Turkey - Public Sector Industrial Credit Loan Project

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1467-TIJ REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DEVLET YATIRIM BANKASI OF TURKEY WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY .FOR A PUBLIC SECTOR INDUSTRIAL CREDIT LOAN June 10, 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 It may not be published, quoted or cited without Bank Group authorization.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$1 TL 13 TL 1 = US$ O 007- TL 1,000 = US$ 74 TL 1,000,000 = US$ 7I,000 Turkish Fiscal Year = March 1 to February 26  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DEVLET YATIRIM BANKASI OF TURKEY WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR A PUBLIC SECTOR INDUSTRIAL CREDIT LOAN 1. I submit the following report and recommendation on a proposed loan to the Devlet Yatirim Bankasi (DYB) (State Investment Bank) for the equivalent of US$40.0 million to help finance public sector industrial sub-projects. Amor- tization would conform substantially to the aggregate of the amortization sched- ules applicable to the specific investment projects financed out of the proceeds of the loan. The interest rate would be 7-1/4 percent per annum. The loan would be guaranteed by the Republic of Turkey. 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. 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. There followed a succession of short-term Governments. In early 1973 a new Presid- ent of the Republic was elected by the Parliament. Subsequently, martial law was ended, and in October parliamentary elections were held. In a shift to the left of center, the Republican People's Party won a plurality and formed a coalition government in January 1974 with the National Salvation Party. The new Government's program stresses reconciliation of the political dif- ferences of the recent past, increased equity, social justice, and adherence to moral values, control of national resources, broader popular participation in economic activity, and improved planning and efficiency. Its specifics in- clude a general amnesty, tax reform aimed at greater progressivity, and meas- ures to promote cooperatives and a more dynamic capital market. While retain- ing most of the essential objectives of the Third Plan, the program places increased emphasis on the role of the public sector, especially in industry. 4. Growth in gross national product in the last decade was high and continuous, averaging about 6.9% per year in the period 1962-72, with gross investment increasing as a share of GNP from 15% to 20% and gross national savings from 11% to 18%. Since 1970, however, the shares of investment and gross national savings have decreased slightly. 5. The main growth sectors in the last decade were industry, power, transport and construction. This reflected the development strategy during  - 2 - the first and second five-year plans (1962-72), which gave highest priority to industrialization. Industrial output grew by about 10% per annum, with textiles, machinery and equipment, steel and chemicals providing the main im- petus. This rapid growth, mainly to meet domestic demand and replace imports, was largely insulated from foreign competition. Other rapidly growing sectors were trade and financial services. Agricultural production had a trend growth rate of about 3.5% per annum, with fluctuations from year to year depending on weather conditions. The share of industry in GDP rose from 17% in 1962 to 23% in 1972 and that of agriculture dropped from 39% to 28%. Growth in 1971-72 was above average. In 1971, GNP increased by 10% in real terms, with value added in agriculture increasing by more than 11%, thanks largely to an excel- lent harvest, a sharp rise in workers' remittances and continued industrial growth. In 1972, GNP increased by 7.7%, with value added in agriculture not increasing over the 1971 level, but with a 12% growth in industry, fast growth in transport, construction and trade and another sharp rise in workers' remit- tances. Preliminary estimates for 1973 indicate chat GDP increased by about 6.4% in spite of a severe drought which led to an 8% decrease in agricultural value added. 6. The balance of payments situation was characterized in 196,'-70 by increasing trade deficits, and a strict systern of import controls which led to shortages of essential imports and, consequently, to under-utilization 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, rising world demand and prices and a rapid rise in workers' remittances (from $140 million in 1969 to $740 million in 1972) helped to improve the situation dramatically. Commodity exports increased by about 23% per annum in 1971 and 1972, with agricultural exports (mainly cotton, tobacco, hazelnuts, raisins and fruits and vegetables) increasing by about 22% per annum and industrial exports by an unprecedented 55% (mainly in food and beverages, textiles, hides and leather products and petroleum products). The improved foreign exchange position also led to a high import growth of 28% per annum, mainly itn invest- ment goods and raw materials (machinery and equipment, transport, steel and other metals, chemicals and