Turkey - Second (TEK) Power Transmission Project

CIRCULATIG COPY FILE COPY to BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No.P-1709-TU REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO TURKISH ELECTRICITY AUTHORITY FOR A SECOND TRANSMISSION PROJECT November 6, 1975 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit Turkish Lira (TL) US$ 1 = TL 14.75 TL 1 = US$ 0.067 TL 1,000 = US$ 67.80 TL 1,000,000 = US$ 67,800 Turkish Fiscal Year = March 1 to February 28  INTERNATIONAL BANK FOR RECONSTRUCTION kND DEVELOPMENT REPORT AiND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO TURKISH ELECTRICITY AUTHORITY FOR A SECOND TRANSMISSION PROJECT WITH GUARANTEE OF THE REPUBLIC OF TURKEY 1. I submit the following Report and Recommendation on a proposed loan to the Turkish Electricity Authority (TEK) with guarantee of the Republic of Turkey for the equivalent of US$56 million, to help finance transmission facilities and training needs required to meet TEK's system growth. The loan would have a term of 20 years including 4 years of grace, with interest rate at 8-1/2 percent per annum. PART I - THE ECONOMY 2. An economic updating mission visited Turkey in November 1974 and its report (No. 71la-TU) entitled "Current Economic Position and Prospects of Turkey" dated June 9, 1975, was circulated to the Executive Directors on June 17, 1975. Country data sheets are attached as Annex I. 3. Overall, Turkey's economic performance continues to demonstrate the essential soundness of the economy, despite an uncertain domestic political situation resulting in frequent changes of Government since 1971 and more recently, the international recession. GNP grew rapidly in the last decade, and averaged an impressive 7 percent annual growth in real terms in the period 1962-72. Industry, power, transport and construction were the main contributing sectors to this growth rate. The growth rate dropped in 1973 to 5.5 percent, largely due to a decrease in agricultural production reflecting poor weather conditions, but is estimated to have recovered to 7.5 percent in 1974. How- ever, growth during the last two years fell short of the Third Plan (1973-78) target of 7.6 percent per annum. Despite some difficult problems that the economy faces, this relatively high growth rate underlines the robustness and vitality of the Turkish economy. The main issues facing the Government and requiring the establishment of priorities as well as the taking of corrective measures are: (a) high rate of inflation; (b) insufficient mobilization of public resources; (c) employment generation problems; (d) deterioration in the balance of payments; and (e) inadequacy of coordination among Government agencies in project implementation (discussed in para 15 below). 4. The budgetary situation in the last decade was dominated by the relatively rapid growth of public expenditures. Although tax revenues also grew rapidly, the increase was more than offset by the rise in Government expenditures and transfers. As a result, the overall budget deficit widened and the Treasury borrowed increasingly from the Central Bank. In 1972 and 1973, the Treasury introduced a stricter control of current expenditures and succeeded to some degree in shifting the sources of finance for the budget  deficit, from the Central Bank to the sale of Government bonds to the public. However, partly due to a shortfall in tax revenues and partly due to increased current expenditures resulting from inflation and the Cyprus operations, the budget deficit rose again in 1974 to TL 7.3 billion (compared to TL 5.4 bil- lion in 1973). Central Bank financing of the Treasury rose by TL 4 billion and became a major factor in monetary expansion at a time when stricter mone- tary controls were needed. The 1975 budget estimates a deficit of nearly TL 9 billion, which is intenced to be financed by domestic borrowing through sale of Government bonds. 5. Over the years, the State Economic Enterprises (SEEs) have generally earned low profits, necessitating increasing budgetary transfers from public resources to meet their operating and investment needs. A significant portion of the SEEs' deficits are accounted for by the Turkish Railways and the Coal Corporation. Other SEEs have shown either small profits or small losses. During 1974 prices of several SEE products were raised substantially (ranging from 20% to 167%) to improve the financial situation. of the SEEs concerned. In addition, railway tariffs were increased by an average of 56 percent in 1975. The savings performance of the SEEs showed some improvement in 1973 and 1974 and their own resources financed an increased proportion of their investment. However, because of delays in implementation of projects as a result of management problems, limited technical capabilities and difficulties in the procurement of imported materials, SEE investment levels and revenues are still below the targets set by the Third Plan. Many SEEs continue to rely heavily on budgetary transfers. The reform of the SEEs - in organization, management, executive and labor skills and pricing policies - remains crucial, especially if Turkish industry is to be prepared for competition from the EEC. Realistically, these basic reforms can only be initiated by a Government with significant parliamentary support, which Turkey has not had over the last few years. 