Turkey - Elbistan Cignite Mine and Power Project

FILE COPY DOCUMENT OF INTERNATIONAt -BANK FOR RaeONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1470-TU REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TURKISH ELECTRICITY AUTHORITY AND THE TURKISH COAL ENTERPRISES WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR THE ELBISTAN LIGNITE MINE AND POWER PROJECT June 17, 1974 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit Turkish Lira (TL) US$1 = TL 13.50 TL 1 = US$ 0.074 TL 1,000 = US$ 74 TL 1,000,000 = US$ 74,000 Turkish Fiscal Year March 1 to February 28  INTERNATIONAL BANK FOR RECONSTRICTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TURK:SH ELECTRICITY AUTHiORITY AND THE TURKISHI COAL ENTERPRISES FOR THE ELBISTAN LIGNITE MINE AND POWER PROJECT WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY 1. I submit the following report and recommendation on a proposed loan to the Turkish Electticity Authority (TEK) and the Turkish Coal Authority (TKI) for the equivalent of US$148.0 million to help finance a project for (a) the development of an open-cast lignite mine near the village of Elbistan in east- central Turkey and (b) the construction of an adjacent lignite-burning 1200 megawatt thermal power station and associated transmission lines. The loan would have a term of 25 years, including 5 years of grace, with interest at 7-1/4 percent per annum. Approximately $123 million of the loan would be allocated to TEK to help finance the power plant and approximately $25 million would be allocated to TKI to help finance the mine. The loan would be coordi- nated witlh co-financing from the European Investment Bank (EIB) and bilateral lenders. (See para. 34 on project financing). PART I THE ECONOMY 2. A report (316a-TU) entitled "The Economic Development of Turkey" dated April 22, 1974 was distributed to the Executive Directors. Country data sheets are attached as Annex I. 3. Following a decade of stability in Turkey, student disturbances and unrest among workers appeared in 1970, accompanied by party disagreements, and in March 1971 the armed forces obtained the resignation of the Government and called for the formation of an "above-party" and reformist Government. There followed a succession of short-term Governments. In early 1973 a new President of the Republic was elected by the Parliament. Subsequently, martial law was ended, and in October parliamentary elections were held. In a shift to the left of center, the Republican People's Party won a plurality and formed a coalition government in January 1974 with the National Salvation Party. The new Government's program stresses reconciliation of the political differences of the recent past, increased equity, social justice, and adherence to moral values, control of national resources, broader popular participation in eco- nomic activity, and improved planning and efficiency. Its specifics include a general amnesty, tax reform aimed at greater progressivity, and measures to promote cooperatives and a more dynamic capital market. While retaining most of the essential objectives of the Third Plan, the program places in- creased emphasis on the role of the public sector, especially in industry. 4. Growth in gross national product in the last decade was high and continuous, averaging about 6.9 percent-per year in the period 1962-72, with gross investment increasing as a share of GNP from 15 percent to 20 percent and gross national savings from 11 percent to 18 percent. Since 1970, how- ever, the shares of investment and gross national savings have decreased slightly.  -2- 5. The main growth sectors in the last decade were industry, power, transDort and construction. This reflected the development strategy during t;-e first and second five-year plans (1962-72), which gave highest priority to industrialization. Industrial output grew by about 10 percent per annum, witih textiles, machinery and equipment, steel and chemicals providing the main impetus. This rapid growth, mainly to meet domestic demand and replace im- ports, was largely insulated from foreign competition. Other rapidly growing sectors were trade and financial services. Agricultural production had a trend growth rate of about 3.5 percent per annum, with fluctuations from year to year depending on weather conditions. The share of industry in GDP rose from 17 percent in 1962 to 23 percent in 1972 and that of agriculture dropped from 39 percent to 28 percent. Growth in 1971-72 was above average. In 1971, GNP increased by 10 percent in real terms, with value added in agriculture increasing by more than 11 percent, thanks largely to an excellent harvest, a sharp rise in workers' remittances and continued industrial growth. In 1972, GNP intreased by 7.7 percent, with value added in agriculture not increasing over thie 1971 level, but with a 12 percent growth in industry, fast growth in transport, construction and trade and another sharp rise in workers' remittances. Growth in 1973 is estimated at about 6.5 percent. Preliminary estimates for 1973 indicate that GDP increased by about 6.4 percent in spite of a severe drought which led to an 8 percent decrease in agricultural value added. 