fertilizers). Tourism receipts, although still relatively small, doubled between 1970 and 1972. The improvement in the balance of paymnents continued into 1973, with exports and imports of goods increasing by 49% and 34% respectively over 1972. Workers' remittances reached an estimated $1.1 billion. The overall result was a continuing increase in gross official foreign exchange reserves, whiclh stood at $2.1 billion at the end of 1973. Net foreign assets, which had been negative in 1966-63, rose to about >1 billion, i.e. about 6 months of imports. One of the contributory factors to the rising foreign exchange reserves was the inflow of short-term capital (with convertible lira accounts rising from $70 million at the end of 1970 to a peak of $480 million in April 1973) which was subsequently restricted by the Government. I May 1974, the lira was revalued vis-a-vis the dollar to TL 13.5 per US$ while its previous parity vis-a-vis other currencies was maintained. This action was taken to adjust to previous parity changes made vis-a-vis the dollar by Turkey's major trading partners.  - 3 - 7. The budgetary situation in the last decade was dominated by the relatively rapid growth of public expenditures. Although tax revenues grew rapidly, their share in GNP rising from 12.9% in 1962 to 17.9% in 1972, the increase was more than offset by the rise in current expenditures and trans- fers. The overall budget deficit increased and was particularly large in 1971 when the full impact on current expenditures of overdue public salary increases was felt. The Treasury had 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 investment expenditures falling short of targets, and to an actual decline in public fixed investment in real terms in 1971. In 1972 and 1973, Central Bank financing of the Treas- ury was reduced considerably as a result of a strict control of current expend- itures and a sharp increase in the sale of Government bonds to TL 4 billion (0.8 billion in 1971). Public investment also recovered, increasing by 19% in 1972. 8. Inflationary pressures have appeared in the economy in recent years, as expenditures, fueled by rapid monetary expansion, grew more rapidly than available resources. The GNP price deflator increased by about 6% per annum during 1967-70, and accelerated to 18% and 14% in 1971 and 1972 respectively. Excess demand was created in this period by rapidly rising workers' remit- tances and convertible lira accounts; by substantial deficit financing by the public sector which, however, was strictly checked in 1972 and 1973; and by rising private investment demand. Prices of imported goods rose as a result of the 1970 devaluation, the subsequent depreciation of the lira, and rising world export prices. The rate of inflation increased to about 20% in 1973 as the same pressures persisted and intensified. In these cir- cuilstances, effective demand management should be a major concern of economic policy. Improved mobilization of resources by the public sector will be needed to finance growing public investments. It will be essential to develop the capital market to supplement existing sources of long-term domestic borrow- ing. Proposals for a capital market bill are now being considered. In ad- dition, revisions in the interest rate structure to ensure a reasonable real rate of return are needed to encourage private savings. Further liberaliza- tion of imports to improve the competitiveness of domestic industry and re- duce the inflationary growth of foreign exchange reserves is also desirable. 9. Development strategy has emphasized the growth of output and labor productivity rather than employment. As a result, the labor surplus, includ- ing estimates of labor surplus in agriculture, rose from about 1 million in 1962 to 1.6 million in 1972, i.e., about 11% 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 14), unemployment should be a major concern of economic policy.  - 4 - Speedy implementation of land reform and integrated rural developmerLt pro- grams would help to dampen the migration from rural to urban areas. In ad- dition, labor intensive methods need special emphasis in the choice of proj- ects. H1owever, even with tLese measures and faster growth than planned in construction and services, urban unemployment is likely 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 standardls of living to those of Italy in 1970 through rapid industrialization and decreas- ing dependence on external resources. The Third Plan targets are an. 8% GDP growth rate, a 10.7% fixed investment growth rate, a marginal savings ratio of 38% on national savings (compared with about 18% in the Second Plan), com- modity imports and exports growing at 9.4% and 7.1% respectively and a decline in gross inflows of official external assistance to $130 million in 1977 (comn- pared 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 eco- nomic report. The general conclusion is that, though the prospects for a growth rate of 7% are good, the Plan projections seem to underestimate the difficulty of raising the savings level and balancing the external accounts at a reduced level of external assistance. 