - Eleventh Industrial Development Bank (TSKB) Project

FILE COPY ERN vv Z ~RETURN TO DOCUMENT OF INTERNA R ( UCTION AND DEVELOPMENT Not For Public Use Report No. P-1543-TU REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED ELEVENTH LOAN TO TURKIYE SINAI KALKINMA BANKASI A.S. WITH GUARANTEE OF THE REPUBLIC OF TURKEY December 20, 1974 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 It may not be published, quoted or cited without Bank Group authorization.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$1 TL 13.85 TL 1 US$ 0.072 TL 1,000 US$ 72 TL 1,000,000 = US$ 72,000 Turkish Fiscal Year = March 1 to FebruAry 28  INTERNIATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AID RECONMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED ELEVENTH LOAN TO TURKIYE SINAI KALKINMA BANIKASI A.S. WITH GUARANTEE OF THE REPUBLIC OF TURKEY 1. I submit the following Report and Recommendation on a proposed loan to Turkive Sinai Kalkinma Bankasi A.S. (TSKB) with the Guarantee of the Republic of Turkey for the equivalent of US$65 million to help finance lend- ing for industry. 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 8 per- cent per annum. PART I - THE ECONOMY 2. A report (316a-TU) entitled "The Economic Development of Turkey" in five volumes dated April 22, 1974 was distributed to the Executive Directors. An economic updating mission visited Turkey in November 1974 and its report is currently being prepared. Country data sheets are attached as Annex I. 3. Following a decade of stability in Turkey, student disturbances and unrest among workers appeared in 1970, accompanied by party disagreements, and in March 1971 the armed forces obtained the resignation of the Government and called for the formation of an "above-party" and reformist Government. After a succession of short-term Governments, martial law was ended and in October 1973 parliamentary elections were held. In a shift to the left of center, the Republican People's Party (RPP) won a plurality and formed a coalition government in January 1974 with the National Salvation Party. How- ever, underlying differences in the basic orientation of the two parties, coupled with disagreement over policy towards Cyprus, led to the collapse of the coalition in mid-September. After two months, during which none of the major parties were able to form a government, a new cabinet made up largely of technicians and non-party Senators and headed by a neutral prime minister was formed in mid-November 1974. While this Government failed to win par- liamentary backing, it remains in power as a caretaker regime pending the outcome of further efforts to resolve the political crisis. 4. Growth in gross national product in the last decade was high and continuous, averaging about 6.9 percent per year in the period 1962-72, with industry, power, transport and construction the main growth sectors. This re- flected the development strategy during the first and second five-year plans (1963-72), which gave highest priority to industrialization. In 1972 GNP in- creased by 7.6 percent, but growth dropped to only 5.5 percent in 1973, mainly due to a decrease in agricultural production as a result of poor weather con- ditions. Transport, communications and private sector services also recorded low growth rates, although this was offset in part by high growth rates in  industry, trade and financial services. For 1974, preliminary estimates by the government indicate a higher growth rate of around 8 percent. 5. The balance of paymnents situation was characterized in 1967-70 by increasing trade deficits, and a strict system of import controls which led to shortages of essential imports and, consequently, to under-utilization of production capacity. To alleviate balance of payments pressures, the official exchange rate was changed in August 1970 from TL 9 to TL 15 per US$ and re- vised to TL 14 in December 1971. The 1970 devaluation, together with associated stabilization measures, rising world demand and prices and a rapid rise in workers' remittances (from $140 amillion in 1969 to $740 million in 1972) helped to improve the situation dramatically. This improvement continued in 1973, with an inflow of $1.2 billion in workers remittances, and with exports in- creasing by 49 percent and imports by 34 percent. The overall result in 1973 was a surplus in the current accounit and a gross increase in reserves over 1972 of $700 million. The balance of payments position remained strong throughout most of 19;4, with workers remittances increasing by 25 percent during the first nine months of 1974 compared with the same period in 1973. But it has come under increasing pressure during the fourth quarter, as the inflow of workers re,mittances slowed down, accompanied by a widening trade gap which will approach $2 billion by the end of 1974. Gross reserves, which stood at $2.2 billion in August have declined to $1.8 billion in mid-November 1974. In May 1974, the lira was revalued vis-a-vis the dollar to TL 13.50 per US$ while its previous parity vis-a-vis other currencies was maintained. In September 1974, the exchange rate per US$ was readjusted to TL 13.85. 6. The budgetary situation in the last decade was dominated by the rela- tively rapid growth of public expenditures. Tax revenues also grew rapidly, but the increase was more than offset by the rise in current expenditures and transfers. As a result, the overall budget deficit increased and the Treasury had growing recourse to the Central Bank for short-term advances and other short-term borrowing. In 1972 and 1973, Central Bank financing of the Treasury was reduced considerablv as a result of a strict control of current expenditures and a sharp increase in the sale of Government bonds, but this situation appears to have been reversed in 1974, because of a large increase in expenditures, including funds for the Cvprus operation. 7. While State Economic Enterprises (SEEs) have had consistently low profits, necessitating increasing budgetary transfers to meet current and investment needs, there are sharp differences among them, with railways and coal being the major losers and manufacturing showing improving profits. Reform of the SEEs - in organization, mranagement, executive and labor skills, and pricing policies - remains cruciai, especially to prepare Turkish industry ior competition from the EEC. Prices of SEE products were raised in 1971 and again in early 1974 to improve their financial situation. Measures agreed upon in connection with Loan 893-TU have begun to lead to improvement in the financial situation of the railways, and those in connection with Loan 957-TU provide for establishment of a paper mill on a sound commercial basis.  -3- 8. Inflationary pressures have been high in recent years, with whole- sale prices increasing by 20 percent during 1973 and 17 percent from December 1973 to October 1974. However, the rate of price increases appears to have slowed down somewhat in the second half of 1974. The inflation has been fueled in large part by a growth in domestic liquidity which has averaged about 25 percent per year during 1970-72 and even higher since then. Other con- tributing factors have included increased workers remittances, increases in agricultural support prices, an increase in the minimum wage, and deficit financing by the Central Bank. To ease this inflationary pressure, policy should be directed towards restricting domestic liquidity without discouraging investment and growth. While the Government has recently raised interest rates to encourage private savings and term lending, additional revisions in the lending rates would be advisable in view of the high inflation rate. 9. Development strategy has emphasized the growth of output and labor productivity rather than employment. As a result, the labor surplus, in- cluding the estimated labor surplus in agriculture, rose from about 1 million in 1962 to 1.6 million in 1972, i.e. about 10 percent of the labor force. Emigration has so far greatly eased the pressure on employment. Between 1965 and 1972, net emigration amounted to about 400,000 and was expected to be about 70,000 per year during the Third Plan period (1973-77). The Third Plan continues the emphasis on investment in capital-intensive industries and projects a growth in non-agricultural labor surplus by another 300,000 by 1977. With the added effect of a slowdown in Europe on employment of Turkish workers (paragraph 13), unemployment should be a major concern of economic policy. Speedy implementation of land reform and integrated rural development programs would help to dampen migration from rural to urban areas. In addition, labor intensive methods need special emphasis in the choice of projects. However, even with these measures and faster growth than planned in construction and services, urban unemployment is likelv to remain a serious problem. 10. The prospects for continued high economic growth are good. The Third Plan constitutes the first phase of a long-term strategy for the period 1973-95, the ultimate objective of which is to raise Turkish standards of living to those of Italy in 1970 through rapid industrialization and decreasing dependence on external resources. The Third Plan targets are an 8 percent GDP growth rate, a 12.7 percent fixed investment growth rate, a marginal na- tional savings ratio of 38 percent (compared with about 18 percent in the Second Plan), commodity imports and export growth of 9.4 percent and 7.1 per- cent respectively and a decline in gross inflows of official external assistance to $130 million in 1977 (compared with over $300 million in 1972). Workers' remittances are estimated in the Plan at $600 million at constant 1971 prices in 1977. 11. A detailed analysis of these targets is presented in the basic economic report. The general conclusion is that, though the prospects for a growth rate of 7 percent are good, the Plan projections seem to underes- timate the difficulty of raising the savings level and balancing the external accounts at a reduced level of external assistance.  - 4 - 12. The Plan anticipates that two-thirds of the increase in national savings will come from the public sector through large increases in both tax revenues and in surpluses of the State Economic Enterprises (SEE's). Given the past performance of SEEs and delays in implementing a general reform, the expected rapid growth in their surpluses does not appear feasible. It will also be difficult to raise tax revenues to the extent implied by the Plan, but there is scope for a smaller increase if vigorous policies are pursued, e.g., further improvements in tax administration and effective col- lection now under way, widening the tax net to cover agricultural incomes, increases in the rates of property taxation, introduction of a value-added tax and liberalization of imports to offset tax losses due to import substi- tution and reductions of custom duties under the EEC agreement. The problem of domestic resource mobilization by the public sector is therefore likely to remain a constraint in the growth of public investment, and, apart from improved SEE performance, higher external borrowing and policies to increase long-term domestic borrowing from the private sector would be necessary to achieve the ambitious investment targets. 13. On the external side, commodity imports and exports in 1973 were above the level projected for 1977. Workers' remittances in 1972 were already higher than the 1977 target and have continued to grow, although their future was made uncertain by the decision of the Federal German Government in November 1973 to temporarily prohibit further entry of foreign workers from non-EEC countries because of the consequences of the energy crisis. It remains to be seen what course this policy will take over the longer run. Although exports, particularly of industrial commodities, have shown continued growth in cur- rent US dollars, they have actually declined in volume during 1974 as compared to 1973. This has been due largely to increased domestic demand for exporta- ble goods and the rise in prices of Turkish goods in the world market. 