Turkey - Small and Medium Scale Industry Project

DaaMint of The World Bank FOR OMCIAL USE ONLY Rqot No. 12573 PROJECT COMPLMEION REPORT TURKEY SKALL AND MEDIUM SCALr INDUSTRY PROJECT (LOAN 2647-TU) DECEMBER 1, 1993 MICROGRAPHICS Report No: 12573 Type: PCR Country Operations Division Country Department I Europe and Central Asia Regional Office This document has a rsticted distrbution and may be used by reipients only in the perfonance of ther officia dudes. Its contents may not othewnise be dilosed widhut Wodd BDak auriation.  FZRlS- Foreign Exchange Risk Insurance Scheme Ft - Financial Intermediary as - Halk Bank MIS - Management Information System PCI - Participating Credit Institution PCR - Project Completion Report S100 - Small Industry Development Organization 8MS - Small and Medium Scale Industrial Enterprises SMIDO - Small and Medium Scale Industry Development organization SYXB - Industrial Investment and Credit Bank SSI - Small Scale Induotrial Enterprises TA - Technical Assistance WPI - Wholesale Price Index  FOR OFFICIAL USE ONLY THE WORLD BWK Wangton. D.C 504 USA Offic . Dttoo4na Om" of ao December 1, 1993 SUBJECT: Prect Compledon Report on Turkey Small and Medium Scale Indutr Prol (Loan 47-T[ Attached is the Project Completion Report On Turkey - Smal and Medi Scale Idusy Project (Loan 2647-TU) prepared by the Europe and Cental Asia Regional Office. Par I, c iutd by 91e Borrower, sggess that the level of credit subsid tion under the project was minimal. The objes of the project were to () 2Mce lbor Inteive sm and medium scab nUSties (SMIs), epecialy veqr small ind es, where Turley has a comparative advantg, (i) srqte instional capabilidies of pardtipating Developme Finance Insituions (DFIs), and (I) st a rtiona program of tcncal asisan to SMI The target for the number of sbpojec to be financed wasmet Howeve, the mor specific objective of directing some of the lead to very ma wtezle wau only pardy achieved. The finnca Institution building of one DPI was met, wIh Ban finced techical assistance. About balf of the TA progam to SMI was impleted, with the remainig ud Aids reallcatod to a DPI for sub-project financing. The project was implemented durmg a period of mac o instabWity. As a resut, te objecive of acieving positive onlending int rates to beneficiaes was not met SMI itvestnn may not be sustained and fiaci iemdWs may not be able to provide suitab fiancing If unstabl macroeconomic conditions peist Overall, the project outome is rated as satsfctry, its sustalnability as unertain and its Intitionl development impact as partial. The PCR prvides a f&an and informative account of project oucomes and derives mean lessons of experience on project design. No audit is phnned. Attachment I ri docum e teiclsd diurlbutlad amy b by ipany I tim p eofkofiat_ Ion_a amy ,a o*mwIm be diacd wiA WoeA ,w* _mhaika. I  FOR OMCLAL USE ONLY QRJS CNPETON REIMR SMALL AND MDIUX SCAME INDUSTRY PROJECT LOA (2647-ZUI Table of Contents Page No. RVALUTIONSaU i PAMII PROJECT REVIEW FROM BINK'S&RSPECTIyJ . . . . . . . . . . . 1 A. Project Identity . . . . . . . . . . . . . . . . . . . . 1 S. Background . . . . . . . . . . . . . . . . . . . . . . . 1 C. Project Objectives and Description . . . . . . . . . . . 2 Project Objectivoe . . . . . . . . . . . . . . . . . . 2 Project Description . . . . . . . . . . . . . . . . . . 2 D. Project Design and Organization . . . . . .. . . . . . . 3 3. Project Implementation . . . . . . . . . . . . .. .. 4 credit Component . . . . . . . . . . . . . . . 4 Tchnical Assistance Component ............ 6 P. Project Results . . . 7. . . * . . . . .* . . . . . 7 credit Component . . . . . . . . . . . . . . . * . . 7 Technical Assistance Component . . . . . . . . . . . . 7 G. Project Sustainability . . . . . . . . . . . .. . . . . 8 H* Bank Performance . . . . * * * . . . . . . 8 I. Borrower Performance . . . ,. . . . . . . . . . . . . . 9 J. Lessons and Recommendations . . . . . . . . . . . . . .. 10 PART II PROJECT REVIEW FROM BORROWER'S PERSPECTIVE . . . . . . . . . 11 This documt tas a rstict distribution and may be used by mcipients ny in th pwefome of their ffiecl dutis. Its contonts nmy not otherwis be disclosed without World Bak authoriaton.  Table of Contents (continued) PART . x STIIQ ALS iF.MgION ... . . . . . . . . . .*.*. .*.*.*. 15 1. Related Bank Loans/Credits . . . . . ..... . ... 15 2. Projeft Timetable . . . . . . . , . . .* . . . 16 3. Loan Disbursements . . . . . . . . * * .,, *. .* 16 4. Project Zmpl_mentation ................ . 17 5. Project Costs and Financing . . . . . . . . . . . . . . . 18 6. Project Results . . . . . . . . . . . . . . . . . . . . . 19 7. Status of Covenants .a.t.s. . . . . . ................... 19 8. Use of Bank Resource ................... 20 ANNEXE8 Annex ls Sectoral Allocation . . . . . . . . . . . . . . . . 23 Annex 2: Averagse 7RI8 Interest Rates vs. Average WPI ... . 24 Annex 3s Geographic Distribution of Subloans . . . . . . . . 25 Annex 4: Subsectoral Distribution of Encouragement Certificates in Manufacturing Sector . . . . . . . 26  - i - PROJECT COMPLETION REPORT SMALL AND MEDIUM SCALE INDUSTRY PROJECT LOAN 2647-TU PREFACE This is the Project Completion Report (PCR) for the Small and Medium scale Industry Project in Turkey, for which Loan 2647-TU in the amount of US$100 million was approved on January 7, 1986. The loan was closed on December 31, 1992, six months later than the date planned at appraisal. The loan has been disbursed to the extent of US$98.51 million, and the residual amount of US$1.49 million mostly comprises the unused amounts for technical assistance. The PCR (preface, evaluation summary, and Parts I and III) was jointly prepared by Country Operations Division and Resident Mission in Turkey of Country Department I in the Europe and Central Asia Region and the Government of Turkey, SYXB and Halk Bank (Part II). The preparation of this PCR was started in December 1992 and was based, inter alia, on the Executive Project Summary, the Staff Appraisal Report, Staff Appraisal Reports of associated projects, Loan and Subsidiary Loan Agreements and Supplementary Letters, Supervision Reports, Project Correspondence Files, Internal Bank Memoranda, Subproject Files and interviews with the managers of Participating Credit Institutions (PCI) and Bank staff.  - ii - PROJECT COMPLETION REPORT SMALL AND MEDIUM SCALE INDUSTRY PROJECT (LOAN 2647-TUI EVALUATION SUMMARY (i) Obiectives and Design. The Bank provided this loan to the Government of Turkey for financing small- and medium-scale industrial enterprises (SKI), focussing particularly on smaller enterprises, to assist in reducing urban unemployment. Related to this objective, the project also aimed to help develop financial intermediaries that are proficient in providing term finance to SMIs. The project included technical services for SNIs through the Small Industry Development Organization (SIDO), which was then the only government agency respon ible for providing promotional and extension services to SMIs. To attain these objectives, the Bank extended to the Government the equivalent of US$100,000,000. Of this amount, $98.4 million was to be used for financing eligible SMI sub-projects while the remaining $1.6 million was for technical assistance to financial intermediaries and SMIs. (Ii) Imlementation Experience. Loan effectiveness was delayed mainly due to protracted discussions between the Bank and the Government about the Foreign Exchange Risk Insurance Scheme (FERIS), the credit program under which on-lending under the project was to be undertaken. There were also delays in the preparation of necessary legal documents by the Government. After loan effectiveness, however, the level of commitments and disbursements quickly reached a much higher level than appraisal estimates. However, rapid commitment and disbursement could I ve been due to the favorable interest rate offered under FERIS. (iii) The Bank and the Government had agreed that the FSRIS interest rate would be adjusted every six months for new subloans in line with market conditions. However, in the period between January 1986 and December 1989, adjustments were less frequent than agreed, and average interest rates were usually negative when compared to the average Wholesale Price Index (WPI). At the beginning of 1990, the FERIS rate was indexed to the re-discount rate of the central bank to make it more responsive to market conditions. However, this rate was also negative in real terms. Thus, the lending rate under the project continued to be a preferred rate throughout the life of the project. FERIS was io be reformed under a follow-up project (Second SMI Project) when the interest rate was made a variable rate tied automatically to the three- month Treasury bill rate. Finally, under the Private Investment Credit Project approved in May 1991, the Bank and the Government agreed to wind down the FERIS program altogether.  - iii - (iv) The appraisal targets in terms of the number of subprojects to be financed were met, indicating the existence of stronger than expected demand from medium scale and small scale industrial enterprises for the loan, at the interest rate offered. However, the objective of directing some of the lending to very small industrial enterprises was only partially realized. Halk Bank (HB) was required to direct 70% of its allocation to very suall enterprises. Only about half of this target was achieved. (v) The allocation of funds for TA had to be revised during implementation mainly because of implementation problems and changed conditions. Originally, US$0.35 million was allocated for technical assistance to HB. Subsequently, HS decided to use its own funds for the staff training and other institution building components envisioned under the project. Upon the request of HE and the Government, US$0.30 million were reallocated to sub-project financing through HE. The major portion of the TA funds (US$ 1.25 million) were originally allocated to SIDO. It was expected that SIDO would utilize about 60% of this allocation for consultants* services, and the remaining for equipment, reference materials and training. S1DO successfully implemented the recommendations of its consultants for developing a Management Information system (MIS), and improved its infrastructure by installing a computer system and acquiring personal computers. However, the component providing for technical services to SMIs did not proceed as well, as a result of changes in SIDO's organizational framework and mandate. The residual amounts of SIDO's allocation (US$0.6 million) were reallocated to the Industrial Investment and Credit Bank (SYKB) for sub-project financing. (vi) Proiect Results and Sugtainabilitv. The project was successful in supporting the SMI sector and increasing SMI's access to financial assistance, and in encouraging the two financial intermediaries to expand their SMI portfolios. However, unless macroeconomic stability is attained, it is unlikely that SKI investments will be sustained. Likewise, it is unlikely that financial intermediaries would continue to provide an uninterrupted flow of funds to SMI under unstable conditions. (vii) Almost 20,000 direct jobs were created at an investment cost per job of approximately US$17,000. The number of direct jobs created has exceeded the appraisal estimates of 18,000 which indicates the success of the project in achieving one of its primary objectives, that is, job creation. on the other hand, the actual cost per job of US$17,000 was above the expected level of US$10,000, indicating more capital-intensive subprojects were financed than expected at appraisal. (viii) The changes in the organizational structure and management of SIDO and an expansion of its mandate within the Ministry of Industry led to major budgetary changes and altered SIDO institutional needs and priorities. Thus the institution building objectives for SIDO under the project were not achieved. On the other hand, although the TA funds for HB were not utilized, this was principally because HS decided to use its own funds for TA. The agenda for staff training and other institution building components for HB proceeded as expected.  - iv - (ix) Lessons Learned and Recomm1endaLtons. While the credit component of the project provided financial assistance to more SNI units than expected at appraisal and helped build SMI lending capability in SYKB and HB, it has not helped develop alternative sources of funds for SKI lending because of the preferential interest rate offered. By distorting the credit markets, FERIS may have prevented the development of an SMI lending program that is sustainable for the long-term. The Bank should take issue with preferential and subsidized credit programs and work toward their elimination or, at least, reduction to levels that minimize distortions in credit markets. (Further reform and subsequent winding-down of PERIS were achieved under subsequent operations.) Provision of technical assistance for SMIs by a government agency, such as SIDO, will succeed only if there is close collaboration with the private sector. Without private sector involvement, such programs quickly become bureaucratic and unresponsive to the needs of the sector they are supposed to assist. Technical assistance for HS was more successful since objectives were not only clear but shared by both the Bank and HB. This led to a ,ecision by HB to use its own resources, indicating the value it attached to the TA.  PROJECT COMPLETION REPORT TURKEY SMALL AND MEDIUM SCALE INDUSTRY PROJECT LOAN 2647-TU Part Is PROJECT REVIXW FROM THE ANK'S P-RSPECTIVE A. Project Identity Project Name Small and Medium Scale Industry Project Loan No. 2647-TU RVP Unit s EcA Region Country Turkey Sector Finance and Industry B. Baclkbrggng 1. Turkey did not make the necessary adjustments to the economic disruptions that were caused by the general unfavorable conditions in the world economy in the 1970s. As a result, Turkey developed a large external debt burden which led to balance of payment crisis, a sharp deterioration in credit worthiness, shortages of imports, disruptions in industrial production and a rise in unemployment. Starting in 1980, the Government of Turkey adopted a new economic development strategy, including a wide ranging program of structural reforms. In this context, one of the major objectives of the government was to stimulate growth, employment and exports through strengthening the private sector. Numerous studies of Turkey's industrial sector had shown that factor productivity was significantly higher in private than in public industry, and that privately owned small and medium scale enterprises (S1I) offered high returns per unit of capital invested, while being more labor intensive. 