12. The Plan anticipates that two-thirds of the increase in national savings will come from the public sector through large increases in tax re- venues and in surpluses of the State Economic Enterprises (SEEs). Given the past performance of SEEs and delays in implementing a general reforti,, 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 collection 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 liberal- ization of imports to offset tax losses due to import substitution and reduc- tions 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, the Plan projections have been overtaken by events, and commodity imports and exports in 1973 are likely to have been at about the level projected for 1977. Workers' remittances in 1972 were already higher than the 1977 target. However, their future was made uncertain by the decision of the Federal German Government in November to temporarily prohibit further entry of foreign workers from non-EEC countries because of the energy crisis. It remains to be seen what course this policy will take over the  - 5 - longer run. The emphasis on capital intensive industrial development and the rise in the prices of imported fuel and raw materials will require a more rapid import growth rate, especially since the import regime is likely to be more liberal than in the past. Exports, particularly of industrial commodities, should continue to show good growth unless inflation continues at high rates, which would erode the competitive advantage gained as a result of the 1970 devaluation and the subsequent depreciation of the lira vis-a-vis Turkey's main trading partners in Europe. Gross official external inflows of the order of $500 million a year may be required. 14. At the end of 1972, total external debt outstanding and disbursed was $2.5 billion, of whichi all but 3% is public or publicly guaranteed. The share of the Bank Group in total debt outstanding was 8.3% in 1972 and is ex- pected to rise. The average terms of new credits have been hardening in re- cent years and this trend is expected to continue. Of the total gross offi- cial external assistance of about $380 million in 1972, the Consortium mem- bers provided an estimated $220 million. Of this about $58 million came from the United States, $44 million from the Federal Republic of Germany, $35 mil- lion from the Bank Group, $27 million from the European Monetary Agreement (EMA) and $22 million from the United Kingdom. The USSR disbursed $113 mil- lion. As a result of increased remittances and other foreign exchange earn- ings, and successive debt reschedulings and other arrangements for debt relief, the debt service ratio fell considerably from 24% in 1964 to 10.2% in 1972 and dn estimated 7.6% in 1973 and is likely to remain at about this latter level in the medium-term. However, 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. PART II - BANK GROUP OPERATIONIS 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 and FY73 amounted to $114 million, $173.3 million, and $175 million respectively. In these three years sixteen lending operations were carried out, of which five were in agriculture, four in industry (including DFCs), three in power and the rest in urban development, transportation, and vocational education. Agriculture accounted for 30% of the funds lent, and industry and DFCs for nearly 40%. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of April 30, 1974, and notes on the execution of on- going projects. Implementation of projects in the private sector has been satisfactory; on the other hand, projects in the public sector - especially those breaking new ground in agriculture - have been seriously affected by political instability and resulting administrative problems, and disburse- ments have been much slower than expected. A comprehensive review of the problems besetting these projects has been started with the new Government.  16. In view of the sustained improvement in the balance of paymients situation, no further IDA lending is contemplated. Bank lending is being increasingly directed to support Turkish efforts to improve: (a) lagging public sector saving through financial and management reform of the State Economic Enterprises (SEEs); (b) distribution of income and living standards in an economy entering its second decade of roughly 7% yearly growth, through more attention to employm,lent in investment projects, more concerted rural de- velopment efforts, and better urban planning; and (c) long-term capacity to earn foreign exchange, through diversification, especially promotion of in- dustrial exports and tourism. Bank lending for the Turkish Industrial De- velopment Bank (TSKB) and Fruit and Vegetables emphasizes exports; a Bank tourism project identification and preparation missions have recently visited Turkey. 