Turkey - Private Investment Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 17233 IMPLEMENTATION COMPLETION REPORT TURKEY PRIVATE INVESTMENT CREDIT PROJECT LOAN 3346-TU December 16, 1997 Private and Financial Sector Development Unit Europe and Central Asia Region This document has a restrctd distribution and may be u'sed by recipients only in the| perfonmance of their official duties. Its contents may not otherwise, be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS Currency Unit : Turkish Lira (TL) 1989 US$1 = TL 2,027.0 1990 US$1 - TL 2,930.1 1991 US$1 = TL 5,079.9 1992 US$1 TL 8,564.4 1993 US$1 TL 14,472.5 1994 US$1 TL 38,726.0 1995 US$1 = TL 59,650.0 1996 US$1 = TL 94,756.0 June 1997 US$1 TL 143,670.0 WEIGHTS AND MEASURES Metric Svstem ABBREVIATIONS AND ACRONYMS EU European Union PICP Private Investment credit Project FE Foreign Exchange FERIS Foreign Exchange Risk Insurance Scheme FSAL Financial Sector Adjustment Loan GOT Goverm ent of Turkey TSKB Turkiye Sinai Kalkinma Bankasi (Industrial Development Bank of Turkey) SYKB Sinai Yatirim ve Kredi Bankasi (Industrial Investment and Credit Bank) TVB Turkiye Vakiflar Bankasi YKB Yapi ve Kredi Bankasi INTER Interbank KORFEZ Korfezbank GARANTI Turkiye Garanti Bankasi IEDP Industrial Export Development Project ERR Economic Rate of Return FRR Financial Rate of Return PCI(s) Participating Credit Institution(s) PFI(s) Participating Financial Institution(s) PCB(s) Participating Commercial Bank(s) TURKEY FISCAL YEAR January 1 to December 31 Vice President Johannes Lin Country Director Ajay Chhibber Previous Manager Franco Batzella Task Manager Gurhan Ozdora  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT TURKEY PRIVATE INVESTMENT CREDIT PROJECT (Loan No. 3346-TU) Contents Preface Evaluation Summary Part I. Project Implementation Assessment A. Statement I Evaluation of Objectives B. Achievement of Objectives C. Major Factors Affecting the Project D. Project Sustainability E. Bank Performance F. Borrower Performance G. Assessment of Outcome H. Future Operation I. Key Lessons Learned Part II. Statistical Tables Table 1: Summary of Assessments Table 2: Related Bank Loans/Credits Table 3: Project Timetable Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual Table 5: Project Financing Table 6: Economic Costs and Benefits Table 7: Compliance with Operational Manual Statements Table 8: Bank Resources: Staff Inputs Table 9: Bank Resources: Missions TablelO: Status of Legal Covenants Part III. Borrower's Contribution to the ICR MAP NO. 24903R This document has a restricted distribution and may be used by recipients only in the perfonnance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   IMPLEMENTATION COMPLETION REPORT TURKEY PRIVATE INVESTMENT CREDIT PROJECT (LOAN NO. 3346-TU) Preface This is the draft Implementation Completion Report (ICR) for the Private Investnent Credit (PICP),Turkey, for which Loan 3346-TU in the amount of US$ 200.0 million equivalent was approved on June 13, 1991 and became effective on November 22, 1991. The loan was closed on June 30, 1997, compared with the original closing date of December 31, 1996. Final disbursement under the loan component took place on 07/30/1997. An undisbursed portion of US $1.8 million is being canceled. Any funds in the Special Account already disbursed and not accounted for will have to be refunded, and subsequently canceled. This issue is being addressed as of this writing. The draft ICR was prepared by Gurhan Ozdora, Task Manager, RMT. It was reviewed by Mr. Tunc Uyanik and Ms. Yvonne Jones. Written contributions were provided by Undersecretariat of Treasury; Sinai Yatirim ve Kredi Bankasi (SYKB); Turkiye Vakiflar Bankasi (TVB); Turkiye Sinai Kalkinma Bankasi (TSKB); Yapi ve Kredi Bankasi (YKB); Interbank (INTER); Korfezbank (KORFEZ); Garanti Bankasi (GARANTI), and are included as appendixes to the ICR. Preparation of this ICR had begun during the Bank's final supervision mission in May 1997. It is based on material in the project file and data collected after the loan closing date . The Treasury and the implementing agencies contributed to preparation of the ICR by providing views and evaluation reports on the Project's execution.   IMPLEMENTATION COMPLETION REPORT TURKEY PRIVATE INVESTMENT CREDIT PROJECT (LOAN NO. 3346-TU) Evaluation Summary Introduction 1. The US $ 200.0 million IBRD loan for The Private Investment Credit Project was approved in June 1991 and made effective in November 1991. The Bank provided this loan to the Government of Turkey (GOT) for supporting GOT's program for export expansion and diversification efforts by providing long-term funds for private investments. The Executing agencies were seven Participating Financial Institutions (PFIs). The loan was closed on June 30, 1997, 6 months after the planned completion date of December 31, 1996. Project Objectives 2. The project objectives were: (i) to assist the borrower in its efforts to increase the capacity to produce tradable goods and services through activities in which the borrower is economically efficient, especially export-oriented activities, but excluding agriculture; and to that end, (ii) to provide financing through PFIs for financially and economically viable private investments in such activities; (iii) to continue to assist TSKB and SYKB in their efforts to diversify their business and resources; (iv) to ensure PCBs' continued operation as financially sound and efficient institutions. The project, building on the success of the Industrial Export Development Project-IEDP (Ln. 2901-TU) was designed to help finance the expansion of Turkey's productive capacity needed to sustain its export drive by providing long-term funds, and improving the credit delivery system that can perform the investment financing on its own in the future . Technical assistance component of the project was $ 1 million and this was geared to assist the PFIs in institutional strengthening, with particular focus on improving their project appraisal and supervision to strengthen their project finance capability. 3. The project was intended for supporting Turkey's export expansion and diversification efforts by providing long-term funds for private investments. In doing this, the project would pursue sustained implementation of the Government's financial reforms at the intermediary level by ensuring that the participating financial institutions (PFI) continue to comply with prudential banking regulations and by improving the efficiency of the financial system especially in allocating investment credit.  - 11 - Achievement of Objectives 4. Although not stated explicitly in the legal documents, from the context of the SAR, the implicit development objectives of the loan can be interpreted as that of facilitating the implementation of the Government's program of financial sector reforms, which were supported by the FSAL II. The development objective of this project is therefore measured against the improvements in the financial sector. To this end the GOT since 1995 has been working on a number of reforms to meet the international, and in particular EU standards especially in the following areas; (a) appropriate restrictions to current blanket deposit insurance scheme; (b) improvement of the prudential regulations on loan provisioning, currency and interest rate risk, loan concentration and connected lending, and an effective enforcement system; and (c) reduction of the subsidized investment credit scheme. 5. As a result of these efforts: (i) consolidation of financial subsidiaries; (ii) application of inflation accounting; and (iii) regulations against money laundering, were introduced in 1997. In addition to these changes, Turkish Banking Law is currently under revision and the new draft law contains many articles related to connected lending, bank ownership and loan provisioning. These changes, are clear indications of an improvement in the financial sector. 6. Credit component of the project was to provide financing to private sector investments and operations in order to support their production capacities, financial structures and market competitiveness. These objectives were fully achieved. Overall, the Loan of $200 million financed 58 sub-loans with an average size of $3.4 million. At appraisal, it had been envisaged that sub-borrowers would contribute $200 million. In the event the sub-borrowers provided $ 821 million, with the net result that total investment in sub-projects amounted to $1,019 million, some 154 % higher than the $400 million envisaged at appraisal. These investments were generally viable, yielding average FRRs of 40 %. Incremental output resulting from these investments is estimated at $788 million and incremental exports at $362 million at fuill capacity utilization. 7. The objective of assisting PCIs in improving their project appraisal-supervision capabilities, information systems and operating procedures related to investment lending, was not realized through this loan because PFIs had decided to finance this component with their own resources. Although the PCIs did not utilize the technical assistance for improving their operating procedures, the requirements of the loan agreement relating to project preparation and appraisal and to the PCI audits, contributed substantially to the institutional improvement of the PCIs and their portfolio quality. Major Factors Affecting the Project 8. Commitments and disbursements of the loan were much below the appraisal estimates during the 1991-1994 period. Starting with 1993 there was a decrease in the disbursements, and  - iii - in 1994 commitments came to a virtual standstill where there was an uncommitted balance of $167 million for the PICP. 9. As a result of this situation and in response to the Government's request, some amendments were made in the loan agreement in December 1994. The loan was restructured for financing of permanent working capital, pre-shipment export finance and leasing. In addition to these, there was another amendment which provided for single-currency lending in US Dollars as well as DMs, with an adequate premium over their respective LIBOR rates. 10. Following this restructuring, there was a significant acceleration in the loan utilization. Disbursements made by the PCIs was 99.0 % (98.93%) of the total loan amount and cumulative disbursements amounted to $198.0 million, with the final disbursement made in July 30, 1997. The 1994 restructuring was followed by an improved investment climate which gradually developed throughout 1995. 11. In addition to the improvements in the investment climate, another reason for increased demand for the Bank funds, was the unavailability of other medium-term sources of finance. Due to the uncertain macro-economic environment and high rates of inflation, the prospects for the banking system and foreign creditors to provide medium-and-long term finance to the private sector were very weak. Given this situation, the availability of stable medium and long-term finance from the Bank proved to be very attractive to investors. Project Sustainability 12. Due to the high public sector borrowing requirement (PSBR) since 1990, the GOT has continued to finance its deficit mainly through the sale of Government securities. The banks invested heavily in these instruments, which crowd out medium and long-term lending to private industry. Another constraint for the banks was the unavailability of medium-to-long term funding resources. Under these conditions, it would be unrealistic to expect commercial banks to provide MLT credit on a sustained basis as envisaged in the project objectives. However, the success of the credit component in a narrow sense can be considered as sustainable because loans made in foreign exchange can be recycled; the PCIs can re-lend the foreign exchange repayments from their sub-borrowers which exceed their repayment obligations to GOT. The current interest rates make project lending profitable for the PCIs, by providing protection against capital erosion. Bank Perfonnance 13. The Bank's performance at preparation and appraisal was satisfactory. Bank's missions were able to translate the results and build on the successful experience of the earlier Industrial Export Development Project (IEDP) and to firther the initiatives started under the earlier project by pursuing sustained implementation of the GOT's banking reforms at the intermediary level by ensuring that the participating financial institutions (PFI) continue to comply with prudential regulations and by improving the efficiency of the financial system especially in allocating  -iv - investment credit. Bank performance during the implementation phase was also satisfactory. Supervision missions were fielded in regular intervals twice per year and the relationship of the Bank staff with the Treasury and PFIs' staff was excellent. Treasury and the PPIs also rate the project implementation as highly satisfactory and maintain that, had the Bank accepted utilization of the loans in a blend with subsidized credit, the project implementation could have been much faster. Borrower Performance 14. The performance of GOT and the implementing agencies was highly satisfactory in some aspects, satisfactory in others and deficient in some. The performance of the PCIs in carrying out the credit operations and their compliance with the financial covenants, agreed