Turkey - Third Agricultural Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY _ 4A1 3c7> L -- _ Report No. 6627-TU STAFF APPRAISAL REPORT TURKEY THIRD AGRICULTURAL CREDIT PROJECT MAY 12, 1989 Agriculture Operations Division Country Department I Europe, Middle East and North Africa Regior. This document has a retdcted distribution and may be used by redpients only In the perfonnmue of their offlcil duties. Its contents may not othenwise be disclosed without Wold luk authorization.  CURRENCY EQUIVALENTS (April, 1989) US$1 , Turkish Lira (TL) 2,057 TL 1,000 - US$0.49 TL 1,000,000 - US$486 WEIGHTS AND MEASURES 1 kilogram (kg) = 2.20 pounds 1 metric ton u 1,000 kilograms, 0.98 long ton 1 hectare (ha) 2.47 acres 1 decare 0.1 ha I square kilometer (kmn2) - 0.386 square mile ABBREVIATIONS AND ACRONYMS USED AEAR - Agricultural Extension and Applied Research Project ASAL - Agricultural Sector Adjustment Loan DODP - Drainage and On-farm Development Project EC - European Community FAO - Food and Agriculture Organization of the United Nations FSAL - Financial Sector Adjustment Loan IAEE - Igdir-Aksu-Eregli-Ercis Irrigation Project MAFRA - Ministry of Agriculture, Forestry and Rural Affairs MIS - Management Information System PAD - Project Analysis Department of TCZB PPAR - Project Performance Audit Report SACP - Second Agricultural Credit Project SEE - State Economic Enterprise SEKER - Sugar Factories Company SIS - State Institute of Statistics SPO - State Planning Organization TCZB - Turkiye Cumhuriyeti Ziraat Bankasi (Agricultural Bank of Turkey) TIGEM - Turkish Agricultural Enterprise TKK - Agricultural Credit Cooperatives TMO - Soil P.-oducts Office TSEK - Milk Industry Organization TZDK - Agricultural Supply Organization UNDP - United Nations Development Programma FISCAL YEAR Government of Turkey - January 1 to December 31 TCZB - January 1 to December 31 TKK - January 1 to Del'ember 31  FOR OMCi4L USE ONLY TURKEY THIRD AGRlCULTURAL CREDIT PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. Loan and ?roject Summary ........................ ............... .... i I. INTOUTRDCION*ooso**ooo.o*o.oo.eo*.** 1 II. THE AGRICULTURE SECTOR .................... .1 A. Agricultural Development and Sectoral Adjustment....... 1 B. Sectoral Characteristics 3..........3 C. Bank Strategy for Support of Agriculture Sector and Performance tnder Previous Projects.............. 6 III. AGRICULTURAL CREDIT INSTITUTIONS ............................ 8 A. Financial Sector .................................. 8 B. The Agricultural Bank of Turkey (TCZB) ................. 9 C. Agrihultural Credit Cooperatives (TKK).. ............... 16 IV. THE PROJECT.*.*......................................... 17 A. Objectives and Rationale ....... .. ................ ...... 17 B. Project Description........... ....................... 18 C. Detailed Features. ..... ....................... 18 D. Project Costs .......................................... 24 E. iacn .............. 25 F. Procurement ................... 26 G. Disbursement .................... 27 V. PROJECT IMPLEMENTATION ............................ 28 A. Coordination ....................... 28 B. Institutional Development ................. ... ........ 29 C. Credit Program ............................ 30 D. Monitoring and Evaluation ............................ 32 E. Accounting and Auditing ......... * .... 33 VI. PRODUCTION AND MARRETING ............................ 34 VII. BENEFITS, JUSTIFICATION AND RISKS....................... 35 A. Financial Benefits and Returns.**.********************. 35 B. Economic Benefits and R e t u r n s 36 C. Project Riss....................... 38 VIII. AGREEMENTS TO BE SOUGHT AND RECOMMENDATION.................. 39 This document has a restricted distribution and may be used by recipients only in the performance of their official dutie& Its contents may not otherwise be disclosed without World Bank authorization.  Page No. ANNEXES 1. TCZB Financial Data ...................................... 41 2. TKK Financial Data .................................... 58 3. Draft TCZB Policy Statement .......... ......... 64 4. TCZB Institutional Development Program Action Matrix ..... 70 5. TCZB Training Program .................................... 78 6. Project Credit Guidelines ................................ 83 7. Credit Program Area...................................... 86 8. Project Cost Phasing and Disbursement Schedule ........... 87 9. Data on Marketing, Prices and Economic Analysis .......... 92 10. Selected Documents and Data Available in the Project File ........................................... 100 ll.* Agricultural Bank of Turkey (TC Z B ) 12.* Agricultural Credit Cooperatives (TKK)................... 13.* Draft TOR for TCZB Institutional Development............. 14.* Draft MAFRA Coordination Protocols...... 15.* Illustrative Farm Modelso................... . ..... . .. . CHARTS TCZB Head Office Organization (as of October 1988) TKK Central Union Organization MAP IBRD 20320R Credit Program Area * These annexes are contained in the Implementation Volume.  TURKEY THRD AGRICULTURAL CREDIT PROJECT STAFF APPRAISAL REPORT Loan and Project Summary Borrower: Republic of Turkey Implementing Agency: Agricultural Bank of Turkey (TCZB) Loan Amount: US$250 million equivalent Terms: Seventeen years, including a five-year grace period at the Bank's standard variable interest rate. Onlending Terms: The Government would onlend the proceeds of the Bank loan to TCZB for a duration identical to that applicable to the Loan, and at the interest rate applicable to the relevant sub-loan, less a spread of 4% for TCZB. Medium- and long-term sub-loans to farmers would generally be for two to twelve years, including a grace period of up to five years, with terms for individual loans decided in accordance with cash flow projections. Incremental short-term credit would be for one year or less. All lending for agriculture would carry positive interest rates in real terms by March 31, 1991. The foreign exchange risk for the credit components would be assumed by the Government, with the Borrower paying an exchange risk premium. Project Description: The proposed project would contribute to the objectives of (a) expanding agricultural credit to facilitate increased production and invtestment and (b) strengthening the agricultural credit institutions (TCZB and tha Agricultural Credit Cooperatives - TKK). The project would support the continuation of TCZB's institutional development program, with particular emphasis on measures such as revision of the organizational structure, refinement of lending policies and procedures, strengthening financial management, and personnel development, all designed to promote a more efficient use of TCZB's resources. Institutional development of the TKK would focus on improved lending policies and procedures. The project credit program would consist of incremental short-term production credit and medium/long-term investment credit in the 45 provinces where a core extension service is in place and the capacity of the credit institutions is considered adequate.  - ii - Estimated Proiect Cost: Local Foreign Total - - - - - US$ million - - - - Farm Development Incremental Production 87.5 30.4 117.9 Investment 578.4 526.5 1,104.9 Total 665.9 556.9 1,222.8 Institutional Development 0.5 2.7 3.2 Total Base Cost 666.4 559.6 1,226.0 Contingencies 0.1 0.4 0.5 Total Project Cost 666 5'i 560.0 1,226.5/1 Financing Plan: Farmers TCZB TKX Bank Total - - - - US$ million - - - - - - - Farm Development Incremental Production 23.6 64.5 6.8 23.1 117.9 Investment 322.9 537.4 18.4 226.3 1,104.9 Total 346.5 601.8 25.1 249.4 1,222.8 Institutional Development - 3.0 - 0.6 3.7 Total 346.5 604.9 25.1 250.0 1,226.5 Estimated Disbursement: Fiscal Year 1990 1991 1992 1993 1994 US$ million Annual 78 60 69 36 7 Cumulative 78 138 207 243 250 Beneficiaries: About 210,000 Turkish farmers supported by TCZB and the Agricultural Credit Cooperatives (TKK) Risks: Deterioration in economic conditions leading to credit ceilings to curb inflation. Delays or changes in TCZB's institutional development program. /a Includes taxes and duties of about $122.6 million equivalent.  TURKEY THIRD AGRICULTURAL CREDIT PROJECT STAFF APPRAISAL REPORT I. INTRODUCTION 1.01 The Government of Turkey, the Agricultural Bank of Turkey (TCZB), and the Agricultural Credit Cooperatives (TKK) have requested a World Bank loan to help finance the proposed Third Agricultural Credit Project. The project would build on two previous Bank-supported agricultural credit projects, implemented by TCZB, and the credit components of other projects supported by the Bank, for which TTCZB was the financial intermediary. By strengthening the credit delivery system through the enhanced institutional development of TCZB and the TKK and raising agricultural productivity through expanding improved access to and supply of credit, it would help to achieve the Government's development objectives and the Bank's assistance strategy for the agriculture aector. 1.02 The project was identified and prepared by TCZB and the TKK with assistance from the Bank and the FAO/IBRD Cooperative Programme. It was appraised in November 1986 by a team composed of Messrs. Luhm,n and Argyle (Bank) and Messrs. Godbole and Basu (FAO/CP). Messrs. Hunting, Tellex, Yaron and Akhavan and Ms. Bonnell (3ank) assisted in the preparation of the report. A follow-up mission comprising Mr. Duester conducted a post-appraisal and revised the report. 1I. THE AGRICULTURE SECTOR A. Agricultural Development and Sectoral Adjustment 2.01 While the relative importance of the agriculture sector in Turkey's economy is declining, the sector in 1988 still represented about 15S of gross domestic product (GDP), 20 of export earnings and 57% of civilian employment. The growth rates of agricultural GDP and exports are projected to remain below those of the economy as a whole, but the sector will continue to play a significant role in generating employment, meeting domestic food requirements, supplying industrial raw materials, and sustaining export levels. 2.02 Over the past two decades, Turkey's agricultural policies have undergone a major shift in orientation, from inward- to outward-looking. Through the 1970s, its policies stressed self-sufficiency in food production through subsidized inputs and producer prices. Relatively rapid growth of agricultural production was achieved, averaging 4.7% per year during 1972-75. However, the macroeconomic situation began to deteriorate, and the level of subsidization to agriculture became increasingly difficult to maintain. Sectoral growth slowed to 1.51 per year during the late 19709, largely due to  -2- ineffective investment policies, weak technical services, and marketing and credit difficulties. During this period, agricultural exports accounted only for a small portion (about 4S) of total production due to the overvalued exchange rate and other disincentives to export. 2.03 Based on structural adjustment policies adopted by the Government in 1980 and reinforced by a series of structural adjustment loans and, in 1985, by an agriculture sector adjustment loan (ASAL), economic policy has emphasized export growth, import liberalization, more involvement of the private sector, and reliance on market forces, all in the interest of achieving better internal and external balances. Within the agriculture sector, most commodity prices were brought in line with world market prices as the result of a flexible exchange rate policy; price supports for many commodities were withdrawn and floor prices rather than incentive prices established for the remainder; agricultural exports were to a large extent deregulated; and the import regime liberalized for commodities and inputs, for which most subsidies were removed or reduced, although important exceptions were made (para 2.05). Pesticide and fertilizer distribution, previously monopolized by state economic enterprises, were opened up to the private sector. Over the same period, the Government began to strengthen its agricultural investment program by eliminating low-priority projects, expediting completion of existing projects, and constraining expenditure on new ones. Further, in 1984, the Ministry of Agriculture, Forestry and Rural Affairs (MAFRA) was reorganized in order to decentralize responsibility to the provincial level and to eliminate overlapping services and other inefficiencies. The reorganization process is being supplemented by actions directed toward increasing further the efficiency of the various services. 2.34 Within the context of adjustment, sectoral performancR has been mixed. While growth of GDP averaged 5.0% per year during 1981-87, the sectoral growth rate for agriculture was 3.8%. It experienced wide swings, ranging from -0.1 (in 1983) to 6.4S (in 1982). In 1986, agriculture GNP growth was 7.81, stimulated by good weather, increased fertilizer supplies, and a general rise in aggregate demand. Starting from the high base of 1986, growth in 1987 reached only 2.2%, but is estimated to have reached 6.2% in 1988. Agricultural exports have also fluctuated from year to year, but navertheless increased marginally from US$1.7 billion in 1980 to US$1.9 billion in 1986 and 1987. They reached a new high in 1988 of US$2.3 billion Agro-industrial exports (including forestry and hides and leather products) rose from US$o.1 billion in 1980 to US$1.1 billion in 1986 and US$1.7 billion in 1987. 