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 require- ments. As discussed in Part I, Turkey's Third Plan goals of an 8% growth rate and increasing competitiveness withi the EEC in preparation for eventual full membership require further import liberalization and higher external borrow- ing 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% and 25% respectively through the 1970s. 18. In supporting the broad objectives of improved SEE performance, better distribution of welfare, and diversification of external earning ca- pacity outlined in paragraph 17 above, it is planned to continue concentrat- ing the bulk of Bank lending (a) in industry (including mining and DFCs), where financial and management strengtheniing of SEEs is the key task, and (b) in agriculture, where rural development, employmuent, 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 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. 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. Continued selective lending to the TSKB is also contemplated, with emphasis being placed increasingly on encouraging 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  - 7 - Authority (TEK). A proposed Bank loan for the Elbistan project is intended to continue support for TEK's long-term reform objectives and to establish a Bank working relationship with TKI in the coal mining sector. The Antalya Forest Utilization 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 proposed new mill subsidiary at Antalya. The proposed industrial credit loan to the State Investment Bank (DYB), the Government's main lending institution for public sector enterprises, would aim to strengthen DYB's role in financing small and medium-sized SEE indus- trial projects. The Bank is also considering a loan in FY75 to a public sec- tor project for iron mine expansion and pelletizing at Divrigi in east central Turkey, which will be complementary to the Erdemir Steel Expansion (817-TU) and to modernization of the Railways (893-TU), which are heavily engaged in ore traffic. Divrigi and Elbistan also represent greater geographic disper- sion into lower income regions. 20. The Bank's main effort in support of the distribution objective is the twin strategy of promoting rural alternatives to urban migration and im- proving urban development. As a beginning in rural development, the Bank ap- proved 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. The Forestry part of the Antalya Forest Utilization Project should also make a signifi- cant contribution to rural employment through expanded cutting, reforesta- tioin and afforestation. Future lending for rural development in forest village areas is also contemplated. In urban development the Bank lent for Istanbul Water Supply and Urban Studies in FY72 and for Istanbul Power Distribution in FY73. A second Urban Studies project is being prepared for FY75, and fur- ther 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. As a result of the expanded membershiip of the Common Market and some leveling off of bilateral aid, the European Investment Bank (EIB) has become along with the Bank Turkey's major source of external finance on non- commercial terms. The Bank has developed informal cooperation with EIB in the past, for example, in related but not formally parallel lending last year to the Turkish Railways and to TSKB. The Antalya Forest Utilization Loan represents a further step into formal joint financing with EIB, and we anti- cipate continuing a close partnership in the proposed Elbistan Lignite Power Project and in other future large-scale projects as appropriate. 22. The Railways and Antalya Forest Utilization Projects also exemplify the Bank's continuing collaboration with UNDP. In both projects UNDP financed the feasibility study for which the Bank acted as executing agency with the help of outside consultants. In addition, UNDP is financing further railway technical assistance studies which form an integral part of the implementa- tion 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 col- laborating with UNDP and FAO in the preparation of the Rural Development Project noted above, with UNDP in a tourism study, and collaboration is anticipated on other projects in the future. 23. 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 $44 million. IFC is currently in- vestigating new investment opportunities in various sectors, including tex- tiles and synthetic fibers. PART III - TIIE STATE ECONOMIC ENTERPRISES SECTOR IN TURKEY 24. 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 lhave also been charged with various social goals such as development of backward regions, absorption of manpower, and mainitenance of price stability, which have tended to become a hidden financial burden. 25. The overall financial results of the more than 100 State Economic Enterprises (SEEs) have been consistently poor, but there are sharp differ- ences among them, with railways and coal being the major losers and manufac- turing showing improving profits. The SEEs now account for about 20% of the fixed investment in the economy and about 10% of value-added. However, since 1969 the average rate of return on investment for the 28 largest producing SEEs has been less than 3% despite subsidized interest rates averaging about 4%. Losses in some enterprises and low profits in others have necessitated increasing budgetary transfers to meet current and investment needs; such transfers amounted to about TL 3.5 billion in 1971 and TL 6 billion in 1972, which was about 12% of total Government expenditures that year. 26. The Third Plan projects an SEE investment growth rate of 11.5% and provides that SEE investments should stress new technology, external economies, natural monopolies, and complementarity with private initiatives. Reform of the SEEs - in organization, management, executive and labor skills, and pric- ing policies - is especially important to prepare Turkish industry for compe- tition that will arise from the EEC. Prices of some SEE's were raised in 1971  - 9 .