under the Project was satisfactory in general. Treasury also contributed to a smooth operation of the credit line. Two of the PCIs, Vakifbank (TVB) and Yapi ve Kredi (YKB) had some problems in meeting the eligibility criteria of the loan agreement in 1993, but later regained their eligibility after complying with the financial covenants. Assessment of Outcome and Future Operation 15. The Project achieved most of its objectives. Its outcome is satisfactory, despite the delays in implementation caused to a large extent by the economic environment. A plan for the project's future operation is attached as Annex A Key Lessons Learned 16. Several lessons have been learned: (i) entrepreneurs like predictable debt service obligations and prefer assuming the foreign exchange risk rather than covering it at the cost of fluctuating relative and high interest rates; (ii) in an economy with a high rate of inflation, sound economic and financial returns can be obtained if lending activities are sheltered from the effects of inflation through appropriate interest rate mechanisms; (iii) free-standing permanent working capital loans with long-term maturities can be vital for the enterprises in an economy where banks are reluctant to provide medium-to-long term financing, due to macro-economic uncertainty; (iv) for export-oriented enterprises, borrowing in foreign exchange does not entail the same degree of FE risk as is the case for non-exporting firms; (v) lending mechanisms should be simple so that sub-borrowers understand their obligations; (vi) when problems arise between the Bank and the Borrower, solutions should be sought right after the emergence of the problems; (vii) a credit line can be highly satisfactory even in an inflationary environment if negative interest rates are avoided by lending in foreign exchange or indexing sub-loans to foreign currencies; and (viii) sub-project performance can be improved substantially through close ex-ante and ex-post review and supervision of the Bank.  IMPLEMENTATION COMPLETION REPORT TURKEY PRIVATE INVESTMENT CREDIT PROJECT (LOAN NO. 3346-TU) Part L Project Implementation Assessment A. Statement/Evaluation of Objectives 1. In the loan agreement, the project objectives were stated as follows: (i) to assist the borrower in its efforts to increase the capacity to produce tradable goods and services through activities in which the borrower is economically efficient, especially export-oriented activities, but excluding agriculture; and to that end; (ii) to provide financing through PFIs for financially and economically viable private investments in such activities; (iii) to continue to assist TSKB and SYKB in their efforts to diversify their business and resources; (iv) to ensure PCBs' continued operation as financially sound and efficient institutions. The project, building on the success of the Industrial Export Development Project-IEDP (Ln. 2901-TU), was designed to help finance the expansion of Turkey's productive capacity needed to sustain its export drive by providing long- term funds, and improving the credit delivery system that can perform the investment financing on its own in the future. The project aimed to achieve these objectives by channeling the equivalent of $200 million through Participating Financial Institutions (PFIs) to finance eligible private sector investment projects. A technical assistance component of $1 million to be contributed by the PFIs was geared to assist the PFIs in improving their project finance techniques, systems and procedures, was not realized through the use of loan funds. Nevertheless, the requirements of the loan agreement relating to project preparation and appraisal and to the PCI audits contributed substantially to the institutional development of the PCIs and their portfolio quality. 2. The project was intended to support the Bank's strategy for: (i) assisting the GOT to achieve its "base case" macro-economic framework by focusing on priority sectors; (ii) strengthening the international competitiveness of the industrial sector by supporting export and technological development as the critical agenda for the long term; and (iii) developing a stronger and more diversified financial sector to facilitate the growth of a dynamic, competitive and export- oriented private industry. In this framework, the project forms an integral part of the Bank's country and sector assistance strategy and contributed to the attainment of the developments in the industrial and financial sectors. 3. In the industrial sector, it aimed to support reforms that had been undertaken or were planned, by providing the private sector with long-term funds to adjust, by investing in, or restructuring activities that make economic sense under a reforming environment. The Bank's involvement was called for to help ensure the required supply response by providing the additional resources needed as a consequence of the reform program in the industrial sector. In the financial  2 sector, it was designed as a continuation of the sector assistance strategy (as successfully implemented under the IEDP) and complement the reforms that were undertaken under the FSAL II, by helping individual financial institutions to develop into efficient intermediaries in an increasingly competitive enviromnent. 4. The objective of this loan was not to substitute for the banks' own efforts to mobilize term resources. Rather, the intention was that the proposed project would directly support the reform process by providing long-term resources in the transition period between policy changes and increased financial intermediation by the banking sector, and by strengthening the financial sector's institutional capacity to carry out prudent term transformation. The project was to provide long-term funds to help fill the financial gap for private investments needed to help finance the private investments needed to sustain Turkey's export drive in the 1990s. By channeling these funds through the private banking system the project aimed to support the process of strengthening individual financial institutions as a strategic complement to the on-going program to improve the efficiency of the financial system. B. Achievement of Objectives 5. Building on the success of the Industrial Export Development Project (Ln. 2901-TU) the project aimed to help finance the expansion of Turkey's productive capacity needed to sustain its export drive by providing long-term funds, and improving the credit delivery system so that it can perform the investment financing function on its own in the future. Specifically, the project aimed at; (i) supporting financially and economically viable private investments in areas of Turkey's comparative advantage, especially export-oriented activities, excluding agriculture; (ii) to continue to assist TSKB and SYKB in their business and resource diversification efforts to enable them to grow in an increasingly competitive financial system; and (iii) to support the implementation of the Government's financial sector reforms at the intermediary level by ensuring that participating private commercial banks (PCBs) continue to be financially sound and develop into intermediaries capable of mobilizing and allocating long-term resources more efficiently. 