Turkey - Program Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No.4086 PROGRAM PERFORMANICE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) August 27, 1982 Operations Evaluation ])epartment This document has a restric-ted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ABBREVIATIONS IMF - International Monetary Fund SAL - Structural Adjustment Loan SDR - Special Drawing Right SPO - State Planning Organization TL - Turkish Lira TSKB - Turkiye Sinai Kalkinma Bankasi CURRENCY EQUIVALENTS TL per US$ 1977 March 16.50 September 17.50 1978 March 25.25 1979 June 47.10 1980 January 70.00 August 80.00 December 91.75 1981 April 98.20 June 107.50 September 121.10 1982 January 138.00 April 147.30  FOR OFFICIAL USE ONLY PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) TABLE OF CONTENTS Page No. Preface ....... ................................................... Basic Data Sheet .......................... ....................... Highlights ....................................... ................ iv PROGRAM PERFORMANCE AUDIT REPORT I. BACKGROUND . ............................................ 1 II. LOAN OBJECTIVES AND INSTRUMENTS ...... ................. 3 III. LOAN IMPLEMENTATION ......... ........................... 4 Slow Disbursements .................................. . 4 The Exchange Rate ................................... . 5 Other Measures to Encourage Exports ................. . 6 Deficient Repcrting ................................. . 7 IV. LOAN IMPACT ............................ . 8 Capacity Utilization ........ ......................... 9 Impact on Exports .................................... 10 Capital Inflow.'s ...................................... 10 Timirg of the Loan ................................... 11 V . CONCLUSION . ............................................ 11 Appendices Table 1 - Percentage Change in Some Selected Variables ...... 13 Table 2 - Currect Account of the Balance of Payments .... .... 14 Table 3 - Capital Account of the Balance of Payments .... .... 15 PROJECT COMPLETION REPORT I. Background ............................................. 17 1 . Introduction .................................. 17 2. Economic Background ......... ............. ................ . 17 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contenis may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS (continued) Page No. II. History and Features of the Loan ....................... 18 1. Loan Justification ........ ................... . . 18 2. Loan History ............... ....................... 19 3. Loan Objectives and Features ....................... 19 III. Impact of the Loan ........*** ....................... 21 1. Background - Economic Development in 1979 .... ...... 21 2. Balance of Payments .. .. ........................... 22 3. Exports ....*******e******........... ...... ............ 25 4. Output and Capacity Utilization ..... ............... 28 5. Public and Private Sector Balance ......... * ........ 30 6. Use of Counterpart Funds ........................ 30 IV. Implementation Arrangements ............................. 31 1. Reporting on Export Performance and Policies ....... 31 2. Procurement ......... ..... .s..e ...................... 31 3. Disbursements ........ ......... .. .......................... 32 V. Conclusions ................................ ... ......... 34 VI. Lessons Learned and Applied in Subsequent Loans ........ 35 Annexes: 1. Letter of Minister of Finance ..... ..................... 37 2. Memo to Mr. E. Asfour on Turkey - Program Loan Discussion ........................................... 43 3. Program Loan Allocations and Payment Requests .......... 49  PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) PREFACE This Program Performance Audit Report evaluates the first program loan extended by the Bank to Turkey during a relationship that has spanned three decades of intermii:tent, but often active lending. This loan was made in late 1978 at a time of extreme balance of payments stringency, and proved in retrospect to be a precursor of a series of Structural Adjustment loans that began in 1980 and still continues. Loan 1627-TU for US$150 million was approved by the Board on November 7, 1978, signed the following day and became effective a week later, on November 16. By March 24, 1980, it had been fully disbursed. Section 2.04 of the Loan Agreement had set the closing date at June 30, 1980 "or such later date as the Bank shall establish." The present Program Performance Audit Report comprises a Program Completion Report (PCR) prepared by the Europe, Middle East and North Africa Region (EMENA), and a Program Performance Audit Memorandum (PPAM), prepared by the Operations Evaluation Department (OED). The latter was undertaken in conjunction with the evaluation of the First Structural Adjustment Loan (Loan 1818-TU) and its Supplement (Loan 1915-TU) which has been issued as a separate OED report (Report No. 4015, dated June 30, 1982). In preparing the PPAM for this Program Loan, research was carried out involving examination of Bank files and discussions with staff members in the Bank as well as the Fund, and a field mission visited Turkey in October 1981 for the evaluation of SAL. In Turkey, discussions were conducted with the Prime Minister's Office, the Ministry of Finance, the State Planning Organization (SPO), the Central Bank, TSKB, commercial banks, Chambers of Commerce and Industry, the private sector, the academic community and others. OED is grateful for the help received and the courtesies extended to that mission. The PCR, written in November 1980, provides a candid and thorough review of the Program Loan, its antecedents and objectives and provides an assessment of its success and shortcomings. The PPAM, written more than a year later, concerns itself with the broad findings of the PCR, but attempts also to throw some light on certain aspects of the operation which the PCR did not fully cover. The PPAM, on the whole, concurs with the conclusions reached in the PCR and, in some respects, and with the benefit of a longer perspec- tive, goes even further In concluding that the impact of the Program Loan was positive, particularly in paving the way toward the more fundamental reforms which have been effected since January 1980 and which have become part of the structural adjustment process supported later by Bank lending.   - ii - Copies of the draft report were sent on April 29, 1982 to the borrower for comment. The comments OED received (dated July 20) covered both audits for this Programa Loan and for the First Structural Adjustment Loan and Supplement. Since the PPAR for the latter operation had already been issued, borrower's comments on both PPARs are being circulated as a separate Addendum to the two audits.  I  - iii - PROGRAMI PERFORMANCE AUDIT BASIC DATA SHEET TURKEY--FIRST PROGRAM LOAN (LOAN 1627-TU) PROJECT DATA (US$ Million) As of 03/31/82 Original Disbursed Cancelled Repaid Outstanding Loan 1627-TU 150.0 150.0 - - - Cumulative Loan Disbursement FY79 FY80 (i) Planned 9O.oZa 150.0 (ii) Actual 76.8 150.0 (iii) (ii) as % of (i) 85% 100% Original Loan Dates Actual Loan D)ates Board Approval 11/07/78 11/07/78 Loan Agreement 11/08/78 11/08/78 Effectiveness 12/08/78 11/16/78/b Loan Closing 06/30/80 03/26/80Lc MISSION DATA Month/ No. of No. of Man- Date of Year Weeks Persons weeks Report Identification 03/78 - - - - Preappraisal 04/17-05/78 - - - - Appraisal 04/17-05/78 2-1/2 - - 05/26/78 Supervision I 04/79 1 3 3 06/05/79 Supervision II 07/79 1 1 1 08/16/79 Supervision III - - - - - Supervision IV - - - Supervision V - - - - - Completion 06/80 - - - 11/12/80 /a From the combined President's and Staff Appraisal Reports. Controller's Cumulative Estimated and Actual Disbursements of Loans indicates: "Balance indeterminate." /b Or earlier if conditions of effectiveness satisfied. /c According to Controller's Department.   - iv - PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) HIGHLIGHTS In retrospect, this is judged to have been a successful opera- tion that met the major objectives of the loan, namely a quick transfer of resources, preventing further capacity underutilization, helping the borrower to effect needed adjustments in a period of critical shortage of foreign exchange, and paving the way for a fundamental and long-delayed reorientation of macro-economic policies that appear now to be alleviating Turkey's balance of payments difficulties. Capital inflows into Turkey seem also to have been encouraged since this operation. Three principal findings which deserve to be highlighted are: (a) the good timing of the operation in terms of Turkey's balance of payments situation and the need to initiate an adjustment process; (b) while it is desirable to identify items to be procured under program loans, particularly for the purpose of monitoring loan disbursement and to provide a basis for assessing impact on industry and capacity utilization, too much effort need not be expended in this regard since in the final analysis funds are fungible; and (c) requirements of the borrower must not be defined so precisely as to defeat their objective: instead of obligating the borrower to report regularly on export performance, the obligation in this case was for specified reports on exports to be communicated to the Bank when these reports were produced. However, as these specific reports failed to materialize they could not be made available to the Bank (PPAM1, paras. 15 and 16).   PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) I. BACKGROUND 1. The story has often been told (not least in Bank documents on Turkey) of Turkey's special approach to economic development, its achievements and shortcomings.11 The economic strategy that characterized Turkey's development until January 1980, had as an integral feature an over-valued exchange rate that discouraged exports. Little importance was attached to selling abroad, as Turkish enterprises found the highly protected domestic market quite rewarding. The capital-intensive industry that developed could offer only limited emiployment to Turkey's surplus population which found temporary relief as gueast workers in the industries of Western Europe in the sixties and early seventies. Two-thirds of exports by value in 1978 were agricultural primary products, and the remainder was dominated by textiles. 2. From about 1974 onwards Turkey began to experience serious balance of payments difficulties as it had increasingly become dependent on imports of raw materials, fuel and intermediate goods, essential to feed its industry and agriculture, but had failed to develop the capacity to earn the foreign exchange necessary to pay for these imports. Exports were hampered by the overvalued Lira, administrative controls, insufficient incentives to switch goods from a profitable domestic market, lack of credit and insurance support, inadequate marketing and quality standards, and high cost, scarcity and low quality of many inputs necessary to produce exports. The recession that hit Turkey's European trading partners in the mid-seventies constrained their ability to absorb Turkey's migrant workers, and Turkey's terms of trade seriously deteriorated, notably on account of the explosions in petroleum prices in 1973-74 and later in 1979-80. Despite these difficulties, Turkey continued to pursue rapid growth, shouldering an excessive investment effort, financed increasingly by budgetary deficits and Central Bank credits. Arrears built up on imports and servicing foreign debt. Sagging international confi- dence all but put an end to foreign capital inflows. Reduced imports added to the inflationary pressures, depressing the level of activity and further limiting exports. A v:Lcious circle thus developed which was compounded by political instability and lack of a firm leadership that could face the painful decisions of economic adjustment. 3. Although the economic problems of Turkey were clearly structural, requiring drastic change in fundamental policies, many of these problems surfaced as short-term difficulties, manifesting themselves in acute foreign 1/ See OED, "Turkey's Structural Adjustment, A Program Performance Audit Report", op. cit., paras. 1-8.  - 2 - exchange shortages, high inflation and budgetary deficits. These called for stabilization measures, and Turkey sought the support of the IMF in working out a number of stabilization arrangements. 4. After an initial attempt to contain the external gap by exchange and trade restrictions, and after a scheme had backfired to attract deposits from expatriate nationals in the form of convertible Lira accounts, Turkey adopted a stabilization program in April 1978 which the IMF supported by a two-year stand-by arrangement for SDR 300 million, while simultaneously an OECD working party agreed to reschedule debt service payments, including arrears, amounting to some US$1.3 billion.L/ Despite the devaluation of the Lira exports con- tinued to be hampered by rising domestic prices. The prevailing political atmosphere contributed to a situation where restraint on domestic demand proved inadequate and where it "proved difficult to achieve the desired tightening of budgetary policies or stem the deterioration in the finances of the State Economic Enterprises."!/ As an indication of Turkey's critical financial situation at the time, it should be mentioned that total short-term liabilities of the monetary authorities, including arrears, which had stood at US$299 million at end-1974, reached US$6,555 million three years later and were to increase further to US$8,376 million by end-1978 at which time total external debt exceeded US$14 billion. While exports stagnated at levels ranging between US$1.5 billion and US$2 billion a year in the period 1974-77, imports continued to mount, reaching US$5.8 billion in 1977 when the trade balance exceeded US$4 billion and the current account balance, at US$3.6 billion, was 7 percent of GNP. The economic situation in Turkey in late 1978 had become quite critical. 5. When the Bank decided to extend the Program Loan to Turkey in November 1978, the Fund was in the middle of reviewing Turkey's compliance with the conditions of the April stand-by arrangement, and it was clear then that these conditions were not being met. Later, the 1978 stand-by was cancelled and replaced in July 1979 by a new one-year stand-by for SDR250 million. (The latter was followed by a three-year stand-by for SDR1,250 million in June 1980 and this remains effective.) In this series of stabili- zation programs, as the PCR points out (para. 1.04) adjustment focused on restraining the growth of aggregate demand and also imports by restrictive monetary policy, reduction and rationalization of public investment, greater mobilization of resources through higher prices charged by the State Economic Enterprises, and a greater effort behind export promotion. Simultaneously an attempt was made to reschedule much of the short-term obligations in respect of the external debt into longer term ones. 1/ Aggregate debt relief provided by the OECD consortium countries and Japan in the three-year period 1978-1980 was US$5,477 million. See The Republic of Turkey, Information Memorandum prepared by the Central Bank of Turkey, April 1981, p. 27. 