2.05 Future sectoral development will depend on the Government's ability to continue its adjustment-based initiatives and to deepen the process. Export constraints are posing potential problems, however. Depressed agricultural prices in export markets due to European Community (EC) competition and economic slowdown among trading partners in the Middle East and in local markets (due to EC dumping of livestock and livestock products and increased domestic production of some crops) have caused income losses for some Turkish farmers. In response, some relief measures, including input and interest subsidies, have been reintroduced by Government, although such subsidies detract from adjustment policies agreed with the Bank under the  -3- ASAL. Among inputs, animal feed, pesticides and fertilizer have been granted new subsidy rates, with the most important subsidy affecting fertilizers. While the retail fertilizer price subsidy (net of taxes and duties) had been lowered from 45S in mid-1985 to 272 in mid-1986, it was raised to about 342 in 1987 and reduced again to 28b in 1988 (para 2.12). Similarly, interest rate subsidies for agriculture were re-introduced in late 1986 and early 1987 (paras 3.u3-3.09). The Government has indicated that such measures are tear orary, and that it's commitment to liberalizing agriculture sector policies is firm. As steps towards restoring positive interest rates, Government imicreased agricultural lending rates by 7-112 in February and again in No.vember 1988 (para 3.08). The sector also requirer further efforts for strengthening institutional infrastructure, improving extension and research, conso3idating MAFRM's organization, upgrading the distribution of inputs, improving the agricultural credit system, and maintaining discipline regarding public investment. With continued reform, agricultural GDP could be expected to achieve an annual growth of 32 in real terms, although there may be a setback in 1989 because of the draught. Export constraints are placing a premium on adjusting agricultural production to shifting marketing opportunities and on improving productivity and marketing efforts. B. Sectoral Characteristics 2.06 Organization of Production. Agricultural production at the farm level is in the hands of a large number of smallholders, but there are some large holdings as wedl, although none directly under the auspices of the Government. The agricultural service industry, including production or importation of seeds and feed, input distribution and farm services, domestic marketing and exports have largely been privatized with a minor role for the public sector in supply of some inputs and marketing of some crops. The public sector is the major actor in the development of irrigation infrastructure, research and extension and credit. 2.07 Land Use. Of total agricultural land of 47.7 million ha, 23.9 million ha (501) is in crops and 20.2 million ha (42X) is in forests.X' Of the crop area, 18.2 million ha (761) is under field crops and 5.8 million ha (242) is in fallow. An additional 3.6 million ha (8X) is under orchards, vineyards, and vegetables. The irrigated area amounted to about 3.4 million ha, or about 141 of total crop area. About 86% of farms are engaged in mixed crop and animal production, while 11% are dedicated to crops and 31 are engaged solely in animal production. The distribution of farms is characterized by a large number of small holdings and a few large holdings. The average farm size is 6.4 ha, 612 of all holdings are under 5 ha, 821 under 10 ha and 942 under 20 ha. 2.08 Irrigation. Irrigation and drainage account for about two-thirds of public sector agricultural investment. About 402 of crop output and 252 of agricultural exports are produced under irrigation. However, investment has not always been directed to priority schemes. Cost recovery has been quite low (less than 302 of operation and maintenance cost, for example, between I/ SIS Statistical Yearbook of Turkey 1987.  -4- 1978 and 1983), although significant progress has been achieved since 1983 in raising assessments and collections. Inadequate drainage has caused the deterioration of soil conditions in some areas, and on-farm development has lagged behind the expansion of irrigation infrastructure. The ASAL (2585-TU) and the Drainage and On-farm Development Project (DODP, 2663-TU) are supporting rationalization of irrigation investment, improvement of cost recovery, and completion of priority drainage and on-farm development works to increase productivity. 2.09 Livestock. The livestock subsector contributes about 25% of agricultural GDP and 15S of agr'zultural exports. Low-income areas, predominantly in the eastern provinces, support the major part of the country's livestock herd under low input/low output conditions. Fattening and processing operations are concentrated around major population centers, primarily in the central and western provinces. Overgrazing of natural grasslands in Turkey restricts growth of the national herd. Increased competition in recent years from livestock-producing areas in the southern hemisphere and Europe requires that measures be taken to improve productivity. This will require improved feeding and animal management, a substantial increase in health care, and upgrading of the genetic base. Recently, in order to counteract the effect of EC dumping practices, the Government increased duties on meat and milk product imports and introduced subsidies on animal feed and cash grants for livestock investment. In case the livestock investment is financed with a loan from TCZB the cash subsidy is replaced by an interest rate subsidy. 2.10 Extension and Applied Research. Since the growth of agriculture will require the intensification of both crop and animal production, the development of improved technology suited to diverse conditions in different areas of the country and the dissemination of this technology to farmers are essential. Much research has been done in Turkey, but the system suffers from severe fragmentation and has not always focussed on problems of highest priority to farmers. The extension service has achieved success in ptomoting the use of improved inputs but devoted less attention to appropriate farm anagement practices, had relativelv weak links with the research system, suffered from divided responsibility for crop and livestock extension, and had to allocate considerable time to administrative and statistical functions. Government has undertaken a reorganization of MAFRA which has established the foundation for an efficient, integrated crop and livestock extension service. Under the Agricultural Extension and Applied Research Project (AYAR, 2405-TU) covering 16 of Turkey's 67 provinces, a modified training and visit extension system is being introduced in combination with media-oriented extension programs, strengthening the links between extension and research, and coordinating the efforts of research institutions with increased emphasis on applied research. Start-up of the project was initially disrupted by the reorganization of MAFRA, and further delayed by slow progress in procurement. However, progress has accelerated considerably over the past year and a half. A proposed project for expansion of the system to 18 additional provinces is expected to be appraised shortly.  -5- 2.11 Marketing. Both public and private sectors are involved in the marketing of agricultural production, with the private sector assuming a growing role under present market-oriented policies. Tthe Soil Products Office (TMO), a state economic enterprise, purchases in a typical year about 15% of the marketed cereal output and undertakes both import and export operations. It has been raising the efficiency of its operations and expanding and modifying its storage facilities with support from the Bank under the Grain Storage Project (Loan 1742-TU). The remainder of the marketed cereal output is purchased by a large number of private traders, some of whom also export. Other SEEs and sales cooperatives are involved in the marketing of pulses, animal products, horticultural crops, and industrial crops in competition with private sector firms. Fresh fruit and vegetables are marketed by a large number of private traders. 