6. Although not stated explicitly in the legal documents, from the context of the SAR, the implicit development objectives of the loan can be interpreted as that of facilitating the implementation of the government's program of financial sector reforms, which were supported by the FSAL II. Furthermore the rationale behind the 1995 decision to restructure the project was predicated on the expectation that the Government would make substantial progress in reducing the scope and size of the subsidized investment credit scheme. The development objective of this project is therefore measured against these standards. The improvement of the situation in the aftermath of the financial sector crisis of 1994 was verified by previous missions. This improvement was highlighted by a reduction in the banking system's short foreign exchange positions which have been brought in line with the legal ceiling, that is determined as a percentage of the equity, introduced by the Government in 1995. Furthermore, the independent audit reports of most of the PFIs/PCBs are unqualified. And, although it is not a legal requirement, all PFIs have applied IAS 29 (inflation accounting).  3 7. These developments constitute a genuine improvement of the situation, but are not deemed sufficient to satisfy the criteria discussed above. The actions that would satisfy the development objectives are the following; (a) appropriate restrictions to the current blanket deposit insurance scheme; (b) improvement of the prudential regulations on loan provisioning, currency and and interest rate risk, loan concentration and connected lending, and an effective enforcement system; (c) reduction of the subsidized investment credit scheme. 8. To this end since 1995, the GOT has been planning a number of reforms to meet international, and in particular EU, standards especially in the following areas: (a) revision and phased limitation in the deposit insurance coverage scheme; (b) establishment and enhancement of the legal framework to prevent money laundering operations through the banking system; (c) consolidation of the financial statements of the banks' subsidiaries (IAS 27 and 28) which would also increase accuracy of capital adequacy calculations; (d) amendments to auditing regulations to define the eligibility and operational standards for auditing firms in performing bank audits; (e) application of key accounting principles, especially those related to the development and application of the inflation accounting standards (IAS 29) ; (f) revisions to the loan provisioning methodology; (g) enhancement of the risk-weighted capital adequacy measurement methodology and standards; and (h) new measures and reforms in the banking law related to loan concentration and connected lending. 9. In 1997, GOT, in an effort towards harmonization of the Turkish banking regulations with EU standards, started to implement some changes in the banking regulations. As a result of these changes: (i) consolidation of financial subsidiaries; (ii) application of inflation accounting; and (iii) regulations against money laundering, were introduced. In addition to these, Turkish Banking Law is being revised and the new draft law contains many articles related to connected lending, bank ownership and loan provisioning. These changes, are clear indications of an improvement in the financial sector. 10. The credit component of the project was to provide financing to private sector investments and operations in order to support their production capacities, financial structures and market competitiveness. These objectives were fully achieved. Overall, the Loan of $200 million financed 58 sub-loans with an average size of $3.4 million. At appraisal, it had been envisaged that sub-borrowers would contribute $200 million. In reality, the sub-borrowers provided $821 million, with the net result that total investment in sub-projects amounted to $1,019 million, some 154 % higher than the $400 million envisaged at appraisal. These investments were generally viable, yielding average FRRs of 40 %. Incremental output resulting from these investments is estimated at $788 million and incremental exports at $362 million, at full capacity utilization. 11. The objective of assisting PFIs in improving their project appraisal-supervision capabilities, information systems and operating procedures related to investment lending, was not realized through this loan because PFIs decided to finance this component with their own resources. Although the PFIs did not utilize the technical assistance for imnproving their operating procedures, the requirements of the loan agreement relating to project preparation and appraisal and to the PFI audits, contributed substantially to the institutional improvement of the PFIs and to their portfolio quality.  4 12. Of the 58 projects financed by the loan, 48 were for plant modernisation and/or expansion, 5 financed working capital and 5 were for pre-export financing. Eighty percent of the investments were made in developed regions while 10% each were in semi-developed and underdeveloped regions. ERRs and FRRs were calculated for individual sub-projects. The appraisal reports prepared by the PCIs for individual sub-projects showed ERRs ranging from 17 % to 83% and FRRs ranging from 22 % to 87 %. A post-evaluation exercise carried out by the PCIs on a sample of 14 sub-projects revealed that actual ERRs range from 29 % to 44 % and FRRs from 34 % to 46%. C. Major Factors Affecting the Project 13. Commitments and disbursements of the loan were much below the appraisal estimates during the 1991-1994 period. Overall, PICP implementation proceeded slowly since approval (June 13,1991). As of May 1993, subloan commitments were totaling only about $27 million, and disbursements only about $20 million, as compared to appraisal estimates of $80 million. In addition to this, of the seven banks participating in PICP, only four had submitted subproject proposals during this period. Of the 9 project proposals that were submitted, 3 did not meet the eligibility criteria and of the 7 participating banks (PFIs ) only 5 were