2/ IMF, Turkey - Staff Report for the 1981 Article IV Consultation, (SM/81/178), dated August 24, 1981, p. 2.  - 3 - 6. Outside the Eramework of the stabilization measures worked out with the IMF, the Bank sought a longer-term change of policy that would help improve the balance of payments. The five-year plan which was to have run from January 1978 had been postponed for one year in view of the severity of the economic problem and the difficulty to plan in the prevailing circum- stances. Political instability also contributed to the uncertainty. However, the government came ur, with a plan strategy paper which put emphasis on the encouragement of exports as a new drive for salvaging the economy. No such emphasis was present in the current IMF stand-by arrangement. In the absence of a firmer framework which was unlikely to materialize for some time, and anxious to provide expeditious support, the Bank chose to take this fundamen- tal aspect of the new strategy and make it a cornerstone of the conditionality attached to the program loan. The Bank, therefore, required a statement of intent from the Turkish authorities on measures and policies aiming at export encouragement and this was given by the Minister of Finance for Turkey in a letter addressed to t:he President of the World Bank, dated August 23, 1978, which is attached to the PCR. II. LOAN OBJECTIVES AND INSTRUMENTS 7. The loan, made in the spirit of a "Category Four" program loan,l/ had four principal objectives, viz: (a) to provide a quick transfer of resources to Turkey in an attempt to maintain essential imports and fill part of a projected 1979 foreign exchang gap; (b) consequently, to contribute to increasing capacity utilization in industry and agriculture, and thus help sustain production and employment, and enable the government to implement its adjustment policies; (c) to facilitate a planned expansion of exports by helping to finance imported inputs; and (d) to induce other foreign capital flows into Turkey. To reach these objectivres, the main instruments agreed upon were the follow- ing: (a) specified categories of imports eligible for procurement under the loan; 1/ Operational Manua:L Statement No. 1.19 (August 1977) identifies four categories of program loan, namely, for post-war or post-natural-calamity rehabilitation; for redressing a sudden fall in export earnings; when otherwise a sharp deterioration in the terms of trade had occurred; and "cases involving ;tructural constraints or capacity under-utilization."  (b) a drive by the borrower to encourage exports by a variety of measures outlined in the Minister's letter to the Bank, with a specific undertaking to match loan disbursements with allocations from own finance to replenish an existing scheme for export promo- tion; and (c) allocation of counterpart funds in local currency to development projects. It was agreed that a mid-term review of export policies and measures be undertaken by the Bank (by April 30, 1979), and that a favorable judgment on progress was necessary for disbursements to continue after that date. 8. Eligible import items to be financed under the Loan were high- priority inputs for the manufacture of fertilizers; plant protection chemicals and inputs necessary for their production; spare parts for manufacturing industries and for crop-spraying aircraft; raw materials and intermediate inputs for an "Import for Export" promotion scheme; also steel, copper, aluminum, and chemicals and petrochemicals. Besides, the private sector was guaranteed at least a third of the loan proceeds. Reallocation was allowed under the loan from the industrial to the other categories of permissible imports but not vice versa. For greater detail, see PCR, paras. 2.06 and 2.07. III. LOAN IMPLEMENTATION 9. Though the primary objective was to make quickly disbursable funds available to Turkey, the Bank sought to enlarge the impact of the loan by earmarking its proceeds to the importation of the high priority items listed in para. 8 above. Bank staff were aware that if the loan's proceeds were drawn in 1978 and 1979, the funds would make only a marginal contribution to the import bill, accounting for some 1.6 percent of the total in each year. In the event the bulk of the loan (96 percent) was disbursed in 1979 and covered about 3 percent of the total imports of that year, valued at US$5,069 million, the remainder being disbursed in 1980. The items identified appear to have been carefully chosen, particularly with the view of ensuring that vital subsectors should not fall behind in their contribution to production and particularly to exports. The fertilizer and chemical inputs to agricul- ture were especially important for that sector. Slow Disbursements 10. Apprehensions contained in the President's Report (para. 75) regard- ing the risk of slow disbursements proved justified, though the source of the risk which had been identified as bureaucratic inertia over import licensing turned out, in retrospect, to lie largely elsewhere. The PCR (para. 4.10) mentions inadequate internal procedures which initially hampered disburse- ments. But the main reason for delay, as the PCR indicates, was that Turkey's severe financial troubles had undermined foreigners' confidence and obstructed  - 5 - the flow of short-term facilities (provided by the foreign commercial banks) necessary for effecting international trade. Letters of Credit for the imports financed under the loan had initially to be paid for fully in cash (PCR, para. 4.06), but: eventually the problem was resolved. The Bank cor- rectly observed its formal procedures for disbursements, and could not have been expected to waive these (as suggested in the PCR, para. 5.05) and advance funds ahead of procurement. This is particularly the case as the Government was reluctant to reveal its difficulties to the Bank (PCR, para. 5.05). On the other hand, the suggestion of simplifying procurement provisions espe- cially regarding large import contracts placed by public sector enterprises (PCR, para. 4.03) is worthy and appears to have been observed in subsequent operations. 11. Before the end of April 1979, the Bank mounted a mid-term review mission which reported favorably on progress under the loan, and disbursements continued unhindered. In December 1979, the Bank responded favorably to a request by the Borrower to effect a reallocation of loan proceeds away from industry in favor of agriculture, and away from spare parts in favor of the Import-for-Export scheme. (Letter in Files dated December 13, 1979.) The Exchange Rate 12. Devaluation was not a specific measure emphasized under the loan, but of course, it was a major instrument if exports were to be successfully promoted. As argued before, Turkey tended to maintain an exchange rate for the Lira which militated against exports and, in addition to tariffs on imports, resorted to quantitative controls in order to contain imports and to keep them within reasonable distance of the country's earnings of foreign exchange on current account and capital inflows. At the time the program loan was made, the exchange rate had been set at TL 25.25 per US dollar, and in line with previous practice, had remained at that level while Turkey's export competitiveness deteriorated as a result of domestic prices rising faster than international prices. By end-1978, according to calculations by IMF staff, the real export-weighted effective exchange rate had reached its worst level in four years, seriously obstructing the flow of exports.l/ 13. In the spirit of Turkey's undertaking under the Program Loan to encourage exports, therefore, and to improve export competitiveness, three (nominal) devaluations of the Turkish Lira were effected during loan imple- mentation: a minor one in April 1979 of about 6 percent and two major ones: 1/ See Table 26, p. 62 of Turkey - Recent Economic Developments, (SM/79/58), dated February 21, 1979. The real effective exchange rate deteriorated further until the eve of the June 1979 devaluation. See IMF, Turkey - Request for Stand-by Arrangement, (EBS/79/390), dated July 6, 1979, Table 7, p. 14. This result was later corroborated (in respect of exports and imports combined) in a Bank study entitled, "Turkey: Industrialization and Trade Strategy," Report No. 3641-TU, dated February 18, 1982.  32 percent in June 1979, and 100 percent in January 1980.11 Despite the accelerating inflation in Turkey, (45 percent in 1978; 73 percent in 1979 and 103 percent in 1980,2/) these devaluations, in addition to rebates on exports, restored by mid-1979 Turkey's export competitiveness roughly to the reference level of the fourth quarter of 1970. In the words of an IMF staff report, this represented "a depreciation in effective export-weighted terms of about 75 percent since the fourth quarter of 1970, and about 50 percent since the last major adjustment in March 1978."3/ The new level of exchange rates had more than offset the differential inflation rate between Turkey and its trading partners that had occurred in the course of 1978-79.4/ Some deterioration in competitiveness did, however, occur in the latter part of 1979 on account of domestic inflation, but this was virtually offset by the January 1980 devaluation.5/ Over the life of the program loan, roughly between end-1978 and mid-1980, a real depreciation of a significant magnitude took place in the effective exchange rate for the Turkish Lira, and this was a real achievement in support of the drive to promote exports. Other Measures to Encourage Exports 14. The Finance Minister's letter contained a fairly large number of measures intended to be taken over the medium term with the purpose of promot- ing exports. The PCR (para. 3.14) lists those measures which were introduced in 1979, namely the simplification of the regulations governing the imports- for-exports scheme and other administrative procedures affecting exporters; 1/ The June devaluation, which set the nominal exchange rate at TL35 per US dollar, was accompanied by the introduction of a two-tier official market for foreign exchange which resulted in an "effective" rate of TL47.1 per US dollar applying to all transactions other than exports of certain agricultural products, petroleum, petroleum products, and chemical imports for the production of fertilizer. Besides the exchange rate, other incentives were also given to exporting. 2/ As measured by the implicit GNP deflator. 3/ IMF, Turkey - Request for Stand-by Arrangement, (EBS/79/390), dated July 5, 1979, p. 13. 4/ See also Chart 5 on page 66b of IMF, Turkey - Recent Economic Develop- ments, (SM/81/180), dated August 27, 1981 which adjusts somewhat the previous measurements. In this chart, the nominal effective exchange rate is deflated by a ratio of a consumer price index for Turkey to a weighted index of trade partners' consumer prices. 5/ Reading from the chart quoted above the "real effective exchange rate" (quarter 4, 1970=100) had risen to about 158 by end-1978, but fell to about 110 by mid-1980.  - 7 - relaxing limitations on foreign capital participation in export-oriented projects; and adjusting agricultural export prices to encourage production and export. Several other reforms mentioned in the letter were introduced after completion of disbursement, and during implementation of the structural adjustment loans. There were yet other measures, not mentioned in the letter, but which were introduced in 1979. Besides the devaluation of the Lira, the authorities devised various incentives to exporters. These included a foreign exchange retention scheme; a risk fund to enable exporters to bid for large contracts; greater access of exporters to commercial bank credit; interest rate and tax rebates for exports; an export coordination committee to help exporters; and incentives introduced on investments for exports. Some of these measures were much developed and extended later, and contributed suc- cessfully to a great expansion of exports in 1981. Deficient Reporting 15. Periodic reporting by the borrower on exports was irregular and, as the PCR mentions (para. 4.01), in contravention of the loan agreement. The PCR, however, credits the government with having "instead" intermittently communicated information on relevant matters to the Bank, particularly to the "special economic mission" which undertook the mid-term review. Section 3.07 of the Loan Agreement had obligated the borrower to: (a) "...Promptly after their preparation, the Borrower shall furnish to the Bank copies of the quarterly reports prepared by its State Planning Organization for submission to the Borrower's High Planning Council on l:he implementation of its program referred to in Recital A of the Preamble to this agreement. Such reports shall include: (i) an account of actual export performance in relation to the targets established under said program and under the annual programs established each year in connection therewith; (ii) an evaluation of the Borrower's current export oriented policy measures and the effectiveness of their implementa- tion; and (iii) recommendations concerning changes to be made in the economic and finiancial policies of the Borrower to achieve the targets referred to in paragraph (a)(i) of this Section. (b) Promptly after the reports referred to in paragraph (a) of this Section have been issued, the Borrower shall furnish to the Bank a summary of policy decisions taken on the basis of the recommenda- tions contained in such reports.  - 8 - (c) The Borrower agrees to exchange views with the Bank from time to time on the quarterly reports, summaries, recommendations and deci- sions described in paragraphs (a) and (b) of this Section and shall provide the Bank with all such further information as the Bank may reasonably request. 