6. The rate of domestic inflation has been high in recent years. The average rate of increase in wholesale prices accelerated froml about 20 percent per annum between 1972-73 to nearly 30 percent in 1974. Inflationary pressures have been partly fueled by growth in domestic liquidity, which averaged about 25 percent per year during 1970-74. Other contributing fac- tors are increases in agricultural support prices for domestic and export goods as well as in minimum wages, besides substantial increases in the inter- national price level of most Turkish imports. Measures to reduce the growth of domestic liquidity, without discouraging investment and growth, are es- sential to ease inflationary pressures further. The trend towards rapid in- creases in central bank financing of the public sector needs to be reexamined. In late 1974, the Government raised interest rates to encourage private savings and long-term lending. The increase included raising the interest rate on medium term credit from 12 to 14 percent and rates on time deposits up to one year from 4 to 6 percent. The present Government of Prime Minister Demirel regards the restoration of domestic price stability to be one of the key problems on which Government policy must be focused. Some reduction in the rate of inflation has been witnessed in the last few months, and for 1975 as a wnole, the Government estimates a rate of inflation to be around 15 percent.  -3- 7. Turkey's development strategy places greater emphasis on growth of output through higher labor productivity, than on increased employment. As a result, the labor surplus, including that in agriculture, rose from an estimated 1 million in 1962 to 1.6 million in 1973, or about 10 percent of the labor force. Emigration, especially to Germany, has so far partially eased the pressure on employment. Between 1965 and 1973, net emigration to- taled about 450,000 and was expected to be about 60,000 per year during the Third Plan period. However, new emigration fell sharply during 1974 due to the economic slowdown in Europe. The Third Plan continues to emphasize in- vestment in capital-intensive industries, thus projecting a growth in non- agricultural labor surplus of 300,000 by 1977. With the reduced prospect of further emigration of Turkish labor to Europe, at least in the medium-term, unemplovment should be a major concern of economic policy. Speedy imple- mentation of land reform and rural development programs would help to dampen migration from rural to urban areas and ease unemployment in both sectors. In addition, labor intensive production methods need to be emphasized, where appropriate, in the formulation of projects. However, even with these meas- ures and faster growth than planned in construction and services, unemploy- ment is likely to remain a significant problem. 8. The Third Plan constitutes the first phase of Turkey's long-term strategy for the period 1973-95, the ultimate objective of which is to raise standards of living in 1995 to those of Italy in 1970, through rapid indus- tralization and decreasing dependence on external resources. The Plan aims at annual growth rates of 8 percent in GDP, 12.7 percent in fixed investment, a marginal national savings ratio of 38 percent (compared with about 18 per- cent in the Second Plan), an annual increase in commodity imports and exports of 9.4 percent and 7.1 percent respectively and an increase in invisible earnings (mainly workers' remittances) leading to a decline in gross inflows of official external assistance to $130 million in 1977 (compared with over $300 million in 1972). 9. The prospects for continued high economic growth remain good, al- though in view of the shortfall of the first two years of the Third Plan, achievement of the 8 percent average rate of annual growth during the Plan period seems unlikely. The Plan's projections also seem to be overly optimis- tic about the prospects of raising the savings level and balancing the ex- ternal accounts with reduced levels of external assistance. Experience during the last two years suggests that present efforts to mobilize greater domestic savings to support a rapid growth of investment, especially in the public sector, need to be intensified. The Plan anticipates that two-thirds of the increase in national savings will come from the public sector, through increases both in surpluses of the SEEs and in tax revenue. Given the past performance of SEEs and delays in implementing a general reform, mentioned in paragraph 5 above, the expected rapid growth in their surpluses is unlikely to be realized. It will also be difficult to raise tax revenues to the extent envisaged by the Plan. There is nevertheless scope for increases, if appropriate policies are pursued more vigorously, e.g. improving the tax administration, widening the tax coverage to include agricultural incomes and service incomes, increasing  -4- the rates of property taxation, and introducing a value added tax. Domestic resource mobilization in the public sector is, in any case, likely to con- tinue to be a constraint in the growth of public investment. Besides improved financial performance from the SEEs, increased borrowing abroad as well as increased long-term borrowing from the domestic private sector will be neces- sary to achieve the ambitiously planned public sector investment targets. As Turkey's development program requires funds in excess of the savings that can be raised domr,estically, and these cannot be provided in adequate amounts by financing only the foreign exchange costs of high priority development pro- Jects, some local expenditure financing by foreign lenders will be required. 