found in compliance with the eligibility criteria of PICP. Starting with 1993 there was a decrease in the disbursements, and in 1994 commitments came to a virtual standstill where there was an uncommitted balance of $167 million for the PICP. The reasons for this were: (i) weak market demand for investment credits due to the uncertain macro-economic environment; (ii) The Bank requirement of non- blending of the Bank credit line with funding under the Government's subsidized credit program. Since majority of PFIs clients were recipients of incentive certificates entitling them to funding at interest rates far below the inflation rate, expectations about the possibility using these subsidized credits significantly decreased the entrepreneurs' interest in using the Bank's credit lines; (iii) currency pool system whereby the Bank's currency pool was onlent by the Government to the PFIs and PFIs did not want to onlend in a single currency and take the cross currency risk, while the sub-borrowers were reluctant to borrow from the currency pool for variety of reasons; and (iv) availability of funding alternatives such as short-term foreign currency financing with rollover possibilities 14. The crisis that emerged early in 1994 drastically limited debtor funding flexibility as domestic and foreign funding resources suddenly and unexpectedly dried up, with interest rates rising to historic highs. Banks were forced to pay off large amounts of foreign currency lines which were not rolled over. Additionally, the shift in deposits from small banks to the biggest banks induced a cut in the credit exposure of the less liquid banks, without a commensurate rise in the lending by the major banks. These radically changed conditions in the financial markets created a situation which lead to a substantial demand for Bank funds. 15. As a result of this situation and in response to the Government's request, some amendments were made in the loan agreement in December 1994. The loan was restructured for financing of permanent working capital, pre-shipment export finance and leasing. In addition to these, there was another amendment which provided for single-currency lending in US Dollars as well as DMs, with an adequate premium over their respective LIBOR rates.  5 16. Following this restructuring, there was a significant acceleration in the loan utilization. Disbursements made by the PCIs were 99.0 % (98.93%) of the total loan amount and cumulative disbursements amounted to $198.0 million, with the final disbursement made in July 30, 1997. The 1994 restructuring was followed by an improved investment climate which gradually developed throughout 1995. This improvement was due to reactivation of investment decisions which were postponed because of the economic crisis and also due to new expectations arising from the Customs union with EU. 17. In addition to the improvements in the investment climate, another reason for increased demand for the Bank funds, was the unavailability of other means of medium-term sources of finance. Due to uncertain macro-economic environment and high rates of inflation the prospects for the banking system and foreign creditors to provide medium-and-long term finance to the private sector was very weak. Given this situation, the availability of stable medium and long- term finance from the Bank proved to be very attractive to investors. 18. Project implementation was also influenced by the macro-economic Factors. The inflation rate which was 70 % in 1988 persisted at high levels through the 1990s, averaging over 60 % and reaching a level of 80% at the end of 1996. The exchange rate also developed at a similar pace. From TL 1,875 for one US dollar in January 1989, to TL 17,204 in January 1994 and in four months of 1994 to TL 33,408 and to TL 143,670 at the end of June 1997. In addition to these, due to debt financing with very high real rates, investments became unattractive. This, combined with the ineligibility of the projects benefiting from the Government's incentive program slowed the project implementation. 19. As a result of this situation and in response to the Government's request, in 1994, Government and the Bank agreed to restructure the loan to take into account the changed circumstances and to accelerate the loan disbursement. Accordingly some amendments were made in the loan agreement in December 1994. The amended Loan agreement, signed on December 29,1994 contained the following changes: (i) the interest rate base for foreign exchange loans for single-currency loans in US dollars or Deutsch Marks was made more market-oriented and no longer tied to the World Bank pool rate; (ii) Free-standing permanent working capital loans, and loans for equipment leasing and pre-export financing were permitted. D. Project Sustainability 20. Due to the high public sector borrowing requirement (PSBR) since 1990, the GOT has continued to finance its deficit mainly through the sale of Government securities. The banks invested heavily in these instruments, which crowd out medium and long-term lending to private industry. Another constraint for the banks was the unavailability of medium-to-long term funding resources. Under these conditions, it would be unrealistic to expect commercial banks to provide MLT credit on a sustained basis, as envisaged in the project objectives. However, the success of the credit component in a narrow sense can be considered as sustainable because loans made in foreign exchange can be recycled; the PCIs can re-lend the foreign exchange repayments from their sub-borrowers which exceed their repayment obligations to GOT. The current interest rates make project lending profitable for the PCIs, by providing protection against capital erosion.  6 21. The credit component of the Project can be rated sustainable. The investments financed were profitable with FRRs averaging around 40% and the recovery rates were very high. Unlike the FERIS (Foreign Exchange Rate Insurance Scheme - see para 47) scheme, the PCIs have the opportunity to re-lend part of the foreign exchange repayments from the sub-borrowers that exceeds their repayment obligations to GOT. Recycled funds from these repayments will be used for the same purposes and since the subloans are nominated in foreign exchange, demand for these funds is expected to continue. Since the interest levels provide protection against capital erosion and make project lending profitable the project is also sustainable for the PCIs . The Project is also sustainable from the point of view of the sub-borrowers. They have greatly benefited from the investments made under the Project by expanding and modernizing their plants, increased their outputs and capacity utilization rates and have developed a good sense of financial discipline. E. Bank Performance 22. The Bank's performance at preparation and appraisal was satisfactory. The Bank's missions were able to translate the results and build on the successful experience of the Industrial Export Development Project (IEDP). Missions were able to further the initiatives started under the earlier project by pursuing sustained implementation of the Government's banking reforms at the intermediary level by ensuring that the participating financial institutions (PFI) continue to comply with prudential regulations, and by improving the efficiency of the financial system, especially in allocating investment credit. The PFIs involved in the project was selected on the basis of sound criteria such as financial strength and project financing expertise, in line with OD 8.30 of the Bank's guidelines. 