16. This elaborate covenant had the objective of bringing developments important for loan implementation to the attention of the Bank, with the purpose of ensuring regular consultation on measures and policies adopted to address a changing situation. As Recital A of the loan agreement indicated, the Bank was anxious to follow up on the "strategies and policies designed to reestablish...balance of payments equilibrium in the medium term through measures aiming at increasing substantially Turkey's industrial and agricul- tural exports." Such a follow-up was an integral part of the implementation of the program loan. The fact that this covenant was honored in the spirit but violated in the letter shows clearly the drawback of defining the report- ing requirement in terms of too precise an institutional setting. The PCR states (para. 4.01) that since the High Planning Council did not meet regularly, the State Planning Organization's reports were not submitted to it every quarter, and therefore all the obligations cited above, that were based on the regular production of these reports (e.g., their contents, their being furnished promptly to the Bank, etc.) could not be fulfilled. More effective would have been a broadly defined undertaking whereby the borrower furnished such periodic reports to the Bank without reference to precise institutional instruments. The Region responsible for appraisal, in any case, should have realized that such instruments were bound to be irregular. IV. LOAN IMPACT 17. Despite the delay in withdrawals of loan proceeds already mentioned, the loan was fully disbursed before the original completion date of June 30, 1980. Small as the amount of the loan was in comparison with the import bill in 1979, it did make a difference to the foreign exchange gap in 1979 and to the high priority items identified, and thus the loan's principal objectives appear to have been met. 18. Although the loan was specifically earmarked for the procurement of certain imports necessary for identified lines of activity as well as the promotion of exports, the fact that funds are fungible lessens the importance of such earmarking. This is particularly the case if the items concerned are high-priority ones, likely to be favored under the import regime. The President's Report made a case (on grounds of their contribution to produc- tion) for the identification of these items, which were written into the loan agreement, and the Bank procedures of disbursements were applied to ensure that loan proceeds went to finance the specified items. Paragraphs 3.08 and 3.09 of the PCR discuss the merits and demerits of this approach and the latter paragraph concludes that "the effort at commodity selection was greater than really necessary." Without the loan, it is likely that Turkey would have  - 9 - attempted to maintain the level of its imports of the identified high priority items, particularly as finance was available for some of them (PCR, para. 3.13). However, in view of the critical foreign exchange situation prevailing at the time of the loan, it was by no means certain that such essential imports would flow in anyway in the requisite amounts. On balance, therefore, particularly from the point of view of facilitating the monitoring of loan disbursements, and the industry-specific impact on capacity utilization, the specification of eligible commodities was probably justified. Capacity Utilization 19. A main objecl:ive of making funds available for the procurement of specified imports was, therefore, to promote greater utilization of capacity. The President's Report had pointed out the slower growth of total industrial production after 1977, stating that the decline "reflected a decline in the utilization of installed capacities" (para. 50). The surveys of the Turkish Industrialists and Businessmen's Association (TUSIAD), covering "a large sample" of private firms in industry in and around Istanbul, had indicated that the estimated capacity utilization was 83 percent in 1976, declining to 56 percent by the end of 1977 (ibid.) 20. The concept of full-capacity utilization is not a tidy one, and the measurements of shortialls from it are necessarily fuzzy. Consequently, interpretations of underutilization of capacity are often inconclusive. Excess capacity may be found when additions have just been made to capital equipment, or where complementary capital units have not yet been fully balanced. Besides, where there are elements of monopolistic competition (and there is evidence of concentration in several lines of industry and banking in Turkey)./, one would expect excess capacity to be a feature of market equilibrium. The evidence on excess capacity provided by TUSIAD and later by the Istanbul Chamber of Industry lacks rigor and continuity, and perhaps the PCR was wise not to attach much significance to it. Both the President's Report and the PCR show awareness of the existence of factors other than import shortages to account for less than full capacity utilization. Apart from work stoppages in 1978 and 1979 due to labor unrest, and also shortages of electricity, (the latter, however, traceable in part to shortages of petroleum imports, which were not eligible under the loan), underutilization of capacity may have resulted also from insufficient demand, financial diffi- culties and other factors. 21. It appears that average capacity utilization in industry as measured by the Istanbul Chamber of Industry remained roughly at the same level in 1978 (55.8 percent) as it had been in 1977, but fell further in 1979 (to 45 1/ See I. Pekeli, S. Ilkin, A. Aksoy and Y. Kepenek, Concentration in Turkish Manufacturing Industry, Middle East Technical University, Ankara, ESA Working Paper No. 18, December 1980.  - 10 - percent). During the last quarter of the life of the loan, i.e., in the quarter January-March 1980, utilizatin stood at 47.3 percent. A year later, this had risen to 56.4 percent.l/ 22. As the PCR indicates (paras. 3.21-3.23) the subsectors benefiting from the imports eligible under the loan showed a varied record during 1979, this being, on the whole, consistent with the overall record of industry. Capacity utilization declined in the subsectors of plant protection chemicals, copper, petrochemicals and other chemicals, and remained roughly the same in aluminum.2/ The subsectors showing significant increases in capacity utilization were fertilizers (both nitrogenous and phosphatic) and steel. 23. It should be mentioned that manufacturing industry which had led overall growth before 1977 had settled down to a 2.6 percent growth in 1978 and actually shrank by 5.6 percent and 5.0 percent in real term in 1979 and 1980, respectively. Agriculture also recorded very slow growth in this period.3/ Impact on Exports 24. The PCR (para. 3.19) attempts an assessment of the contribution made by the loan to exports. It should be remembered that GNP, industrial output and export volume, all actually declined in 1979, the latter by as much as 16 percent (see Appendix, Table No. 1). In the absence of precise information on the linkages between imports of specific items, outputs and exports, it is difficult to reach firm conclusions about the impact of the loan on exports, particularly as many other factors were changing also. It is, however, the attendant policies of export encouragement, most notably the effective deval- uation of the Lira, which Turkey adopted in this period that must have had an impact on exports, albeit after a time lag. Capital Inflows 25. Table 3 sets out the capital account of the balance of payments in the years 1977-80. It will be seen that net capital inflows in 1979 were actually a third less in nominal terms than they were in 1978, the latter 1/ Istanbul Chamber of Industry, Research Department "Capacity Utilization Rates in Industrial Production in 1980", September 1981. 2/ See Table 4, para. 3.21 of the PCR. the decline in copper production between 1978 and 1979 shown in this table (as well as the sharp decline in capacity utilization) is at variance with an increase of 10.4 percent in copper output in 1979 as depicted in Table 4, p. 9 of Turkey (OECD Economic Surveys), March 1981, published by the Organization for Economic Cooperation and Development. 3/ Owing to updating small discrepancies may exist between some of the numbers used here and those in the PCR.  - 11 - having been another third below their level in 1977. In real terms, the decline was much more precipitous. Practically all items of capital were affected, particularly foreign commercial bank lending to Turkey. But the tide turned quite remarkably in 1980 when net capital inflow was US$2.3 billion, as compared with US$0.68 billion in 1979. The springs behind this rebound can be seen (in the Table) to have begun in 1978, and to have devel- oped in 1979, affecting program loans, the special assistance under OECD and notably the debt relief. While it is not possible to attribute this change to the impact of the program loan, it cannot be divorced from it either. Quite early, the Bank seems to have perceived that urgent balance of payments support of Turkey was desirable and likely to be fruitful, and in this, it was followed by other donors and lenders. Timing of the Loan 26. Should the Bank have come forward with the Program Loan before the Fund and Turkey had reached a satisfactory agreement? This question, which was raised during the Board's discussion of the loan, was addressed by Bank staff at the time who assured the Board that the Fund was not averse to the Bank proceeding with the loan, and this view was corroborated to the OED. The Bank had to act independently from the Fund, and in the circumstances had appeared to provide Turkey with public support in the international capital markets that was truly valuable. The borrower has expressed appreciation of the Bank's stand at the time, especially as this was followed by an expanded lending program. Afterwards, the Fund also came through with a revised stand-by. It should be emphasized that these were difficult times for the economic managers of Turkey and that the dialogue on macro-policy with the Bank had been uneasy ior some time. In retrospect, the Bank's preparedness to grant this financial support with few conditions demonstrated sympathy, declared confidence in Turkey's prospects, and provided a truly needed shot in the arm and led to improved relations between the Bank and Turkey. In Turkey, the expansion of the Bank's lending program at that time was singled out as the most significant contribution the Bank made towards the country's economic recovery. The PCR perhaps leans a little to the pessimistic side in reporting (para. 3.16) that "the consensus of Government officials interviewed was that the existence of the program loan and of the policy dialogue on exports made no difference to the pc,licies the Government actually followed." V. CONCLUSION 27. In the area of macro-economic policy, measures usually take time to produce the results sought, and in an assessment like the present audit, one has to be content with examining progress towards implementing the measures agreed upon, taking into consideration the broad objectives of the operation. In this respect, the principal measures agreed upon were implemented, as well as others which proved quite effective.  - 12 - 28. The major objectives of this Program Loan appear to have been achieved: the loan provided a quick resource transfer to Turkey at a time of dire need; capacity utilization in industry showed some improvement or other- wise was prevented from deteriorating further; in agriculture (though the connection between inputs of fertilizer and plant-protection chemicals on the one hand and output, on the other, has not been demonstrated) 1969 produc- tion of the major cereals (wheat and barley in particular) expanded, and no serious reduction was experienced by other crops on account of reduced flow of imports. Though the amount of the loan was very small in relation to the magnitudes of the financial requirements, it made an appreciable contribution to the imports of the eligible items in general, and a substantial contribu- tion in particular to the imports of fertilizers, plant protection chemicals, copper and aluminum. Another objective achieved was to contribute to the flow of funds from other sources, though again this only occurred after a lag. 29. Turkey's principal commitment was to encourage exports and this was done through a number of administrative measures and financial instruments, most effectively via the drastic adjustment of the exchange rate. Although exports did not respond immediately, no fair observer could have expected them to do so, and there were many factors outside Turkey's control affecting the volume and terms of trade of exports. Maniy of the measures to be taken by the Government and contained in the Finance Minister's letter of August 23, 1978, were in the nature of future policies, intended to be implemented over the medium term and were not time specific to the period of loan implementation. Even such projections as were specified there for exports, related to growth during 1979-83 when the base (1979) could not have been known (Letter, second paragraph). Some of the promised institutional and administrative reforms were slow to occur or otherwise never materialized. In the event, however, the January 1980 stabilization program (which subsequently became the basis for the Bank structural adjustment loans and further arrangements with the Fund), and measures taken since, were to represent a major re-orientation of policy, placing stress on exports, which the Program Loan had sought in the first place. In a very real sense, therefore, the program loan may be said to have been the precursor of such changes, and at least part of the credit should go to the timing of this loan. If it were possible to calculate an ex post rate of return on this loan from the vantage point of the present, it would prove to be much higher than was originally envisaged, especially now when exports appear to be finally responding to the various incentives intro- duced under this loan, and further developed on its basis.  - 13 - Table 1 PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) PERCENTAGE CHANGE IN SOME SELECTED VARIABLES (Compared with Preceding Year) 1977 1978 1979 1980 At Constant Prices GNP 4.0 2.9 -0.5 -0.7 Consumption 5.3 2.3 0.1 0.3/a Fixed Capital Investment 6.9 -10.9 -7.8 ./a Stock-building 0.9 -0.3 0.8 2.5/a Value Added in Agriculture -0.6 2.5 2.9 1.2 Value Added in Industry 6.6 3.7 -5.6 -4.8 Value Added in Manufacturing 6.5 2.6 -5.3 -5.0 At Current Prices Import Value 13 -21 10 51 Import Prices 10 14 18 35 (of which oil) (12) (1) (38) (75) Import Volume 3 -30 -7 12 (of which oil) (16) (-3) (-11) (21) Export Value -11 31 -1 29 Export Prices 9 6 18 18 Export volume -18 23 -16 9 /a Provisional. Source: IMF: Turkey - Recent Economic Developments, (SM/81/180) dated August 27, 1981..  - 14 - Table 2 PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) CURRENT ACCOUNT OF THE BALANCE OF PAYMENTS (millions US dollars) 1977 1978 1979 1980 Current Account -3,635 -1,780 -1,650 -3,419 Exports (f.o.b.) 1,755 2,288 2,261 2,910 Imports (c.i.f.) -5,797 -4,599 -5,069 -7,667 Trade Balance -4,043 -2,311 -2, 808 -_4757 Workers' Remittances 982 983 1,694 2,071 Interest Payments before Debt Relief -570 -750 -1,010 -1,138 Other Services (net) -4 298 474 405 Services Balance 480 531 1,158 1,338 Source: IMF: Turkey - Recent Economic Developments, (SM/81/180), dated August 27, 1981, Table 35.  - 15 - Table 3 PROGRAM PERFORMANCE AUDIT REPORT TURKEY: FIRST PROGRAM LOAN (LOAN 1627-TU) CAPITAL ACCOUNT OF THE BALANCE OF PAYMENTS (millions US dollars) 1977 1978 1979 1980 Project and Suppliers' Credits 499 450 356 347 Program Loans 3 80 230 352 Private Foreign Capital 168 147 210 130 Petroleum Loans 365 163 50 215 Loans from Banks 710 450 -370 165 Special Assistance under OECD - - 225 989 Debt Repayments before Relief -214 -570 -945 -1,556 Debt Relief - 295 924 1,450 Capital Account Net 1,531 1,015 680 2,292 Source: Table 1, page 14 of IMF: Turkey - Staff Report for the 1981 Article IV Consultation, (SM/81/178) dated August 24, 1981.   - 17 - TURKEY PROGRAM LOAN - (1627-TU) COMPLETION REPORT I. PROJECT BACKGROUND Introduction 1.01 On November 8, 1978, the Bank signed a $150 million program loan with the Republic of Turkey. The loan was designed to help increase capacity utilization in agriculture and industry in a situation of acute scarcity of foreign exchange, and was predicated on the Government's strategy to make exports the cornerstone of its development policy. 1.02 Disbursements were completed on March 24, 1980. A mission in June 1980 gathered information and views on the implementation and impact of the loan from the Government: and from beneficiaries in both the public and private sectors. These are reflected in this completion report on the loan. Economic Background 1.03 The President'" Report (No. P-2374a-TU, dated October 19, 1978) analyzed the causes of the economic crisis which gripped Turkey from early 1977 and continues even today. These were partly external: price rises for oil and other imports since 1973, and the simultaneous recession and high unemployment in Western Europe in 1974 and 1975 which affected Turkey's exports and worker remittances. However, poor domestic policies were equally important: over-ambitious growth and investment targets given the unfavorable external environment, insufficient incentives to export, and lagging domestic savings especially savings by the public sector. As a result, excess aggregate! demand led to strong domestic inflationary pressures; the gap between exports and imports widened sharply; Turkey borrowed heavily abroad to cover it, largely on short-term. By early 1977, foreign confidence was affected and credits dried up, leading to the emergence of shortages cf imported items, extensive underutilization of capacity (especially in industry, and including industries serving agriculture), and mounting payments arrears. 1.04 From early 1978, the Government began implementing the first of several rounds of stabilization measures. These were supported by IMF Standby Arrangements approved in April 1978 and July 1979. The main measures were intended to restrain the growth of aggregate demand and imports through restrictive monetary policy, reduce public investment and direct it to priority areas, mobilize additional resources through large increases in the prices charged by State Economic Enterprises (SEEs),  - 18 - restore external competitiveness and promote exports through substantial devaluations and other incentives, and convert outstanding short-term debt into medium-term obligations while tapping new sources of medium and longterm external capital. The Government also produced a realistic strategy document for the Fourth Plan (1979-83) in August 1978, making a vigorous export drive the cornerstone of a planning strategy designed to restore viability gradually to the economy. Later in November 1978, after the 1978 Program Loan was signed, the Government incorporated this policy in the Plan document itself. 1.05 Despite these steps in 1978 implementation of the stabilization program was partial during the year, and the results were therefore mixed. The balance of payments did improve in 1978; the current account deficit halved, but mainly because the volume of imports was cut by about 30 percent, which slowed real growth to 3 percent and increased the underutilization of capacity. On the other hand, exports rose by 30 percent, and the debt position and capital inflows improved. II. HISTORY AND FEATURES OF THE LOAN Loan Justification 2.01 These economic circumstances provided a convincing justification for a Category IV program loan. The most relevant of these circumstances were the existence of a structural problem in the balance of payments due to the inadequate development of exports, and widespread underutilization of capacity especially in industry. IMF facilities were being used in support of an agreed stabilization program, but were nowhere near sufficient to fill any reasonably estimated balance of payments gap. In any case, the adjustments required would take some years to carry out, while the debt burden was already insupportable, suggesting the need for longer-term financing. Neither project nor sector lending would be sufficient, although complementary action was taken through FY79 DFC, ports and grain storage loans in particular to allocate limited investment funds to serve exports. Meanwhile, the Government's Fourth Plan strategy document suggested that policies would be followed which would permit the resumption of sound growth in the medium term. 2.02 Turkey's foreign exchange crisis was a severe one. Reserves were very low. There were limits to the speed with which export and workers' remittances could be expanded. Further payments arrears would have threatened debt rescheduling negotiations. Thus if supplementary foreign exchange had not been made available, the import program - already limited to essential items--would have had to be cut further. Since imported stocks were largely exhausted, reductions in imports would have directly affected capacity utilization, output, and hence even exports. Agriculture and industry would both have been severely hit.  - 19 - Loan History 2.03 Bank program assistance was first recommended in the Program Division's desk analys,is of the economic situation in summer 1977. The case was elaborated progressively during early 1978, and after preliminary discussions initiated by the Bank, the Government in March 1978 formally requested a program loan to increase capacity utilization. During his visit to Turkey in Apri.l 1978, the President approved the processing of a loan subject to several conditions, including most notably a review of the Fourth Plan, soon to be drafted for the years 1979-83, witli the Bank. 2.04 The Region had meanwhile mobilized staff on a contingency basis. It was thus able to mount an appraisal mission the very next week after this decision was taken. Given the timing of the production of the Fourth Plan, the mission reached agreement with the Government to review the strategy document for the Plan during loan processing, rather than the Plan itself. The Loan Commi.ttee suggested that the review focus particularly on exports, in view of their importance for economic recovery. The review resulted in a letter from the Minister of Finance to the President dated August 23, 1978 (attached as Annex 1) detailing export potential, targets and policy measures and intentions. Formal negotiations were brief, and Board presentation on rlovember 7, 1978 came six months after the return of the appraisal mission. The Government moved with unprecedented speed after loan signature and enabled the Bank to declare the loan effective within a week. Loan Objectives and Features 2.05 The broad objEctives of the loan can be summarized as follows: (a) provide a rapid resource transfer to Turkey, to help fill a large foreign exchange gap projected for 1979, and hence permit Turkey to maintain essential imports; (b) help increase capacity utilization in agriculture and industry, and hence sustain output and employment; this would also help permit the Government to implement its stabilization program and medium-term policies; (c) support policies and actions necessary to achieve the planned major increase in exports, and meet part of the import needs of exporters; and (d) help Turkey to increase other inflows of medium- and long-term external capital. 2.06 Allocations; The $150 million loan was allocated among four categories, as described below. Eligible commodities were spelled out in some detail in Categories l(a) and 4, fertilizer raw materials and industry. The Government and Bank further agreed that reallocations from the Industry category to the others would be considered, but not those in  - 20 - the reverse direction, thus emphasizing the priority within the loan of agriculture, spare parts and imports for exports. To ensure adequate balance between public and private sector uses, the Bank required and the Government agreed that not less than $50 million of the loan would be used to finance direct imports by private sector firms. 2.07 The loan was allocated as follows: 1. Agriculture $40 million (a) Materials for production of fertilizers (b) Plant protection chemicals and their raw materials 2. Spare parts for manufacturing industries and for crop-spraying aircraft $20 million 3. Raw materials and intermediate inputs to be imported under the Import for Export Promotion Scheme $30 million 4. Industr $60 million (a) Steel (b) Copper (c) Aluminum (d) Petrochemicals and chemicals 2.08 There were two other noteworthy conditions of the loan, both related to exports; (a) the Government undertook to allocate foreign exchange, earned using the Import for Export Promotion Scheme, to replenish the Scheme, in amounts equal to the actual financing of imports under the program loan; and (b) disbursements after April 30, 1979 - almost six months from loan signature and effectiveness - were made conditional on a mutually satisfactory exchange of views on export policies and any necessary changes in them to achieve the Government's export targets.  - 21 - III. IMPACT OF THE LOAN Background - Economic Developments in 1979 3.01 Major indicators of economic developments in 1979 are compared with those for 1978 in Table 1 below. Table 1: Selected Economic Indicators, 1978-79 1978 1979 (% p.a.) GDP growth 2.9 -0.9 Agriculture 2.7 2.8 Industry 6.6 -5.6 Other 4.1 0.2 (US$m) Current Account Deficit -1710 -1771 Merchandise Exports 2288 2261 Merchandise Imports 4599 5069 Interest (net) -680 --930 Workers' Remittances 983 1694 In 1979 GDP stagnated, particularly in the industrial sector due to severe shortages of imported raw materials and energy. In agriculture, further growth was held back by a sizable decline in production of industrial crops, mainly cotton, aind a bad olive crop; the area cultivated declined, due to shortages of fuel and fertilizers which mostly have to be imported. On the external account, there was a marginal decline in the value of recorded exports of goods, although in volume terms, exports actually declined by an estimated 16 percent. The value of merchandise imports was about 10 percent higher than the previous year; but due to substantial price increases, the volume is estimated to have declined by 7 percent. Severe import rationing therefore continued. Turkey achieved some success in diversifying the sources, and increasing the level, of M&LT commitments. Perhaps the most important arrangement arrived at was the May 1979 OECD sponsored pledging of $1.45 billion in special assistance, including about $900 miLlion in M&LT bilateral credits and export credits, besides $407 million of medium-term credits from commercial banks (finalized in September 1979). However, actual capital inflows were about the same as the previou; year, and despite the largest debt rescheduling operation anywhere, net arrears of about $500 million emerged. 3.02 The balance of payments outcome in 1979 was somewhat different from expectations at appraisal, especially on capital account. Exports fell $250 million short, while imports exceeded expected levels by $250 million. Since workers' remittances quite unexpectedly were $600 million above projected levels, the current account deficit turned out to be very close to the projected 'l.85 billion. On capital account, public M&LT  - 22 - gross disbursements were $400 million above expectations, thanks to OECD special aid and debt relief. However, there was a major shortfall in coummercial inflows, and as mentioned above the Government was forced to accumulate further arrears. 3.03 In January 1980, when all but a few million dollars of the Bank's Program Loan had been disbursed, a new government launched a more radical program, going beyond stabilization and including measures which initiated far-reaching institutional changes needed to bring about changes in the structure of the economy over the medium term. Balance of Payments 3.04 Relation to Total Imports; Although disbursements of the program loan were completed only in March 1980, $143.7 million (or 96 percent) of the $150 million loan was disbursed during calendar 1979. Given the data available, and for convenience of analysis with the risk of only minor error, the use made of the whole $150 million loan is here compared with figures for calendar 1979. 3.05 The program loan financed about 3 percent of total imports in 1979. This was a slightly higher share than the original expectation of 1.6 percent of total imports in 1978 and 1979 together mentioned in the President's Report (the import level of 1979 was 10 percent higher than 1978). 3.06 In the absence of the loan, it is likely that total imports would have been reduced to some extent; there might also have been a larger buildup of arrears. 3.07 Imports of Eligible Items; The Bank made a considerable effort to identify high-priority commodities for financing even within Turkey's already stripped-down import program. Imports for 1978 and 1979 together were projected at appraisal at $9.3 billion. Petroleum products and finished fertilizers were excluded on policy grounds. Thereafter high-priority items were selected for which about $1.2 billion in imports were foreseen and actually made in 1979. The loan thus financed about 12 percent of these imports. 3.08 The President's Report noted that commodities were selected, and allocations proposed, on the basis of the following criteria; high direct and indirect multiplier effects on utilization of installed capacity in the user sectors; direct or indirect export impact; a balance between public and private sector beneficiaries; acceptable methods of procurement; and rapid loan disbursements. The method used was to apply these criteria to lists of high-priority commodities suggested by the Government from within the already-restricted total import program for 1979. The Bank reviewed available input-output and other statistical data as well as the direct import requirements for exported goods. Specific information from a sample of significant suppliers of important materials for further agricultural/ industrial processing and from potential exporters was also evaluated. In  - 23 - the absence of sufficieintly detailed data, the selection was necessarily based in good part on information regarding recent performance and short-term prospects for capacity utilization and exports. The allocations took account of production projections, the current stock situation and import pipeline, and tbE piss'ble availabili'v of external financing to cover part of the deman' 3.09 The reasons for all this effort were basically two. The first was to maximize the impact of the loan, particularly its impact on capacity utilization and exports. The second was the desire to ensure that these high-priority needs would definitely be met, if eventually not enough foreign exchange became available to finance the entire import program. It could perhaps also be argued that the Bank was not in a position to pronounce on the merits of the whole import program, and therefore needed to protect itself by selecting specific items. However, there are several arguments on the other side of the question. Firstly, the Bank was convinced of and endorsed the appropriateness of the criteria by which the Government was compressing the high import programs of previous years (particularly 1977) to match foreign exchange availability. Secondly, to the extent these items were really high-priority ones, the Government would have attempted to provide for their import even if there had been an overall shortage of foreign exchange for the program. Thirdly, even though Turkey's room to manoeuvre was quite limited, and its free foreign exchange receipts from exports and workers' remittances were almost fully committed to debt service and petroleum and military imports on cash terms, the fungibility of money cculd mean that the Bank was ultimately financing the marginal imports which the existence of the program loan made possible. In that case, the contribution of the loan should be measured by the other activities made possible by the foreign exchange it released. These arguments are impossible to resolve fully. However, what is clear is that the loan actually financed the import of high priority items, including some like fertilizer raw materials where the timing of imports is crucial. Also, there is no reason why the program loan should be singled out as the marginal source of funds from the viewpoint of Turkey's whole balance of payments. Nevertheless, it seems reasonable to conclude that the effort at commodity selection was greater than really necessary. 