10. In addition, the balance of payments projections of the PlAn have not taken into account recent developments on the international scene. The sharp increase in the price of petroleum and other imports during 1974, and the prospect of further increases in the next several years, mean that the foreign exchange needs for f:inancing imports will be much higher than pro- jected. Commodity imports and exports in 1973 were already above the level projected for 1977. At the same time, workers' remittances in 1972 were higher than the 1977 target and continued to grow until recently. However, they have slowed down appreciably in the first half of 1975 and their future is uncertain, due to the temporary restrictions on further entry of foreign workers into the major labor--importing countries of Europe. On the other hand, recent agreements between Turkey and Libya to send Turkish workers to Libya, and the possibilities of similar arrangements with other oil-producing countries, should alleviate the situation until the pace of economic activ- ity accelerates in Europe. 11. The 1970 devaluation, together with associated stabilization meas- ures, rising world demand and prices and a rapid rise in workers' remittances (from $140 million- in 1969 tc $740 million in 1972) helped to improve Turkey's balance of payments considerably in 1971 and 1972. This improvement continued in 1973 with an inflow of $1.2 billion in workers' remittances, and with exports increasing by 49 percent and imports by only 34 percent. The overalL result was a surplus in the current account for 1973 and an increase in gross reserves of about $720 million over the level at the end of 1972. 12. After substantial surpluses in 1972 and 1973, the overall balance of payments experienced a deficit in 1974, with net reserves declining by about $360 million. This was due partly to sharp increases in the trade deficit and a slow-down inI the growth of workers' remittances, besides rec-- tion in the official capital aid inflows. The large trade deficit resulted mainly from the 80 percent increase in the import bill (in particular, pecro- leum, wheat, iron and steel), mainly attributable to higher import prices. The relatively high growth rate of imports continued in 1975, with imports totalling about $2.4 billion dluring the first six months of the year. Export earnir.gs on the other hand, which totalled about $0.6 billion for the same period, registered a decline, because of the recession in major importing countries, agricultural supply constraints, restrictions on exports to relieve domestic shortages, diversion of some goods to Cyprus, and the worsenirng _erms of trade. Export pricing policy was not flexible enough, particularly for  -5- cotton, whose export volumes fell sharply as the Government's minimum export price remained fixed while international prices fell well below it. As a result, gross reserves, which stood at over $2.1 billion in August 1974 de- clined to about S1.8 billion at the end of the year and further to about $1.2 billion at end of June 1975 (the equivalent of about 3 months of imports at the present rate). The pressure on the balance of payments could be partly eased by promoting export recovery through the lifting of export restrictions. Besides this, a slowing down of the rate of import liberalization is clearly essential to prevent a further erosion of reserves. The Government should also avoid fixing support prices at high levels, when there is softening of commodity prices in international markets. In May 1974, the Turkish lira was revalued vis-a-vis the dollar from TL 14.00 per US$ to TL 13.50 per US$, with- out a change in parity with other currencies. In September 1974, the exchange rate per US$ was readjusted to TL 13.85, and in April 1975, it was restored to the previous parity of TL 14.00. As a result of subsequent small devalua- tions, the rate per US$ stood at TL 14.75 at the end of August 1975. 13. At the end of 1974, total external debt outstanding and disbursed was estimated at $3.1 billion, of which all but 3 percent is public or publicly guaranteed. The share of the Bank Group was about 11 percent of total debt outstanding and about 8 percent of total debt service in 1974. The average terms of new credits made available to Turkey, have been hardening in recent years. This trend is expected to continue. Debt service as a ratio of exports of goods and non-factor services plus workers' remittances was about 6.5 per- cent in 1974 compared to 12 percent in 1971. Despite the deterioration in the balance of payments in 1975, the debt service ratio is expected to remain within manageable limits in the medium term, provided that proper policies are pursued. In view of the decline in foreign reserves, Turkey needs to continue to exercise considerable care in its external debt management, and resort to suppliers' credit financing should be kept within closely monitored limits. Meanwhile, Turkey continues to be creditworthy for Bank financing. PART II - BANK GROUP OPERATIONS IN TURKEY 14. The 1970 economic stabilization program (see para 11 above) and devaluation of the Turkish lira, which improved the balance of payments, en- abled Bank Group lending, which had previously been intermittent, to be es- tablished on a continuing basis at a high level. Inclusive of the proposed lo^l, the Bank Group will have lent $1,140.8 million to Turkey through 42 lending operations, of which $1,008.2 million is outstanding. Thirteen of these operations have been in agriculture and rural development (including multipurpose), fifteen in industry (including DFCs), nine in power and the rest in urban development, transportation, and education. Agriculture and rural development account for 25 percent of the funds lent, industry and DFCs for 38 percent and power for about 30 percent. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of September 30, 1975, with notes on the execution of ongoing projects.  