14. At the end of 1973, total external debt outstanding and disbursed was $2.8 billion, of which all but 3 percent is public or publicly guaranteed. The share of the Bank Group in total debt outstanding was 12.1 percent in 1973 and is expected to rise. The average terms of new credits have been hardening in recent years and this trend is expected to continue. Of the total gross official external assistance of about $411 million in 1972, the Consortium members provided an estimated $260 million. Of this about $105 million came from the United State and $38 million from West Germany. As a result of in- creased remittances and other foreign exchange earnings, and successive debt reschedulings and other arrangements for debt relief, the debt service ratio fell considerably from 24 percent in 1964 to 8.6 percent in 1973. and is likely to remain at about this latter level in the medium-term. Ilowever, in view of the uncertainties surrounding remittances and oil prices, Turkey should continue to exercise great care in its external debt management, including restraint in its resort to suppliers' credit financing.  -5- PART II - BANK GROUP OPERATIONS IN TURKEY 15. During the lengthy period of chronic balance of payments difficul- ties before the 1970 stabilization program and devaluation of the Turkish lira, Bank lending was only intermittent. Since then, rapid improvement in the balance of payments and in creditworthiness has made possible a large increase and continuity in Bank/IDA lending, which in FY71, FY72, FY73 and FY74 amounted to $114.0, $173.3, $175.0 and $228.0 million respectively. In these four years nineteen lending operations were carried out, of which five were in agriculture, six in industry (including DFCs), four in power and the rest in urban development, transportation, and vocational education. Agriculture accounted for 20 percent of the funds lent, industry and DFCs over 30 percent and power about 20 percent. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of November 30, 1974, and notes on the execution of ongoing projects. Implementation of projects in the private sector has been satisfactory; on the other hand, projects in the public sector have been seriously affected by political insta- bility and resulting administrative problems, and disbursements have been much slower than expected. A comprehensive review of the problems besetting these projects was undertaken with the Ecevit Government and will be resumed as soon as conditions permit. 16. In view of the sustained improvement in the balance of payments situation, no further IDA lending is contemplated. Bank lending is mainly directed in support of Turkish efforts to improve: (a) lagging public sector saving through financial and management reform of the State Economic Enter- prises( SEEs); (b) distribution of income and living standards in an economy entering its second decade of roughly 7 percent yearly growth, through more attention to employment in investment projects, more concerted rural develop- ment efforts, and better urban planning; and (c) long-term capacity to earn foreign exchange through diversification, especially promotion of industrial exports and tourism. 17. While the focus of Bank lending is on supporting the institutional and structural changes noted above, continuation of recent levels of lending is also important in view of the increase in projected capital import re- quirements. As discussed in Part I, Turkey's Third Plan goals of an 8 percent growth rate and increasing competitiveness with the EEC in prepara- tion for eventual full membership require further import liberalization and higher external borrowing in the near term. Under contemplated lending, the shares of IBRD/IDA in total debt outstanding and in total debt service are likely to remain under 20 percent and 25 percent respectively through the 1970's. 18. In supporting the broad objectives of improved SEE performance, better distribution of welfare, and diversification of external earning ca- pacity outlined in paragraph 16 above, it is planned to continue concentrat- ing the bulk of Bank lending (a) in industry (including mining and DFCs),  - 6 - where financial and management strengthening of SEEs is the key task, and (b) in agriculture, where rural development, employment, and institution building are the main focus. This core of the program will be supplemented by repeater loans for railways and selected loans for power (which also cen- ter on financial reform of state enterprises), follow-up lending for urban development in Istanbul and possibly in Izmir in support of the second ob- jective, and by lending in tourism. Bank lending has thus far been geograph- ically focused mainly in the Istanbul region, with emphasis on urban devel- opment and industrial finance, and in the Cukurova region around Adana on the southern coast, with emphasis on power, irrigation and fruit and vege- tables. This pattern is likely to broaden in pursuit of the second objective, with wider lending in the Anatolian plateau and eastern Turkey in response to the Government's effort to widen the geographic base of development, dis- courage too rapid urban migration, and improve the distribution of income. The proposed loan would further encourage TSKB to broaden its private sources of capital and to step up its efforts to finance private investment in the poorer regions of Turkey. 19. With regard to public sector reforms, past Bank lending for power over the course of several years helped bring about a comprehensive reorgan- ization of the power sector including the creation of the Turkish Electricity Authority (TEK). The recent Bank loan for the Elbistan project (1023-TU) continues Bank support for TEK's long-term reform objectives and establishes a working relationship with the Turkish Coal Authority (TKI) in the coal mining sector. A further loan to TEK for transmission lines as a follow-up to Loans 763-TU and 1023-TU is being prepared for FY 1975. A second loan to IGSAS (Istanbul Fertilizer Company) is also being prepared for FY 1975 to help finance an enlargement of the project financed under Loan 845-TU (cfr. Annex II, page 6). The Antalya Forest Loan (957-TU) aims to strengthen the State Pulp and Paper Enterprise (SEKA) in its overall investment planning as well as to promote effective financial management in the new mill subsidiary at Antalya. In addition, the industrial credit loan to the State Investment Bank (DYB) (1024-TU), the Government's main lending institution for public sector enterprises, aims to strengthen DYB's role in financing small- and medium-sized SEE industrial projects. The Bank is also involved in the mo- dernization of the Railways (893-TU) and in the iron and steel industry with its loan for Erdemir Steel Expansion (817-TU). 