3.10 In the event, actual imports financed did not precisely match the original expectations. The original and final allocations of the proceeds are compared in Table 2. Table 2: Loan Allocations Original Final ------($ million)------ 1. Agriculture 40.0 57.2 2. Spare Parts 20.0 13.2 3. Imports for Exports 30.0 36.6 4. Industry 60.0 43.0 150.0 150.0  - 24 - 3.11 There was a formal reallocation of loan proceeds towards the end of the disbursement period, when it proved difficult to assemble the needed documentation on the many small private sector purchases of spare parts. Financing of fertilizer raw materials was unexpectedly large at S46 million. Industry served as the residual category as anticipated. 3.12 The share of imports in 1979 of major eligible items for agriculture and industry financed by the program loan ranged from 3 percent for chemicals and 5 percent for (iron and) steel to as much as 38 percent in the case of fertilizer raw materials and higher shares for blister copper and aluminum (Table 3). Figures for total imports of spare parts and total imports for exports were impossible to obtain. The figures may be compared to the original expectation of an average of 8 percent of imports of eligible items over 1978 and 1979. No average can be constructed from the actual numbers, as complete information could not be obtained. However, the unforeseen rise in oil prices in 1979 led to a considerable squeezing of non-oil imports. As a result, the program loan assumed greater importance than originally expected in the financing of imports of the eligible items, especially the important inputs to agriculture. Table 3: 1979 IMPORTS AND THE PROGRAM LOAN Imports under Total Financed by Program Loan Imports /1 Program Loan ------($ million)----- --(percent)- 1. Agriculture 57.2 184.3 31.0 (a) Fertilizer raw materials (45.6) (118.6) (38.4) (b) Plant protection materials (11.6) (65.7) (17.7) 2. Spare Parts 13.2 n.a. n.a. 3. Imports for Exports 36.6 n.a. n.a. 4. Industry 43.0 895.7. 4.8 (a) Steel (17.7) (347.3) /2 (5.1) (b) Copper /3 (3.0) (3.6) (83.3) (c) Aluminum (8.2) (19.8) (41.4) (d) Petrochemicals and chemicals (14.1) (525.0) (2.7) Memo Item; Total 150.0 5,069.0 3.0 /1 Of eligible items. /2 Iron and steel. 73 Only blister copper. 3.13 Without the loan, however, it is likely that Turkey would have attempted to maintain the level of its imports of the eligible items, since they were of high priority and also since other sources of financing were available for some of them. It is clear that this could only have been done at the expense of other imports of lower priority and for which finance was harder to come by.  - 25 - Exports 3.14 In his letter to the President of August 23, 1978 (attached as Annex I) the Minister of Finance emphasized the importance the Government placed on export growth. Its objective was for the volume of merchandise exports to grow by more than 15 percent per annum during 1979-83, with agri-1 7ttral -xn\rts growing 1y c percent and man',factuled exports by over 30 peicent j)et ainum in volume. The lKiaister desc-ibed the financial, administrative and institutional measures to be gradually introduced whereby the Government intended to promote exports. Of these measures, the following were implemented in 1979; (a) Simplification of the Temporary Import Regime, which governs imports for re-export, and other administrative procedures affecting exporters; (b) Revision of the rules governing direct foreign investment, to permit foreign participation of up to 100 percent in projects which are primarily export-oriented; (c) Modification of the agricultural price support policy, to give less emphasis to income support, and more to encouraging the production of exportable (or import-substituting) commodities. To this end, support prices began to be announced earlier than previously. 3.15 Some of the measures mentioned in the Minister's letter were not implemented during the loan disbursement period. These were: (a) The proposed export risk insurance scheme; (b) The proposed national export promotion center; (c) Special incentives for large-scale export projects were not introduced, although all export-oriented projects were accorded various special investment incentives (see also para. 3.9, 2(c)); and (d) Export targets were specified for SEEs and Agricultural Sales Cooperatives in the 1979 Annual Program, but there was no monitoring of performance. 3.16 On the other hand, a number of export promotion measures not explicitly mentioned in the Minister's letter were implemented in 1979. The most important of these were: 1. Financial Measures: (a) The lira was devalued in April and again in June 1979, adjusting the exchange rate from 25 per US dollar to 47 per US dollar;  - 26 - (b) A foreign exchange retention scheme was introduced. Exporters of minerals and manufactures were allowed to retain first 25 and then 50 percent of their foreign exchange earnings, to finance either their own or their subcontractors' import requirements. This replaced the Export Promotion Foreign Exchange Fund, which the Government was unable to replenish satisfactorily under conditions of extreme foreign exchange scarcity. This measure has had a substantial favorable impact on industrial exports; (c) In order to increase Turkish foreign exchange earnings in the overseas contracting market, the Government, in conjunction with the leading commercial banks, established a risk fund to overcome the difficulties which Turkish firms experienced in posting performance bonds of the size required in bidding for large contracts; (d) Priority was given to exporters in the allocation of foreign exchange for the purchase of imported inputs both for export production and, up to a prescribed limit, for the production of essential goods for domestic sales; (e) Special permission was given to exporters to finance their import requirements through acceptance credits and the Central Bank was authorized to discount such bills; (f) Higher priority was given to exporters than before in the allocation of commercial bank credit, and the commercial banks are required to allocate at least 5 percent of loan portfolio to export credit; (g) Interest rate rebates on domestic borrowing by exporters were increased in May 1979; (h) Tax rebates on exports were restructured in June 1979 to give more emphasis on value added in production; the revised rebates ranged from 5 to 35 percent depending on commodity. 2. Administrative Measures: (a) An inter-ministerial Export Coordination Committee was set up to resolve some of the administrative problems of exporters; (b) Exporters were provided certain locally produced inputs (so far only cotton yarn) at world prices; (c) Investment incentives were changed in 1979 so that projects in certain fields only received incentives if exportoriented.  - 27 - The emphasis given to export growth in the Plan document was, therefore, generally followed through in terms of policy changes. It should be noted that the consensus of Government officials interviewed was that the existence of the program loan and of the policy dialogue on exports made no diffference to the policies the Government actually followed. 3.17 The prescribed review of export policies was conducted in April 1979 in conjunction with the Special Economic Mission. The review report (attached as Annex II) discussed the measures implemented to promote exports, as well as important policy actions undertaken to improve the current economic situation. The review concluded that in the mission's opinion, "the Government has been successful in arousing, for the first time ever, widespread awareness of the need to export," and that the mission was "encouraged with the initiatives of the Government regarding export promotion". The continuation of disbursements was therefore approved. 3.18 Export performance in 1979 was disappointing, despite the measures outlined above. In volume terms, exports declined by 17 percent from the 1978 level, and in value by 1 percent from $2288 million to $2261 million. They were adversely affected by unfavorable relationships between export prices and domestic prices, and in particular by uncertainty regarding the exchange rate and its belated adjustment. While the Turkish lira was devalued from TL 25 = US$1.00 to TL 47 = US$1.00 between April and June, the competitive advantage offered was quickly offset by continuing sharp increases in domestic prices, which rose by 65 percent in 1979 and even faster towards the end of the year. Shortages of material inputs and rising costs of domestic materials also adversely affected exports and export profitability. Agricultural exports, which comprise about 60 percent of the total, declined particularly sharply (about 13 percent in value) despite a 1.8 percent increase in agricultural value added. They were adversely affected by a weakness in external demand, particularly for cotton and tobacco, EEC restrictions and a general lack of incentive for producers to seek markets abroad because internal prices of many agricultural products increased much faster tnan export prices. Inappropriate pricing policy also contributed to the sharp decline in cereal exports. An additional factor contributing to the decline in agricultural exports was the shortage of fuel and fertilizers, which resulted in a sizeable decline in the output of certain crops, particularly tobacco. Manufactured exports, on the other hand, grew by 24 percent in value in 1979, compared to only 6 percent in 1978. This was achieved despite a decline of 5.9 percent in manufacturing value added in 1979, which was caused by shortages of imported raw materials and energy which severely disrupted production. This performance of manufactured exports can be attributed in part to exporters' response to incentive measures, and in part to industrialists' increasing realization that, in present conditions, they must earn their imported requirements through exports. 3.19 Assessing the impact of the $36.6 million of the loan used for imports for exporters is difficult, especially since the import content of exports is not known with any precision, and the Government was unable to provide detailed information relevant to this assessment. However, a rough  - 28 - calculation can be made. It may be assumed that the loan financed inputs only for industrial exports. These totaled $785 million in 1979, but $378 million were textiles with very low import content, and another $151 million were processed agricultural products presumably of domestic origin. Thus the loan contributed essentially to some proportion of the remaining $256 million worth of industrial exports. If it is assumed, as is reasonable, that the average import content of those exports was between 25 and 50 percent, the loan may have helped finance between 28 and 56 percent of relevant industrial exports in 1979. This conclusion must be qualified, however: during the life of the loan, the Import for Export Promotion Scheme under which imports were financed was superseded by the foreign exchange retention scheme (para. 3.16, l(b)). Before this happened, the contribution of the loan may have been even larger than suggested by the above figures. Afterwards, the loan would still have been important for meeting the needs of existing exporters above the retention quotas (first 25 and later 50 percent). In addition, it may well have been crucial in meeting the import needs of first-time exporters. Output and Capacity Utilization 3.20 Since the program loan financed such a small proportion (only 3 percent) of total imports in 1979, its impact on total output while surely positive is practically impossible to estimate, requiring detailed assumptions about the level and composition of imports in its absence and a reasonably up to date input-output table, neither of which is available. The period of disbursement of the loan happened to be one in which the economic situation was deteriorating: real GDP growth in 1979 declined by 0.3 percent; and capacity utilization in industry as a whole could not be prevented from falling from 56 percent in 1978 to 45 percent in 1979, according to the best estimates available. The volume of imports fell by 19 percent in 1979 despite the disbursements from the program loan, and imported stocks were already very low. Therefore only a rather negative assessment can be made, namely that without the program loan, the outcome for 1979 would clearly have been somewhat worse. 