Turkey - Agroindustry Project

Docinient of The World Bank FOR OICIAL USE ONLY A/ 3c77-7- rO. Report No. P-5014-TU MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO USO150 MILLION TO THE REPUBLIC OF TURKEY FOR AN AGROINDUSTRY PROJECT MAY 10, 1989 This document has a restricted distribution and may be used by recipients ony In the performance of their oMcial duties. Its contents may not oherwise be disclosed without World Bank authrization  CURRENCY EQUIVALEWS Oharch, 1989) US$1 . Turkish Lira (TL) 2,027 TL1 US$0.00049 TL 1,000,000 . US$490 ABBREVIATIONS AND ACRONYMS FERlS - Foreigl Exchange Risk Insne Scheme GOT - Govemment of Turkey HB - Halkl ank LIB - Limited International Bilding PCIis) - Partti Credit Institution( SYKB - i Yatirim ve Kredi Bakasi ndustridal Investment and Credit Bak) TCZB - Turkiye Cumhriyet Zraat Bankasi (iculal Bank of the Republic of Turkey) FISCAL YFAR January 1- December 31  FOR OMFCIAL USE ONLY TURKEY AGROILNDUSTRY PROECT LOAN AND PROJECT SUNMARY Borrower: Government of Turkey (GOT) BEneficariebs: Participating Credit Institutions (PCIs), including the Agricultural Bank of Turkey (TCZJ), Balk Bank (BB), and Industrial Investuent and Credit Bank (SYKB), and additional banks which may be deemed eligible at a later date, the Ministry of Agriculture, and private agroindustry enterprises. Aunount: US$150 million equivalent Terms: Seventeen years, including a five-year grace period, at the Bank's standard variable interest rate. ChQendi4R The Government would onlend the proceeds of the Bank loan Terms: (excluding $6.7 million for a fisheries development survey and a marketing training component) to the PCIs. Aside from $0.5 million for technical assistance to the PCIs (to be onlent on the same terms as the Bank loan), proceeds of the loans to the PCIs would be onlent to private agroindustry subborrowers. Each loan to a PCI would be repayable on a schedule based on the composite amortization of its subloans under the project. The subborrovers would be given an option to borrow either 'an local currency under the Foreign Exchange Risk Insurance Scheme (FERIS) or in foreign currency. For subloans in local currency, the Government would onlend Bank funds to PCIs on FERIS terms which include a 31 spread for the PCIs and a variable interest rate based upon the -verage rate of three-month Treasury Bills. The PCIs would onlend such funds to subburrowers on the FERIS terms plus a 21 commission. For subloans in foreign currency, the Government would relend the Bank funds to the PCls at the Bank interest rate, and the PCIs would onlend to subborrowers at this rate plus a spread of up to 4 p.a. Fnanegb Plan: I/ IBRD US$150.0 million PCIs " 57.5 N GOT " 1.2 Private Investors n 200.0 Total USJ =8.7 million Economic Rate of Return: Not applicable. (Subprojects will have a minimum * ERR of 15X.) Staff Appraisal ReLort: Report No.7653-TU map: IBRD 16453R 1/ If grant cofinancing should become available for some of the technical assistance components, IBRD funds would be reallocated for additional agroindustry subloans. This document has a restricted distribuion and may be used by recipiets only in the performance of their offcial dutie Its contents may not otherwise be disclosed without Wodd Bank au_thontton.  MEMORANDUM AND RECOMMDATION OF THE P OF THE lNTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR AN AGROINDUSTRY PROJECT 1. The following memorandum and recommendation on a proposed loan to the Republic of Turkey for US$150 million equivalent is submitted for approval. The proposed loan would have a term of 17 years, including a five-year grace period, and the Bank's standard variable interest rate. The Government would onlend the proceeds of the Bank loan (excluding $6.7 million for a fisheries survey and a marketing training component) to participating credit institutions (PCIs), including the Agricultural Bank of Turkey (TCZB), Balk Bank, and the Industrial Investment and Credit Bank (SYmB), and any other bank which may be deemed eligible at a later date. Aside from $0.5 million for technical assistance to the PCIs, proceeds of the loans to the PCIs would be onlent to finance private agroindustry investments. 2. Background. Agroindustry is the single largest subsector in Turkey's manufacturing sector, contributing 30% of manufacturing output, and 19% of the sector's exports. Much of the agroindustry capacity was developed prior to 198G, during a period when Turkey was following, an import substitution industrial development strategy. Since these industries acquired foreign debt at an overvalued exchange rate, assuming continuation of policies of nominal domestic interest rates and import protection, many were unprepared for the stabilization policies of the 1980s based upon realistic exchange rates, positive interest rates, and a more open economy. High inflation has led to severe decapitalization, while high real interest rates have caused a scarcity of investment capital, leading to a rapid increase in short-term debt, high financial charges, and reduced profitability. Some enterprises were able to shift direction and regain a measure of financial health through exporting. Agroindustry exports have grown at an average of 152 per year over the past ten years, and exports of particular products (olive oil, fruit juices, tomato paste, and fresh and processed fruits and vegetables) are projected to grow at even higher rates. However, many other firms, did not have the managerial ability in such areas as marketing and product quality, or the financial strength to cope satisfactorily with the changed circumstances. Much of the industry is still facing serious financial problems, and is not in a position to take advantage of opportunities for exports and growth. 