Turkey - Small and Medium Scale Industry Project

Document of The World Bank FOR omcIL USE ONLY /f / epG y )- -Fil Rlee NO- P-4148-TU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO USt100 MILLION TO THE REPUBLIC OF TURKEY FOR A SMALL AND MEDIUM SCALE INDUSTRY PROJECT December 12, 1985 j s dogugat b a uuicd dlsdbelm mud my be med by redleats ei the perfornumu of tbdr offic dht ha mut my m othdse be didesd wi Wod l.k auth.rlzati.u  TURKEY CURRENCY EQUIVALENTS C0rrency Unit Jan. L980 /1 Jan. 1982 Jan. 1983 Jan. 1984 Jan. 1985 Oct 1985 US Dollar - TL70.00 TL139.60 TL191.15 TL309.20 TL45L.40 TL548.80 TL 1 - US$0.0L4 US$0.007 US$0.005 US$0.003 US$0.002 US$0.002 /1 Since January 1981, the rate is being adjusted for the differential infLatiou between Turkey and its major trading partners. Fiscal Year January 1 - December 31 LIST OF ABBREVIATIONS DESLYAB Devlet Sanayi ve Isci Yatirim Bankasi DFC Development Finance Company DYB Devlet Yatirim Bankasi FEKIS Foreign Exchange Risk Insurance Scheme HE Halk Bankasi SEE State Economic Enterprise SILO Small Industry Development Organization SMI Small and Medium Scale Industry SPO State Planning Organization SSI Small Scale Industry SYKB Sinai Yatirim ve Kredi Bankasi TCZB Turkiye Cumhuriyeti Ziraat Bankasi TSKB Turkiye Sinai KaLkinma Bankasi UNDP United Nations Development Programme UNIDO United Nations Industrial Development Organization  FOR OMCIAL USE ONLY TURE SHALL AND ]EDIUK SCALE INDUSTRi (SMI) PROJECT Loan and Project Sumary Borrover: Republic of Turkey Beneficiaries: Sinai Yatirim ye Kredi Bankasi (SYKB) Balk Bankasi (HB) Amounl: USg100 million Term: Fifteen years, including three years of grace, at the standard variable interest rate. Relending Terms: The Borrower would onlend $98.4 million to SYKB and HB for relending to eligible sub-borrowers in the small and medium scale industrial sector and $0.35 million to BB for technical assistance. The balance of $1.25 million would be-allocated to the Small Industry Development Organization (SIDO) for technical assistance to SMI enterprises. For sub-loans covered under the Foreign Exchange Risk Insurance Scheme (FElIS), sub-borrowers would pay the fixed FRIlS interest rate while the Borrower would onlend Bank funds denominated in TL to SYKB and HB at a fixed interest rate equal to the onlending rate to sub-borrowers minus an intermediation fee of 4 percent. Alternatively, Bank funds would be onlent in foreign exchange to SYKB and RB at a fixed interest rate equal to the then prevailing Bank rate plus a fee of 0.75 percent. The rate to sub-borrowers would be fixed at 5 percent above the prevailing Bank rate. Amortization of $98.4 million for financing of industry would conform substantially to the aggregate of the amortization schedules of individual sub-loans, while amortization of $0.35 million for financing technical assistance would be over 15 years including 3 years of grace. Project The project is designed to support a program for the Description: development of labor-intensive SMI, with special emphasis on Small Scale Industry (SSI), through lines of credit to SYKB and BB, technical assistance for the institutional strengthening and efficiency improvement of HB and technical assistance to SMI enterprises through SIDO. Tbis doc_mem th a n=kdi tibution and -y be usd by repients only in the pefonnce of thewr oficd dUbis In coensomay not oerwie be dmicod wihout World Dank authonizautn|  - ii - Benefits and Risks: The project would support the development of labor-intensive SMI projects in industries where Turkey has a comparative advantage and thus contribute to both job creation and growth of manufactured exports. The project is estimated to create about 18,000 direct jobs. The project would also provide technical assistance to SMI resulting in their increased productivity and efficiency. In addition, the project would help strengthen the institutional structure for financial assistance to SMI. The project risks mainly relate to the overall investment situation in the private industrial sector and the timely utilization of the proposed loan by the intermediary banks. Substantial delays in loan utilization are unlikely, however, in view of the measures taken by the - Government to stimulate the growth of the private sector. Estimated Disbursements: $ Million IBKD FY 1987 1988 1989 1990 1991 1992 Annual 12.0 27.0 27.0 19.0 11.0 4.0 