3.21 The experience of industries using items imported under the loan is set out in Table 4 below; Table 4: OUTPUT AND CAPACITY UTILIZATION Capacity Production ('000 Tons) Utilization (x) 1978 1979 1978 1979 Fertilizers 486 635 32.4 42.4 (a) Nitrogenous 271 356 31.7 42.4 (b) Phosphatic 213 273 33.1 42.1 Plant protection chemicals 28 26 38.4 34.8 Steel 3,138 3,252 50.0 57.0 Copper 26 23 38.1 33.4 Aluminum 32 32 53.8 53.6 Petrochemicals & other chemicals 94 97 50.0 41.0  - 29 - 3.22 From this Table, it is clear that the performance of the fertilizer industry was exceptional in 1979, in that not only did its production increase, but also its capacity utilization improved from 32 percent in 1978 to 42 percent in 1979 as the Government accorded it high priority. This improvement was common to the production of nitrogenous and phosphatic fertilizers. The program loan contributed significantly to this development, financing some 38 percent of total imports of fertilizer raw materials. Production of plant protection chemicals declined somewhat in 1979, with capacity utilization falling from 38 to 35 percent. It is likely that without the program loan financing of 18 percent of total imports of plant protection chemicals and their inputs, this performance would have been worse. The same is true for metal industries; production of copper declined, and the rate of capacity utilization deteriorated from 38 to 33 percent. The aluminum industry repeated its 1978 performance. Steel output was somewhat better and capacity utilization also increased, this being another industry accorded high priority by the Government. The petrochemical and chemical industries increased their output, but their rate of capacity utilization declined sharply as new units came on stream. At first sight, it may seem as if without the program loan, the 1979 performance of these industries would have been worse, in strict relation to the shares of their imports financed by the loan. However, this analysis is vitiated by the likelihood, mentioned above, that in the absence of the program loan, the Government is most likely to have attempted to maintain imports for these high priority subsectors at the expense of others. Thus no definite conclusion can be reached at broad industry levels, other than the one provided above. 3.23 It may be more feasible to assess the impact of the loan at the firm level. The experience of the 3 public--and quasi-public (Erdemir)--and 4 private sector firms interviewed, which together handled the procurement of $81 million or 54 percent, and actually used $51 million or 34 percent of the loan, is summarized in Table 5 below; Table 5: BENEFICIARIES' PRODUCTION AND CAPACITY UTILIZATION Capacity Volume of Output Utilization % of Imports 1978 1979 1978 1979 Financed by -----(tons)----- -----%----- Program Loan Public Sector and Quasi-Public Azot Sanayii (N fertilizer) 498,000 565,000 53 52 43 Petkim (petrochemicals) n.a. 85,256 n.a. 63 21 Erdemir (steel) 706,702 718,062 n.a. 62 n.a. /1 Private Sector Trafosan (transformers) (MVA) 193 208 32 35 18 Koruma Tarim (plant protection) 7,506 11,532 22 24 23 Nasas (aluminium products) 14,534 11,444 76 60 58 Kordsa (nylon tire cord) 6,913 6,511 49 47 12 /1 The loan financed close to 100 percent of Erdemir's imports other than iron ore and coal.  - 30 - 3.24 For individual firms, the program loan often made a significant difference. One private sector firm felt its imports would have declined by an equivalent amount in the absence of the loan, as suppliers had strictly limited their acceptance credits which finance the balance of its imports. On the other hand, another noted it would have relied on a combination of methods to largely substitute for the loan. In any case, individual firms (perhaps particularly exporters) could perhaps have received other foreign exchange in lieu of the loan, and their high-priority industry would probably have received some even if the individual firm had not. Public and Private Sector Balance 3.25 Private sector firms finally received a total of $89 million, in part through direct purchases and in part via public sector companies which, until near the end of 1979, were given a monopoly of imports of steel products and certain petrochemicals. Fertilizer raw materials were also bought by the public sector fertilizer company, but as a matter of convenience requested by the Ministry of Finance, not by statutory authority. Periodic representations by large private firms in Turkey, to the effect that the private sector was being kept from benefiting from the loan, appear to have been unjustified, although it is true that domestic market- and non-agriculture-oriented industries received little from the loan. Use of Counterpart Funds 3.26 The loan agreement provided for the Government to use the counterpart funds to help finance the local currency portion of capital expenditures on development projects included in its investment budget. During the loan disbursement period, the Government informed the Bank that it would allocate the entire counterpart to local currency expenditures on the Elbistan lignite mine and power station project, the highest-priority project in Turkey and partly financed by the Bank (Loan 1023-1 TU and 1023-2 TU, dated June 28, 1976, for $123 million and $25 million, respectively). This project was advancing very slowly despite its overwhelming priority, largely because the Government simply could not find sufficient local currency to keep up the pace of construction. 3.27 In practice, the arrangements made were more complicated. The total of TL 3,990 million in counterpart funds was allocated to the electricity authority (TEK) building the power station. TL 1,490 million was a straightforward budget allocation. The remaining TL 2,500 million was a part payment to TEK of large overdue payments from municipalities, for which the Treasury had agreed to assume responsibility. 3.28 TEK then used the funds, under an informal agreement with the Treasury, to increase its local currency expenditures on Elbistan and on two other high-priority power projects, Soma and Yatagan. The TL 4.0 billion in counterpart funds financed 26 percent of TEK's 1979 local currency investment program of TL 15.7 billion, of which TL 2.5 billion for Elbistan, TL 4.1 billion for Soma and TL 1.2 billion for Yatagan. For these three  - 31 - projects, the contribution of the loan was 51 percent. Bank supervision missions have reported that these infusions led to a considerable improvement in the pace of implementation of Elbistan, and the other two projects were also among the few large projects in Turkey which moved ahead during this period. Although local currency resources may be more fungible than foreign exchange, the absolute resource scarcity was such that it is reasonable to conclude that the objective of the counterpart funds provision was attained. IV. IMPLEMENTATION ARRANGEMENTS Reporting on Export Performance and Policies 4.01 While the technical targets of the loan were achieved, and in some respects exceeded, SPO's quarterly reports to Turkey's Higher Planning Council to enable it to make policy decisions on improved export performance, and which were to be submitted regularly to the Bank, were not received. To that extent, this covenant was not observed. On the other hand, it appears that the main reason was that the Council did not meet regularly. Instead it responded to developments as they occurred, and the concerned Ministries then took actions. Therefore, the Government instead communicated information on relevant matters to Bank staff from time to time, and in particular to the Special Economic Mission in April 1979. Procurement 4.02 Imports were to be made directly by actual users, except for steel products and certain petrochemicals where import by SEEs for domestic resale was prescribed by law zit the time. Bulk imports by public sector enterprises costing $1 million equivalent or more were to be procured through international competitive bidding (ICB) procedures consistent with Bank Guidelines. Imports contracted by public sector enterprises for industry and agriculture and costing between $250,000 and $1 million equivalent, and other import contracts costing $250,000 or more were to be procured on the basis cf competitive evaluation of at least three offers from major suppliers in. Bank member countries and Switzerland. Contracts for $250,000 or less were to be awarded under normal procurement procedures of the public and private sectors. Spare parts were to be procured on the basis of either competing offers, or negotiation, depending on the number of potential suppliers and the need for compatibility with existing equipment. These sets of procurement procedures were intended to permit rapid disbursement in support of the loan's objectives, and still help somewhat widen the procurement sources of some Turkish firms that are closely tied to traditional suppliers, and therefore give Turkey the benefit of the access to suppliers who might be able to supply the inputs more competitively. Further, to speed loan withdrawals, the Bank in the case of contracts of $1 million equivalent or more, was to receive a description of the advertising  - 32 - and tendering procedures as 4ell as of the contracts only after they were awarded, and in other cases only copies of the contracts after their award, i.e. prior Bank review of contract award was waived. 4.03 With hindsight, simpler procurement provisions--especially regarding large import contracts placed by public enterprises--would have had no adverse impact, as Turkish public sector procurement practice is reasonably efficient and economic. In the event, the loan provisions caused a large proportion of the supervision problems experienced and involved considerable Bank manpower input. Firstly, the loan brought a wide range of public enterprises into contact with Bank procurement requirements for the first time, involving both the Treasury and the Bank in efforts at education, including a procurement seminar held in Turkey and covering also Bankfinanced projects. Secondly, the search for rapid disbursements led to the Goverment submitting many contracts, some based on bidding held prior to the loan, which required much flexibility of interpretation by the Bank and on occasion the granting of exceptions. Some of these cases involved eligible commodities with standard specifications for which international market practice is to request quotations by telex from the relatively small number of potential suppliers' firms; the replies are almost immediate and the price options expire within a few days. The Turkish experience suggests that formal ICB is unsuitable for procuring such commodities. 4.04 The existence of the loan was advertised in newspaper reports and by the normal publication of the loan agreement in the Official Gazette. However, many private firms remained unaware of it for a long time, and finally the Treasury had to contact firms both directly and through two development banks to encourage applications. Disbursements 4.05 When the loan was made, disbursements were expected to begin almost immediately and be completed within one year of loan effectiveness. They were to involve reimbursement by the Bank (disbursement procedure 1) of amounts already paid by Turkey from its own resources. Previous Bank program loans had worked this way, and Controller's Department stressed its convenience for the Bank in terms of both rapid disbursements and minimum paperwork. No special problems were anticipated, and the Bank rejected the Government's unusual request for an advance payment of part of the loan to facilitate the start of disbursements. 4.06 However, actual disbursements did not begin for three months. Thereafter over 90 percent of the loan was disbursed in nine months, and disbursements were completed sixteen months after loan signature. The Government faced major problems throughout the disbursement period. In the first place, it had not made clear to the Bank the extreme tightness of its day-to-day cash position in foreign exchange. As a result of the collapse of its creditworthiness vis-a-vis foreign banks, the latter would only confirm Turkish letters of credit if backed 100 percent by cash, a condition  - 33 - which soon tied up all Turkey's foreign exchange reserves. The Government could not afford the wait between its own payment and even rapid reimbursement by the Bank under the program loan. 4.07 After a delay and with some difficulty, the Government was able to arrange 40 day bridge financing with the Banca Commerciale Italiana (BCI) in New York and the Deutsche Bank (Germany), with limits of $20 million (later raised to $30 million) and $10 million equivalent respectively. These arrangements provided the initial financing for some $100 million out of the $150 million worth of imports under the loan. Without them, disbursements would hardly have been possible given Turkey's circumstances. Even so, the relatively low limits several times forced a halt to commitments and limited the possible pace of disbursements. 4.08 Another $30 million in purchases under the loan were financed either by direct Bank payments to suppliers or via Bank qualified agreements to reimburse. Only some $30 million was initially financed from Turkey's own resources, mainly miscellaneous small orders for spare parts and imports for exporters. 4.09 The Bank and BCI, the main bridge financing bank, had to provide weekly statements to enable the Treasury to monitor its commitments. Furthermore, the low bridge financing limits led the Government to request the Bank's informal approval of every sizeable contract prior to either signature or its formal submission under the loan. 4.10 Apart from these difficulties, it took some time for Turkey to establish adequate internal procedures. The loan was handled by the Central Bank's Consortium Section, since it already had experience with earlier program loans extended by members of the OECD Consortium for Turkey. Within the section, two people worked on the loan, although as other program (and project) loans were made during the period, one was sometimes detached. The Central Bank and Treasury staff had to be educated in Bank procedures, and Controller's Department provided considerable technical assistance. Obtaining the documents required by the Bank proved most difficult in the case of private firms. The Central Bank was somewhat passive, waiting for commercial banks to respond to two circulars; the Treasury stepped in to provide active follow-up, and every Bank mission returning to Washington brought more documents. 4.11 Turkey's foreign exchange scarcity was clearly of exceptional severity, leading to great difficulties in applying procedures used successfully in nearly all previous Bank program loans. Had the Bank been made better aware of the day-to-day situation, it might reasonably have decided to advance a portion of the loan to facilitate start-up, as done on occasion by Germany in its earlier program lending to Turkey.  - 34 - V. CONCLUSIONS 5.01 The program loan achieved three of its four objectives (paragraph 2.5), namely to provide a rapid resource transfer to Turkey, to help increase capacity utilization in agriculture and industry, and to support export policy changes and finance exports directly. There is no direct evidence that the existence of the loan helped Turkey to attract other inflows of medium- and long-term external capital, but it may have contributed to the willingness of other donors to assist Turkey during these periods. 5.02 The loan made a modest but useful contribution to alleviating Turkey's balance of payments difficulties in 1979, financing 3 percent of total imports and about 12 percent of imports of eligible items. It financed a considerable proportion of total imports of fertilizer raw materials, where the timing of imports was also an important factor, and was a major source of financing also for plant protection chemicals, copper and aluminum. It was also important for some of the firms assisted, although others could have obtained financing from other sources for their needs. 