20. The Bank's main effort in support of the objective of better income distribution is the twin strategy of promoting rural alternatives to urban migration and improving urban development. As a beginning in rural develop- ment, the Bank approved a credit in FY72 for the Second Livestock Project, which focuses on fodder cropping and breeding, raising and fattening of animals in Eastern and Central Anatolia. For FY75 the Government is preparing an integrated Rural Development Project in rainfed areas of central Turkey and for FY76 a project for agricultural credit and agro-industries which is plan- ned to include a component for supervised farm credit. The Forestry part of the Antalya Forest Utilization Project should also make a significant contri- bution to rural employment through expanded cutting, reforestation and af- forestation. Future lending for forest village development is also contem- plated. In urban development the Bank lent for Istanbul Water Supply and Urban Studies in 1Y72 and for Istanbul power distribution in FY73. An urban  - 7 - transport bus project is being prepared for FY75 or early FY76; and further infrastructure lending in support of better planning and coordination of development in Greater Istanbul and possibly in other cities is anticipated, should the institutional objectives underpinning earlier projects in Istanbul be satisfactorily attained. 21. The objective of diversification of capacity to earn foreign ex- change has been supported in the past with the Fruit and Vegetables project, which is aimed mainly at production and processing for export to Europe. The proposed project, while focused heavily on investment in Turkey's underdevelop- ed areas, will also enable TSKB to continue its encouragement of investment in export industries. For the future, the agro-industries component of the Agricultural Credit Project will be export-oriented, and the Government is preparing a Tourism Infrastructure Project on the Mediterranean coast west of Antalya. 22. As a result of some leveling off of bilateral aid, the European In- vestment Bank (EIB) has become, along with the Bank, Turkey's major source of external finance on noncommercial terms. The Bank has developed informal cooperation with EIB in the past, for example, in related but not formally parallel lending in FY 1973 to the Turkish Railways and to TSKB. Both the Antalya Forest Utilization Loan and the loan for the Elbistan Lignite Power Project represent further steps toward formal joint financing with EIB, and we anticipate continued close association in other future large-scale projects as appropriate. The Kreditanstalt fur Wiederaufbau (KfW) has also become an important source for financing on non-commercial terms and is closely associat- ed with several Bank projects, especially Elbistan for which it is a major co-financer, and in lending to TSKB. 23. The Railways and Antalya Forest Utilization Project also exemplify the Bank's continuing collaboration with UNDP. In both projects UNDP financed the feasibility study undertaken with the help of outside consultants, for which the Bank acted as executing agency. In addition, UNDP is financing further railway technical assistance studies which form an integral part of the implementation of the project. In 1973 UNDP financed a study of forest industries in the Marmara region of Turkey to help define a larger study recommended for inclusion in the Antalya Forest Utilization Project. The Bank is also collaborating with the UNDP in the preparation of the tourism project, with UNDP and FAO in the preparation of the Rural Development Project noted above, and cooperation is anticipated on other projects in the future. 24. IFC has been active in Turkey, having participated in investments for nylon yarn, pulp and paper, glass, aluminum, steel pipe, and tourism. Total commitments so far amount to about $71 million. IFC is currently in- vestigating new investment opportunities in various sectors, including tex- tiles, and synthetic fibers.  - 8 - PART III - INDUSTRY IN TURKEY 25. Turkish industry has grown rapidly during the past 15 years, aver- aging 10.5 percent per year during the First Plan (1963-1967), 9.8 percent during the Second Plan (1968-1972), and an estimated 15 percent in 1973. The First, Second and Third Five Year Plans have all 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. The Third Plan places a comparatively greater emphasis on investment goods. The long-term aim is to accelerate the transformation of Turkey's industrial structure in preparation for full association with the EEC in 1995. Under the Plan this means estab- lishing intermediate and investment goods industries in the shortest possible time to permit the application of advanced technology, the development of a more diversified industrial structure, and the production of a wide range of industrial exports. 26. Although traditional consumer goods industries remain important, modern industries such as basic metals, metal products, machinery, chemicals and petroleum products now constitute over 40 percent of manufacturing produc- tion. Along with the growing sophistication and diversity of the sector, industry has absorbed a growing portion of the nation's resources as the num- ber and size of the projects have increased in both the State and private sectors. The share of manufacturing in total gross investment rose from 24 percent in 1962 to near 30 percent in 1972. However, the growth of output and investment in industry has been accompanied by a high capital-output ratio and a slow growth of employment. Employment in industry increased to about 11 percent of total employment in 1972 compared to 8 percent in 1962. 