Cumulative 12.0 39.0 66.0 85.0 96.0 100.0 Economic Rate of Return: Not applicable. Staff Appraisal Report: Report No. 5526-TU, dated December 11, 1985 Map: No. 116561  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENITION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE RtEPUBLIC OF TURKEY FOR A SMALL AND MEDIUM SCALE INDUSTRY PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Turkey for the equivalent of US$100 million to help finance a Small and Medium Scale Industry (SMI) Project. The loan would have a term of 15 years including 3 years of grace, with interest at the standard variable rate. The equivalent of $80 million and $18.75 million would be onlent to Sinai Yatirim ve Kredi Bankasi (SYKB) and Halk Bankasi (RB) respectively. Amortization of $98.4 million for financing of industry would conform substantially to the aggregate of the amortization schedules of individual sub-loans, while amortization of $0.35 million for financing technical assistance would be over 15 years including 3 years of grace. Of the amount of $98.75 million, the portion covered by the Government's Foreign Exchange Risk Insurance Scheme (FERIS) would carry the fixed interest rate established under FERIS minus a fee of 4 percent, while the balance would be onlent at a fixed interest rate equal to the then prevailing Bank interest rate plus a fee of 0.75 percent. The foreign exchange risk would be borne by the sub-borrowers in the latter case. PART I - THE ECONOMY 2. An economic mission visited Turkey in June 1982, and its report entitled "Turkey: Country Economic Memorandum, Recent Economic Developments and Medium-Term Prospects" (No. 4287-TU) was distributed to the Executive Directors in June 1983. The report of a mission to review the financial sector, entitled: "Turkey: Special Economic Report - Policies for the Financial Sector" (No. 4459-TU), was distributed in September 1983. A Bank mission reviewed the Government's Fifth Five-Year Development Plan (1985-89) in September 1984 and its report: "Turkey: The Vth Five Year Plan in the Context of Structural Adjustment" (No. 5418-TU) was distributed in July 1985. 3. Turkey's area is about 781,000 square kilometers (i.e. about equal to the area of France and West Germany combined) with a population of around 5U million and GNP per capita of $1200 in 1984. The density of population is low (78 per square kilometer of agricultural land), and about 47 percent live in urban centers. Population growth (2.2 percent per annum) is below the median for middle-income countries. Despite rapid economic growth in the mid-1970s as well as emigration of workers (to Western Europe and more recently, to the Middle East), there is still substantial unemployment which, including disguised unemployment in agriculture, is estimated at about 19 percent of the civilian labor force. There is, however, little or no absolute poverty, although income distribution is skewed. There are considerable regional differences in income and large rural-urban disparities. Recent data indicate a probable increase in income inequality since the 1970s, especially a relative deterioration of the position of wage and salary earners and an improvement in the position of the trading and commercial classes, and, more generally, of capital-owners. Educational enrollment has expanded greatly, but the level of adult literacy remains relatively low ccmpared to the European average for middle income countries.  -2- Background 4. During the 1970s Turkey did not make the necessary adjustments to the shocks caused by the steep rise in oil prices, stagflation in the OECD economies, aud the consequent deterioration of its terms of external trade. Until 1977 Turkey maintained high rates of economic growth by increasing public investment. The foreign exchange requirements were financed initially by workers' remittances and then increasingly by borrowing, a large part of it short-term. The rapid GNP growth came to an abrupt halt in 1977 as the massive external debt burden led to a sharp deterioration in creditworthiness, severe shortages of imports, disruptions in industrial production and a rise in unemployment. By the end of 1979, domestic inflation had also become an issue of critical importance. 