6. The balance of payments situation was characterized in 1967-70 by increasing trade deficits, and a strict system of import controls which led to shortages of essential imports and, consequently, to under-utilization of pro- duction capacity. The overvalued official exchange rate was changed in August 1970 from TL 9 to TL 15 per US$ and revised to TL 14 in December 1971. This, together with associated stabilization measures, rising world demand and prices and a rapid rise in workers' remittances (from $140 million in 1969 to $740 million in 1972) helped to improve the situation dramatically. Commodity ex- ports increased by about 23 percent per annum in 1971 and 1972, with agricul- tural exports (mainly cotton, tobacco, hazelnuts, raisins and fruits and vege- tables) increasing by about 22 percent per annum and industrial exports by an unprecedented 55 percent (mainly in food and beverages, textiles, hides and leather products and petroleum products). The improved foreign exchange po- sition also led to a high import growth of 28 percent per annum, mainly in investment goods and raw materials (machinery and equipment, transport, steel and other metals, chemicals and fertilizers). Tourism receipts, although still relatively small, doubled between 1970 and 1972. The improvement in the balance of payments continued into 1973, with exports and imports of goods increasing by 49 percent and 34 percent respectively over 1972. Workers' re- mittances reached an estimated $1.1 billion. The overall result was a con- tinuing increase in gross official foreign exchange reserves, which stood at $2.1 billion at the end of 1973. Net foreign assets, which had been negative in 1966-68, rose to about $1 billion, i.e. 6 months of imports. One of the contributory factors to the rising foreign exchange reserves was the inflow of short-term capital (with convertible lira accounts rising from $70 million at the end of 1970 to a peak of $480 million in April 1973) which was subse- quently restricted by the Government. In May 1974, the lira was revalued vis-a-vis the dollar to TL 13.5 per US$ while its previous parity vis-a-vis  -3- other currencies was maintained. This action was taken to adjust to previous parity changes made vis-a-vis the dollar by Turkey's major trading partners. 7. The budgetary situation it the last decade was dominated by the relatively rapid growth of public expenditures. Although tax revenues grew rapidly, their share in GNP rising from 12.9 percent in 1962 to 17.9 percent in 1972, the increase was more than offset b7 the rise in current expenditures and transfers. The overall budget deficit ix.creased and was particularly large in 1971 when the full impact on current experditures of overdue public salary increases was felt. The Treasury had growing recourse to the Central Bank for short-term advances and to other short-term borrowing. The difficulties facing public mobilization of resources led to public investment expenditures falling short of targets, and to an actual decline in public fixed investment in real terms in 1971. In 1972 and 1973, Central Bank financing of the Treasury was reduced considerably as a result of a strict control of current expenditures and a sharp increase in the sale of Government bonds to TL 4 billion (0.8 bil- lion in 1971). Public investment also recovered, increasing by 19 percent in 1972. 8. The overall financial results of the State Economic Enterprises (SEEs) have been consistently poor, but there are sharp differences among them, with railways and coal being the major losers and manufacturing showing improving profits. The SEEs now account for about 20 percent of the fixed investment in the economy and about 10 percent of value-added. However, since 1969 the average rate of return on investment for the 28 largest producing SEEs has been less than 3 percent despite subsidized interest rates averaging about 4 percent. Low profits have necessitated increasing budgetary transfers to meet current and investment needs; such transfers amounted to TL 3.5 billion in 1971 and over TL 6 billion in 1972. Reform of the SEEs - in organization, management, executive and labor skills, and pricing policies - is especially important to prepare Turkish industry for competition that will arise from the EEC. Prices of SEE products were raised in 1971 and again in early 1974 to improve their financial situation. Measures agreed upon in connection with Loan 893-TU have begun to lead to improvement in the financial situation of the railways; and the Antalya Forest Ultilization loan (957-TU) provides for establishment of the Antalya mill on a sound commercial basis. 9. Inflationary pressures have appeared in the economy in recent years, as expenditures, fueled by rapid monetary expansion, grew more rapidly than available resources. The GNP price deflator increased by about 6 percent per annum during 1967-70, and accelerated to 18 percent and 14 percent in 1971 and 1972 respectively. Excess demand was created in this period by rapidly rising workers' remittances and convertible lira accounts; by substantial deficit financing by the public sector which, however, was strictly checked in 1972 and 1973; and by rising private investment demand. Prices of imported goods rose as a result of the 1970 devaluation, the subsequent depreciation of the lira, and rising world export prices; and prices of SEEs products were raised in 7971. The rate of inflation increased to about 20 percent in 1973 as the same pressures persisted and intensified. In these circumstances, effective demand management should be a major concern of economic policy. Improved mobi- lization of resources by the public sector will be needed to finance growing  -4- public investments. It will be essential to develop the capital market to supplement existing sources of long-term domitstic borrowing. Proposals for a capital market bill are now being considercd. In addition, revisions in the interest rate structure to ensure a reasonable real rate of return are needed to encourage private savings. Further liberalization of imports to improve the competitiveness of domestic industry and reduce the inflationary growth of foreign exchange reserves is also desirable. 