- 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 the Antalya Forest Utilizat-ion Loan (957-TU) provides for establishment of the Antalya mill on a sound commercial basis. The new Government has underlined the need for reform in its program, and has already raised the output prices of several SEE's to bring them more into line with costs. PART V - THE PROJECT 27. A detailed description of the proposed project is given in the report entitled "Appraisal of the Devlet Yatirim Bankasi of Turkey", Report: No. 406b- TU, dated June 10, 1974, which is being distributed separately. A Loan and Project Suummary is attached as Annex III. 28. Che proposed project was appraised during two missions to Turkey, in November 1973 and January-February 1974. Negotiations took place in Washington in May. The Government was represented by Mr. Muammer Akinci, Chief Counselor for Financial and Economic Affairs of the Turkish Enmbassy and DYB by Mr. Zeki Dosluoglu, Deputy Managing Director. General 29. The project consists of a relending operation by DYB for about 8-10 sub-projects in public sector industry over a period of two years. Sub-projects would involve total investment costs of about $7-40 million each and would thus be small- and medium-sized projects within DYB's context. Sub-loans financed by the Bank would cover foreign exchange costs in a range of about $1-E million per sub-project. Sub-projects will be primarily in manufacturing, heavy industry and processing, with possibly one or two in non-fuel mining. They will be drawn largely from DYB's 1974 program of 37 industrial projects, many of which meet proposed lending criteria and are being appraised by DYB. 30. The project would be the first DFC operation with DYB and would seek to provide a sound basis for continued Bank lending to DYB for relenlding to industrial SEEs and encouragement of improved SEE performance. DYB's role in financing SEEs has traditionally not included encouragement of reform or improved performance beyond a check on the financial and technical viability of investment proposals submitted for financing. For example, admir,istrative and financial management of SEEs or their subsidiary establishments has not been the subject of DYB's loan negotiations. Project supervision typically does not extend beyond the construction period. One of the purposes: of the proposed loan would be to encourage and assist DYB to strengthen its appraisal and supervision, and to play a broader part in investment decisions and reform in the public industrial sector. 31. DYB's Organization and Resources. DYB was created in 1964 to pro- vide to SEEs long-term credits, guarantees, and other services (excluding equity investments). DYB is managed by a Board of five directors, three of  - 10 - whom are DYB's general manager and two deputy general managers; the other two are appointed by the Council of Ministers upon nomination of the Minister of Finance. DYB's staff includes 58 professionals; high calibre andt low turn- over have been achieved through recruitment based on competitive examination, use of contract hiring at higher salaries for appraisal staff, and extensive training abroad. The Finance Ministry is DYB's parent ministry and owns 100% of DYB's share capital. Most of DYB's lending resources are raised ihrough sale of long-term bonds to the Pension Fund and Social Insurance Corporation. Except for financing DYB will receive through the Government from the Bank and from EIB for financing the Antalya integrated pulp and paper miiL, the proposed loan would be DYB's first foreign borrowing operation. 32. DYB's Policies and Procedures. DYB is required by law to appraise the technical, economic, and financial aspects of proposed projects, but the law is silent regarding sponsoring SEE's and establislhments, and DYI; has not appraised t:hem. Thus DYB does not reject financially sound projectE- because of deficiencies in the sponsoring organization and it does not reject a proj- ect on purely economic grounds. DYB's appraisal nf the technical ar,d financial soundness of projects seems satisfactory, and a substantial proportion of the applications it receives are rejected or returned for project revision. Under the Lending Policies and Procedures set out in Schedule 3 of the Loani Agreement DYB has agreed to improve its economic analysis and appraise the sponsor's ability to help finance, implement and operate any sub-project to be considered for financing under the proposed loan. DYB has also agreed to review the borrowing SEEs' procurement procedures (which appear to be satisfactory) to ensure procurement at reasonable prices and quality. 