2. As part of the new economic strategy, a large devaluation of the Turkish Lira and major policy reforms such as trade liberalization, and export promotion had been enacted. These reforms led to a large shift of production from domestic to export markets. Over the medium term, total factor productivity was increased. However, lack of access to institutional finance, particularly to financing machinery, plant, and adequate working capital was still a serious problem for SMIs. Also, SMIs faced bottlenecks in benefiting from then existing sources of technical assistance. This was particularly true for those in the private sector who failed to resolve various technical, management, marketing problems both because of lack of information on the availability of such services and the high costs involved. 3. Given the important role of SMIs in the manufacturing sector and their potential to contribute to employment creation and export growth, the government's Fifth Five Year Development Plan enunciated a strategy and accompanying policy measures specifically to promote SMI. These included strengthening the Small Industry Development Organization (SIDO) to develop appropriate strategies, policies, and technical extension activities to assist  - 2 - in SKI development and enlarge the flow of investment and working capital loans. C. Proiect Oblectives and Descrintion 4. iroject Obiectives. In line with the government objectives to promote SMIs and thereby contribute both to job creation and growth in manufactured exports, the Project aimed at building on the Bank's first project in this area, Labor Intensive Industry Project (Loan 1952-TU), and provide further assistance for the development of the small and medium scale manufacturing sector. In this context, the project was expected to place special emphasis on assistance to small scale industrial enterprises (88I) particularly those that are located in remote areas of the country. Also, parallel to this, the project intended to assist in developing financial intermediaries (PI) capable of providing term finance and financial services to SMIs in an efficient manner and thus improve SMI's access to term finance. Another objective was to help initiate a national program of technical assistance to provide a range of technical and management services to SMIs in a cost effective manner. 5. Proiect Descrintion. The Bank extended to the government the equivalent of US$100,000,000 for the development of labor intensive SMIs with special emphasis on small scale enterprises. US$98.4 million of this amount was to be used for financing eligible sub-projects and the remaining US$1.6 million for technical assistance. Sinai Yatirim Kredi Bankasi (SYUB) and Balk Bank (HZ) were the two FIs which were found eligible to on-lend the project funds. $80 million was allocated to SYKB and US$18.4 million to HB to be utilized in financing sub-loans. The project was estimated to create 18,000 direct jobs through approximately 700 sub-projects, of which 500 were to be financed through HB. HB would finance only SSIs# and within the SSI category 70% of HBl's share for sub-loan financing would be channeled to very small enterprises'. On the other hand, SYXB was allowed to utilize up to 20% of the project funds for financing non-SMI projects which satisfied the cost per job criteria3 and were considered export-oriented based on certificates of Encouragement. SYXB was required to finance SMI4 projects with at least 80% of its portion of the loan proceeds and: within this limit, minimum 30% of the loan would be on lent to SSIs. The onlending terms for tthe sub-loans were a maximum of 15 years including a grace period of 3 years. For sub-loans that 1 For an investment to be considered an SSI, the maximum investment limit for new projects should be $500,000 and $650,000 for expansion projects. 2 Very small enterprise was defined as an enterprise whose total fixed assets excluding land and buildings was less than US $200,000. 3 All eligible subprojects would have a maximum average capital investment, excluding land and buildings, of $18,000 per job. 4 For investments to be considered SMI, maximum investment limit should be US $2.5 million for new investments and $3.5 million for expansion projects.  were overed under the Foreign Exchange Risk Insurance Scheme (UERIS), subs rrowers paid the fixed FERIS interest rate and the maximum terms were eight years with three years grace period. SYKB and HB received the funds from the GOT with a rate which vas decided to be FERIS minus an intermediation fee of 4%. The government was to beaz the foreign exchange and lntereet rate riske. 6. For technical assistance (TA) to HB $0.35 Million was allocated to institutLonal strengthening of BB. In addition to thie, $1.25 Million was set aeide to develop inetitutlonal capabillty to provlde extenslon services to SMIs and to facLiltate subcontracting on a national basis. For this purpose, 8100 was expected to bulld up a decentralized network of branch offLces staffed with multldlsclpllnary extension teams. Each branch office would promote TA by visiting and undertaking diagnostlc surveys of SMI firms tc. assess their problems and needs and refer firms needing speclalized assistance to appropriate experts or LretLtutions capable of provlding such services. Upon completion of the TA program, 810D was expected to provlde assistance and guidance to about 350 SMI enterprLses, train about 200 entrepreneurs, and develop about 900 company proflles annually. D. Proiect Design and OraanLxztion 7. The SMI project was designed with a larger scope ln terms of financial and technical assistance than Loan 1952-TU. The latter was provided to SYKB for supportlng the development of labor intensive SMIs, whereas the coverage of SMI project was enlarged by adding a TA component and expanding the credit delivery wlth increasing the funds and by including HB as an additional PI. The SNI project also aimed to support the government efforts to develop SMI as stated ln their fifth five year plan. S. Although, under its previous industrial credits to Turkey, the Bank had endeavored to diversify lts assistance on a geographlcal basis and to intensify support to sSIs, these objectlves were met wlth limited success. The major reason for this was the limited access of DFIs to the less developed regions of Turkey. In order to be more effectlve in the promotion and extensLon of the loan, the SKI project lntroduced a commerclal bank (HB), whlch had a vast branch network spread all over the country and which was specialized ln loans to small enterprlses. Towards this end, the Bank also required RB to focus on the smaller end of SSI. 9. Interest rates and foreign exchange rlsk was one of the major issues ln project preparation. In contrast to the then existing fixed lnterest rates under the forelgn exchange risk lneurance scheme (UERIS), the Bank supported the LntroductLon of floating lnterest rates which would be adjusted on a six monthly basli in relation to an inflation based reference rate. The aim was to ellminate subsidies and move to positive interest rates. Also, the Bank lnsisted that the FERIS should be transitional ln nature and should be self-financlng. The Bank and the government agreed that the FERIS would be admLnLstered by the Central Bank of Turkey, the FERIS interest rate would be adjusted every six months and the prevaillng lnterest rate at the date of the TL contract would be applled until the end of the maturity of the  sub-loans. It was also agreed that the future of the FERIS should be discussed appropriately under the Financial Sector Adjustment Loan, which was then under preparation. 