10. Development strategy has emphasized the growth of output and labor productivity rather than employment. As a result, the labor surplus, including estimates of labor surplus in agriculture, rose from about 1 million in 1962 to 1.6 million in 1972, i.e. about 11 percent of the labor force. Emigration has so far greatly eased the pressure on employment. Between 1965 and 1972, net emigration amounted to about 400,000 and was expected to be about 70,000 per year during the Third Plan period (1973-77). The Third Plan continues the emphasis on investment in capital-intensive industries and projects a growth in non-agricultural labor surplus by another 300,000 by 1977. With the added effect of a slowdown in Europe on employment by Turkish workers (paragraph 14), unemployment should be a major concern of economic policy. Speedy implementation of land reform and integrated rural development pro- grams would help to dampen the migration from rural to urban areas. In addi- tion, labor intensive methods need special emphasis in the choice of projects. However, even with these measures and faster growth than planned in construc- tion and services, urban unemployment is likely to remain a serious problem. 11. The prospects for continued high economic growth are good. The Third Plan constitutes the first phase of a long-term strategy for the period 1973-95, the ultimate objective of which is to raise Turkish standards of living to those of Italy in 1970 through rapid industrialization and decreasing depend- ence on external resources. The Third Plan targets are an 8 percent GDP growth rate, a 10.7 percent fixed investment growth rate, a marginal savings ratio of 38 percent on national savings (compared with about 18 percent in the Second Plan), commodity imports and exports growing at 9.4 percent and 7.1 percent respectively and a decline in gross inflows of official external assistance to $130 million in 1977 (compared with over $300 million in 1972). Workers' remittances are estimated in the Plan at $600 million at constant 1971 prices in 1977. 12. A detailed analysis of these targets is presented in the basic economic report. The general conclusion is that, though the prospects for a growth rate of 7 percent are good, the Plan projections seem to underes- timate the difficulty of raising the savings level and balancing the external accounts at a reduced level of external assistance. 13. The Plan anticipates that two-thirds of the increase in national savings will come from the public sector through large increases in both tax revenues and in surpluses of the State Economic Enterprises (SEE's). Given the past performance of SEEs and delays in implementing a general reform, the expected rapid growth in their surpluses does not appear feasible. It will also be difficult to raise tax revenues to the extent implied by the Plan, but there is scope for a smaller increase if vigorous-policies are  -5- pursued, e.g., further improvements in tax administration and effective col- lection now under way, widening the tax net to cover agricultural incomes, increases in the rates of property taxation, introduction of a value-added tax and liberalization of imports to offset tax losses due to import substitu- tion and reductions of custom duties under the EEC agreement. The problem of domestic resource mobilization by the public sector is therefore likely to remain a constraint in the growth of public investment, and, apart from im- proved SEE performance, higher external borrowing and policies to increase long-term domestic borrowing from the private sector would be necessary to achieve the ambitious investment targets. 14. On the external side, the Plan projections have been overtaken by events, and commodity imports and exports in 1973 are likely to have been at about the level projected for 1977. Workers' remittances in 1972 were already higher than the 1977 target. However, their future was made uncertain by the decision by the Federal German Government in November to temporarily prohibit further entry of foreign workers from non-EEC countries because of the energy crisis. It remains to be seen what course this policy will take over the longer run. The emphasis on capital intensive industrial development and the rise in the prices of imported fuel and raw materials will require a more rapid growth rate, especially since the import regime is likely to be more liberal than in the past. Exports, particularly of industrial commodities, should continue to show good growth unless inflation continues at high rates, which would erode the competitive advantage gained as a result of the 1970 devalua- tion and the subsequent depreciation of the lira vis-a-vis Turkey's main trad- ing partners in Europe. Gross official external inflows on the order of $500 million a year may be required. 