2.12 Input Supply. The private sector is also expanding its role in the supply of agricultural inputs. Whereas fertilizer distribution was monopolized by two SEEs - the Agricultural Supply Organization (TZDK) and the Sugar Factories Company (SEKER) - the private sector was permitted to enter the trade in June 1986. LIberalization of the seed industry began in 1984 with actions on pricing, imports, and testing requirements, and there are now at least 20 private seed companies operating alongside the reorganized (1983) Turkish Agricultural Enterprise (TIGEM), which will continue to produce seed for self-pollinated cereals such as wheat and barley. Actions are being taken, with support from ASAL, to. improve the efficiency of TIGEM. Farm machinery, implements and agrochemicals are widely available in the country, primarily through the private sector, and their demand is increasing rapidly with a consequent increase in credit demand. The retail price subsidy on fertilizer has been progressively reduced since 1980, and averaged about 341 of the retail price in 1987, compared to about 70% in 1979, 48. in 1984, and 271 in the second half of 1986. It is Government policy to phase out the remaining fertilizer subsidy and thus, average net price subsidy levels were reduced in February 1988 to 24% but were raised again to 282 in August 1988. Due to inelastic demand for fertilizer in terms of volume, the demand for fertilizer credit in monetary terms has risen as the fertilizer price has increased because of reductions in price subsidies. This trend has been reinforced in 1987 because of the interest rate subsidy on fertilizer loans introduced in October 1986. In 1988, TCZB has experienced difficulties in meeting the credit demand because of a scarcity of funds (para 3.14). In order to induce farmers to use improved seed, the Government subsidizes 50% of the price of hybrid soybean, maize and sunflower seeds. Seeds for other crops are not subsidized. A subsidy of 201 of the sales price of pesticides that was abolished in 1984 was reintroduced in 1986. 2.13 Credit. The Agricultural Bank of Turkey (TCZB. and the Agricultural Credit Cooperatives (TKK) lend to about half of the country's 3.7 million farm families, although the average loan is relatively small (TL 400,000 or US$466 in 1987). Farm credit disbursements increased from about 8.51 of agricultural GDP in 1979 to 16.9% iu 1987, while total agricultural credit disbursements (including credit to sales cooperatives, SEEs and agro-industries) declined irom 27% of agricultural GDP in 1979 to 21% in 1987 with large fluctuations in between (Annex 1, Table 1). The latter decrease reflects Government's policy of shifting from incentive to floor pricing, and causing sales cooperatives and SEEs to pay higher rates to TCZB or obtain credit from commercial sources,  -6- 2.14 Government's policy for the development of the agricultural credit subsector is to maintain preferential interest rates but to keep all of them at positive real levels; expand the supply of credit, particularly for small- and medium-scale farmers; and strengthen the credit institutions. In.erest rates for agriculture had reached positive levels by mid-1986 but with the introduction of new interest rate subsidies at the end of 1986 and the rise in inflation in 1987 and 1988 the rates are no longer positive. The weighted average interest rate for all agricultural lending is expected to be positive in 1990 (para 3.08). Government contributes funds for agricultural credit by channelling deposits of Government and parastatal agencies to TCZB and periodically providing TCZB with additional equity resources. C. Bank Strategy for Support of Agriculture Sector and Performance under Previous Projects 2.15 The 'Bank's strategy for assisting development of the agriculture sector is to support policy reforms, stimulate primary production, and strengthen the input supply, processing and marketing, and credit delivery systems. It builds on policy and institutional changes introduced between 1980 and 1985 with support from five Structural Adjustment Loans (SALs) and the ASAL and assists the transition from a highly subsidized and protected system of agricultural production to one that can survive in an open economy and is responsive to policy signals and market incentives. Since 1985, the ASAL has supported sectoral adjustment, with emphasis on sectoral planning and analysis in MAFRA,' rationalization of public expenditure (especially irrigation), liber&lization of the trade regime, seed and fertilizer pricing and distribution, and managerial strengthening of fertilizer distribution and SEEs involved in seed production and distribution. The Drainage and On-farm Development Project (2663-TU), building on the Igdir-Aksu-Eregli-Ercis (IAEB) Irrigation Project (2433-TU), focuses on a core program for completion of essential drainage and on-farm development works, strengthening of the investment planning/implementation processes, expansion of cost recovery, and strengthening of the technical and managerial capabilities of Government staff involved in these tasks. The Agricultural Extension and Applied Research Project (AEAR, 2405-TU) and a proposed follow-up project are aimed at the development and dissemination of improved technology in support of increased productivity. Two agricultural credit projects (paras 2.17-2.18) were designed to support the strengthening of credit institutions and the expansion of agricultural credit. Other projects in rural development, livestock, fruit and grain marketing, and forestry have also contributed to the implementation of the strategy. A proposed agro-industries project, intended to support the processing of agricultural produce, would focus on restructuring existing enterprises and developing and/or strengthening technical, financial and marketing institutions in the private sector. Proposed extension and research projects would focus on the institutional development of MAPRA and further strengthening of the technology adaptation and delivery system. 