27. Modern Turkey has developed as a mixed economy since the early days of the Republic and the State Economic Enterprises (SEE's) have become the principal mechanism for managing public sector economic activity. In the productive sector, SEE's dominate electricity, petroleum refining, steel, nitrogen, paper, rail and air transport, shipping and communications, and play an important role in textiles, cement, coal, sugar, machinery, and chemicals. SEE's are also important in finance, and hybrid organizations like Etibank in mining and Sumerbank in textiles, ceramics, etc., act as holding companies and as lenders for their operating subsidiary "establish- ments". The Agricultural Bank and the State Investment Bank (DYB) are SEE's created to finance SEE investments generally in agriculture and industry. While the primary purpose of SEE's is production and finance, they have also been charged with various social goals such as development of backward regiors, absorption of manpower, and maintenance of price stability, which have tended to become a hidden financial burden. Although some have shown good operational results, their overall financial performance has been poor. 28. About 40 percent of the value added in manufacturing industry comes from the public sector, which has a virtual monopoly in steel, petro- leum refining, fertilizers, petro-chemicals, pulp and paper. It has also ac- counted for about 55 percent of industrial investment during 1963-72. As a  -9- general rule, the public sector enters fields considered of vital importance or where the private sector is unwilling to invest, either because of shortage of financing capacity or because of low financial return. 29. In the private sector, high rates of protection coupled with invest- ment incentives have encouraged investment in food, textiles, chemicals, cement, non-metallic products, metals, machinery and vehicles. In current prices, private industrial investment increased from TL 6.5 billion in 1972 to an estimated TL 10.9 billion in 1973, or about 65 percent of total invest- nient, whereas public investment in manufacturing remained constant. 30. About two-thirds of private fixed investment in manufacturing is financed by internally generated funds of the companies and the unorganized money market. Long-term loans from TSKB and the Industrial Development and Credit Bank (SYKB) account for 10-12 percent, foreign direct investment and suppliers' credits 10-15 percent, commercial banks 6-8 percent, and corporate bonds 3-5 percent. In 1973, TSKB's disbursements corresponded to about 9 percent of the total of private fixed investments, and TSKB provided about 18 percent of the financing for private investment using foreign exchange. 31. Apart from Government bonds, whose market is confined largely to social security organizations and other financial institutions which are re- quired to hold them, the only long-term fixed interest financial instrument available in Turkey is the corporate bond. This is a relatively new instru- ment which began to be significant in 1968 when TSKB took the lead in guaran- teeing such bonds. Nevertheless, the corporate bond market remains fairly thin and TSKB itself only began to issue bonds in 1973. Growth of this market has been impeded by the attractiveness of Government bonds (they are tax-free and redeemable at par after one-year), the ceiling on interest rates, the worsening of inflation and tight money policy. As a result, the public has shifted to higher yielding securities or shares in holding companies and other companies. Nevertheless, the market for corporate stock also remains limited, with most of the capital of joint stock companies still controlled by families or by a small number of shareholders, and most new capital is still being raised from existing owners. In December 1974 the interest rate paid on bonds was increased from 15 to 18 percent, a step which will improve the attractive- ness of bonds to investors. The need for other measures to stimulate the mobilization of long-term capital in the capital market is widely recognized and legislation has been under consideration by the Government for some time. PART IV - THE PROJECT 32. A detailed description of the proposed project is;'iven in the report entitled "Appraisal of Turkiye Sinai Kalkinma Bankasi, A.S., Turkey; Report No. 529a-TU, dated December 20, 1974, which is being distributed sepa- rately. A Loan and Project Summary is attached as Annex III. 33. The proposed project was appraised during a mission to Turkey in May and June 1974. Negotiations took place in Washington in November. The  - 10 - Government was represented by Mr. Muammer Akinci, Chief Counselor for Finan- cial and Economic Affairs of the Turkish Embassy and TSKB by Mr. Ozhan Eroguz, Senior Assistant General Manager. General 34. Established in 1950, TSKB is the oldest client among the Develop- ment Finance Companies associated with the Bank Group. It is also one of the first clients of IFC which became a shareholder in 1963. From its founding to March 31, 1974, TSKB obtained about TL 5.0 billion (about $352 million) for financing of Turkish industry, of which 80.6 percent was in foreign ex- change. Six Bank Loans and four IDA Credits together with one IFC loan and four IFC investments contributed $180 million in foreign exchange or 51 percent of TSKB's overall resources in this period. The current Bank Loan (873-TU) is now almost fully committed. TSKB is an efficient development finance company with an extremely competent appraisal staff and no internal managerial prob- lems. Its major contribution to Turkey's industrial development effort has been its role in channeling funds to private industry on the basis of a care- ful appraisal process. Capital Structure and Finances 35. As of March 31, 1974, TSKB's total assets amounted to TL 3.4 billion (about $242.0 million), of which the loan and equity portfolios represented 81 percent and 5 percent respectively and liquid funds 8 percent. The Govern- ment has been the principal source of domestic resources, having provided eight loans representing about 51 percent of local currency resources outstand- ing. Since a share capital increase in 1972, there has been no major change in the structure of ownership. 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; eleven other Turkish private institutions own an additional 39.1 percent. Foreign insti- tutions, of which IFC is the most important, own 10.8 percent. In addition to the Bank Group, which accounts for 64 percent of TSKB's outstanding foreign debt, foreign exchange funds have been provided by the European Investment Bank (18 percent), Kreditanstalt fur Wiederaufbau (14 percent) and USAID (4 percent). 