3. ProjectLekves. The agroindustry subsector in Turkey has the potential to increase production for both domestic and export markets. Increasing output by increasing capacity utilization in existing plants is in most cases more economic than by constructing new plants. Thus, the primary objective of the project is to provide the needed financial resources to existing enterprises which, under stronger management, will revitalize existing capacity, thus increasing output, employment and foreign exchange  -2- earnings. However, construction of new capacity would also be an objective in the case of products which offer prospects of high capacity utilization or where existing capacity is either unsuitable or has become obsolescent in the face of technological change. 4. ProjeIt DesKioon. The proposed project would have the following components: (i) credit lines totalling $142.8 million equivalent to the participating credit institutions (PCIs) for on-lending as subloans to cover the direct and indirect foreign exchange costs of private sector agroindustry subprojects which are financially and economically viable. Permanent working capital in connection with investment subprojects would also be eligible for financing; (ii) technical assstance to cartlatlngcredit istitutions to improve their capability to carry out financial restructuring and subproject appraisal; (iii) technicalassistance to GOT to undertake a fisheries development survey to provide a basis for long-range planning for the development of the fisheries sector, including preparation of fisheries development projects suitable for international financing; and (iv) a olot market nttral thir amS to test and develop training techniques in international marketing, with emphasis on agroindustry product marketing. PCIs would include initially the Agricultural Bank of Turkey (TCZB), Balk Bank (HB) and the Industrial Investment and Credit Bank (SYKB). Other PCIs satisfactory to the Government and the Bank may be added at a later date. The subborrowers would be given an option to borrow either in local currency under the Foreign Exchange Risk Insurance Scheme (FERIS) or in foreign currency. For subloans in local currency, the Government would onlend Bank funds to the PCIs on FERIS terms which include a 3 percent spread for the PCIs and a variable interest rate based on three-month Treasury Bill rates. The PCIs would onlend such funds to the subborrowers on the FERIS terms plus a 2S commission. For subloans in foreign currency, Government would relend funds to the PCIs at the Bank interest rate and the PCI. would onlend to subborrowers at this rate plus a spread of up to 4% p.a. Government would also onlend $0.5 million equivalent for technical assistance to the PCIs at the Bank interest rate. The loan also includes $6.7 million for a fisheries survey and marketing training program. If grant financing is obtained for these components, these funds would be reallocated for additional agroindustry subloans. The fisheries survey would be implemented by the Miniptry of Agriculture. Establishment of a private foundation for export t:-aining is under active consideration and this proposed foundation could be a suitable implementing agency for the pilot marketing training component. Arrangements, satisfactory to the Bank, for carrying out the marketing training component would be made by December 31, 1989. The total cost of subproject investments and the technical assistance components is estimated at about $409 million equivalent with a foreign exchange component of about 37%. A breakdown of costs and the financing plan are shown in Schedule A. The loan is expacted to  -3- be committed in three years and disbursed in six years. Amounts and methods of procurement and disbursements and the disbursement schedule are shown in Schedule B. A timetable of key project processing events and the status of Bank Group operations in Turkey are given in Schedules C and D, respectively. The Staff Appraisal Report (No. 7653-TU) dated May 10, 1989, is being distributed separately. 