15. At the end of 1972, total external debt outstanding and disbursed was $2.5 billion, of which all but 3 percent is public or publicly guaranteed. The share of the Bank Group in total debt oustanding was 8.3 percent in 1972 and is expected to rise. The average terms of new credits have been hardening in recent years and this trend is expected to continue. Of the total gross official external assistance of about $380 million in 1972, the Consortium members provided an estimated $220 million. Of this about $58 million came from the United States, $44 million from the European Monetary Agreement (EMA) and $22 million from the United Kingdom. The USSR disbursed $113 million. As a result of increased remittances and other foreign exchange earnings, and successive debt reschedulings and other arrangements for debt relief, the debt service ratio fell considerably from 24 percent in 1964 to 10.2 percent in 1972 and an estimated 7.6 percent in 1973 and is likely to remain at about this latter level in the medium term. However, in view of the uncertainties sur- rounding remittances and oil prices, Turkey should continue to exercise great care in its external debt management, including restraint in its resort to suppliers' credit financing.  - 6 - PART II - BANK GROUP OPERATIONS IN TURKEY 16. During the lengthy period of chronic balance of payments difficul- ties before the 1970 stabilization program and devaluation of the Turkish lira, Bank lending was only intermittent. Since then, rapid improvement in the balance of payments and in creditworthiness has made possible a large increase and continuity in Bank/IDA lending, which in FY71, FY72 and FY73 amounted to $114 million, $173.3 million, and $175 million respectively. In these three years sixteen lending operations were carried out, of which five were in agri- culture, four in industry (including DFCs), three in power and the rest in urban development, transportation, and vocational education. Agriculture accounted for 30 percent of the funds lent, and industry and DFCs, for nearly 40 percent. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of April 30, 1974, and notes on the execution of on- going projects. Implementation of projects in the private sector has been satisfactory; on the other hand, projects in the public sector - especially those brea,;ing new ground in agriculture - have been seriously affected by political instability and resulting administrative problems, and disbursements have been much slower than expected. A comprehensive review of the problems besetting these projects has been started with the new Government. 17. In view of the sustained improvement in the balance of payments situation, no further IDA lending is contemplated. Bank lending is being increasingly directed to support of Turkish efforts to improve: (a) lagging public sector saving through financial and management reform of the SEEs; (b) distribution of income and living standards in the economy entering its second decade of roughly 7 percent yearly growth, through more attention to employment in investment projects, more concerted rural development efforts, and better urban planning; and (c) long-term capacity to earn foreign exchange, through diversification, especially promotion of industrial exports and tour- ism. Bank lending for the Turkish Industrial Development Bank (TSKB) and Fruit and Vegetables emphasizes exports; Bank tourism project identifica- tion and preparation missions have recently visited Turkey. 18. While the focus of Bank lending is on supporting the institutional and structural changes noted above, continuation of recent levels of lending is also important in view of the increase in projected capital import require- ments. As discussed in Part I, Turkey's Third Plan goals of an 8 percent growth rate and increasing competitiveness with the EEC in preparation for eventual full membership require further import liberalization and higher external borrowing in the near term. Under contemplated lending, the shares of IBRD/IDA in total debt outstanding and in total debt service are likely to remain under 20 percent and 25 percent respectively through the 1970's. 19. In supporting the broad objectives of improved SEE performance, better distribution of welfare, and diversification of external earning cap- acity outlined in paragraph 17 above, it is planned to continue concentrating the bulk of Bank lending (a) in industry (including mining and DFCs), where financial and management strengthening of SEEs is the key task, and (b) in agriculture, where rural development, employment, and institution building  are the main focus. This core of the program will be supplemented by repeater loans for railways and selected loans for power (which also center on financial reform of state enterprises), follow-up lending for urban development in Istanbul a:ad possibly in Izmir in support of the second objective, and by lending in tourism. Bank lending has thus far been geographically focused mainly in the Istanbul region, with e