15. Implementation of projects has been satisfactory in the private sector, but less so in the public sector, where significant delays have resulted from political uncertainties, limited coordination among agencies, staffing problems and related administrative delays. Disbursements have consequently been slower than expected. To improve this situation, the Gov- ernment has recently established a ministerial coordinating committee' sup- ported by a new secretariat located in the Ministry of Finance, which will be responsible for coordinating all aspects of Bank Group operations. In connection with this new framework, the Government and the Bank have initiated since June 1975, joint quarterly reviews of projects to identify and resolve key bottlenecks impeding satisfactory project implementation. The results so far have been encouraging considering that these reviews were initiated quite recently, and the rate of coonmitments and disbursements in the last few months has begun to improve. 16. Bank lending to Turkey is mainly directed at supporting Turkish efforts to improve: (a) lagging public sector saving, through gradual improve- ment and reform in the SEEs; (b) better income distribution and improvement in the level of living standards, through rural development efforts, better urban planning and increased employment and incomes, and (c) long-term capacity to earn foreign exchange, through promotion of industrial and agroindustrial exports and tourism. While the Bank continues to support gradual institu- tional and structural changes in the sectors in which lending is provided, continuation of substantial external financial assistance, is equally important in view of the increase in the projected capital import requirements. 17. In support of these objectives, it is proposed to continue to devote the Bank's development efforts to certain key sectors, of which agriculture is the most important. In this sector, emphasis is being put on rural devel- opment and the strengthening of agricultural credit mechanisms. Industry (including mining and DFCs) and power, where the gradual strengthening of the SEEs is the key task, will also receive significant support. This program will be supplemented by future projects in selected sectors including urban development, tourism and transport. Until recently, Bank lending was also focused in two geographical areas: (i) the Istanbul region, with emphasis on urban planning, water supply, power distribution and industrial finance, and (ii) the Cukurova region around Adana on the southern coast, with emphasis on power, irrigation, and fruit and vegetable production. Now the focus is gradually being shifted to the Anatolian plateau and eastern Turkey in support of efforts to widen the geographical base of development, develop rainfed agriculture, improve the distribution of income, and discourage rapid urban migration. For instance, the $143 million Elbistan loan approved in FY74 was for the development of a lignite mine and lignite-fired power station in eastern Turkey; the $65 million loan to the Industrial Development Bank of Turkey (TSKB) in FY75 was to help finance small and medium-scale private industrial enterprises, in less developecl Turkish regions and away from the over developed Istanbul-Izmit industrial axis; the $75 million loan for the Corum-Cankiri  integrated rural development project, also provided in FY75, is the Bank's first such project in Turkey and will benefit two of its poorer provinces in the north-central Anatolian dry land farming region. 18. In addition to the proposed loan for the Second Transmission Project of TEK (hereinafter called the TEK II Transmission Project), an agricultural/ agroindustrial credit project has been appraised and is scheduled for negotia- tions by the end of December 1975; the appraisal of a second dairy project has just been completed and a newsprint manufacturing project and the Bank's first tourism project providing infrastructure in the south Antalya coastal area, are currently being appraised. These projects are likely to be ready for Board consideration in the second half of FY76. Other projects under prepara- tion which will be processed towards appraisal in the next twelve-month period, include a hvdroelectric project, wastewater disposal in Istanbul, a second DFC. operation with the State Investment Bank (DYB), and a second railways project. 19. IFC has invested in the production of nylon yarns, pulp and paper, glass, aluminum and steel pipes. As of September 30, 1975, gross commitments totaled S118.11 million, of which $71.5 million were still held by IFC. IFC is currently investigating investment opportunities in the industrial sector, including textiles, synthetic fibers and inorganic chemicals. PART III - POWER SUB-SECTOR AND THE BORROWER Available Resources 20. Imported oil, domestic firewood and dung currently meet, in about equal proportions, some two-thirds of Turkey's energy needs. Energy develop- ment strategy is to reduce dependence on these high cost sources. The prin- cipal domestic alternatives for producing electric power, in descending order of known potential, are low-calorific lignite, low-calorific coal, hydro power, and oil, plus reserves of geothermal energy which have not been extensively explored. At present, the development of lignite, coal and water as energy sources are receiving emphasis. Institutions 21. Under the general authority of the Ministry of Energy and Natural Resources, responsibility for electricity generation and distribution is divided between: (a) TEK, an SEE formed in 1970 with primary responsibility for overall electrical energy planning and construction and operation of thermal plants and transmission lines; (b) the State Hydraulic Works (DSI), a semi-autonomous agency, with responsibility for the planning of hydropower development and for construction in coordination with TEK, which assumes ownership once construction is completed; and (c) various private utility companies, who are authorized to generate and distribute power in specified areas, the most important being the Cukurova Electric Company in the Adana region. Power distribution is normally in the hands of municipal authorities.  