33. When approving a new investment project, DYB does not comnmiLt the entire amount of financing it expects to lend although it considers :its ap- provals as a nominal commitment to finance along the lines of the appraisal. In practice, DYB lends only for projects included in the Annual Inve<,tment and Financial Program prepared by the SLate Planning Organization and makes a financing commitment for disbursement during the year only against the "annual tranche" required under the Annual Program for a given project. As in the case of financing for the industrial part of the Antalya Forest Util- ization Project, DYB has agreed to enter into formal financing commitments to sub-project sponsors for the full loan amount, although the Annual Pro- gram and tranche procedure will also be followed. DYB's disbursemer,t pro- cedures, which normally provide for reimbursement, are generally satisfactory; collection procedures are adequate. The law safeguards completion c,f projects by requiring DYB to supervise through the end of construction; supervision of operations over the remainder of the life of DYB loans is implicitly left to High Control Board audits. For sub-projects under the proposed loan, DYB has agreed to extend its normal supervision to cover the life of each sub-loan. DYB has agreed to pass on to its sub-borrowers the full foreign excl.ange risk under the proposed loan. 34. DYB's Operations. During the period 1969-73, DYB financed 24% of total investments made by operating SEE's. Of the TL 12.2 billion in new projects approved in 1971-73, 41% was in manufacturing, 47% in power and  - 11 - telecommunications, and 12% in mining, transportation, and agriculture. The principal manufacturing sub-sectors were iron and steel, pulp and paper, and chemicals and fertilizers in that order. The average size of the 50 loans approved in 1971-73 was TL 245 million; for industrial loans che aver- age was TL 176 million ($12.6 million). There has been no particular pattern of geograplhic distribution since SEE's are widely dispersed as a result of government regional development and social policy. 35. Relending Terms. Over the past three years DYB's loan maturities for its lending overall have averaged about 10 years including usuaLly 1-4 years' grace. Under the proposed loan for financing in the industrial sector, the maturities of sub-loans are expected to average about 12-15 years. The current normal DYB interest rate on long-term loans (which is subject to approval by the Treasury) is 10-1/2% per annum; a rate of 9-1/2% is offered for infrastructure projects and certain industrial projects of long gestation. There is no commitment fee, but DYB charges a 1-1/2% penalty on the delinquent portion of the loans. DYB's lending rate is considerably below market rates in Turkey, reflecting in part a subsidy corresponding to certain non-economic objectives of SEE's, but high enough, coupled with DYB's borrowing rate of 9%, to cover expenses plus a small margin. DYB's normal rate will apply to sub-projects under the proposed loan. 36. Financial Performance . Except for the year 1970 when it incurred a substantial exchange loss on debt which it had assumed at the timf! of its founding from predecessor organizations, DYB has regularly slhown a profit before taxes, and the average has been about 12% on average equity in recent years. Administrative expenses are relatively low, 0.04% of total assets in 1972. In addition to statutory reserves, DYB currently sets 2% of loans outstanding as extraordinary reserves and has been authorized by the Treasury, pending full payment of share capital, to convert net earnings into paid-in capital. DYB's record of collections has been reasonably good and has improved the past two years, with only 2% of total portfolio principal overdue at the end of 1973. However, seven SEE's have been delinquent in the past. Several SEE's have had to obtain Treasury's assistance directly, or indirectly, to service their DYB loans; DYB has never rescheduled nor written off any of its loans. DYB's provisions and reserves seem adequate in light of the Level of arrears. 37. Creditworthiness. DYB's risk exposure seems to be very smiall because the Ministry of Finance ensures each year that the Government's annual program of financing for SEE's(from all sources including the Treasury) provides fi- nancing to cover every SEE'sdebt service obligations to DYB. As of the end of 1973 the long-term debt-to-equity ratio was about 8:1. If unpaicl authorized capital, for which the Government is fully liable, is included in e(quity, the ratio becornes 5.3:1. If, in addition, deposits of the Central Bank, which have been with DYB since its founding and may reasonably be regarded as permanent funds, are included, the ratio becomes 3.2:1. At the end of 1973 the ratio of loan collections to debt payments was about 3:1, a safe margin. DYB has agreed in the Loan Agreement to maintain this ratio at a leirel of at  - 12 - least 1.3:1 and to take necessary corrective measures whenever the ratio appears endangered. On this basis, DYB is considered suitable for Bank fi- nancing. 38. Audit. Under the law governing SEE's, DYB is audited annually by the High Control Board (1ICB), an arm of the parliament. HCB audits cover comprehensively such topics as administration, personnel, and legal aspects of DYB. DYB hlas informally informed the Bank that the HCB's audits wiLl include an assessmant of DYB's portfolio and an opinion on DYB's provisions for losses. 