10. The financial assistance part of the project was to be carried out by SYKB and Ha. Both Flo would only lend to investment projects defined as the project whose investment cost per job created would not exceed US$18,000. SYRK was required to calcula*. economic and financial rates of return only for investment projects whioh were estimated to cost more than $750,000 each. In this category, SYRB would finance investment projects which had economic internal rate of return not less than 12% and financial rate of return not less than the prevailing rediscount rate charged by the Central Bank of Turkey for medium and long term loans for industrial investments, both in nominal terms. A 5Qs50 debt/equity ratio requirement was established by FERIS administration for sub-loans to be covered under this scheme. Establishment of financial performance measures like minimum current ratio, debt equity ratio and debt service coverage ratio as eligibility criteria for the investment firm were recommended at the appraisal stage. However, they were not included in the later stages of the loan processing. 11. The maximum debt/equity ratio for SYXB was set as 10:1. For further strengthening the institutional capacity of HB, agreement was reached for HB to carry out a program of restructuring in terms of their overall organization as well as their information systems to improve their efficiency. Also, HS agreed to appoint and train additional staff, especially in project identification, appraisal, and supervision. 12. $1.25 million was earmarked for the technical assistance component of the loan to be utilized by SIDO mainly for organizational development and staff training. SIDO was expected to develop a decentralized program of extension services and an efficient system to utilize other resource organizations and consultants to be effective in the improvement of the operations of SRI. Z. Prolect Implementation 13. Credit Component. Loan negotiations and effectiveness were not on schedule mainly due to protracted discussions between t.: Bank and the Government about FERIS, the interest rate which would be applicable to the loan, and also due to some delays in the preparation of necessary legal documents by the Government. After loan effectiveness, within one year, the level of commitments and disbursements reached a much higher level than the appraisal estimates. By the end of 198. disbursements amounted to US$35.99 million, 300% more than the levels anticipated at appraisal. About 87.5% of the loan amount was disbursed by the end of the following year. As of December 31, 1992 US$98.97 million was fully disbursed, six months later than the original closing date. 14. one of the critical issues raised in the preparation of the loan was the introduction of an interest rate structure and a foreign exchange risk coverage which would help to maintain an active demand for foreign currency  loans, but would eliminate subsidies. For this purpose, the Bank advocated the idea of setting floating interest rates in relation to an inflation based reference rate that is to be adjusted every six months. The Government's stated intention was to set FERIS interest rates which would be positive over the life of the sub-loans, and also would be in line with interest rates for similar maturities under the Central Bank's rediscount facility for industrial lending. After intensive discussions, the Bank and the Government reached an agreement on the application of FERIS. According to this, the FERIS interest rate would be adjusted every six months to new commitments. In spite of this, in the period between May 1984 and the last quarter of 1989 the FERIS was adjusted for differing periods (3 months to eleven months) and most of the time, the average interest rates were negative when compared to average WPI (Annex 2). This situation could be one of the determining reasons of the substantially higher than expected level of actual disbursements especially between 1987 and 1990. Only after the introduction of a floating rate for FERIS which is adjusted every month according to the auction determined interest rate of three month T-bills, did the FERIS interest rate become positive in real terms, especially in 1991 and 1992. However, FERIS administration decided to grant the right of making a choice between fixed and floating UERIS rate to the investors for subprojects which would be financed by then existing credit lines, including SMI I. For this purpose, in February 13, 1990, the reference fixed rate of FERIS was announced as the interest rate applied to the advance transactions by the Central Bank. This rate, which is a version of Central Bank discount facility, has been 54.5% since then. I5. It was estimated that a total of 700 sub-projects, 500 by HB and 200 by SYXB, would be financed from the Bank funds, for a total of US$98.4 million. More than 47% of this total amount would be directed to 8SI, of which 27.60% would be on lent to very small enterprises through HB. In other words, 13.09% of the total amount allocated for sub-project financing was earmarked for very small enterprises. 16. Towards the end of 1987, the commitments of HS were below the expected levels and there was agreement between the Bank and HB that commitments would have to be speeded up to meet the submission deadline of June 30, 1988. One of the reasons stated by HB for low commitments were the lack of demand from very small scale industries to which seventy percent of the loan had been allocated. As a result of this development, HB committed the remaining funds to SS1, without being very particular about the distinction between 8SI and very small enterprises. 17. As of end 1992, a total of 387 firms have been financed by the financial intermediaries. SYKB provided funds to 185 firms and HB to 202 firms. Almost 44% of the total amount disbursed for financing these sub- projects was utilized by SSI and only 5.95% of the total disbursements was directed to very small enterprises. HB's non-compliance with the requirement of directing 70% of its allocation to very small enterprises, was one of the main reasons of the variance in disbursement percentages for very small enterprises, as well as the variance between the projected and actual number of sub-projects financed. 