Capacity and Demand 22. Turkey's installed public generating capacity at the end of 1973 totalled nearly 2,500 megawatts. Of this, 84 percent was owned by TEK and 12 percent by Cukurova. TEK's interconnected power generation and transmis- sion system, which meets 90 percent of the demand in western and central Turkey, is based about one-tLird eac'n 3n hydropower, oil-fired and coal-fired the rmal plants. Tne an;nual grow';h -te OL- derand for electrical energy was about 12 percent between ,960 and 1972 but fell to about 10 percent in 1973 and 1974 due to the shortage of powle:. I-t is, however, expected to increase to about 17 percent until around 1976, and thereafter to decrease gradually to 10 percent by the miad 980s. A program of village electrification was begun in 1964, providing service to about 200 villages in the first year, and increasing to about 900 villages per year by 1973. About 5,800 out of 36,000 villages had been electrified by late 1974 and further progress at a rate oL 1,500 villages per year is planned. 23. A shortfall in electricity generation capacity emerged in 1973, which, together with plant failures, forced TEK into load shedding and inter- rupting supply. To eliminate this growing shortfall and to meet projected demand as earlY as possible, the Government has undertaken major power invest-- ments, mainly for hydro and lignite generation, to increase installed capacity to 4,300 megawatts by 1977 and to about 8,600 megawatts by 1981. Major proj- ects intended to meet this demand are: Elbistan lignite (1,200 megawatts under construction with Bank assistance), Keban Hydropower (900 megawatts partly commissioned), Tuncbilek lignite (300 megawatts to be commissioned in 1975 and 1977), and Karakaya hydropower (1,800 megawatts whose construction is expected to begin next year). Coordination 24. The principal institutional constraints in the power sub-sector lie in coordination, organization, management, staffing, pricing policies, and revenue collection. Although under its enabling legislation TEK has the responsibility for coordination, significant improvements in coordination of planning and resource allocation among the various agencies concerned with power have not occurred. For example, while the general policy of reducing dependence on imported oil is undoubtedly the right course for Turkey, the economic cost of industrial production which is being sacrificed because of the shortage of electricity, may argue for some flexibility in considering the limited installation of newq oil-fired capacity. Some agencies have main- tained a fairly independent role; for example, hydropower development appears to have been handicapped by insufficient coordination between DSI and TEK on the planning and design of generating facilities. Similarly, improved co- ordination is needed between TEK and the Coal Authority (TKI), in the planning of coal and lignite mining development and related power generation. The Government is, however, aware of the need to improve coordinatior. and take corrective measures on these matters.  -9- TEK's Organizational Structure 25. TEK's organizational structure has been essentially that of its principal predecessor organization, the Power group of ETIBANK, and has not been suited to TEK's current needs. Pursuant to the proposals which led to the creation of TEK in 1970, recommendations for a reorganization were formu- lated in March 1973 by consultants financed under the Bank's 1967 technical assistance grant of $1.95 million. These recommendations aimed primarily at decentralization of authority for operations to regional offices, as well as the reorganizing of management responsibilities at headquarters. Earlier this year, TEK's Board approved a reorganization plan, generally along the lines of the consultants' recommendations. The first phase of this reorganization, namely the realignment of the headquarters establishment with a more efficient breakdown of functional responsibilities, is being initiated. Plans for proto- type regional offices have been formulated, and it is TEK's intention to create the first of the projected 10-12 regional offices on a pilot basis by the end of 1975. Based on the initial experience obtained, the specific design and timing of subsequent regional offices would be determined. Under the Loan Agreement (Section 4.06), TEK has undertaken to complete the reorganiza- tion and staffing of its administrative and technical structure in accordance with a detailed implementation schedule which would be prepared and sent to the Bank by the end of this year. The Bank also expects to receive, by the same time, the corporate instruments providing for the establishment of new headquarters divisions and two new regional offices together with their respon- sibilities and appropriate delegation of authority. Management and Staffing of TEK 26. Since its establishment five years ago, TEK has experienced a con- tinuing need to improve its management and professional staff, and in particu- lar its engineering cadre. Its responsibilities and workload in power