36. TSKB's profits and overall financial standing remain excellent. Its 1973 profits after taxes and provisions were 42 percent above 1972 and yielded 21 percent of average net worth as compared with 18 percent in 1972. TSKB also paid a 15 percent dividend in 1972 and 1973, which was about 44 percent of its net profit for each year. Operating Policies and Procedures 37. TSKB's policy guidelines set limits for exposure in its loans and investments, restrict the use of foreign exchange to imports, and provide for analysis of the merits and feasibility of projects. Since 1968, TSKB has been making assessments of the economic impact of its projects and in 1970 it began employing effective rate-of-protection calculations. Beginning in  January 1974, TSKU has been calculating the economic rate of return on all new or expansion projects of relatively large size. 38. Until the early 1970's 80 percent of TSKB's lending was concentrated in the Marmara region around Istanbul. However, in the last two years, the geographical distribution has been broadened and TSKB has assumed a more active developmental role. With support from the Bank's last loan, a Promotion Program in the underdeveloped regions was launched. In October 1973 new policy guidelines were laid down. These guidelines focus on the following: the promotion of investment in less developed regions and assistance in project identification, preparation and financing; the analysis of project related sector and sub-sector development and preparation of investment estimates for these sectors; and the extension of the lending program to include tourism and services. Lending to the underdeveloped regions increased significantly in 1974, and TSKB is planning to allocate about 50 percent of its total lend- ing in the underdeveloped regions in the next two years. TSKB has also under- taken to allocate not less than 50 percent of the proceeds of the loan to finance projects in these areas. Management and Organization 39. In line with these new policy guidelines, TSKB's organizational structure underwent a major change at the beginning of 1974, when operations were divided into four regions--northwestern, southwestern, central and eastern Anatolia--, with each region headed by a departmental manager respons- ible for planning and investment program execution. To reinforce this struc- ture, TSKB now has four regional branch offices. TSKB's main Istanbul office has also been strengthened with the establishment of three new assistant general manager positions to supervise resources, accounting and disbursements; research; and loans and investment. TSKB's staff is capable and experienced, with staff turnover at a low level. At present the staff totals 265, includ- ing 38 managers and 78 professionals. 40. TSKB's nine-member Board of Directors is active; it meets twice a month and considers all applications above $50,000 equivalent. Although the Board is still generally conservative in its orientation, it has fully sup- ported the management's efforts to redirect operations more toward the under- developed regions of the country, to accept the risks inherent in more active participation in development, and to seek to raise a larger share of TSKB's resources in the capital markets. Lending Operations and Finances 41. TSKB'p foreign exchange lending in the past few years has increased substantially, with its lendirin for 1973 on a commitment basis more than four times the level of 1971. Nevertheless, because of difficulties in adequately replenishing its resources (para. 47), TSKB's volume of business dropped sharply during the first 8 months of 1974 compared with 1973. Foreign cur- rency loan commitments in January-August 1974 amounted to $28.8 million com- pared with $59.3 million for the entire year 1973, a decline of 27 percent on an annual basis. Local currency loan commitments showed a much sharper  - 12 - drop of 55 percent, with commitments falling from TL 155.6 million in 1973 to TL 46.8 million in the first eight months of 1974. Equity investments re- mained at about the same level with 50.8 million for all of 1973 and TL 53.6 million for the period January-August 1974. 42. Before the Government raised the permissible ceiling on interest rates from 12 to 14 percent effective October 1, 1974, both foreign and local currency loans were lent at the maximum rate of 12 percent, which meant that after a 25 percent tax TSKB's borrowers were paying 15 percent. With the change in interest rates, this cost is now over 17 percent. Borrowers also assume the foreign exchange risk on foreign currency loans. Average terms are about 6 to 7 vears on Turkish lira loans and 9 to 12 years on foreign currency loans. The average size of the loans has continued to increase, rising from TL 4.8 million in 1970 to TL 11.7 million in 1973. The lending portfolio is well diversified among various industries. 43. As of December 31, 1972, the total principal and interest in arrears over three months stood at TL 145.1 million or some 7.7 percent of the loan portfolio. By March 31, 1974, the total outstanding for over three months had increased to TL 276.2 million or about 10 percent of the loan portfolio. Nevertheless, although the arrears situation has gradually worsened during the past two years, TSKB's portfolio remains sound as loans in arrears are well covered by collateral and provisions for losses are adequate. The rigid- ity of the interest rate is a contributing factor in loan delinquency since TSKB, like othler financial institutions, cannot charge penalty rates on new loans because it is already lending at the maximum allowable rate of interest. 