94% of the funds under the loan were disbursed for financing small and medium scale enterprises, which is a better performance  - 6 - than anticipated in the appraisal stage where this percentage was estimated to be around 87%. These results also indicate the existence of better than expected demand from medium scale and small scale industrial enterprises. 18. The project funds were mainly directed to the financing of enterprises in the textiles subsector (42.6%). This subsector was followed by chemical industry (11.4%), metals (9.9%), electronics (5.8%), and food industry (5.7%). However, since the loan funds were not evenly distributed among the two Fla, the above listing is mainly affected by, and reflects the exposure of SYKB (45.9%). 19. Technical Assistance Component. The allocation of funds, which was done at the appraisal stage, had to be revised during implementation mainly due to the problems which are related to the technical assistance component of the loan. US$0.35 million was allocated to HS for TA. USS0.05 million of this amount was allocated for training purposes and USS0.30 was allocated for payments to consultants for their services for organizational development of HB. However, during the execution of the project no significant progress was apparent in HB's preparation of its technical assistance program and in the utilization of TA funds. Following the management changes, BB indicated that it would be prepared to use its own resources for the implementation of an institution building technical assistance program. Upon the request of HS and the Government, US$0.30 million and the unutilized portion of the amount allocated for training were realloceted in order to make these funds available for sub-project financing through HB. 20. The major portion of the TA funds (US$1.25 million) were allocated to SIDO. It was assumed that, SIDO would utilize about US$0.75 million for consultants' services, US$0.42 million for equipment and reference materials, and 0.08 million for training. SIDO successfully implemented the recommendations of its consultants for developing an efficient MIS system, improved its infrastructure by installing a computer system and by the acquisition of PCs. However, especially the technical assistance component of the project did not proceed as well, due to changes within SID0 resulting from management turnover and a redefinition of its role within the Turkish Economy in a broader context as SMTIDC. The intention was for SMIDO to have a broader policy coordination and advisory role, while at the same time maintaining its role as provider of general extension and consultancy services. SMID0's organizational framework and budget had been changed such that the remaining funds allocated were no longer required. At the same time, SYRB's original allocation under the loan had been fully committed and extremely tight credit market conditions continued to exist. Therefore, SMIDO's allocation for consultants' services was decreased to US$0.19 million and its allocation for training was decreased to US$0.038 million, and the residual amounts were reallocated to SYKB for sub-project financing. 5 SNIDO: Small and Medium Scale Industry Development Organization. SIDO was merged into S0IDO.  -7- F. ProIect Regults 21. Aredit Comqonent. S8I I was partly successful in achieving its lending objectives. The project was successful in supporting the Government to assist the SMI sector and also helped to increase SMI's access to financial and technical assistance, and to encourage the two financial intermediaries to expand their SMI portfolios. The credit component was fully disbursed to sub- projects of 387 enterprises of which 384 are in the SNI category. These sub- projects have created 20,000 jobs as compared to l80O00 estimate at appraisal. The actual number of direct jobs has been above the appraisal estimates which indicates the success of the project in achieving one of Its primary objectives, that is, job creation. on the other hand, although the cost per job was expected to be US$10,000, the actual cost was US$17,000. These figures were US$9,000 and US$22,850 for HB and SYKB respectively. SYKS explained this high cost per job as the result of lower capacity utilization in some sub-sectors. According to SYXB, an increase in the capacity utilization ratios of the companies would also increase the employment figures, and thus decrease the average cost per job. In addition to high concentration of SYKB's lending to certain subsectors, the exposure of SYKB to medium scale or larger industrial enterprises which tend to be more capital intensive than 88I, could be another factor to explain the difference between cost per job figures of the two FIIs. 22. Another objective of the project was to particularly assist 88I, especially those located in the remote areas of the country and it was estimated that around 47% of the funds that were made available for the credit component would be on-lent to 88Is by the FIs. However, due to factors such as lack of efficient promotion, lack of investment demand from distant or lesser developed areas most (89.43%) of the sub-projects were located in the three most developed regions of the country: Marmara (65.41%), Eagean (20.29%), and Mediterranean (3.73%). The objective of financing particularly small scale enterprises was barely achieved as 44% of available funds went to this segment of the sector. The project was not fully successful either in meeting the objective of utilizing 70% of H8's allocation to finance very small enterprises. Although it was estimated that around 13% of the funds available for the credit component would be disbursed for this category, only 6% was. 23. Technical Assistance Cormonent. For the execution of the technical assistance component of the project, US$1.25 million was allocated to SIDO and U8SO.35 million to HB. However, nearly US$0.6 million of SIDO's allocation and US$0.3 million of HB's allocation was not utilized, and therefore, was reallocated to sub-project financing. 24. 8IDO was the implementing agency which was to provide more comprehensive technical assistance to SMrs, another major objective of the project. In addition to assisting SMIs through SIDO, technical assistance funds were also allocated to 8IDO to strengthen its organizational structure and capability to carry out its role. 8IDO utilized the latter portion of the TA funds to establish an efficient MIS system and to procure main frame and personal computers. To improve its effectiveness in providing TA to SMIs,  SIDO was expected to expand its extension services. For this purpose, SIDO was supposed to open six more branches in addition to its centers in Ankara and Gaziantep. SIDO opened three more branches in Istanbul, Bursa, and Konya. Beyond these steps, SIDO was not able to carry out the task envisioned for it under the project because of a series of structural problems and organizational changes that occurred during the implementation period of the project. SIDO's failure to implement an extension service meant that the project failed to improve SMI's access to technical services as envisioned. However, the credit program did proceed and