Turkey - Technology Development Project

Document of The World Bank FOR OFFCIAL USE ONLY Ag 3Zq47 -7 Report No. P-5405-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 US$100.0 MILLION TO THE REPUBLIC OF TURKEY FOR THE TECHNOLOGY DEVELOPMENT PROJECT JANUARY 29, 1991 This document has a restricted 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.  CURRENCY EQUIVALENTS Currency Unit - Turkish Lira (TL) Value of USS1.OO 1986* TL 674.5 1987* TL 857.2 1988* TL 1,422.3 1989* TL 2,121.7 1990* TL 2,629.0 1991 (January) TL 2,961.0 _t Annual Average LIST OF ABBREVIATIONS FSAL - Financial Sector Adjustment Loan FWCT - Foundation for World Class Technology GOT - Government of Turkey ITD - Industrial Technology Development MSTQ - Metrology, Standards, Testing and Quality System OECD - Organisation for Economic Co-operation and Development PSBR - Public Sector Borrowing Requirement R&D Research and Development TSE - Turkish Standards Institute TOBITAK - Scientific and Technical Research Organisation of Turkey WPI - Wholesale Price Index REPUBLIC OF TURKEY FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY TECHNOLOGY DEVELOPUENT PROJECT LOAN AND PROJECT SU)WARY Borrower: Republic of Turkey Beneficiaries: The Turkish Standards Institute (TSE) The Scientific and Technical Research Organisation of Turkey (TOBITAK) The Foundation for World Class Technology (FWCT) Amount: US$100.0 million equivalent Terms: Seventeen years including a five year gra-e period at the Bank's standard variable interest race. Relendins Terms: Metrology. Standards. Testing & Ouality Component. US$42.4 million of the Bank loan would be on-lent to TSE as an income note with payments based on TSE revenues over 17 years. Foreign exchange risk will be assumed by the Government. The remaining US$14.3 million of the Bank loan for this component will be allocated by the Government as a grant to TUBITAK. Research and Develoment (R&D) Component. US$43.3 million will be allocated by the Government as a grant to the Foundation for World Class Technology. Venture Caoital COmDonent. IFC will invest up to US$5.0 million in the Fund and US$0.1 million in the related Management Company. There is no Bank loan financing for this component. Financing Plan: Government of Turkey US$ 6.2 Private Sector Investors 131.3 Development Banks 4.0 TSE 7.6 IFC 5.1 Bilateral Governments 4.4 Multilateral Donors 3.5 IBRD 100.0 Total Financing 26. Economic Rate of Return: Not applicable Staff Apnraisal Report: Report No. 9079-TU Nag: IBRD 22207 This document has a restricted distribution and may be used by recipients only in the verform4 ce of their official duties. Its contents may not otherwise be disclosed without World Bank authoti -ation.  NEMORANDVM AND RECOMMENDATION OF THE PRESIDENT QF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO TEE REPUBLIC OF TURXEY FOR THE TECHNOLOGY DEVELOPMENT PROJECT 1. I submit for your approval the following memorandum and recommendation on a proposed loan to the Republic of Turkey for US$100.0 million equivalent. The proposed loan would be on standard Bank terms with 17 years maturity, including a 5 year grace period, and would help to finance an industrial technology development project. The project will be co-financed by the IFC for US$5.1 million. 2. Country and Sector Background. The reform of Turkey's policy framework over the last decade has fostered an era of rapid economic growth and structural change. Trade liberalisation and domestic price deregulation have created competitive pressure on firms to increase productivity. Incentives for exporters have generated opportunities for learning through interaction with buyers, suppliers and competitors in the international markets. Financial market reform is providing a consistent framework for resource reallocation towards high productivity sectors. The most striking indication that this strategy is working has been the export response of the manufacturing sector. A significant shift in relative prices in favor of export industries coupled with domestic stabilisation efforts resulted in a sustained growth of manufactured exports from US$1.0 billion in 1980 to just over US$9.0 billion in 1988. 3. Over the last two years however, appreciation of the real effective exchange rate and a sharp reduction in export subsidies have severely curtailed growth of manufactured exports. Moreover, the composition of exports in terms of commodity compositicn and geographic destination requires further structural diversification. A high proportion of Turkish manufactured exports are supplied to politically volatile, low value added or price- sensitive markets. Sustained productivity growth through investment in physical plant and equipment, know-how acquisition and a shift into higher quality products is essential if firms are to build competitive advantage in more discriminating market segments. 4. With the first round benefits of structural adjustment realised, the GOT now is looking for additional policy instruments to increase the long run rate of productivity growth in the economy. Within the context of a stable macroeconomic environment and a rational incentive framework, selective industrial technology development (ITD) initiatives to offset free rider problems and capture externalities are moving to the centre-stage of industrial policy. In the first phase of the program, the focus will be on investment in a national framework for quality assurance consistent with OECD standards, introduction of market forces into the research and development  - 2 - (R&D) system and catalysing the supply of innovation finance. Second phase projects are likely to include further work on informatics, intellectual property rights, science parks, technical manpower, consumer protection legislation and reform of public R&D financing. By providing technical and financial support at this point, the proposed Project can exert a positive influence over the future direction of the ITD agenda in Turkey. 