5. Agreed Actions. At negotiations agreement was reached with the Government of Turkey and the PCIs on the following: (a) Subborrowers would be given the option of borrowing in local currency (at a variable interest rate tied to the three-month Treasury Bill rate) under the Foreign Exchange Risk Insurance Scheme (FERIS) or in foreign exchange; (b) each PCI would have to submit annual audit reports including certification that it is in compliance with the following financial covenants: (i) a minimum collection ratio of 75% on medium and long-term loans (except for TCZB which would t-ve a minimum ratio of 702 for loans made prior to January 1, 1989 and 85% for loans made thereafter); (ii) a minimum debt-service-cover ratio of 1.1 to 1 for SYKB and 1.2 to 1 for other PCIs; (iii) a cap4*sl adequacy ratio as required by the Banking Law for commercial banks or a 10 to 1 maximum debt-equity ratio for development banks, and (iv) provisions for bad and doubtful debts as required under the Provisions Decree of May 1988; (c) Subproject and enterprise eligibility criteria would include (i) a minimum economic rate of return of 15% in real terms; (ii) a debt-service coverage ratio averaging at least 1.5 during the five year period following the start of commercial operations and no less than 1.2 during any year; (iii) a minimum owners/stockholders equity investment of 351 of assets at the time of application for the subloan, and owners/stockholders provision of at least 501 of the cost of the proposed investment; (iv) maximum Bank financing of $5 million for any subproject and $10 million for any enterprise and (v) compliance with environmental standards acceptable to the Bank; and (d) Government would provide (i) additional equity resources to TCZB to reach a ratio of net worth to total assets of at least 62 by the end of 1991 and (ii) payment to TCZB by December 31, 1989 for arrears on Government guaranteed loans to sales cooperatives. 6. Initial allocations for subloans would be $71.4 million to TCZB, $42.8 million to SYXB and $28.6 million to Ralk Bank. The Government would retain the right to reallocate funds among PCIs (i) if reviews of commitments and pipeline of loans indicate that a PCI may be unable to utilize its remaining allocation; (ii) if additional PCIs should become eligible to participate in the project; or (iii) if a PCI should be unable to carry out its obligations under the Project Agreement or the Subsidiary Loan Agreement. The Bank would be prepared to consider adding additional PCIs to the Project subject to their meeting the financial requirements in paragraph 5 (b) above and their having adequate agroindustry appraisal capacity. Signing of Subsidiary Loan Agreements, acceptable to the Bank, between the Governsmet and at least two PCIs would be a condition of effectiveness. Discontinuation of the former fixed-rate FERIS would also be a condition of effectiveness. No disbursement would be made with respect to a particular PCI until a Subsidiary Loan Agreement acceptable to the Bank had been signed with the PCI. Conclusion of a Subsidiary Loan Agreement could take place only for a PCI which had made adequate provisions for non-performing loans in accordance with Turkey's banking law. PCIs would submit to the Bank for approval full appraisal reports for subloans above a free limit specified for each PCI, and  -4- a summary description of the project and certification of eligibility for subloans below the free limit. 7. Benefits. Agroindustry is the largest single subsector in Turkey's manufacturing sector and plays a major role in the Turkish. economy by generating employment, providing a market for agricultural output, fostering entrepreneurship, reducing regional and income disparities and producing for exports. The proposed project would help revitalize the subsector, thereby creating additional employment, income and foreign exchange earnings. The project, by providing funds to several PCIs on equal terms, would also facilitate increased competition among PCIs for providing improved services to agroindustries. The Bank ioan would not only provide long term resources to the participating credit institutions for on-lending to agroindustrial enterprises but also technical assistance to improve their capabilities to ap;- aise agroindustry projects and carry out financial restructuring of distressed enterprises. The technical assistance component would also provide valuable training programs for those responsible for product development and marketing in agroindustrial enterprises, and help provide the information required to support agroindustry development in fisheries. It is anticipated that the project would finance about 250 agroindustry subprojects resulting in about US$400 million of incremental investments. On the basis of comparable investments in earlier years, it is estimated that the project could create about 20,000 new full-time jobs. The subprojects financed are expected to be fairly labor intensive, with a cost per job usually not exceeding US$25,000. While many of the smaller agroindustry units financed are not expected to be direct exporters themselves, their products would be han"led by established exporters and export trading companies. All of the agroindustry units would be processing local raw materials with direct linkages with the agricultural sector. Many of the workera employed by these units would be less skilled or new entrants into the labor force. 