may have alleviated this problem by providing SMIs with the financial resource to procure technical services without SIDO assistance. G. Proiect Sustainabilitv 25. One of the objectives of the Bank's strategy for SMI lending to Turkey was to assist the Government of Turkey to promote labor intensive SMIs and thus contribute to job creation. Due to continuation of high inflation, which leads to high cost of investment funds and higher uncertainty in project financing, it is unlikely that the uninterrupted supply of funds for financing SMI investments can be achieved. The same considerations apply to the demand for funds by SM.I. As a result of the scarcity of available resources for term financing and high interest rates, sustaining the desired level of private SKI investments is even more difficult. Despite the environment, the overall collection ratios related to the loan funds of the Fl's have been 93.9% for SYRB and 89% for HB. It would appear therefore that the financial viability and sustainability of the sub-projects financed under the loan is above average. The repayment performance of the sub-projects indicate their ability to generate expected benefits over their useful life, testifies to the efficiency of the project selection system put in place by the FIs and to their effort to monitor project implementation. 26. SKI I has achieved some success in enhancing the institutional structure for financial assistance to SKI. It was the first Bank project in Turkey which introduced a commercial Bank (HS) as a financLal intermediary. The project sought to take advantage of the vast branch network of HB in reaching a wide range of SKIs, while assisting US in its structural and organizational strengthening. HE successfully implemented a series of institutional and organizational development programs. Thus, HB added a new department for project evaluation and reorganized its fund credits department to follow up the performance of the existing medium and long term loans in their portfolio. The sustainability of the performance of the two FIs has been achieved through improvements in both the quality of the balance sheet and the operational structure. SMI II, which is the follow up Bank loan in the same sector (Loan 3067-TU), has also benefitted from the improved project appraisal skills in both FIs. H. Bank Performance 27. At the preparation and appraisal stages of the project the Bank emphasized the development of efficient SMIs to help alleviate urban unemployment and increase exports of labor intensive industrial products. The  - 9 _ project met or exceeded the targeted employment estimates. However, the project could not meet the cost per job estimates. The exposure of SYUB to relatively more capital intensive projects, and the lower than expected capacity utilization ratios could be counted as the reasons of this outcome. It should also be added that, another cause of this result could be the underestimation of the expected average cost per job by the Bank at appraisal of the project. 28. Although, from project identification to board presentation, the Bank sought assurances that there would be a balanced geographical distribution of the loan proceeds, this was not realized. On the contrary, almost 90% of the funds for sub-loans were utilized by three relatively more developed geographic regions, and only the remaining 10% was disbursed to the lesser developed four regions. The Bank tried to emphasize this condition by requiring 70% of the allocation of HB to finance very small SSI. This issue was also dealt with as a covenant of the Project Agreement between the Bank and HB. However, HB failed to comply with the covenant. Only about 32% of HB's allocation were disbursed to very small SSI. Unfortunately, the supervision missions did not forcefully address this matter and there was little reference made in the supervision reports. 29. The Bank was successful in introducing a new financial intermediary (HB), to assist improving SMIs access to term finance. HE utilized the segment of the loan which was earmarked for training, to train its staff especially in the area of project appraisal. These events induced institutional and organizational developments in HB. In addition to this, both FIe expanded their medium and long term credit portfolios, especially in favor of SMIs. I. Borrower Performance 30. At all stages of the project cycle, the Government indicated its agreement that, the introduction of an interest rate structure, FERIS, which would help to maintain active demand, but would eliminate subsidies, was essential for the success of overall policy of the economy relying increasingly on market for_.es. To this end, the Government issued the decree and regulations that specified how FERIS would operate in 1985, and also stated that the FERIS fund should be self financing. However, the government could not achieve this objective. The PERIS rate was negative, some years up to 25 percentage points, in real terms from 1984 to 1991, with the exclusion of the year of 1986. Of course, this situation perpetuated distortions in the credit market. 31. Also as a result of the incentive policy of the Government, the even distribution of project funds among subsectors could not have been realized. The largest portion (43%) of the project funds were employed for financing textiles subsector, which is a reflection of subsectoral breakdown of investment incentive certificates given to manufacturing sector (Annex 4). 32. The decisions of the Government to change the organizational structure, and enlarge the area of responsibility which lead to major  - 10 - budgetary changes in SIDO, altered the needs and priorities of this institution. This development had a negative impact on the technical assistance component especially related to extending TA funds to SKI. As a result of this development, project funds which were earmarked for this purpose had to be reallocated. J. Lessons and Recommendations 33. The credit component of the loan has been disbursed earlier than anticipated at appraisal and the collection ratios of the Participating Credit Institutions (PCIs) have been above acceptable levels. The negative interest rates that have been charged to the sub-loans could be one of the notable reasons for this positive outcome. Also, another determinant would be the advancements realized by the FIs in terms of their project evaluation and follow up capabilities. 34. On the other hand, the same success has not been achieved in developing alternative long-term resources for financing SKI investments, thus increasing SMIs' access to term finance. one of the main reasons of this failure have been the distortions in the credit market created by negative real FURIS interest rates. The existence of such subsidized interest rate prevented development of competitive interest rates, and thus, deterred the development of alternative resources for term financing. Therefore, elimination of preferential and subsidized credits, regardless of their degree of association with the Bank loans, would be a requisite for the success of future Bank loans especially in their efforts to assist the Government to secure and improve the availability of alternative resources for term financing of SM? investments. 