2.16 Bank support for the agriculture sector has encompassed 22 operations to date, of which 13 have been completed and nine are under implementation. For irrigation projects, the most recently completed Project Performance Audit Reports (PPARs) and Impact Evaluation Report considered them to be generally  -7- successful, with high economic benefits, but indicated the need for improvements in cost recovery, establishment of project implementation units, and provision of domestic financing. As noted in PPARs, livestock projects have been generally successful in the temperate western areas of the country but less successful in the more difficult eastern areas. The more recent projects were also adversely affected by changing price relationships resuilting from the structural adjustment process, under which more realistic exchange rates raised incentives for meat production relative to milk production. The fruit and vegetable projects had some success in expanding production of these crops, but the efforts to improve the marketing system have not had much impact to date. The performance of other projects in the portfolio has varied, although implementation has improved substantially in recent years. Performance under the on-going ASAL (2585-TU) has been mixed, with more rapid progress than expected on fertilizer pricing and distribution but delays in strengthening sectoral planning/monitoring, implementing the irrigation core program, and formulating management improvement programs for two SEEs. Regarding recent setbacks on fertilizer and interest subsidies, the Government har assured the Ban1 that these represent only temporary deviations from long-te:-m policy intents. Measures have been taken in January/February 1988 to reduce subsidy levels. DODP became effective in June 1987, as regulations for implementation of the new cost recovery law were issued and project consultants hired. The prospects for success of AEAR under the new organizational structure of MAFRA are thought to be good, although delays have occurred because of disruption caused by the reorganization and the limited availability of local funds. 2.17 The two previous credit projects have promoted the allocition of credit to viable production and investment activities and have placed increasing emphasis on the institutional development of TCZB. The Agricultural Credit and Agro-industries Project (Loan 1248-TU of May 1976) supported a supervised farm credit scheme in selected areas, credit for agro-industry, and a study of selected aspects of TCZB's operations and management. The supervised credit was implemented approximately in accordance with expectations, while the agro-industry credit component suffered substantial delays as a result of the initial divided responsibility for implementation (between MAFRA and TCZB) and subsequent sub-borrower unwillingness to bear the foreign exchange risk (eventually assumed by the Government). The institutional study was delayed but finally implemented, and it formed part of the basis for the institutional development program being supported under the Second Agricultural Credit Project (SACP) that became effective in 1984. 2.18 SACP provided US$149.5 million to support short-term and medium- and long-term credit for on-farm development in ten of the provinces where the extension service is being strengthened under AEAR, short-term credit for the Government's second crop and fallow reduction schemes, and credit in support of IAEE (short- and medium- and long-term) and the Corum-Cankiri Rural Development Project (Loan 1130-TU) (incremental short-term). It also supported TCZB's action plan for institutional development and provided US$950,000 for this purpose. The pattern of credit disbursements has been different from expectations, with greater emphasis on the on-farm development  -8- componentL' and delays in the issuance of project credit guidelines by TCZB and thus in implementation of the credit program in 1985. However, in 1986 and 1987, TCZB's credit disbursements accelerated substantially and project disbursements reached 98% of allocations by end of June 1988 and 1002 shortly after the Closing Date of June 30, 1988. Funds have been reallocated among various categories to take account of actual credit demand, and the closing date was extended by six months to June 30, 1988 to achieve a pai passu disbursement of the remaining funds in all categories. Delays also occurred in the implementation of the institutional development program, primarily as a result of legislative and managerial changes. However, major institutional objectives have been achieved (para 4.06). The pr'posed project would build on the experience of the first two projects by supporting a credit program which would be an integral part of the operations of TCZ! (and the TKK) and would address aspects of institutional development that are important for enhancing the effectiveness and efficiency of TCZB (and the TKK), e.g., decentralizing lending an* strengthening financial management. III. AGRICULTURAL CREDIT INSTITUTIONS A. Financial Sector 3.01 The Central Bank, 45 deposit banks, and five development banks constitute the country's well developed banking systeml' and account for nearly 90b of total financial resources. Credit cooperatives, social security institutions, and insurance companies comprise the remainder of financial institutions. Since 1980 the sector has shown substantial growth. Total bank assets grew from TL 1,730 billion in 1980 to TL 15,990 billion in 1985 or in 1985 constant terms, by 94X from TL 8,236 billion to TL 15,990 billion. The credit institutions concerned with financing agriculture-related activities include the Central Bank, TCZB, other deposit banks, and TKK. TCZB provides, either directly or through TKK, virtually all of the formal credit to farmers from financial intermediaries. Close to one-half of all farmers have no access to institutional credit and depend on informal credit, but data on informal credit are unavailable. 3.02 The Government is undertaking a reform of the financial sector aimed at establishing an efficient and flexible system of resource mobilization and allocation which would grow in real terms to meet the needs of the increasingly complex economy. A major element in reform is to improve 1/ Credit demand has been affected by a variety of factors, including a depressed investment climate because of inflation and price uncertainty, which has affected medium- and long-term credit; delays in the implementation of AEAR and IAEE; and various matters concerning the second crop and fallow reduction schemes such as possible overestimates of credit requirements, more limited applicability of the schemes than anticipated, inappropriate timing of credit disbursements and repayment dates, and excessive credit security requirements. 2/ TZCB is counted here among the deposit banks although it has also the role of a development bank.  -9- the efficiency of the banking system. The Bank supported the Government's adjustment program during the period 1986-88 through the Financial Sector Adjustment Loan (FSAL, Loan 2714-TU). A second FSAL (Loan 2964-TU) has become effective in June 1988. It has the following major objectives: (i) reforming the Government's fiscal policy; (ii) strengthening the banking system, including the introduction of regulations on loan classification, suspension of interest accrual, and provisioning, the establishment of a mechanism to restructure insolvent banks, and the development of action programs to restructure state-owned banks; (iii) improving the interest rate structure, including reducing the high non-preferential lending rates, reducing currency substitution, and bringing preferential lending raten to positive levels in real terms; and (iv) developing the fixed income securities and equities market. The proposed project would complement the operations under the FSALs by strengthening the agricultural credit institutions and the agricultural credit delivery system. B. The Agricultural Bank of Turkey (TCZB) Obiectives and Functions 3.03 TCZB, a Government-owned institution, is the oldest and largest bank in Turkey with a network of 1,151 branches and aLout 26% of the total resources of the deposit banks operating in the country. Its policy is to allocate at least 80b of its lending to agriculture, although a smaller proportion has been devoted to the sector in recent years. Included in agricultural lending are loans to saleg cooperatives for the procurement of agricultural commodities (para 3.14). TCZB is also empowered to undertake commercial lending and other functions usually associated with a commercial banking institution. However, a large part of TCZB's commercial lending is related to agriculture such as lending to TMO for grain procurement (para 3.14). In addition, TCZB handles Governmental transactions for the Treasury and the Central Bank. TCZB prepares and implements an annual operations and investment program, which is approved by the Supreme Credit Board.1' 3.04 TCZB serves as an instrument of Government policy, allocating credit in accordance with Government directives and charging preferential interest rates on agricultutal credit. Significant progress has been made over recent years in bringing average interest rates to positive real levels. Lending at preferential rates has been made possible by an interest "rebate" on agricultural credit administered by the Central Bank, borrowings from the Central Bank (a declining share), Government and parastatal deposits kept as demand deposits rather than time deposits, and infusions of capital by the Government. It also has been supported in part by commercial lending at non-preferential rates and the placement of funds in bank deposits and high-yielding Government bonds. This program is expected to continue over the medium term. TCZB will rely on compensation for interest subsidies and 1/ The Board is chaired by the Deputy Prime Minister, and its members include the Ministers of Agriculture and Commerce, the Undersecretaries of the Treasury and the State Planning Organization, and the Goveruor of the Central Bank.  -10- increased infusion of equity to improve its capitalization. Thus, TCZB's financial status and performance results from a balance of policy vrariables controlled by the Government. The viability of the institution rests ultimately on the Government's willingness and ability to provide funds for its continued operation. The proposed project is expected to contribute to increasing TCZB's financial independence over time by bringing all agricultural interest rates to positive levels in real terms by March 31, 1991 and setting them at levels high enough to cover administrative aud risk cost and permit a reasonable profit margin by the end of 1991 (para 5.08). Organization and Management 3.05 Management. TCZB is administered by a Government-appointed Board of Directors and a Credit Committee. The Board is chaired by the General Manager, who is ir charge of TCZB's day-to-day operationst and is assisted by six Assistant General Managers. At the beginning of 1988 a new Ceneral Manager took over and appointed staff from outside TCZB to four of the Assistant General Manager positions. TCZB's new management team has introduced a whole range of institutional development measures which were supported under SACP. 3.06 Organizational Structure. lJntil 1988, the organizational structure of TCZB was centralized, with inadequate delegation of decision-making authority. Its head office organization had expanded to nearly 40 departments. There was considerable overlap and duplication in the functions entrusted to various departments. In implementing the first phase of its restructuring program, TCZB underwent a complete reorganization in 1988 in order to streamline its operations (Chart 43133). Its entire senior management was changed, including the appointment of three new managers with foreign banking experience. The dispersion of inter-related units under different Assistant Geueral Managers was corrected and the number of units reduced. A decision has also been taken to decentralize loan approval procedures by authorizing the main provincial branches to approve loan applications from amaller branches within that province. LendinR Policies and Procedures 3.07 Agricultural Credit Guidelines and Loan Approval Limits. Agricultural lending procedures of TCZB are governed by Agricultural Credit Guidelines issued in 1979. These guidelines are generally satisfactory. They were revised in 1987 to incorporate more modern procedures appropriate for providing adequate credit for all viable farm operations and investments in a timely manner. The revised guidelines are expected to be approved by TZCB's Board in 1989. In September 1985, the Government raised loan approval limits to TL 200 million for the Credit Committee, and to TL 25 million for headquarter units. The latter can delegate their authority to branches, and the loan approval limit for some large provincial branches was raised to TL 25 million at the beginning of 1987. Steps have been taken to adjust the legal limits annually to compensate for the effects of inflation (para 4.08). 3.08 Lending Rates and Inflation. TCZB's agricultural lending rates are determined by the Government. Any changes in rates apply both to new loans and outstanding loan balances. At the beginning of 1985, the base rate of  -ll- interest for farm credit was set at 30% for small loans (production loans up to TL 5 million, or US$4,000 equivalent and loans for investments of up to TL 20 million, or US$16,000 equivalent). A higher rate of 342 for larger production and investment loans and 35% for tractor loans was fixed in September 1985.1' Effective rates to farmers are 1-1.5 percentage points higher because of t -as and fees. Thus, TCZB's effective rates of 30-36.5$ for farm credit were above the inflation rate of about 282 for May 1986 over May 1985, as measured by the wholesale price inAex. In 1987 inflation accelerated considerably and reached 48.91 in TDecember 1987 and 69.62 in December 1988. Since lending rates were not adjusted to take account of inflation, they ceased to be positive at this time. Inflation peaked in January 1989 and started to come down thereafter (61.82 in March 1989). To make deposit rates more attractive and to bring subsidized agricultural lending rates closer to positive levels in real terms, Government increased interest rates twice, in February and November of 1988. The 221 rate for livestock and fertilizer loans, introduced in December 1986, stands now at 341, the rate for other small loans at 43%, the rate for other larger loans at 501, the rates for agro-industry at 501 and 601, respectively, depending on the amount of the investment, and the rate for sales cooperatives at 702. Rates for commercial type lending are 751 for export credits and 85% for other short-term lending. The weighted average interest rate for TCZB loans to farmers in 1988 is estimated to be 41.2% including about 1.51 for fees and taxes. To determine whether these rates are positive in real terms, they are compared with an inflation index that takes account of past and expected inflation, weighted equally (para 5.08). Based on the March 1989 inflation figures and the Government's year-end inflation target of 501, the index wouil currently be 55.91 so that the weighted average interest rate for loans to farmers would be negative by about 14.71. It is expected that the weighted average interest rate for all agricultural lending would become positive by end-March 1990. 