44. TSKB also makes direct investments in the industrial sector, al- though its equity participation represents only about six percent of its total portfolio. TSKB plans to expand its equity investments, particularly in the underdeveloped regions where its participation acts as a strong in- ducement to other potential shareholders. In September 1973 the maximum limit of its equity investment was raised from TI. 175 million to the level of its paid-in share canital and reserves which amounted to TL 376 million as of December 31, 1973. In addition to its equity investments, TSKB has also undertaken a program of joint financing with commercial banks and ex- pects to expand such operations considerably over the next two years. Projected Operations and Resource Mobilization 45. Over the next five years (1975-1979) TSKB expects to reach an over- all commitment level of TL 16.0 billion which is more than four times the level of the previous five-year period. To meet this projected level of lending and investment, an estimated TL 11.9 billion ($850 million) ih foreign exchange and 4.1 billion in Turkish lira would be required. Of the total for- eign exchange requirement, an estimated $300 million would be needed for the period September 1974 to December 1976. The available or anticipated re- sources to meet this need include new loans from EIB and iKfW totalling $36 million which became effective in the second half of 1974. In addition, TSKB will apply for further loans from KfW and EIB for the period 1975 to 1976 hind hopes thiey will total about $66 million. This leaves an overall foreign  - 13 - exchlange gap of about US$200 million equivalent for the September 1974 to December 1976 period. The proposed Bank loan would cover less than a third of this gap up to the end of 1976, thus requiring TSKB to amplify considerably its foreign resource mobilization eflcrts. 46. TSKB's local currency commitments for the September 1974 to Decem- ber 1976 period are expected to reach TL 1.5 billion. This amount would be obtained in part from internal cash generation (estimated at TL 825 million for the period) and by increases in share capital (TL 125 million). The re- naining lira resource gap will be met by additional bond issues which TSKB has undertaken to float, at a negative spread if necessary, during the next two years (TL 200 million in 1975 and TL 350 million in 1976). 47. A major obstacle TSKB faces in raising funds on the domestic market is the 14 percent ceiling on lending rates set by the Government which is below the effective cost of medium- and long-term funds in Turkey. Because of this TSKB has had to borrow local currency at a negative spread, this being offset by large positive spreads on other borrowing. While this is an accept- nble temporary solution, it is not a viable long-term answer to TSKB's resource problem. If further changes in the lending rate are not forthcoming in sub- sequent years, TSKB's profitability would decline below optimum levels. How- ever, during the next two years, TSKB's continued borrowing at a negative spread will reduce, but not seriously affect its overall profitability. 48. In recognition of this problem, TSKB, as recorded in Section 4.08 of the Loan Agreement, has agreed to mobilize resources in both the domestic and foreign capital markets. For the period 1975-76, TSKB has indicated its in- tention to endeavor to raise TL 1,100 million in the domestic market, of which at least 60 percent would be obtained through bond issues and share capital contributions, and substantial amounts of foreign exchange in the international capital market, assuming circumstances permit, in addition to $25 million already authorized by the Government. Spread on Relending Borrowed Funds 49. As agreed with the Bank under the previous loan, TSKB has been assigning 25 percent of the 4-3/4 percent spread to a Special Promotional Account for the underdeveloped regions. Although delays have occurred in making use of these funds, the program is now underwav and will become an increasingly important resource for project identification and other develop- ment tasks in the underdeveloped regions. The funds allocated under the last loan for the promotional funds are sufficient to meet the needs of the program for the coming two years and tihe proposed loan does not provide for further contributions to the promotional accour.t. With the -ncrease ir. len.ding rate to 14 percent, however, the spread earned on Bank funds will increase to 6 percent. To conform to the spread earned on resources obtained from KfW and FIB, agreement has been reached to limit TSKB's net spread under the proposed Bank loan to 2-1/2 percent with the balance to be paid to the Government as a guarantee fee.  - 14 - Financial Covenants 50. The proposed loan will have the usual terms for DFC operations in- cluding the standard commitment charge. Since it is expected that the aver- age size of the subprojects in the underdeveloped regions will be smaller than in the developed areas, and since Bank funds will be used to finance only part of the foreign exchange needs for projects in the developed regions, no change is needed in the present free limit of US$1 million. The Loan Agreemient provides that TSKB will be able to use 30 percent of the proposed loan amount to finance projects below the free limit. The debt/equity ratio as defined in the Loan Agreement will increase from 4.4:1 in 1974 to 6.4:1 in 1976 and lo 9.7:1 in 1979. Because the quality of TSKB's portfolio is sound and covered by good guarantees, with losses adequately provided for, TSKB's present debt equity limit of 5 to 1 should be raised to 6 to 1. To avoid exceeding this limit by 1976, however, TSKB is prepared to increase its share capital in 1976 rather than 1977 as presently scheduled, and, if needed, to consider additional measures in consultation with the Bank. Economaic Benefits 51. In recent years TSKB has increased its support of export-oriented projects and this trend is expected to continue. Actual exports of its borrowers increased from about $45 million in 1971 to $112 million in 1973. The number of new jobs created each year by TSKB-financed projects has also increased from an average of 3,500 to 4,000 during 1970 and 1971; to 7,000 in 1972 and 7,300 in 1973. 52. TSKB is an effective and important institution which has contributed substantially to the growth of private industry in Turkey and is now strength- ening its role in the underdeveloped areas of Turkey. It has demonstrated its ability to use capital effectively. PART V - LEGAL INSTRUMENTS AND AUTHORITY 53. The draft Loan Agreement between TSKB and the Bank, the draft Guarantee Agreement between the Republic of Turkey and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement, and the text of a Resolution approving the proposed loan are being distributed separately to the Executive Directors. The draft agree- ments conform to the normal pattern for loans for development finance com- panies. 54. 1 am satisfied that the proposed Loan would comply with the Articles of Agreement of the Bank.  - 15 - PART VI - RECOMMENDATION 55. I recommend that the Executive Directors approve the proposed Loan and Guarantee Agreements. Robert S. McNamara President By J. Burke Knapp December 20, 1974 Attachments   ANNEX I Page 1 of5 ODUWThT DATA - TURKEY AREA POPVLATION SONSIUY IWT7c. reD mi~~~~~~~~~~~~~~~~~~~~~711'llio (eid-1972) 15/'t e .2f..b.I. SOCIAL INDICATORS Reference Countries l9.T.raek 191 a i IM! SN?P PER CAPITA 83$ (ATLAS BASIS) /8 230 /c 370 /a 40 Ia 490 /8 9 L,9O/ DEMOGRAPHIC Crude biWrt.h rate (per thaucand) 45 /d,e 38 If 45 If h 45 Ifh8 16.8 Crude d.ath rate (P.r thuueand) iA Id a. 13 1f 11 /T' 17 f 9.? Intent cortality rate (per thousnd live birth.) 1A7 d., 145 Ji 70 41 1-10 29.2 Life expectancy at birth (ye.ar) SS ~Ed 5578 59 510/f,h 71.1 0rcen reproduction rat. 2 3.0 2.b6g 3:2 If h 3 4 If 8h 0.9 Population gruoth rate aT 2.? 2.5 1K 33t s 3 71 olnI PoPolati. growth raeta-u-b.. 5.5/u 4.571 57-. 57 .71 Agu etructore (percent) ('I-i 4l. 4i.i 1,7 I. 47 I 24.3 i5- 64 55.2 53.9 0071 50 71~ 64.9 65 an nr3 71 3 71 10.8 Denendeoy rtic lb1: 1.7 7V 1.7 77, 1.1' Ia Urion population an percnt uft.totl 32.0 /c 38.7 I62b la.,q i95/ amily plannIng: Na. of acoaptore of ulati.d (toc.) I- 484 7y,.c 316 662 Ac. of unare (% of sarriad ameen) ~~~~~5.3 I. 8.2 / .5-10 SN? WLODNT $hItl71bor forc (tbho-aode) 13,010C /ab 14,5CC lob 6,2CC /u 9.06lu' 19,600 lao Prrcentag -sploynd in agriculture 71 59 41 4 1 P Scnaeuapuu 2L/d 1.7 3 3 INCOME DSSTRIBUTION Percet of natioco.l in..aa receined by highent 5% 33A cot 32 /,at 33 lg 25 I Percent uf national lncoe rece..ived by bigheut 20% 01i~t 6 SOf 59 aK 56 71 Percnt of ntonale oereevdb lo_nut 20% l ONEt 3 : 731/ 4 71j 5 71 Pnroaot of national incua reocin-d by loweet 1.0% 11 101 571 DISTRIBUTION OFr LAND OVARSHIP %uowned by toplTUVof-oenrc S. 53 % conod by ecailest 10% of oanon . 0.0 HEALTH AND NUT'RITION Pepulati-u Per phy'ioan 3,22G /ad 2,220 2,160 /ab 3,05 5iu Poplto. e orir een3260, lab 1,880 lAi 1,040 ~ 3,230 400lla Popultion Per hospital bed 650 - 191 450 780 /uh 90 _ Per cuPit: calorlie npply ae % of raqireoente 5. 113 l.I 88 1.1 loS 121 . Per cait prtin eupply, total (grace per dayr~L . 78 711 so 711 i 6887- DetOtobc. 1nmyears ule . 277 571 14/Al 42 71 Deotb rate 1-1. yearn /7 ~~~~~~~ ~~~~~~16 la 15 77 12 7Fao_ EWJCATION Adjuted /8 Peieary echoul enrollment ratto 78ll1 95 /14 12 107 Adjueted 7$ -eoMdry cobool corollent ratio 15 28 21 /8 26 59 Yearn. 019ch-oling pronided, first and .ccod leve 11 11 11 12 13 V...ui-oal enrollmnt on % of .... Sochool enrollment 16 14 25 l#s 3 26 Adult literecy rate H0 ap/c 55 /ao 74 37 6.a 37 91 bsqS HOUSING Average No. of pere"oe per roo (urban) 2.0 1.9 ..2.P/lanai 1.1 lar. Percent of occpied unite without piped aotnr 81 ln 64 lan .. 7 /,1,t 38 /ra Ac.e.e to elnotricity (as % of total pepulatiun) 29 7.v 41 7 .. 25 94 Iar.ay Peroent of tra. populati on ounneoted to I-etrlotty 182.t 1t CONSUMIPTION lfT&M linr per 10000 popraticn 1,9 89 103 Ir 93 / 218 Pa..eeognr care per 1000 pepolatiuu 2 4 7 Thb~.a 10 190 E1nobrlc Poaer ounsueption (keh p.o. 102 244 414 267 I 2,26? McoSpriont oonopticn P.c. kg Per year 0).8 2.0 1.9 In 0.4- 5.3 Outre: Figu-n rotor eithrr to the latent periode or ic aoonan uf oirnmanetal t-.pcratar, body ecight., and thbe luet. yau Latnst periods refer In princoiple ti dletrtbatiun b age at SW of national pupalatiune. tbo yearntl1956-60 or 1966-70; the blaent yno-o J. prin- /6 Protein Standarde (rqc.frenenta) fur all cua..tries ac e"tab- ciple to 1960 and 1970. Iichad by t91A Eoononl Research Screice pronide for a sinlun /I Th. for Cepito GNP netcatnn ie ot -aokrt pricco for af-luoo... o f 60 gram of tuta1 pratein per day, acud 20 grasr of y,oro oth-r than 1960,ohculultnd by tho acronorin aiml at polca prutein, of obioh 10 graes nhold be anica t-choique on tbo 1972 World lbk itlau. protein. Thsee et.ndwda -r cbomehat love than, thuse uf 75 /i ino...ge number of daughtnre per oona of rcp-do-ti-o grw of total protein and 23 graw of animal proteio a an .g . -~~~~~~~~~~~~~vrage for the world, propun..d by FLO in the Third World Food ~Popaltic- gcno-h mten or for iho dorodvo o.dlug iii Sarvy. 1960 and 1970. /7 lone etodies hare eoggentd than crode death raise of children Ratio of od-r 15 nod 65 and 00r ago brackete to ag. 1 throagh 4 nay be .sed as a first appronlmt.tl index of tho.e In lobor foror Imnobot of ago8 15 through 6a. nal-atriti- . FAOP0 rn f_ren tcdndord roprenan phynicloglnol rn- 18Pnre.oanorlr 0on sonigpp:Plticc of School age qulrceonto for ocre n tliy and hoolth, iWriog u eio f 0COu . Ia 1972; lb Ecioudlog neadnu ond pastures; /A COmpted by applying to the 2072 fIgure the fnvhr.brte of the OAF/na.. in coal teres fr.. 1960 to 1972; /d 1955-60T /e Derived fruc eample or-y octimaten (9,700 h-ueholde); If 1965-70; IA Deri-ed fro. sample eury eotlwte (21.0,C00 per curs), excluding 17 eactern provincee; lb LIN estimate; 71 oght be ander-uticated; LI( 1968; A6 Mate based on burial parnite; /I Sources and netbade Are dlflereot for 1955-60 and l965-67; Ic 1965-67; A-1l9-60-72; /c Adiniotloiralr coo-t-r of province, and di stirite ('nilayet' and IaSa.' eoe); /P 1T14-72; /q Fop.1atioo livalg in a n..oleoc of 1,500 or nore inbabitante; Ir All Sharcotan canter,, regardlees of Si.., and all plaren of 5,000 or once inhahitanto; Is Population -ovr 2,00Ci; /t 1971 -nno; Ia intimate; In 1971; /a Ratio of popolatlon under 15 and 65 nd over tu to-tal la1bor fore; I Ratio of popolatiun under 15 ond75 and uverto thoee in labor force age 10-64; /Z 1964-jane 1974; Ia 86 perconrbnlng IUD.n; lSa 1963; /ab 15 years and ove r; lao 18 yearn and ovr; lad 1962; /A. DlsPOeh1e income; 1af Hooeeholdn; Zg tco....o11ly actie population; 7aT 1969; lAi Incl;;ding71neistant norneo and eidrivee; 81H piaprnoe only; /ui Inoloding looal or --.Tl hospitlta1e d nedloal bartero; 1.1 1964-66; an196910 a 94 /o lorldlorgaahiu training at third lan1; Ap Poroono oi Ynar od and anoha tlTi ho conone ta rn that they can red and o,ite; I/~ Definition of literacy not bacon; Icr 1961; lan Data refer to hooseholds and macldod nomadic trihos; lot 1966 /ao Urban and coal; Ian Inside cr outeide; 71ar Data refer to lJinng q.. artes; lax Per- Sootgo th Iliog wThout piped -ater ineids;7 lay Percentage of d.eflngo oith electric lighting; Ia Tnc.ludin.g opsolol purpooenhilo 0Tho long-con tratngy of Torkiih plon~ing --rrrtly glnec th.