35. Provision of technical assistance for SMIs by a government agency, such as SIDO, wvil succeed only if there is close collaboration with the private sector. Without private sector involvement, such programs quickly become bureaucratic and unresponsive to the needs of the sector they are supposed to assist. Technical assistance for financial intermediaries was more successful since objectives were not only clear but shared by both the Bank and the institutions concerned. In the case of HB, this lead to a decision to use its own resources indicating the value it attached to the TA.  - 11 - Part Ils PROJECT REVIW rROM BORROWER'S PERSPECTIVE 36. The following comments on the draft PCR were submitted by the Undersecretariat of Treasury and Foreign Trade of the Prime Ministry of the Republic of Turkey. 37. We would like to extend our deep appreciation for your invaluable contributions and kind cooperation during the implementation period of the referred project and also for well prepared Project Completion Report. 38. The small and medium scale industry is the one of the key sector of our economy and has a great impact on the industrialization process of Turkey. In this context, I would like to firstly convey some comments on the Borrowers Performance Section and then on others. 39. Concerning the implementation of Foreign Exchange Risk Insurance Scheme (FERIS), there is no doubt that this scheme made positive effects on the acceleration of the disbursement of funds. As a result, the loan amount have been disbursed earlier than anticipated at appraisal. The main purpose of establishing such a system is to protect small scale investors from the devaluation of the Turkish Lira when they borrow long-term foreign exchange loans. It is a matter of fact that high volatility of interest rates and currency values in financial markets has created an important degree of interest and currency exposure which can not be managed by small scale enterprises on their own. At the beginning of the FERIS implementation, FERIS rate was determined by the Central Bank's rediscount rate applied to preferred investment. If the Central Bank rate was not selected as a reference rate, there was no chance to attract investors to use the Loan proceeds. For this reasons, eventhough the FERIS interest rate became negative level at the beginning of the implementation period, it had prevented competition with respect to Central Banks rediscount facilities for preferential credits. Actually, as a consequence of elimination of Central Banks rediscount facilities, FERIS interest scheme passed to floating interest rate adjusted on a monthly basis according to last three month arithmetic average of auctioned interest rate of three-month Treasury Bill. Within this framework, FERIS interest rate have been reached to positive real level and caused to Loan proceeds much more expensive than all preferential credits. In fact, although the Loan Agreement of SKI I stated that subborrower pay FERIS interest rate to the intermediary banks and these banks pay FERIS rate minus an intermediation fee of 4% to the FERIS, the intermediary banks actually paid current FERIS rate minus an intermediation fee of 4% to the FERIS, the intermediary banks actually paid current FERIS rate without cutting intermediation fee to FERIS according to the decision of Money and Credit Board. For these reason, intermediary banks collected the intermediation fees from subborrowers thus increased the real cost of funds to subborower by 4% Nevertheless, after the introduction of floating FERIS rate, the average rate implemented during the project approximated to real level and disbursement rate of the loans under FERIS slowed down as observed such Loan like 3067-TU, 3077-TU.  - 12 - 40. Furthermore, the largest portion of the project funds were used to finance textile sector projects. But it is not only reason for that textile sector is favored by Government on the distribution of the incentive certificates but also that Turkish manufacturing sector has a comparative advantage on textile because of mainly low labor cost and accessible foreign markets. Nevertheless, it is true that the even distribution of project funds among geographic region was not be realized. There is no adequate investment demand in those region, although heavily subsidized preferential credit shave been given. 41. In line with restructuring of SIDO as SMIDO, has dealt more effectively with small and medium scale e.nterprises through providing technical assistance and consultancy. However, due to reorganization, SMIDO was delayed to use the technical assistance component (T.A.) of Loan. In this regard, Treasury indicated a quick response and reallocated the unused part of T.A. component to SYKB for relenting this component to the eligible projects. Thus the whole amount of Loan have been almost disbursed until the closing date. 42. on the other hand, both of the intermediary banks have failed at some degree to achieve the target of cost per job which became US $ 17.000 contrary to estimated US $ 10.000 at appraisal. However the most important aim of the project, job creation has been largely achieved roughly 20.000 jobs have been created as compared to 18.000 estimated at appraisal. In fact, through the capacity utilization ratio increment, overall cost per job will be certainly diminished. Since very small project projects create more cost efficient job opportunities, one of the other reason for higher cost per job may be counted as the low level of very small project financing by Halkbank. 43. Furthermore, SMI I is the first World Bank Loan in Turkey which introduced a commercial bank, Halkbank, as a financial intermediary. The successful project implementation of Halkbank lead to the participation of several commercial bank in some following Bank Loans such as 3067-TU, 3346-TU. 44. As a consequence, it is clear that the Project has been quite successful in increasing SMI's access to suitable financial sources and encouraging the participating intermediary banks to expand their SMI activities. 45. The individual comments of SYKB and Halkbank regarding the Project Completion Report are also conveyed in the enclosures. COMMENTS OF SYRB 46. The small and medium scale industry sector plays an important role in the industrialization of Turkey. The SMI firms are crucial in the economic and social achievements of Turkey in the sense that, they are mostly labor intensive, need less capital for unit of output and have good export prospects. The SMI firms also contribute to the performance of larger enterprises through sub-contracting, as well as they develop themselves and constitute a backlog to prospective larger scale industries.  - 13 - 47. SYXB, in the utilization of the SMI Loan 2647-TU was also successful as in the case of IBRD Loan 1952-TU. The projects were generally located in developed regions and textiles continued to be the leading of finance. The amount allocated to SYKB, out of the proceeds of this loan, was originally 80 million USD equivalent. Pursuant to the amendment dated April 15, 1992, made to the subsidiary loan agreement of April 14, 1986, signed between Treasury and SYR8 this allocation was increased to USD 80,584,250 equivalent. 