3.09 To compensate TCZB for the shortfall in interest income for fertilizer and livestock loans, TCZB receives a 152 Government interest subsidy on fertili?r. loans and 11% on livestock loans. On other types of farmer credit funded with own funds, TCZB receives a 31 subsidy. Deposit rates vary greatly in accordance with maturities. In October 1988, they were 38% for demand deposits, and ranged from 65% for one-month time deposits to 851 for one-year time deposits. The preferential agricultural lending rates were offset in 1988 by higher lending rates to sales cooperatives, agro-industries and to commerce. Loan Processing 3.10 TCZB borrowers are required to make a minimum contribution to the proposed operation or investment, which normally is 10S for small- and medium-scale farmers and 30-402 for larger farmers. Production loan amounts are based on credit norms for each crop which have proved to be generally insufficient to cover credit needs. Investment loans other than for equipment are appraised on the basis of the borrower's anticipated income and 1/ Credit cooperatives receive a discount of 0.5 percentage point on each type of credit, but the rates to cooperative members are two percentage points above the direct TCZB rates.  -12- expenditure after development and repayment capacity. Beginning in 1987, TCZB introduced crop budgets and investment models to improve the appraisal of production and investment loans. Short-term loans are usually granted for periods of 6-12 months, medium-term loans extend from 2-5 years, and long-term loans from 6-20 years. Maturity periods, including grace periods for investment credits, have been set rather arbitrarily but will be more closely related to repayment capacity under the improved appraisal procedures. The charter of TCZB and credit guidelines issued by TCZB Headquarters permit the acceptance of personal guarantees, chattel mortgages, and mortgage of land and/or buildings as collateral. However, branches have generally insisted on real estate as security, which emphasis has prevented many farmers from obtaining TCZB credit. Supervision and Monitoring and Evaluation 3.11 The shortage of technical staff in TCZB has affected the quality of loan supervision which at present is somewhat cursory. TCZB therefore intends to maintain the necessary complement of qualified staff and introduce a program of regular supervision of loans (short-term loans on a sample basis and all investment credits) (para 5.09). Improved supervision will also facilitate proper monitoring and evaluation (M&E) of loans, a task currently not attempted. TCZB is establishing an M&E unit within the Project Analysis Department at its headquarters which will be supported by 10 regional units. The central and regional units will guide the M&E activities of technical staff at branches. Management Information System, Financial Planning and Accounting. 3.12 TCZB is in the process of upgrading its management information iystem (MIS) to include information on distribution of agricultural loans by purpose, loan benaficiaries by size of holding, repayment performance, and agewise breakdown of overdues. The study of systems and procedures, undertaken by Food and Agriculture Organization (FAO) consultants, has provided an important input. The computerization program, being implemented through 1992, will permit the rapid processing of data. TCZB has prepared a five-year financial plan for the period 1988-92 which has been approved by the Supreme Credit Board. The plan will be reviewed annually and the forecasts extended to cover one more year. TCZB also has developed an improved system to prepare annual budgets. However, this system does not allocate funds according to major programs and activities, a capability which will be introduced tog3ther with cost accounting. During 1986, TCZB introduced the uniform accounting standards for all Turkish banks required under the Banking Law of May 1985. The system will be further developed to meet TCZB's specific requirements and will include a cost accounting capability. Personnel 3.13 TCZB employs about 40,000 staff. Some organizational units and cadres are overstaffed, while others, in particular branches and cadres such as technical services, are understaffed. TCZB's staff compensation levels have been improved with the introduction of the contract system, but its staff evaluation system needs to focus more sharply on job performance. The emphasis of TCZB's current staff training program is on training new recruits  -13- and lower level personnel, and the courses are general in nature. TCZB's institutional development program contains actions to address each of these areas (paras 4.14-4.16). Operations 3.14 Lending. In 1985 terms, farm credit disbursements declined from TL 415 billion in 1977 to TL 334 billion in 1981 before climbing to TL 896 billion in 1987, an average annual increase over the 1977-87 period of 81 (Annex 1, Table 1). In contrast, disbursements of loans to sales cooperatives and Government input supply agencies (mainly TZDK for fertilizer) decreased in 1985 terms from TL 758 billion in 1977 to TL 228 billion in 1987. This reflects a Government decision to treat TZDK and sales cooperatives on a more commercial basis. As a result, disbursements of total agricultural credit (including agro-industry) declined in 1985 terms from TL 1,178 billion in 1977 to a low of TL 637 billion in 1982, although they subsequently grew to TL 1,132 billion in 1987 as result of normal expansion. In terms of total assets, the total agricultural portfolio decreased from 58Z in 1980 to 341 in 1988. The relative decrease of agricultural lending was caused by increases in the more profitable commercial and bond portfolio, and in cash and bank balances (para 3.19). TCZB's lending for agriculture, particularly for farm credit, has been constrained by the low return. While increases in interest rates to positive real levels reduce demand for farm credit, a significant increase in net institutional farm credit in real terms resurte4 in 1986 and 1987 from the growth in production and investment, the reduction of input subsidies, the increase of credit amounts to reasonable proportions of actual production and investment costs, and the greater access of farmers to TCZB credit. There was no growth in agricultural credit in real terms in 1988 due to a squeeze on resources available for lending. The commercial loan portfolio increased in 1985 terms from TL 208 billion in 1980 to TL 1,132 billion in 1987, and increased its share of total assets from 12a to 231 (including the portfolios of three insolvent banks taken over in 1983). However, it contracted considerably to TL 662 billion (15% of total assets) in 1988 due to TCZB's efforts to improve the quality of its portfolio in line with its restructuring policy (para 3.17). 