8. Rationalefor Bank nvolvement. The proposed project would support the Bank's strategy for (i) assisting the development of the agricultural sector and increasing its commercial orientation; (ii) supporting Turkey's efforts to increase exports; and (iii) strengthening financial intermediaries and increasing their areas of competition. Government and the Bank are in agreement on subsectoral development objectives and on the strategy to achieve them, i.e., liberalization and concomitant enterprise restructuring. The Bank's unique contribution to this process would be as a catalytic agent in bringing together within the project the parties with a clear stake in the future of the subsector (the agroindustry enterprises and the participating banks), defining their roles in subsectoral development and promoting implementation of key elements of the subsector strategy, i.e. financial restructuring and development of the marketing function. The Bank's support of the project is critical for the active and growing involvement of the PCIs. The proposed project would increase Turkey's foreign exchange earnings and output, without requiring significant Government budgetary outlays. 9. Risks. Continuation of high inflation and economic disequilibrium could jeopardize the performance of the agroindustry subsector. The Government has committed itself to a package of reforms, which are expected to reduce inflation and the fiscal deficit. The Government and the Bank are closely monitoring implementation of the reform program. Other risks include  the possible slow pace of enterprise restructuring by the PCIs and the inability of enterprises to appreciate and adopt focussed marketing strategies. Training and consultant input are provided to reduce these risks. There may be initial resistance from potential borrowers to the switch from fixed to variable interest rates under the FERIS scheme, but the advantages of the new arrangements should become evident if the Government's anti-inflation policy induces downward movement in these rates. 10. Recommendations. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recouxend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. May 10, 1989 r  -6- Schedule A TURKEY AGROINDUSTRY PROJECT4L Estimated Costs'Z Local Foreign Total ---(US$ million)--- Subproject Investments 257.2 142.8 400.0 Technical Assistance Components 1.5 7.2 8.7 Total 258.7 150.0 40&7 Financing Plan Local Foreign Total - (US$ million) Bank 0.0 150.0 150.0 Private Sector 200.0 0.0 200.0 PCI 57.5 0.0 57.5 GOT _ 1.2 0.0 1.2 Total 250.7 150.0 408.7 oL. If grant financing should become available for the fisheries survey and marketing training components (estimated foreign exchange cost $6.7 million equivalent) corresponding amounts from the Bank loan would be reallocated for agroindustry subloans, with consequent increases in financing amounts from PCIs and Private Investors. t Inclusive of taxes and contingencies.  -7- Schedule B Page 1 of 2 TURKEY AGROINDUSTRY PROJECT Project Element Procurement Method Total LIB IS'1 Other N.A. -(US$ million)--- Subloans 50.0O1 350.OZA 400.0 (50.0) ( 92.8) (142.8) Equipment, vehicles, and materials 2.2 2.2 (2.2) (2.2) Consultants 5.5 * 5.5 (5.0) (5.0) Administrative Costs 1.0 1.0 Total 50.0 367.2 5.5 1.0 408.7 (50.0) ( 95.0) (5.0) (150.0) Note: Figures in parenthesis are the amounts financed by the Bank. International shopping, based on at least three responsive quotations. /2 For contracts below $3 million, local and international shopping based on at least 3 quotations would be used; otherwise limited international bidding would be required. '3 According to the Bank Guidelines for use of consultants issued in August 1981.  -8- Schedule B Page 2 of 2 Disbursements Category Amount 2 US. M Subloans Machinery and Equipment, ) 142.8 100% of CIF cost of directly (including associated ) imported items, 502 of ex-factory services) ) cost of locally manufactured items, ) 70S of imported items purchased ) locally. ) Imported raw materials ) 1002 of CIF cost (up to subloan ) allocation for permanent working ) capital) Civil Works ) 30% Technical Assistance Equipment for fisheries 2.2* 100% of CIF cost of directly survey imported items; 1002 of ex-factory cost of locally manufactured items; 752 of cost of imported items purchased locally. Consultants 5.0* 1002 of foreign expenditures 150.0 Estimated IBRD Disbursements: IBRD Fiscal Yeai 90 91 92 93 94 95 - - (US$ million)- Annual 10.0 13.0 29.0 35.0 40.0 23.0 Cumulative 10.0 23.0 52.0 87.0 127.0 150.0 * Some equipment may instead be included as part of consultants' contract.  -9- Schedule C TURKEY AGROINDUSTRY PROJECT Timetable of Kev Proiect Processing Events (a) Time taken to prepare: 10 months (b) Prepared by: Government with Bank assistance (c) First IB3tD mission: January 1988 (d) Appraisal mission departure: November 1988 (e) Negotiations: March 30-April 5, 1989 (f) Planned Date of Effectiveness: August 31, 1989 (g) List of relevant PCRs and PPARs: Agricultural Credit and Agroindustries Project (PPAR No. 6812) Fruit and Vegetables I (PPAR No. 4265) t  -10- Schedule ) Page 1 of 2 STATUS OF 8ANK GROUP PPERATIONS IN TURKEY A. SToA ENTR OF