23. Bank performance during the implementation phase was also satisfactory. Supervision missions were fielded in regular intervals twice per year and the relationship of the Bank staff with the Treasury and implementing agencies' staff was excellent. Treasury and the PCIs also rate the project implementation as highly satisfactory and maintain that, had the Bank accepted utilization of the loans in a blend with subsidized credit, the project implementation could have been much faster. F. Borrower Performance 24. The performance of Government and the implementing agencies was highly satisfactory in some aspects, satisfactory in others and deficient in some. The performance of the PCIs in carrying out the credit operations and their compliance with the financial covenants, agreed under the Project was satisfactory in general. Treasury also contributed to a smooth operation of the credit line. Two of the PCIs, Vakifbank (TVB) and Yapi ve Kredi (YKB) in 1993, had some problems in meeting the eligibility criteria of the loan agreement but later regained their eligibility after complying with the financial covenants. The major covenants related to the institutional development and financial strength of the PCIs were met and therefore compliance with the loan covenants must be rated as satisfactory.  7 G. Assessment of Outcome 25. The project achieved nearly all of its objectives but project execution took longer than planned. The delay was caused by the difficult economic environment and problems between the Bank and the Borrower concerning subsidized credit. A project which had been earlier rated as unsatisfactory, made a significant turn around due to the successful restructuring and the positive investment climate. As a result of these and improvements in the financial sector performance, the project can be rated as satisfactory. H. Future Operation 26. A plan for the future operations has been agreed with the GOT and PCIs. It contains the arrangements describing how the reflow of funds will be used in lending for similar purposes until all funds have been repaid to the Government as specified in the legal agreements 1. Key Lessons Learned 27. Several lessons have been learned: (i) entrepreneurs like predictable debt service obligations and prefer assuming the foreign exchange risk rather than covering it at the cost of fluctuating relative and high interest rates; (ii) in an economy with a high rate of inflation, sound economic and financial returns can be obtained if lending activities are sheltered from the effects of inflation through appropriate interest rate mechanisms; (iii) free-standing permanent working capital loans with long-term maturities can be vital for the enterprises in an economy where banks are reluctant to provide medium-to-long term financing, due to macro-economic uncertainty; (iv) for export-oriented enterprises, borrowing in foreign exchange does not entail the same degree of FE risk as is the case for non-exporting firms; (v) lending mechanisms should be simple so that sub-borrowers understand their obligations; (vi) when problems arise between the Bank and the Borrower, solutions should be sought right after the emergence of the problems; (vii) a credit line can be highly satisfactory even in an inflationary environment if negative interest rates are avoided by lending in foreign exchange or indexing of sub-loans to foreign currencies; and (viii) sub- project performance can be improved substantially through close ex-ante and ex-post review and supervision of the Bank.  8 PART II: Statistical Tables Tables: 1. Summary of Assessments 2. Related Bank Loans/Credits 3. Project Timetable 4. Loan Disbursements: Cumulative Estimated and Actual 5. Project Financing 6. Economic Costs and Benefits 7. Compliance with Operational Manual Statements 8. Bank Resources: Staff Inputs 9. Bank Resources: Missions 10. Status of Legal Covenants  9 Table 1: Summary of Assessments A. Achievement of Obiectives Substantial Partial Negligible Not applicable (4) (4) (4) (4) Macro Policies FlElEl Sector Policies i ]E]Z] Fl Financial Objectives E I E E Institutional Development El E ] [I Physical Objectives [ El El ] Poverty Reduction [ L [I] El Gender Issues L ] OI] Other Social Objectives E El E ] Environmental Objectives E [ E E Public Sector Management l El L] Private Sector Development E[ E I Foreign Exchange earnings [ El E El B. Proiect Sustinabilitv Likely Unlikely Uncertain (4) (4) (4) ED C. Bank Performance Satisfactorv Satisfactoi Deicient (4) (4) (4) Identification E [3 E Preparation Assistance e [ E Appraisal E [ E Supervision [I E E  10 Hfighly D. Borrower Performance Satisfactorv Satisfactory Deficient (l) (V) (i4) Preparation E] EC LI] Implementation E] K] I-] Covenant Compliance K] I EI] Highly Highly E. Assessment of Outcome Satisfactorv Satisfactor Unsatisfactory unsatisfactory (4 ) (4) (4 ) (4 ) K] I [II K]  11 Table 2: Related Bank Loans/Credits Loan/Credit Title Purpose Year of Status Approval Preceding Operations Loan 1754-TU and 1755-TU To assist financing of 09/04/79 Closed on 12/31/85. Private Sector Textiles Project subprojects to contribute to ICR Issued the development, modernization, increase in productivity and expect capacity of the private textiles sector of the country Loan 1952-TU Labor Intensive To provide credit to support 03/03/81 Closed on 06/30/86. Industry Project the development of Labor ICR Issued Intensive Small and Medium Scale Enterprises Loan 2714-TU First Financial To create a more efficient 06/10/86 Closed on 06/30/91. Sector Adjustment Loan financial sector by developing ICR Issued. a greater variety of financial instruments which would contribute to a revival of private investment Loan 2901-TU Industrial To support the efforts for 03/22/86 Closed on 06/30/93. Export Development