3.15 Equity Investments. TCZB's equity portfolio, consisting mostly of shares in agro-industrial enterprises, is small and has all along constituted less than 1l of total assets. In terms of nominal amount, however, it has increased from TL 1.6 billion in 1980 to TL 43.5 billion in 1988. Many of the present equity investments can be deemed as non-performing, as the enterprises have incurred losses or paid no dividend consecutively for the past three years or more. Therefore, TCZB intends to undertake a review of its equity investment portfolio focussing initially on the agro-industry investments (para 4.11) to determine its true market value and criteria for sale of shares. In line with its intention to divest itself of all participations except those in the insurance industry, TCZB put up the first of its participations for sale in August 1988. 3.16 Foreign Exchange Operations. TCZB's foreign exchange operations consist of purchase and sale of foreign currencies, financing of exports and imports through foreign currency credits, discount or acceptance of foreign bills, and issue of import guarantees. Since 1981, TCZB also has been  -14- accepting deposits in foreign currencies. Such deposits have grown rapidly since 1983 to TL 1,820 million in 1988. TCZB's foreign currency credits have increased comparatively at a much slower pace. TCZB's policy is to match foreign exchange assets and lJabilities, and therefore it has placed most of the foreign currency funds which exceed its foreign exchange loans in deposits at correspondent banks and the Central Bank. Financial Status and Performance 3.17 Restructuring. In 1988, TCZB started a restructuring program in accordance with guidelines issued by the Central Bank within the framework of the Bank-supported financial sector adjustment operations (para 3.02). This program consists of the preparation of a restructuring plan based on the identification of problems and their causes. TCZB's restructuring plan, prepared in 1988 and revised in April 1989, includes a strategic plan, a capitalization plan and an operational plan. It is based on the findings of the audit results for 1987 (audit report by Sworn Bank EPxaminers and partial audit by external auditors) and the results of an internal portfolio review (para 3.19) carried out to determine the magnitude of provisions for bad debts needed in accordance with the Provisioning Decree issued in May 1988. TCZB's management considered it more important to examine the most risky assets (commercial portfolio and foreign exchange transactions) immediately following the issuance of the guidelines by the Central Bank and start the restructuring program on this basis rather than waiting for the results of complete portfolio audit before taking any measures. TCZB plans to have the complete audit in 1989 of the 1988 accounts. ; ; 3.18 Assets and Resources. TCZB's total assets in 1985 terms generally increased to a level of TL 2.6 trillion in 1977, then declined to TL 1.8 trillion in 1980 before climbing to TL 4,530 billion in 1988. As its recourse to Central Bank borrowings has declined, its resources have come increasingly from deposits. However, the composition of deposits has changed since 1985 when local deposits started to dedline in favor of foreign currency deposits. Since TCZB has earned only a small profit in nominal terms, the magnitude of its net worth has depended primarily on Government equity contributions and has fluctuated at a low level relative to total assets. The confidence of its depositors has been maintained through its backing by Government. TCZB's total resouarces reached TL 13 trillion (US$6.5 billion) at the end of 1988, in real terms about 1551 more than in 1980 and about 72% above the level of 1977. Until 1985, deposits have provided a growing share of resources, increasing from 411 in 1980 to 711 in 1985. Conversely, the share provided by Central Bank borrowings has declined from 40S to 52 over the same period. However, in 1987 TCZB financed TMO's grain procurement program largely with Central Bank borrowings. As a result, their share in TCZB's resources jumped back to 151 while deposits declined to 611. Net worth increased from 31 of the total in 1980 to 71 in 1981 as a result of Government contributions, then fell again to 32 in 1985, was maintained at that level through 1987, but increased to 51 in 1988 due to large profits and equity infusions by Government. TCZB's real net worth has fluctuated with the cycle of Government equity contributions and reached peaks in 1970, 1976, and 1981. The level in 1988 of 51 of total resources compares to about 81 for private commercial banks in Turkey and will need to be raised further if TCZB is to adapt itself  -15- to a market environment. The Government intends to provide additional equity resources to TCZB (para 4.11). As a first step in the right direction, TZCB's Board and the High Economic Council"' have decided to increase TZCB's authorized capital from TL 200 billion to TL 500 billion. Additionally, it has been decreed (Law No. 3380) that, starting from 1987, a portion of agricultural taxes collected may be allocated to TCZB. TCZB's projections for 1988-92 show that the equity contributions expected as a result of this law would increase the ratio of net worth to average total resources to about 6.5% by 1990, which would be a more satisfactory level. 3.19 As noted above, the total agricultural credit portfolio has declined in relation to total assets since 1980, while farm credit and the commercial loan portfolio have grown. Large relative increases were encountered in cash and bank balances, which rose from 15S of assets in 1980 to 25% in 1988, and in the bond portfolio, which increased from 42 to 15b over the same period. A rising share of resources has been allocated to these items because of the high returns on time deposits and Government bonds. At the request of the Bank, TCZB carried out in June/July 1988 a preliminary review of its loan portfolio with the objective of: (i) classifying its loans outstanding end-1987 in accordance with the requirements of the provisioning Decree promulgated in May 1988; and (ii) determining also the performance status of those loans which are exempted from the application of the Decree. The review that was carried out by an internal task force of TCZB permits the conclusion that TCZBwill have no difficulty to bring its provisions for bad debts to the level required by the Decree at the end of 1988. Total arrears in agricultu