5. The Project is proposed in light of policy reforms and institutional changes being undertaken and planned on the macro, financial and industrial fronts. Macroeconomic performance has improved with an acceleration in the rate of growth to over 10% in the first half of 1990 from a sluggish 1.7X in the whole of 1989. Wholesale price index (WPI) inflation abated from 68X in late 1989 to a rate of 34% for the first 9 months of 1990. The Government has introduced significant adjustment measures to raise revenue in anticipation of the fiscal impact of the Gulf crisis. Nevertheless, further fiscal adjustment effort remains essential to reduce the PSBR to a more sustainable level, and to mitigate the conflict between monetary and fiscal policy. In the financial sector, policy reforms to phase out the preferential credit system and institutional changes to the supervisory and prudential framework have been successfully completed under the Second Financial Sector Adjustment Loan (FSAL II). In the industrial sector, discussion with the GOT on an adjustment program has focused on a rationalisation of the tax and incentive system, a program for state enterprise reform, trade policy and further reductions in taxes on financial intermediation. GOT has implemented a number of reforms and assuming sustained progress on these fronts, private demand for modern technological goods and services is expected to continue growing. A key task today is to address supply side weaknesses in the ITD institutional and policy framework that constrain the performance of Turkish industry. 6. Rationale for Bank Involvement. The Project forms an integral part of the Bank's country and sector assistance strategy. In the industrial sector, it supports Turkey's integration into the international economy by strengthening the institutional framework for demonstrating compliance with OECD quality assurance standards, and by accelerating the shift from reliance on imported technology to investment in internal ITD effort that complements outward-oriented know-how acquisition. In the financial sector, the Project complements the GOT's strategy to develop the capital malKets by establishing the venture capital industry as a source of innovation finance for technology- oriented companies. The GOT aims to accelerate its own learning in the ITD policy field and has therefore requested the Bank assistance. Through a decade of research followed by operational experience, the Bank is well positioned to transfer knowledge to GOT on best ITD practice. The lessons of this international experience have fed directly into project design, which emphasizes the role of the private sector in ITD, the balance between knowledge generation (R&D) and technology diffusion, and linkages between ITD strategy and the competitive market environment.  - 3 - 7. prolect Objectives.'l The proposed Project has the following objectives: (a) to develop the metrology, standards, testing and quality system to international standards by capacity building in the key public sector institutions and by establishing a framework for greater private sector participation in the system; (b) to make research and development market driven by financing projects on a matching basis with the private sector; and (c) to foster the growth of a venture capital industry by introducing a supportive legal and regulatory framework, by rationalizing the tax environment and by establishing a role model company. 8. Prolect Description. The first component of the proposed Project would provide US$56.7 million of the Bank loan towards a total US$74.2 million program whose objective is to develop a Metrology. Standards. Testing and Ouality QMSM) system that meets OECD requirements and also the demands of Turkey's evolving industrial base. The Project will help finance investments in four sub-components: (a) laboratories, measurement equipment and training for the public agency (TOBITAK) responsible for metrology; (b) the development plan of the Turkish Standards Institution (the lead public agency for MSTQ) including a calibration, testing and training facility in Istanbul; (c) the start-up costs of a National Accreditation Council to support a private testing and certification industry; and (d) the start-up costs of a Professional Institute for Quality Assurance, and a National Media Campaign for Quality Education. The second component would provide US$43.3 million of the Bank loan to a US$92.4 million research and development program that will be managed by an independent Foundation, whose shareholders include both public and private sector representatives. The objective of the Foundation is to encourage greater private R&D effort by providing seed capital for: (a) Strategic Studies on the competitiveness of key industries vis-a-vis economic and technological changes occurring in the international market; and (b) ITD Challenge Programs involving a mix of applied research, development of training programs and information services, international joint ventures for technology transfer, etc. Sub-projects will be financed through a mix of grants, income notes and conditional loans with the medium term goal that the Foundation become self-financing. The third component will support development of the venture calpital industrv by (a) introducing under the Capital Market Board a supportive legal and regulatory framework consistent with the model in other OECD countries, (b) rationalizing the tax treatment of the industry to avoid taxation of financial intermediation; and (c) establishing a private venture capital management company and fund to act inter alia as a role model for the industry. The IFC is providing up to US$5.1 million finance to the operation that aims to generate US$89.0 million investment in innovative business projects (with US$6.6 million estimated as the costs of venture capital financial intermediation). 