5.03 The time spent on determining commodity allocations was natural and a learning experience for both the Government and the Bank in their first program loan. However, it was probably excessive given that the Bank had confidence in the import program as a whole, and given that money was fungible to some extent even in a situation as difficult as Turkey's. 5.04 The loan was made in support of Government policies to promote exports. A large number of financial, administrative and institutional measures was taken during the disbursement period, only some of which were anticipated in the letter from the Minister of Finance. However, exports could not be expected to respond immediately. In fact export performance in 1979 was disappointing, with the volume of agricultural exports and of total exports declining substantially and export value barely maintained. This occurred partly for reasons outside Turkey's control. Where performance was amenable to policy, it was not always export policy--on which the policy discussions focused--which was relevant; for example, agricultural pricing policies may have been responsible for a significant part of the poor performance of agricultural exports. As for export policy, the consensus of Government officials interviewed was that the existence of the program loan and of the policy dialogue on exports made no difference to the policies the Government actually followed. It may be, however, that the Bank's concentration on this topic made the Government think somewhat more about it, and that the dialogue provided an agenda and put matters in focus. 5.05 The procurement and disbursement problems described in paras. 4.02-4.04 and 4.05-4.11 respectively made this first program loan to Turkey  - 35 - a source of considerable! supervision effort for the Bank departments involved. The amount of consultation required on exceptional or unusual procurement cases, and the extra correspondence required to ensure fulfillment of routine clisbursement requirements, were the price the Bank paid for a learning process on the part of the Government and Central Bank. However, part of the problem was self-inflicted, in that the procurement stipulations appear to have been too restrictive, even for a first program loan, because of Turkey's circumstances and its own procedures. On disbursements, the Government was reluctant to reveal to the Bank the dire nature of its day-to-day foreign exchange problem. On the other hand, the Bank was insufficiently sensitive to the problem. Instead, it repeatedly criticized Turkey for failing to disburse the loan sufficiently rapidly, when in fact the situation was so difficult that foreign banks were refusing to accept Turkish letters of credit backed by the Central Bank. Agreeing to the advance of funds initially requested by the Government might have made all the difference. VI. LESSONS LEARNED AND APPLIED IN SUBSEQUENT LOANS 6.01 Loan Allocations: Since circumstances and priorities did not change significantly in 1979, and the basic work of identifying high-priority imports had been done under the program loan, commodity allocation under the subsequent Structural Adjustment Loan (1818-TU, dated March 26, 1980) was much simpler. Besides a confirmation that priorities had not changed, the financing of spares and of imports for exporters was discontinued in view of other arrangements proposed by the Government for these items. In the Structural Adjustment Loan (Supplement), commodity allocation again reflected a continuation of the same priorities, while some additional flexibility was given to the Government by specifying only broad groups of commodities. 6.02 Procurement; Procurement procedures for the Structural Adjustment Loan were modified to take into account the problems encountered in the first operation, namely the excessive level of manpower expended in supervision of procurement actions, the nature of procurement problems encountered and the types of commodities procured, for which international market practice differs substantially from the Bank's conventional ICB procurement procedures. Reflecting the Bank's increasing insight into Turkish public sector procurement practice, which proved to be reasonably efficient and economic, the minimum size of contracts for which Bank ICB guidelines are applicable was raised to $5 million. For contracts below $5 million, procedures were simplified and required that awards should be made on the basis of the normal procurement procedures of the purchaser. For widely traded commodities, contracts could be awarded on the basis of price quotations available from organized international commodity markets. 6.03 Disbursements: Despite the experience under the program loan, the Bank did not provide an advance to the Government under the Structural Adjustment Loan. This was partly because the Government made no such request, partly because the Bank staff believed that bridge financing  - 36 - arrangements were now adequate. In the event, there were again disbursement delays, although less serious than under the program loan, because of the extremely tight foreign exchange position of the Central Bank, continued restrictive limits on bridge financing available from commercial banks and the 100 percent cash coverage of letters of credit required by foreign banks. By the time of the Structural Adjustment (Supplement) Loan, the need for the Bank to provide an advance appeared to have been obviated due to an enlargement of the bridge financing limits.  - 37 - T. C. MALIYE BAKANLI(I ANNEX I ANKARA Page 1 HAZMiIT DUnya Bankasi Pr. D. Soyg 56908 4 7 49 Konu : August 23rd, 1978 Dear Mr. McNamara, The Governoment of Turkey, in order to maintain a rapid pace of economic development, while avoiding the type of balance of payments problems encountered recently, has decided to place a much greater emphasis on export promotion in the Fourth Five Year Plan (FFYP) than in earlier plans. The implications of this change of emphasis are discussed at length in the Fourth Plan Outline Strategy, a copy of wbich has been provided to the bank, and will be spelt out even more fully in the Plan itself, which is expected to be submitted to Parliament in October. In this letter I hope to provide a concise statement of the Government's main targets and policy intentions. Specifically, the target for 1983, the last year of the YFYP, is that merchandise exports will attain a level of more than i 5-billion in 1978 prices,representing an averame annual growth over the Plan period of more than 15 Dercent in real terms. This should be compared with the real annual export growth of around 6 percent during 1970-1977. The principal feature of the export drive is expected to be Jn average real increase of over 30 percent per annum in exports of manufactured goocs, whose share in total exports is expected to rise from 32 percent to 62 percent over the Plan period. AGricultural exports are expected to increase in real terms at about 5 percent annually. In the first two or three years of the Plan period, the planned increase in manufactured exports will be brought about mainly.through fuller use of existing capacity in the food, textiles, leather products. wood products, and road vehicles industriec: and through diversion from domestic unc of the products of the ccment, ccramics and rlans industries as a rcsult of slack demand in thc construction soctor. In addition, during 1978 and 1979 new factories presently under construction will go into production in the food and bevcrage, wood products, .and  - 38 - ANNEX I Page 2 leather products industries. In the latter part of the Plan period, manufactured exports, particularly in the machinery, electrical equipment and transportation equipment sectors, will further increase as a result of the completion of new export-oriented investmcnt projects. The Government believes that this high export growth rate is feasible given the initially low level of Turkish exports but it recognises that achievement of this target will require vigorous implementation of appropriate policy measures and careful monitoring of performance throughout the Plan period. To achieve the planned export targets, the Government intends to make exporting more profitable than selling in the domestic mark.et. This will require measures to ensure that 'Turkish exports are cost ana price-competitive in world markets, and an appropriate response to divergencies between the rates of inflation in Turkey and in her trading partners. It will also require that protection of the domestic market through duties and quantitative restrictions on imports be maintained at a level such that domestic sales are not made unduly profitable relative to exports. In addition, the Government intends to maintain and develop the various financial incentives it presently provides to exporters to the extent consistent with prudent management of the public finances and with the General Agreement on Tariffs and Trade. In addition to the export encouragement measures contained in the stabilisation program introduced earlier this year, the Government has recently implemented a number of measures to promote exsorts. Export rebates have been increased. A scheme has been implemented whereby exporters and their domestic suppliers are to be given priority access to scarce foreign exchange for the purchase of imported inputs both for export production and to a limited extent for production for the domestic market. An Export Coordination Council, composed of representatives of several ministries, has been established to speed up necessary administrative decisions, to exarine the problems of exporting sectors, and to recommend appropriate measures. As a result of this Council's work, there has already been a simplification of export licencing and regintration procedures, and a decision has been taken to provide exporters with locally produced inputs such as cotton, leather, and grain at world prices. Exporters have been granted cpecial permission to finance their purchases of imported inputs through acceptance credits. Intorest rate rebates on various types of domestic borrowing by exporters have been increased, as has the degree of priority accorded to exporters in the  - 39 - ANNEX I EAB.e~ 3 allocation, of domestic: credit. The exDort targets of State Economic Enterpriscs and Agricultural Sales Cooperatives are now set in advance, and a cuccoCsful effort is being madc to cxport the existing large stocks of certain agrLcultural commoditiec, particularly whoat. The Goveniment intends to introduce additional mcasures to stimulate exports to whatever extent appears necessary, in the light of further experience, to achieve the planned export targets. The main measures presently planned or under concideration are discussed below. (a) To achieve the planned increase in agricultural exports, the Government will bring agricultural support prices more closely into line with world prices, thus providing a stronger incentive to farmers to produce erportable commodities. Ilore generally, the Government .intends to continue its policy of stimulating agricultural production through increased use of modern inputs and techniques, including irrigation, through better education and extension services, and througn support to cooperatives. In addition, the Government recognises the need for investment and planning to eliminate present storage and transportation bottleneceks, for financial support of market research to identify promising non-traditional export crops, and for financial support of export-oriented production and marketing projects in the agricultural sector. (b) Administrative procedurcs will be further simplified. A study on the bureaucratic delays arising in the implementation of the Temporary Import Regime has been completed with the participation of the Ministries of Customs, Commerce, Finance and Industry. Based on its findings an official decree is due to be published, which would simplify the procedures related tc temporary importation of goods and their re-exportation, and abolish the guarantee deposits required for temporary imports. (c) Control of standards and product quality will be improved. (d) Export insurance schemes which will cover both the creditor and producer are being studied and will be put into effect as soon as possible. (e) A Foreign Trade Institution will be set up which will collect information, undertake market research and act as a means of communication for both public and private sector.  - 40 - ANNEX I Page 4 (r) State Ecc omic Enterprises will bocome more active in increasing exports. SUncrbank for cxanple, har already been asked to try to mcet all export orders; in cascs where it does not produce thc necessary items, it will cooperatc with the private sector to fill te order. (g) Attempts will be made to divernify the comnodities cxported and the markets to which Turkey exports with a rpecial emphacis on mecting the needs of neighbouring countries in the Mdiddlc East. (h) Long term trade agreements will be sought and investment and production will be planned accordingly. (i) Domestic and foreign investments aimed at exports sill be given special facilities. Forcign credit, private foreign capital and foreign technology will be encouraged for the purpose of export expansion. (j) Special incentives will be provided for large scale projects which intend to achieve more than a certain level of exports. (k) The protect exporters from e:change risks, the Central Bank, under a forthcoming decree, will convert foreig- exchange earnings either at thle rate prevailing at the time of actual conversion or at the rate prevailing at the time of export registration, whichever is tlhe more favourable tothe exporter. Since several different ministries and agencies will be involved in implementing the export promotion strategy, overall responsibility will be with the Hligh Planning Council for coordinatinc their various efforts, and for ensuring that the planned export targets are achieved. The Council is chaired by the Prime Minister, whose members include three Ministers chosen by the Council of Ministers, normally the Minister.- of Finance and two others concerned with economic matters, and the head of the State Planning Organisation. The State Planning Organisation is required to submit quarterly reports to the High Planning Council on the implementation of the Plan. These reports will include an account of actual export performance in relation to the targcts established in the Plan and in the Annual Programs, an evaluation of existing export-oriented policy mcasures and of the effectiveness of their implementation, and reco.mcndatioris conoerning changes in policy mcasures. These reports and recommendations will be discussed by the M[igh Plainninmg Council. A summary of the ou-rterly reports nlong with the decisions taken on new pol icV mca',lCO wi.ll be provided qtuarterly for ionfration to the World 1,;nmk ciirrinr tne first eightcen months follOwTnr tnc effectLveness of theC Pro-r;m lyman. The HiM IPlann-ing Couancil wi1Lai turn recomend policy ch:nge to the Cover-nment where thcsc appear necessary to achievo export targets.  - 41 - ANNEX I Page 5 In thin letter it is clearly not possible to spoll out every detail of the Covernmcnt's utratcry to increase Turkey's forciga exchange earning capacity. But thc paragraphs above, I hope, give a fairly concrete imprcsoion of the scriousness of the Governmcnt in pursuin- a vigorous export prcimotion policy, and of the broad targets and the types of measures which the Government intends to pur3ue. With this strateg,y, we believe that Turkey will bc able to achieve high rates of economic growith without encountering serious balance of payments problems. And in this taslk we look forward to a continuiation and extension of our close and valuable relationiship wvith the W4orld Banl;. With personal regards. Yours Sincerely, Ziya l.EzZiJ2 I Minister of Finance The TIonourable Robert S. Mcllamara President The Wlorld Bank Washington, D.C., 204.33 U.S.A.   - 43 - WORLD BANK / INTERNATIONAL FINANCE CORPORATION OFFICE MEMORANDUM ANNEX 2 TOMr. E. Asfour, Acting Director, EMENACPII (Through M.T.Baig, Acting Division Chief, EM2DA) DATE: Ray 2, 1979 FROMS. A. Faruqi, EM2DA SUBJECTTURKEY - Program Loan Discussion 1. During the .cecent visit of the Special Economic Mission to Turkey, mission members (Mes3rs. Faruqi, Thadani and Wood) discussed Program Loan matters with the Government. As per Loan Agreement, by the end of April, the Bank and the Government were to have completed a mutually satisfactory review of the initiatives of the Government concerning export promotion. This brief note, therefore, concerns itself with this matter and also summarizes progress in the implementation of the Program Loan. Allocations and Disbursements 2. As of mid-April, total official allocations of foreign exchange for the import of items authorized under the Program Loan amounted to $175 million. Of this $54.0 million has been requested for reimbursement from the Bank, and about $34 million has been disbursed by the Bank, and the applications for another $7.0 million should be ready for disbursement over the next 7-10 days. The allocations are higher than the Program Loan amount to ensure that enough payment requests, eligible under the Bank procedures, would be available to draw down the loan amount. The excess allocation for imports would be met from Government's own foreign exchange resources under its regular program of imports. Sizeable allocations have been made to the private sector, including; (a) nearly $45.0 million under the Import for Export Promotion Scheme; (b) $19.4 million for materials for plant protection and other chemicals for agriculture sector; (c) about $22.0 million for materials for the production of fertilizer; and (d) about $2.7 million for spare parts. Thus, the total allocations made to the private sector amount to about $89 million, and the remaining $86 million have been allocated to the public sector. Further, the Government estimates that $153.3 million of $175 million allocated has already been transferred or paid for by the Central Bank of Turkey, and foreign commercial banks such as Banca Commerciale Italiana, for which reimbursements from the Bank would be claimed depending upon if the procurement were satisfactorily made under Bank procedures. 3. With regard to actual disbursements, the Government concedes that the necessary arrangements to use the Program Loan did not begin to be effective until mid-February t:his year, and hence during November 1978 -- February 1979, the draw down was very slow. Further, the Government has encountered serious difficulties in effecting the import orders, since the commercial banks involved demand proof of full coverage of letters of credits opened. This has been difficult to a:rrange in view of the serious foreign exchange and payments problems that Turkey is now facing. Moreover, Bank procedures did not permit financing a large chunk of imports currently being obtained on various trade financing arrangements such as cash against goods and acceptance credits, which particularly affected steel imports.  - 44 - ANNEX 2 Page 2 4. The mission discussed these matters with the Government and its view is that after an initial slow start, disbursements are likely to pick-up, provided the Government accords a higher priority to the use of Program Loan funds by guaranteeing the LCs until the reimbursements are secured from the Bank for suitable imports. Further, the mission stressed that since bulk orders are quicker to process and have been particularly helpful in utilizing the loan amount, therefore, the Government should try to move away from small import orders to the bulk ones. To do this the Government will have to suitably readjust the allocation between the sectors; and would have to raise the total allocations to around $200 million to ensure rapid utilization of all the funds in the loan. 5. The Government has agreed to this proposal and in fact has already made a larger allocation to agricultural sector and would increase allocations to petrochemicals in the industrial sector. Under the Loan Agreement, a minimum of $30 million were to be allocated to the Import for Export Promotion Scheme. These allocations are already substantial and would be further increased, though the draw down is likely to be slow, due to a large number of fairly small parties involved. The Government has provided the mission a list of these allocations, which are mainly to the private sector. During May and June, the Government expects further drawings of $42.0 and $47.0 million respectively from the loan. This is somewhat optimistic, though if the Government readjusts the allocations and provides foreign exchange guarantees for the LCs to be used for drawings under the loan, a large part of the loan could be disbursed over the next two months. Export Performance and Policy Developments Performance 6. In 1978, merchandise exports amounted to $2.25 billion, an increase over 1977 of 28 percent in value terms, and about 24 percent in volume terms. Most of the increase was contributed by agricultural commodities; but industrial exports also, after a poor performance in the first half of the years, increased rapidly in the latter part of the year. In the first two months of 1979, the value of both agricultural and industrial exports was about 45 percent greater than in the corresponding period of 1978. In March, however, in anticipation of the latest incentive measures, export receipts declined sharply. Nonetheless, it seems likely that the 1979 export target of $2.75 billion will be achieved. Policy Development 7. Of the various export promotion measures under active consideration at the time of the Finance Minister's letter to Mr. McNamara (August 23, 1978), and mentioned in that letter, several have been implemented:  - 45 - ANNEX 2 Page 3 (a) Export targets for State Economic Enterprises (SEEs) and AgricuLtural Sales Cooperatives have been specified in thie 197' Implementation Program (part of the Annual Program), and SEE employees have been given a financial incentive to surpass these t:argets. (b) The Temporary Import Regime, which governs imports for re-export, has been simplified. (c) The rules governing foreign investment have been revised to permit foreign participation of up to 100 percent in projects which are primarily export-oriented. (d) There has been a shift in agricultural price support policy, with less emphasis being given to income support, and more to encouraging the production of exportable (or import-substitutable) commodities. To this end, support prices are being announced earlier than usual. 8. Some of the measures mentioned in the Minister's letter have not yet been implemented: (a) The proposed export risk insurance scheme is still under preparation by the Ministries of Finance and Commerce, with the assistance of TSKB staff, following a study of comparable schemes in other countries. (b) The proposed Export Promotion Center is still at early planning stage. (c) Special incentives for large scale export projects have not been introduced, although export-oriented projects in general continue to be among those accorded priority in the allocation of certificates of encouragement. 9. On the other hand, a number of export promotion measures not explicitly mentioned in the Minister's letter have been, or are about to be, implemented: (a) In April 1979, the lira was devalued against the US dollar by 6 percent (from TL25 per dollar to TL26.5). (b) More im,portantly, an official parallel foreign exchange market for industrial exporters has recently been introduced. Under this scheme, exporters of minerals and manufactures are allowed to retain 50 percent of their foreign exchange earnings; they may use this either to finance their own import requirements, or they may dispose of it to other industrialists who hold import Licenses at whatever prices are mutually agreed. The  - 46 - ANNEX 2 Page 4 effective exchange rate received by industrial exporters is thus elevated above the official rate by a margin dependent on the disparity between the official rate and the rate prevailing in the (well-developed) unofficial market for foreign exchange. This is expected to have a substantial favorable impact on industrial exports, and thus on production and capacity utilization. (c) In order to increase Turkish foreign exchange earnings in the promising overseas contracting market, the Government, in conjunction with the leading commercial banks, has established a Risk Fund to overcome the difficulties which Turkish firms have hitherto experienced in posting performance bonds of the size required in bidding for large contracts. (d) A decree shortly to be published will remove a number of the main obstacles to exporting posed by the present export licensing and registration system. 10. In addition to the various specific measures mentioned above, it is worth recording that the recent economic mission, after extensive contacts with businessmen and bankers, as well as with civil servants, formed the impression that the Government has been successful in arousing, for the first time ever, widespread awareness of the need to export. Other Economic Policy Measures 11. In addition to the measures with regard to export promotion discussed above, the Government has recently undertaken important economic policy actions to improve upon the current economic situation. These are briefly discussed below: (a) In addition to the 6 percent devaluation of the Turkish Lira mentioned above, a 40 percent premium will be paid on workers' remittances and tourism receipts, raising the rate to TL37.1 = 1.00. A further premium ot TL10 will be paid during April 10 - May 9, which will be reduced to TL5 for transactions during May 10 - June 9, 1979. This would mean an exchange rate of TL47.1 = $1.00 during April 10 - May 9, and TL42.1 = $1.00 during May 10 - June 9, 1979, applicable to worker's remittances and tourism receipts. These new rates are much closer to the rates prevailing in the unofficial market and are expected to capture a significant part of foreign exchange currently being channelled to it. (b) The Government also recently announced significant increase in the prices of the SEEs, which are expected to yield an additional TL80 billion in SEE revenues. This is equivalent to about 5 percent of the GNP. The price increases are  - 47 - ANNEX 2 Page 5 particularly significant for gasoline (84 percent), fuel oil (80 percent), diesel (82 percent), kerosene (110 percent), cement (63 percent), and sugar (34 percent). The new oil prices are now well above their imported cost at the current rate of exchange. Increase in the prices of fuel oil is expected to cause a 50 percent increase in power tariffs through fuel cost adjustment clause. The Government estimates that these additional revenues will keep the operating deficit of SEEs i:o about TL26 billion, and thus help to lower the financial requirements of the SEEs, and in turn, their need to borrow from the Central Bank. (c) Production and export targets for the SEEs have been specified and in some cases have been backed up with incentives. Further, the SEEs have been granted limited autonomy to adjust their product prices so as to enable them to remain within the budgeted level of operating deficits that would be financed from Treasury's resources. Also, a ceiling of 2 percent has been imposed on increase in the workers employed by the SEEs. This compares with nearly 20 percent annual increase in the employment by the SEEs in the previous years, which has been a major source of increases in SEEs operating costs. On both these measures it remains to be seen whether the prescribed restraints would be maintained. (d) To ensure more effective mobilization and allocation of financial resources, interest rates for both deposit and lending have been substantially augmented. For time deposits, increased rates range from 12 percent for deposits between 6-12 months to 24 percent for those between 3-4 years. There is a premium o0: 10 to 15 percentage points on the repatriated savings of migrant workers. The interest rates for medium- and long-term loans have been increased from nearly 10 percent to 16-20 percent. (e) The Government expects to significantly lower its (consolidated) budget deficit from an estimated TL3& billion last year to about TL24 billion in the current year. Since there is nearly a year lag in tax revenues, the Government expects a 40 percent increase in tax revenues this year as a result of last year's fiscal measures and inflation, while its investment expenditures are anticipated to be held about 10 percent below the level provided for in the approved investment budget for the current year.  - 4E - ANNEX 2 Page 6 Recommendation 12. The mission is encouraged with the initiatives of the Government regarding export promotion, and recommends that the disbursements on the Program Loan be continued. Attachment cc and cleared with: Mr. Dubey cc: Messrs. Benjenk (EMNVP), Bart (o/r) (EM2), Thadani (IDF), Wood (EM2) Messrs. Davar, Palmer, Berk, Gregory (EM2), Zaidan, Gowen (EMP), Perera (CTR), Grossman (LEG) SAFaruqi:cml  - 49 - ANNEX 3 TURKEY Program Loan Allocations and Payment Requests Official Allocations Disbursement Authorized Private Public Requests from Category Allocations 1/ Sector Sector Total the Bank 2/ Not less than 1. Agriculture 40.0 41.4 8.8 60.2 18.6 Raw Materials for: a. Fertilizer 22.0 8.8 40.8 18.0 b. Chemicals for plant protection 19.4 - 19.4 0.6 Not less than 2. Spare Parts 20.0 2.7 20.0 22.7 0.9 3. Raw Materials under Import for Export Not: less than Promotion Scheme 30.0 45.0 9.0 54.0 5.7 4. Up to Industry 60.0 0.4 37.4 37.8 28.7 a. Steel - 15.8 15.8 14.5 b. Copper/Tin - 5.1 5.1 3.8 c. Aluminum d. Petrochemicals 0.4 16.5 16.9 10.4 TOTAL 150.0 89.1 85.9 175.0 53.9 1/ As per Program Loan Agreement 2/ As of April 27, 1979, including about $13.0 million of requests in transit.