plan- ning, project implementation and operation of its plants have grown geometrical- ly in this period. There has been considerable concern whether TEK's ability to attract and retain staff, especially experienced engineers with senior and middle level management capabilities, has kept pace. Two aspects of this problem appear crucial. First, because of the relatively low salaries and benefits offered to SEE emplovees, under the Turkish civil service system, and which were being eroded by inflation, together with the considerably higher emolument packages offered to engineers in the private sector, TEK experienced some difficulty in the early 1970's in holding and replacing experienced staff. However, in 1974 and 1975, major increases in salaries and benefits were ap- proved by the Government. These have contributed to some easing of problems in recruiting and retaining at least the lower and middle level professional staff. At higher levels, the concern persists even though opportunities for alternative employment in Turkey of power specialists is more limited. TEK has, for example, recently taken steps to hire senior personnel on a contract basis in order to staff the Elbistan project, as provided for under the Loan Agreement. On balance, TEK believes and has confirmed to the Bank, that the emolument package (including intangibles) which it is now able to offer, will enable it to meet its staffing needs adequately at least through the end of 1976.  - *0 - 27. The second and equally cruciai aspect of TEK's staffing problem is that its manpower planning and personnel management techniques have been unable to provide TEK's management with reliable estimates of the true magni- tude and composition of its staffing needs in the period ahead. To deal with this aspect of its staffing problem, TEK has agreed (Sections 3.02 and 4.06 of the Loan Agreement) to complete, with the assistance of experts, a detailed meditum and long-term manpower studv of its annual professional staff require- ments for the five-year period 1977-81, and to implement a program of staffing and recruitment each year, based on the recormmendations of the study, as up- dated from time ro time. Rate of Return and Tariffs 28. The pricing of electric power in Turkey has long been affected by twTo interrelated difficulties: first, the level of tariffs has often been inadequate to enable TEK to cover its production costs and at the same time to make a reasonable contribution to the cost of its continuing investment pro- gram; and second, the structure of tariffs, which is unrelated to the cost of supply, as well as their low level, has led to the inefficient use of electric energy. Under the provisions of the TEK Law, that SEE is required to earn an 8 percent return on net fixed assets. The requiremenit of an 8 percent return, on periodically revalued assets, is also contained in past Bank loan agreements with TEK. However, in view of the persistence of inflation in the last few years, recent governments have been reluctant to raise TEK's tariffs suffi- ciently to keep pace with general price increases. As a result, TEK has con- sistently fallen short of the 8 percent rate of return target. TEK's revenues have been increased periodically, however, to meet increased fuel costs through fuel adjustment provisions which form part of the tariff structure. In con- nection with the aforementioned Elbistan Loan, a previous government undertook, as a condition of effectiveness, to increase TEK's tariffs to a level which would yield an average net revenue of TI 0.51 per kwh, as a first step toward achieving a rate of return of 8 percent by 1976. Taking into account the present Government's current anti-inflationary policies, particularly after the rather high inflation experienced in Turkey in 1974, the Bank accepted its proposal to defer the achievement of the rate of return target until 1977. This was done on the understanding, as incorporated in a letter from the Gov- ernment to the Bank, that the Government and TEK will take such measures as are necessary, including waiving of the 15 percent discount for prompt payment, to achieve a rate of return of 6 percent in 1976 and 8 percent from 1977 on- wards on its assets, as revalued from time to time. In addition, the Government irtends to introduce a self--adjusting mechanism into its electricity tariff review procedures to facililate tariff adjustments commencing in 1977. With these steps all the conditions of effectiveness of the Elbistan Loan have now been fulfilled with the excention of certain conditions of disbursement of the loans of the co-lenders, EIB and KfW, which are expected to be met shortly. Meanwhile, procurement arrangements are going forward. 29. It is worth mentioning that as envisaged under previous loan agree- ments, TEK revalued its assets as of tihe end of 1974. Under the proposed Loan, TEK would continue to revalue its assets as rneeded periodically in the future (Section 5.06 of th.e Loan Agreement). To provide a basis for rationalizing the structure of tariffs and improving electricity pricing policies, TEK has also  agreed to undertake a nationwide tariff study of the electric power sector, with the help of qualified experts (Section 3.03 of the Loan Agreement). Under the Guarantee Agreement (Section 3.02), the Government has not only agreed to assist TEK in carrying out this study, but after exchanging views with the Bank on its recommendations, to prepare measures for revised power tariff systems. Arrears Owed by Municipalities 30. TEK has been experiencing significant difficulty in collecting receivables from its customers, especially municipalities to