39. Future Operations and Resource Needs. Based on Third Plan invest- ment targets for producing SEEs and continued financing by DYB of about one- fourth of the SEEs' requirements, the Bank projects DYB annual lending (com- mitments to disburse) to double from about TL 3.8 billion in 1973 to about TL 7.6 billion in 1977. The bulk of the resources required to finance this inicreased lending in 1974-77 would colle as in the past from bond saiLes and miscellaneous sources. Since resources from social security and pension funds may not be sufficient to cover DYB needs, resources will have to come from other official assistance (e.g., Treasury or Central Bank). In the past, foreign exchange costs have averaged about 45% of total SEE project costs, whichi suggests an uncovered foreign excnange component requirement of about *300 million for 1974-75. 40. The Proposed Loan. The amount of $40 million for the proposed loan is small as compared with estimated requirements for the next two years. The amount is adequate to finance, as proposed, about 8-10 industrial sub-loans, each of about $1-6 million. DYB staff appears able to undertake the supple- mentary work required for expanding its appraisals of sub-projects t:o be financed under the proposed loan. Sub-loans would normally represent at least 15 percent of total sub-project cost. Activity would be concE!ntrated in a few SEE's. No free limit is proposed since DYB needs experience in evaluating sponsoring organizations and economic benefits. In reviEwing each of the sub-loans submitted for approval, the Bank will pay particular attention to DYB's treatment of these aspects. 41. Projected Financial Performance. As a result of increased finan- cial expenses related to increased borrowings, DYB anticipates a dip in its rate of ret:urn to about 97% in 1974, but forecasts a rebound to the previous average of about 12% in 1975 and higher rates in subsequent years as opera- tions grow. Debt service coverage is projected at 2.3-3.3 times through 1977. PART V - LEGAL INSTRUMENTS AND AUTHORITY 42. The draft Loan Agreement between DYB and the Bank, the draft Guar- antee 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  - 13 - being distributed separately to the Executive Directors. The draft agree- ments conform to the normal pattern for loans for development finance com- panies. Schedule 3 to the Loan Agreement contains the lending policies and procedures for the project. 43. I am satisfied that the proposed Loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 44. I recommend that the Executive Directors approve the proposed Loan and Guarantee Agreements. Robert S. McNamara President Attachments June 10, 1974   ANNEX I COUNTRY DATA - TUTRKEY aie1of 3 AREA 7-80-,000 k.2POPULATION DENSIT 2 km2 ~~~~~~~~~~~~~~38.2 million (mid-173 4 pe . (1 2 140 per km of arable land SOCIAL INDICATORS Reference Cosoarisons Turkey ~ France Spa' --____E t 19yo ~1970 1970D--- 1-970 DNP per- CapitLa J15$ (Atlas basis) 230 210 3,100 1,02') 210 2Mnogr_aphi c Grade bir-th rate (per thokusandc) P43.0/a 39.6/b 16.9/a 20..; 66.1 Crudle dleathi rate (Pei, thiousand) 13.57; lii.6757 11.0 8.3 16$5 Infant mortality rate (per thousanid live births) i65. o7d 163.07; 18.8 31.9 123.1 ti le expectancy It birthi (years) 146.07k 64.5-- 72.5 70.5 49.9 Gross reproduction rate /I. 2.9/a 2.9 1.3 1-.u 3.0 Popuilation growth rate /72 2.8T. 2.5 1.0 1.1- 2.5 Peputation growth rate -7urban 6.17W. 5.8 2.0 1.3 P4.0 Age stricture (percent) 0 -lI, [41.2 P41.9/n 23.8 28.? 42.7/c 15-tt. $5.1 5P4.17We 62.8 62.5 5. 66 and over ~~~~~~~~~~ ~ ~~~~~~3.7 P4.07We 13.P4 9. 3 3.5 Dependency ratio /3 81.5 86 .5- 59.2 60.0 85.9 Populatio,n density per sq. kmn. 37.0 L65 93 66 33 Urban populationi as percent of total 31.9 36.8 70.1 60. 43.1 Family planninig: No. of acceptor-s cumulative (thous.) 5.0 282 . 200 No. of users (% of married women) ni.a. 46. . 9.0 Emaployment Total labor for-ce (thousands) 12,993 15,96 21, 946 12,138 9,1,,4 Percent-age employed in agriculture'P. 66.2 14.13 33.7 54.7 Percentage unemployed n..6.0 1.1 1.2 3.1 Income Distribution Percent of national income received by lowest 20% ri.a. 3 Ak Percent of national incone received by highest 6% ni.a. 33 - Percent .f- national income received by lowest 40% n.a. 9 Nealtib and Nutrition Populati-on per physician 2,850 /e 2,260 747 770 2,006 Popuilatijon per nursing person 3,432 7-f 1,960 360 1,e3D 1,400 Population per hospital bed 670 7- 500 113 220 P472 Per capita calorie supply as % of requirements /P4 123.9 110.0/h 129.2 110.1. 12P4.4/f Per capita protein supply, total (grains per dayFL/5 97.5~ 7 7.9~ 103. 7 83.6 76. 3 Of which, animal and pulse 15.9 21.9 66.4 62.6 18.5 Death rate 1-6 years /6 . 0.8 1.0 37.9 Education Adjusted /7 primary school enrollment ratio 66.0 77 126i 77 70 Ad~justed 77- secondlary school enrollment ratio 16.0 26 66 36 /a 30 Years of schoolinig provided, first and second level 11 13 12 15 12 Vocatiosal enrollment as % of see. school enrollment 17. 7 16.6- 24.9 21 .6 16.8 Adult literacy rate % 38.0 46 /e 9e 96 26 Housing Average No. of persons per room (urban) nk.a. 2.6i 1.0