48. Total withdrawals made by SYKB amounted to USD 79,640,F43.26 which included the residual amount at the Special Account after the closing of the books. After making the refund of the deposit of USD 7,056.01 at the Special Account the final withdrawals amount to USD 79,633,487.25. References made to these in the statistical information section of the draft project completion report we think, need revision. 49. our further remarks on the Project Completion Report relating to SKI Loan (2647-TU) are as follows: 50. In connection with the FERIS interest rates applied to sub-loans falling under this loan, rates applied by the Central Bank for the fixed investment rediscount loan was used. The main reason why the Central Bank's rediscount rate was chosen as reference was to prevent a competition. Meanwhile, as the consequence of the Central Bank's new approach in the direction of terminating its project finance, Loan 2647-TU was not facing competition from the rediscount facility from on 1989. 51. During the loan negotiations Treasury insisted on reducing the level of loans proposed to SIDO and in order to facilitate the actions and performances to be taken by SIDO, SYRB and HB offered their financial support which would partially make up the reduction in the proposed IBRD loans. In this respect as agreed SYKB donated TL 90 million through Dec 31, 1986- Dec 31, 1988. 52. The data SYKB presented regarding the actual job created by sub- projects financed is likely to increase as sub-projects approach full capacity utilization. Accordingly overall cost per job will be reduced 53. Towards the later years of the availability of the loan, projects matching the criteria of the loan regarding the cost per job were decreasing and perhaps it was an indicator of the new trend in the business circles avoiding manpower. COMMENTS OF HALNBANK 54. We would like to inform you that we have reviewed the Project Completion Report of Small and Medium Scale Industry Project Loan No. 2647-TU which had been enclosed in you letter dated 04.03.1993, no. DEI-VI-I-105/28996 and mall changes have to be made in page 14, article 5/A;  - 14 - * HB's allocation for on-lending to eligible subprojects actual (US$) should be 18,126,714.24. * The figures written for SIDO'e allocation consultant services should be written for HB's allocation for training. * The figure. written for SIDO's allocation consultant services should be written for HB's allocation for training. 55. However, we have no objection on the general evaluation of the Project Completion Report of Small and Medium Scale Industry Project (Loan No.2647-TU).  - 15 - Part IIIs STATISTICAL INFORMATION 1. Related Rank LanslCredits LasnICred1t Tftle Purpose Date of Status/Comnts _ dfpt~~~~~~~~Wovat_ _ Loan 1754-TU and 1755-TU To assist financing of 09/04/79 Closed or 12131/85. Reuaining Private Sector Textiles subprojects to eontribute to balances of USS0.13 N and Project the development US$1.32 N were cancel led from modernization, increase in Loans 1754 and 1755 TU productivity and expect respectively. capacity of the private I____________________ textiles sector of the country Loan 1952-TU Labor To provide credit to support 03/03/81 Closed on 06/30/86. USS39.54 N Intensive Industry the development of Labor was disbursed. balance of Project Intensive Small and Nodium USS0.46 N was cancelled. Scale Enterprises Loan 2714-TU First To create a more efficient 06/10/86 Closed on 06/30/91. Fully Financial Sector financial sector by developing disbursed. Adjustment Loan a greater variety of financial instnments which would contribute to a revival of _ _ _ _ _ private investment Loan 2901-TU tndustrial To support the efforts for 03/22/88 The loan closing date is Export Oevelopment expanding industrial export by 06/30/93. However, the loan is ProJect providing financial support to already fully disbursed. private expect-oriented projects" and improving the institutional framework for l ______________________ expect finance. Loan 2964-TU Second To suport the developoent of 06/21/88 Closed on 12/31/92. US$100 N Financiat Sector a more efficient and deeper was not disbursed. Adjustment Loan financiat sector which woutd mobilize end allecate funds more efficiently this generating a higher level of investments as well as a higher rate of return To promote and support 05/23/89 The closing date is 06/30/95. Loan 3067-TU Second efficient SNI investment and Disbursements are ahead of small and Nedium Scale operations; to improve credit schedule. Industry Project access for SNI by increasing the number of financial institutions that can serve as efficient intermediaries for SNI finance and by providino credit at efficient market prices; improving SN! product quality and expending their markets by providirg technfcal ________________________ and marketing assistance. _  - 16 - LoanVCredit Title Purpose Date of Status/Comments _______ ~_ _._I Loan 3077-TU To provide funds through 06/15/89 The closing date is 12/31/95. Agroindustry Project participating Credit I Institutions to financialty and economically viable private sector agroindustry projects for Increasing the agroindustry output. Loan 3346-TU Private To finance financially and 06/13/91 The closing date is 12/31/96. Investment Credit economically viable private Disbursements are slower than Project investments, especially export forecasted. oriented activities, to thel country's productive capacity: to continue to assist the private development banks in their business and resource diversification programs: to support sustained imptementation of the Government's banking reforms at the intermediary level. 2. Project Timetable Item Date Ptwened Date Revised Date Actual Preparation 09/13/84 to 09127/84 Appraisal Mission 11/19/94 to 12/07/84 11/20/84 to 12/06/84 Loan Negotiations 04/29/85 11/06/85 11/06/85 to 11/22/85 Board Approval 06/18/85 01/07/86 Loan Signature 01/17/86 Loan Effectiveness 04/17/86 05/14/86 Loan Closing 06/30/92 12/31/92 12/31/92 Loan Completion 03/31/93 09/30/93 3. Loan Disbursement Cumulative Estimated and Actual Disbursement (by fiscal year) (US$ Millions) __________________ 1986 `1987 1988 1989 1990 1991 199 1993 Appraisal Estimate 12.0 39.0 66.0 85.0 96.0 100.0 l Actual 5.93 35.99 70.31 87.48 95 .87 98.34 98.91 98.97 Actual as X of N.A 299.91 180.31 132.5X 112.8# 102.4X 98.9% estimate a____ I_ -  - 17 - 4. Proiect Implementation _ndicators , A1aisal Estimte | Actual X amount of SSI financed 47,43 43,68 X amount of very smali 13,09 5,95 enterprises financed X amount of enterprises targer 16,26 5,12 than SW financed HuWber of subprojects financed 200 185 by SYKS Number of subprojects financed 500 202 by HB TotaL Number of subprojects 700 387 financed Number of SHIs benefited from TA 350 6 funds if SIDO (per year) (financed by project funds) Number of SXis received 50 3 assistance from SIDO for export promotion (per year) (financed by project funds) Number of additional branch 8 5 officer to be established by SIDO  - 18 - S. Proiect Costs and Financina A. pKigc