Project expanding industrial export ICR Issued. by providing financial support to private export-oriented projects' and improving the institutional framework for export finance. Loan 2964-TU Second To support the development 06/21/88 Closed on 12//31/92. Financial Sector Adjustment of a more efficient and deeper ICR Issued. Loan financial sector which would mobilize and allocate funds more efficiently thus generating a higher level of investments as well as a higher rate of return. Following operations Guarantee for Development Bank support and guarantee 1997 Under preparation Banks (SYKB-TSKB) to assist the Development Banks SYKB and TSKB issue bond for equivalent of $200 million. Funds to be used to finance industrial sector investments  12 Table 3: Project Timetable Steps in Project Cycle Date Actual Identification/Preparation 05/15/89 Appraisal 06/03/90 Negotiation 01/12/91 Board Presentation 06/13/91 Signing 06/28/91 Effectiveness 11/22/91 Project Completion 06/30/97 Loan Closing 06/30/97 Table 4: Loan Disbursements: Cumulative Estimated and Actual (US$ thousands) FY92 FY93 FY94 FY95 FY96 FY97 Appraisal 20,000 80,000 155,000 190,000 200,000 200,000 estimate - 20,900 26,180 28,340 164,870 198,045 Actual Actual as % of 26 17 15 82 99 estimate Date of final disbursement: July 30, 1997 Table 5: Project Financing Appraisal estimate Actual/latest estimates l US$imillion) . (US$ million) Item Local costs Foreimn costs Total Local costs Foreign costs Total 1. IBRD - 200.0 200.0 198.0 198.0 2. PFIs 0.5 0,5 1.0 - - 3. Sub-borrowers 200.0 - 200.0 821.0 - 821.0 Total 200.5 200.5 401.0 821.0 198.0 1,019.0  13 Table 6: Economic Costs and Benefits Economic Rates of Return (ERRs). Specific estimates of the project's ERR were not made at appraisal; PCIs were required to demonstrate the economic viability of individual projects which had to show ERRs in excess of 15% (except for projects specifically aimed at environmental amelioration). An analysis of the ex ante rates of return on investment projects for SYKB, TSKB and TVB which accounts for 69% of Investments indicated a weighted average ERR from 58 projects of 29%. Ex post evaluation on 8 of these (which had ex ante ERRs of 34%) resulted in an average ERR of 38%. Ex Ante ERRs and FERRs for investment Projects in SYKB, TSKB, and TVB (represents 69% of Loan and 82% of Project investment) No Investment Av. ERR at Range Av. FRR at Range (US$'000) Appraisal Appraisal SYKB 12 236,000 36% .17%/6-83% 40% 220/-83% TVB 22 468,000 33% 200/o-73% 38% 19%-96% TSKB 11 189,500 32% 17%-50% 36% 160/6-61% Total 45 893,500 34% 38% Ex Post ERRs and FRRs for Sample Investment Projects in SYKB, TSKB and TVB (represents 36% of Loans for Investment) No Investment Av. ERR at Av. ERR Av. FRR at Av. FRR l_________ (US$'000) Appraisal ex Post Appraisal Ex Post SYKB 4 51,857 32% 41% 40% 41% TVB 2 24,325 48% 44% 48% 46% TSKB 2 10,513 31% 29% 40% 34% Total 18 86,695 370% 38% 43% 41% Estimates of Full Time Job Creation (at Sub Project Appraisal) No. Disbursement Investment Jobs Cost/Job (US$'000) (U$$'000) (US$'000) SYKB 12 40,000 236,000 1,311 180,000 TSKB 11 49,953 189,500 906 209,161 TVB 22 47,918 468,000 1,925 243,116 YKB 6 29,904 98,500 608 162,006 INTER 4 10,270 27,000 225 120,000 KORFEZ 3 20,000 . . Total 58 198,045 1,019,000 4,975 204,824  14 Table 7: Compliance with Operational Manual Statements Basically, there was compliance with the applicable Bank Operational Manual Statements. Table 8: Bank Resources: Staff Inputs Planned Inputs Actual Stage of project cycle SWS US$'OOO SWS US$'000 Through Appraisal 98.9 262.8 98.9 262.8 Appraisal Board 53.9 142.3 53.9 142.3 Board Effectiveness N/A N/A N/A N/A Supervision 139.6 335.0 139.6 335.0 Table 9: Bank Resources: Missions Performance Rating Stage of project Month/ No. of Days Specialization(1) ImpL. Dev. Type cycle Year Persons in Status Obj. of ______ Field Prob. Through appraisal 06/90 7 - E,F,AD Appraisal Board 06/91 1 - F Supervision I 06/92 1 - F 2 3 - Supervision II 08/93 4 - C,E,F 3 3 - Supervision III 06/94 4 - C,E,F,AD U S - Supervision IV 06/95 4 - C,E,F,AD S U - Supervision V 09/95 2 - AC,F S U - Supervision VI 03/96 2 - AC,F S U - Supervision VII 06/96 2 1 F S U - Supervision VIII 10/96 2 20 F S U - Supervision IX 06/97 2 12 F S S - 1- Key to Specialized staff skills: 2- Key to Performance Ratings: 3- Key to Types of problems AC= Agricultural credit 1= Minor problems F= Financial Spec. 2= Moderate problems T= Technical E = Economist 3= Major problems M= Managerial F = Financial Analyst C = Consultant AD= Advisor  Legal Covenant Report: Latest status of Covenant Compliance ECA - Europe & Central Asia Regional 0 ECS - Private/Financhtl Sectors Devt ECSPF - Private/Financial Sectors Devt Form 590 Date: 10/15/1996 Project ID: TR-PE-9036 -PRIVATE INVESTMENT C Covenant Status Original Fulfill Revised Description of Covenant Comments Class (s) Date Fulfill Date Text Reference: LA Section 4.02 01 C 06/28//1991 Submission of annual audited financial statements. Complied with. Text Reference: LA Sec. 4.02(b) 01 C 06/28/1991 Auditors' certification of compliance with Received. eligibility criteria. Text Reference: LA Sec. 4-c 02 CP 06/28/1991 Capital adequacy, loan loss provisioning, loan Substantial compliance. concentration. Text Reference: LA Sec. 4-d 02 CP 06/28/1991 Positive real rate of return on equity Substantial compliance. Text Reference: LA Sec. 3.06 02 C 06/28/1991 Debt-service coverage ratio (SYKB and TSKB) Complied with. Text Reference: LA Sec.4.e; PA Sec.3.08 02 C 06/28/1991 Collection ratio on medium and long-term loan. Complied with. Text Reference: PA Sec. 3.05 02 NYD 06/28/1991 Debt/Equity ratio Legal agreement amended to replace this covenant with minimum 10% capital adequacy ratio for TSKB and SYKB. Status: C - Complied with CD - Compliance after Delay NC - Not Complied with SOON - Compliance Expected in Reasonably Short Time CP - Complied with Partially NYD - Not Yet Due  Legal Covenant Report: Latest status of Covenant Compliance ECA - Europe & Central Asia Regional 0 ECS - Private/Financial Sectors Devt ECSPF - Private/Financial Sectors Devt Form 590 Date: 10/15/1996 Project ID: TR-PE-9036 -PRIVATE INVESTMENT C Covenant Status Original Revised Description of Covenant Conmnents Class (s) Fulflll Date Fulflll Date Text Reference: LA Sec. 4-b 01 CP 06/28/1991 Unqualaified auditors' opinion. Partial compliance. Text Reference: LA Sec. 4.02 02 C Complied with Comnplied with. Status: C - Complied with CD - Compliance after Delay NC - Not Comnplied with SOON - Compliance Expected in Reasonably Short Time CP - Comp NYD - Not Yet Due  Covenant Class I Accounts/audit 2 Finacial petfornance/generate revenue from beneficiaries 3 