9. Agreed Actions. During negotiations agreements with the Government on the following were reached: (i) NSTO System. The Government would (a) during the life of the Project provide budgetary allocations to TOBITAK of 1 GOT preparation of this Project was partly funded by the Japan Grant Facility.  - 4 - US$19.9 million; (b) provide US$42.4 million for inivestment by TSE in the form of an income note based on TSE revenues with an amortisation schedule of 17 years including a 5 year grace period; (c) place the National Accreditation Council on a legal basis independent of TSE by December 31, 1994; and (d) revise legislation that provides TSE with a de jure monopoly over certification services by December 31, 1992; (ii) Research and DeveloRment. The Government would (a) guarantee the tax exempt status of the Foundation; (b) ensure the contractual freedom of the Universities and public research institutes in their transactions with the Foundation; and (c) develop a consistent accounting framework to identify sources and uses of resources for technology development; (iii) Venture Capital. The Government would (a) maintain a regulatory framework conducive to the development of the venture capital industry; and (b) ensure that venture capital funds as defined under the Capital Market Board regulations would not be subject to double taxation. 10. Environmental Aspects. The proposed Project has been reviewed under the provisions of Operational Directive 4.00, Annex A, "Environmental Assessment" and placed in Environmental Screening Category B. The project will not require the preparation of an environmental assessment; however, environmental review procedures have been adopted for project supported activities. The proposed Project will support the environmental objectives of the GOT. First, the MSTQ component will strengthen the institutional capacity to prepare standards that reflect environmental and energy conservation guidelines (e.g., in the building materials industry), and to ensure accurate testing of vehicle emissions. Under the second component, the Foundation is planning to include energy conservation as an area of strategic focus for applied research and development. Third, portfolio companies financed under the venture capital component are expected to have an exceptionally low probability of causing environmental damage. Each portfolio company will however, be required to demonstrate compliance with the environmental protection regulations of the GOT and municipal authorities. This approach to environmental protection will be reflected in the policy statement of the Venture Capital Company. 11. Project Benefits and Risks. The Project will generate three main benefits. First, it will catalyze private investment in ITD. For some firms, the benefit of the Project will be the finance that venture capital mobilizes for innovative investments. For a much larger group, the main consequence will be a MSTQ system that enables improved quality management. Second, the Project will strengthen delivery of public services where market imperfections result in an under-investment of private resources. In this respect, the project has focused on investment in MSTQ, preempting a potential competitive disadvantage of Turkish firms in OECD markets, and on the provision of seed capital through the Foundation for ITD in industries where Turkey can develop a dynamic comparative advantage. Third, the Project will strengthen linkages between private and public stakeholders in the technology community, and will improve the coordination of bi- and multi-lateral aid flows to the science and technology sector. The Project is financing two new institutions, the Venture Capital Company and the Foundation that will invest in sub-projects where the payback can be hard to quantify and where failures are an inevitable part of the innovation process. Nevertheless, the Project has been designed to  - 5 - minimize these risks. First, the major financial commitment is to its lowest risk component - the NSTQ system, whose long term significance is unlikely to be affected by short term economic cyclicality. Second, the active role played by the private sector in project preparation and implementation will ensure the commercial relevance and client orientation of the Project components. Moreover, the design of each component transfers best international practice to Turkey. 12. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the loan. Barber B. Conable President Attachments Washington, D.C. January 29, 1991  SCHEDI A TURKEY INDUSTRIAL TECHNOUOGY DEVELOPMENT PROJECT ESTIMATED COSTS AND FINANCING PLAN Estimated Costs: Local Foreign Total --- (US$ million)------ MSTQ 17.2 57.0 74.2 R&D 49.1 43.3 92.4 Venture Capital 58.0 37.6 95.6 Total Costs U124. 137.9 5k.12_ Financing Plan: Government of Turkey 6.2 0.0 6.2 Private Sector Investors 99.0 32.3 131.3 Development Banks 4.0 0.0 4.0 TSE 7.6 0.0 7.6 Multilateral Donors 2.0 1.5 3.5 Bilateral Donors 0.4 4.0 4.4 IFC 0.0 5.1 5.1 IBRD 5.0 95.0 100.0 Total Financing 12413  -7 SCHEDULE B TURX^Y INDUSTIAL TEChNOLOGY DEVELOPMENT PROJECT PROCUREMENT NETHOD AND DISBURSEMENTS ?r.curement ICB LIB SHOPPING Others 61 Total (US$ Million) MSTQ 27.6 32.0 7.0 7.6 74.2 of which IBRD: 17.7 27.7 5.0 6.3 56.7 Foundation 13.4 45.6 18.0 15.4 92.4 of which IBRD: 13.4 10.2 9.0 10.7 43.3 Venture Capital 6.0 31.6 54.0 4.0 95.6 of which IBRD: 0.0 0.0 0.0 0.0 0.0 Total 47.0 109.2 79.0 27.0 262.2 of which IBRD: 31.1 37.9 14.0 17.0 100.0 a/ Consultants to be engaged in accordance with Bank guidelines on use of consultants. Disbursements Amount Percentage of Expenditures gat;egay IUSS Million to be financed Machinery Jls Equipment 66.5 100l of foreign expenditures; 100l of ex-factory cost of domestically supplied equipment under ICB/LIB; 50X of other local expenditures Consultants 17.0 100l of expenditures Training 6.5 100l of foreign expenditures Civil Works 10.0 80X of expenditures  Estimated Disbursement Schedule Bank Fiscal Year FY9I FY92 FY9