whom it sells electricity in bulk. This has happened despite a 15 percent discount for payment within one month and a penalty of 1 percent per month for payments thereafter. In 1971-73, the end-of-year arrears averaged around four months' revenues. In connection with the Elbistan Loan, TEK and the Government in- formed the Bank of their intention to monitor the collection of receivables and ensure prompt collection. Unfortunately, the situation deteriorated rapidly thereafter, and by the end of 1974, receivables totalled over TL 2.0 billion, or about six months of revenues of TEK. Of this, nearly TL 400 mil- lion was owed by the Ankara Municipality alone. Faced with this situation, TEK in turn, has been forced to defer some of its own payments for several months to suppliers and other creditors. At the end of 1974, such overdue payments totalled nearly TL 1 billion. A key source of the problem is that municipalities have only limited access for their own purposes to the revenues collected in their areas of jurisdiction, and have to depend on the Government for much of their financing. Therefore they seek to retain for as long as possible, revenues they may have collected from sale of utilities such as power, by not paying a bulk supplier like TEK. 31. In the absence of available long-term solutions, the Government proposed legislation providing for consolidation and pavment of intra-public sector debts outstanding as of December 31, 1974. This legislation was approved by the Parliament in July this year, with one critical amendment which provided for the consolidation of TEK's receivables and debts only up to December 31, 1973. While the implementation of this law will eliminate some of TFK's receivables and debts, it still leaves a significant problem. In view of this limited legislative action, the Government has agreed (Guar- antee Agreement Section 3.03) that it will cause each of its agencies and municipalities to pay debts outstanding to TEK in excess of three months in accordance with a plan of action acceptable to the Bank and the Borrower. As one measure aimed at prevention of recurring arrears, the Government also undertakes under the Guarantee Agreement (Section 3.04) to ensure that muni- cipal tariffs for the sale or distribution of power are promptly adjusted in a manner and in amounts commensurate with adjustments TEK may make from time to time in its tariffs, which are largely wholesale prices on power delivered to such other distributors.  Past Bank Loans to TEK 32. In 1968, the Bank provided a $25 million loan to Turkey for relend- ing to TEK's predecessor, ETIBANK, for the construction of transmission lines and substations related to the Keban HIvdro-electric Project. Although the Transmission line Project was delayed by nearly two years because of contrac- tors' problems, arising from disputes primarily over compensation for cost increases, it was completed in August 1974 by force account and provided much experience to TFK staff in the construction of high voltage transmission lines. In 1971, the Bank made a $24 million loan to TEK for expanding TEK's transmis- sion system. This project is now expected to be completed by the end of 1975. In 1974, the Bank approved a $148 million loan to TEK and TKI (The Coal Authority) for the Elbistan Project. PART IV - THE PROJECT Project History 33. The proposed project originated last year, following an exchange of views between the Turkish authorities and the Bank and the mutual apprecia- tion that the high cost of the Elbistan Project was placing a great strain on the availability of foreign. exchange for other needs of the power sub-sector. Transmission projects, in particular, were feeling the pinch, in part as a result of a shift of some anticipated financing to Elbistan. The proposed project was, therefore, formulated as a group of items from TEK's total trans- mission program for 1975-79. Appraisal took place in October/November 1974. Negotiations were held in Washington in May/June 1975. The Governmrent was represented by Mr. Cengiz Alper, Deputy Financial and Economic Counselor in the Turkish Embassy in Washington, and TEK, by Mr. Huseyin Tekinel, its As- sistant General Manager. However, these negotiations could not be substantive- ly completed until the above-mentioned legislation with regard to TEK's receivables and debts was passed and the agreements already discussed were reached on the critical issues relating to staffing and tariffs. These out- standing matters were settled to mutual satisfaction and agreement reached on the negotiated documents in early October. The Project 3-'. The proposed project includes: (a) the construction and placing into operation of 380/154 kV and 154/33 kV substations having aggregate capacities of about 3,200 MVA, and 755 km of related transmission lines in various parts of Turkey, including the link between Elbistan and Keban and a second crossing of the Bosporus; (b) the training of TEK engineers in transmission system design and operation;  - 13 - (c) a nationwide power tariff study as well as a study of TEK's medium and long-term professional personnel staffing needs for the period 1977-81; and (d) project engineering and related studies. The proposed project is more amply detailed in the Loan and Project Summary provided in Annex III. An appraisal report (679-TU) dated November 4, 1975, and entitled "Appraisal of TEK Transmission Project II , is being distributed separately to the Executive Directors. 