Flow and utilization of project funds 4 Countepart funding 5 Management aspects oftbe Project or of its executing agency 6 Environmental covenants 7 Involuntary tlement 8 digenous people 9 Monitoring, review and reporting 10 Implementation 11 Sectoral or cross-sectoral budgetary or other resource allocation 12 Sectoral or cross-sectoral regulatory/institutional action 13 Other  18 TURKEY PRIVATE INVESTMENT CREDIT PROJECT (Loan 3346-TU) Plan for Proiect ODeration after Closin! on June 30 1997 Project Objective 28. The project objectives as stated in the loan agreement were: (i) to assist the borrower in its efforts to increase the capacity to produce tradable goods and services through activities in which the borrower is economically efficient, especially export-oriented activities, but excluding agriculture; and to that end, (ii) tqprovide financing through PFIs for financially and economically viable private investments in such activities; (iii) to continue to assist TSKB and SYKB in their efforts to diversify their business and resources; (iv) to ensure PCBs' continued operation as financially sound and efficient institutions. The project, building on the success of the Industrial Export Development Project-IEDP (Ln. 2901-TU) was designed to help finance the expansion of Turkey's productive capacity needed to sustain its export drive by providing long- term funds, and improving the credit delivery system that can perform the investment financing on its own in the future . 29. The institutional development objectives for the PFIs were to be achieved through the Technical assistance component of the project, with particular focus on improving their project appraisal and supervision to improve their project finance capability. The objective of assisting PCIs in improving their project appraisal-supervision capabilities, information systems and operating procedures related to investment lending, was not realized through this loan because PFIs had decided to finance this component with their own resources. Although the PCIs did not utilize the technical assistance for improving their operational procedures, the requirements of the loan agreement relating to project preparation and appraisal and to the PCI audits, contributed substantially to the institutional improvement of the PCIs and their portfolio quality. 30. The project was also complementary to the efforts to restructure the financial sector in Turkey assisted by the Second Financial Sector Adjustment Loan (FSAL II, Loan No. 2964-TU) which became effective in June 1988. The FSAL II contained covenants regarding: (i) the strengthening of the banking system through the introduction of prudential regulations that required specified levels of equity and provisions for bad debts, establishment of a mechanism to restructure insolvent banks and action programs to restructure state-owned banks; and (ii) improvement in the interest rate structure, including an increase in preferential lending rates to positive levels in real terms. 31. It was a sector policy objective specified in FSAL II to bring about positive interest rates and positive interest rates were to be attained by using the Foreign Exchange Rate Insurance Scheme (FERIS) mechanism. Under FERIS, the Government converted the proceeds of foreign loans into TL-denominated loans with a variable rate set at the average of the proceeds of the  19 three-month Treasury bill rate over the preceding three months. Additionally, the option of lending in foreign exchange through the Bank's pool rate was offered. Previously, the funds under other Bank projects including IEDP were on-lent in local currency and the foreign exchange risk was assumed by FERIS. In 1990 the Government decided to abolish FERIS and, according to an agreement with the Government, the PICP sub-loans were to be denominated in foreign currency. Under this arrangement, the Government was fo on-lend the Bank funds to the PFIs on the same term and conditions as the Bank loans plus an on-lending fee. Since there was no use of the foreign exchange option under the pool rate, Government agreed in 1994 to convert the pool of currencies to single-currency sub-loans to the PCIs. 32. These objectives remain valid after the implementation of the project and the full disbursement of the project funds. Since the PCIs have the opportunity under foreign exchange lending (unlike FERIS) to roll over the funds obtained for a certain number of years, the reflow of funds will be used to support lending operations for similar purposes, until all funds have been repaid to Government, as stated in the Loan Agreement. Equally important, the institutional development of the PCIs will continue along the lines that were started in this and other projects supported by the World Bank. Future Project Operations 33. The Loan was made to the Government of Turkey for 17 years, including five years of grace. On-lending maturities to the PCIs depend on the type of investment financed. For sub- loans in foreign exchange, maturities to sub-borrowers are up to eight years, including three years of grace for investment projects; and up to eight years with no grace period for financing of permanent working capital and leasing. The PCIs have thus the opportunity to revolve the part of the foreign exchange repayments from client that exceeds their repayment obligations to Govermment. 34. The legal agreements stipulate that the reflows of funds will be used for similar purposes. The PCIs confirm that they intend to follow this agreement and make loans to individual sub- borrowers for similar purposes until all funds have been repaid to Government. It is likely that the bulk of funds to be reinvested will be used to finance permanent working capital and investment loans. In this sense this Plan of Operation foresees that the Loan will continue to benefit the private sector. PCIs intend to supervise the portfolio of sub-loans outstanding in accordance with the agreed procedures until all funds have been repaid. 35. Institutional development will remain one of the PCIs' main objectives. They will aim to further strengthen their financial position and to maintain compliance with the financial covenants set out in the legal agreements.  20 PCI Actual as of Total Allocation Allocation in 06l30/1997 06/30/1997 Percentage of (SS'000) (USSOOO) Total SYKB 40,000,000 40,000,000 21 TSKB 49,953,040 49,953,040 25 TVB 47,918,055 47,905,055 24 YKB 29,904,433 29,904,433 15 INTERBANK 10,270,000 10,270,000 5 KORFEZBANK 20,000,000 20,000,000 10 GARANTI -0 - -0- TOTAL 198,045,528 198,045,528 100 Afsaneh Farzin P:\!UNITS\ECSPF\ICRTURKDOC December 16, 1997 6:42 PM  IBRD 24903R GEORGIA Z BULGARIA . _DI .N E