35. The effect of the Project on the environment is small. However, the proposed loan provides for an undertaking by TEK to carry out the project w;ith due regard to ecological and environmental factors (Loan Agreement, Section 3.07). Project Cost and Financing 36. The estimated cost of the proposed project, excluding interest during construction, is about US8146 million, of which US$76 million would be in foreign exchange. The proposed Bank loan of US$56 million, will finance the foreign costs of (i) equipment and materials for substations and their installation, (ii) insulators, hardware and conductors for transmission lines, (iii) training and training equipment, and (iv) consulting services for the design and construction of the project. The remaining foreign exchange cost of the transmission lines, some US$20 million including contingencies, as well as the entire local cost of the project, totalling another US$70 million equivalent, will be financed by the Borrower under its investment program. Project Implementation 37. TEK plans to contract the larger civil works, transmission tower procurement and erection. However, the bulk of the project will be done by force account. The construction schedule is phased over four years. TEK will employ a firm of engineering consultants to assist in the preparation of designs, plans, and specifications for the construction of the 380/154 kV substations and to help supervise construction. (Loan Agreement, Section 3.02). Experts and specialists will be also employed by TEK to assist in carrying out the studies referred to in paragraph 34 above. (Loan Agreement, Section 3.02). While by and large, TEK has the capacity to implement and operate the project, there is still a need to train additional engineers for the design and operation of TEK's growing transmission system. TEK will define a mutually acceptable training program by April 30, 1976 (Section 3.01(b) of the Loan Agreement) and implement it thereafter. The Project is expected to be completed by June 30, 1979.  - 14 - Procurement and Disbursement: 38. - All contracts to be financed from the proposed loan (except for consulting services) would be awarded on the basis of international competitive bidding in accordance with the Bank's Guidelines for Procurement. Disbursements would he made against the CIlF cost of imported equipment and materials and the foreign cost of services. Although local manufacturers are not expected to participate in contracts financed by the loan, in the event they do develop this capacity and compete successfully, disbursements would be made for the ex-factory costs of goods sc, supplied, and such suppliers would be granted the usual 15 percent preference. Disbursements are expected to begin in the second half of fiscal year 1976 and the loan should be fully disbursed by the end of FY80. Financial Position 39. TEK's current financial position is weak due largely to the low rate of return and collection problems discussed above in paragraphs 28 - 31. Al- though the debt position is satisfactory, the cash position is poor as indi- cated by a current ratio of 0.8 estimated for 1975. Although the current ratio is projected to remain at or below 1:1 during the period 1976-81, reflecting a tight working capital position, the overall financial situation is expected to improve as a result of the measures agreed in connection with the proposed Loan (also described in paragraphs 28 - 31), such that TEK will be able to self- finance about 33 percent of its investment program covering the construction period of the project. Economic Justification 40. Over the life of the proposed project, TEK has planned new generating capacity, including Elbistan, in excess of 2,500 MW to meet the forecast in- crease in demand for electrical energy. In the appraisal of the Elbistan proj- ect, the system development program to 1987 was assessed as being the least- cost solution relative to reasonable alternatives. Planning of the transmis- sion element of this program, of which the Project is an important part, has been done by TEK as part of their ongoing planning process, using mathematical models to assure technical and economic optimization. The transmission program is essential to balance the major investments being made in generating capa- city (e.g. Keban and Elbistan). Economic benefits cannot be attributed directly to the Project, so no rate of return can be calculated. However, the internal raLa of return for TEK's total development plan has been calculated to be at least 16 percent if benefits are measured by incremental revenues attributable to the total investment in the system operated by TEK and financial costs are adjusted for taxes and internal transfers. It is likely that the incremental revenues understate the benefits, some of which will arise from improving the reliability of electricity supply.  - 15 - PART V - LEGAL INSTRUMENTS AND AIJTIORITY 41. The draft Loan Agreement between the Borrower 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. Features of special interest are referred to in paragraphs 25-39 of this Report. In other respects, the draft loan documents conform to the normal pattern for loans for power projects. 42. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 43. I recommend that the Executive Directors approve the proposed Loan and Guarantee Agreements. Robert S. McNamara President by J. Burke Knapp Attachments   ANNEX I Page 1 of5 COUTRhYl DAta - TU5938 Y87576 Rex 2 7 mllon ui-T76 115 /u.b Per ke2of enable lan SOCIAL ThDICAIORS Reference Countries Turkey~L C-olnabla i- n I a . UP FIR CAPTIA 93$ (ATAS BASIS) Q 30 370 Wto L. 490 La 1,960 DEOGRAPOIfc raetekrate (Per thsnusad) 45 d2 38 4. 45 'If h 4.5 4r.i 16.3 Crude death rate (per thsou.and) I81 U 111?/h 9. Ilant motltbus(prto n irethint) 187 4L i IL 151 70