5. In response to the crisis of the late 1970s, the Turkish authorities made a major shift in development strategy in 1980, moving towards outward orientation and giving an increased role to market forces. To alleviate the balance of payments constraint and import shortages, policies were adopted to expand exports, increase workers' remittances, liberalize imports, encourage foreign investment and improve external debt management. On the domestic front, the objectives were a reduction in the inflation rate, reform of the State Economic Enterprises (SEEs), a more efficient financial sector, improved resource mobilization and better selection of investments, especially in the public sector. 6. The adjustment program, which has been supported by the Bank through five structural adjustment loans and an agricultural sector adjustment loan, involves far-reaching changes in attitudes, institutions, and the legal and policy framework, all of which require time to be put in place. Major structural changes have been made in the exchange rate system, the export and import regines, the tax system, interest rate and selective credit policies and the public investment program. Implementation of the adjustment program started in January 1980, continued under a military regime during the period September 1980 - November 1983, and has since been carried out by an elected goverment. The Structural Adjustment Program - 1980-85 7. The Turkish economy has shown an impressive response to the structural adjustment program and actual outcomes met or exceeded the Government's own targets through 1982. The overall performance deteriorated in 1983 due to a combination of factors (slowdown of export growth, slippages in the monetary program, shortfall in Government revenues), but improved again, except in the area of inflation and the budget deficit, in 1984. The improvement has been maintained in 1985, as evidenced by a slowdown in inflation and a reduction in the budget deficit. 8. After expanding by 4.1 percent in 1981 and 4.6 percent in 1982, real GNP growth slowed down to 3.2 percent in 1983, due to the effects of a bad harvest, stagnant exports, and lower workers' remittances. The growth rate rebounded in 1984 to 5.9 percent, mostly on account of favorable performance in agriculture (3.7 percent growth) and industry (9.3 percent growth). Exports also expanded strongly, by more than 25 percent in dollar terms. In 1985, the growth rate of the economy is, according to the latest estimates, expected to be about 4.9 percent, as against the program target of 5.5 percent. The slowdown of growth is apparent across the board, but is most significant in agriculture (2.3 percent growth) and manufacturing  - 3 - (5.6 percent), due respectively to less favorable climatic conditions and slackening domestic demand. On the expenditure side, the average almual real rate of growth of public fixed investment over the period 1980-85 has been fairly stable, at less than 3 percent p.a., while the growth rate of private investment has recovered, following a 17.3 percent decline in 1980, and rose by 7.1 percent in 1984 and an estimated 5.2 percent in 1985. Private consumption, after declining by 5 percent in real terms in 1980, grew by 5 percent in 1983 and 1984 before slowing down to an estimated 3 percent in 1985. Strict budgetary discipline contributed to a steady decline in the real rate of growth of public consumption from 8.4 percent in 1980 to 1.8 percent in 1983; however, it increased to 3.8 percent in 1984 and an estimated 4.4 percent in 1985. 9. Through 1982, the Government met with considerable success in reducing the rate of inflation by a combination of fiscal, monetary and incomes policies. After peaking at 107 percent in 1980, the average annual rate of increase in the wholesale price index decelerated to 37 percent in 1981 and 27 percent in 1982. In 1983 the downward trend was reversed and the inflation rate rose to 30 percent. Inflation accelerated further in 1984, and reached 50 percent. The major factors that brought about the worseniug of the inflationary situation in 1984 were the lagged impact of the expansionary monetary policy pursued during the second half of 1983, and a significant increase in agricultural product prices, especially of fresh fruits and vegetables, as a consequence of export liberalization and higher export market prices. Other contributory factors included substantial "catch up" increases of SEE prices - since January 1984 most SEEs have effectively been allowed to set their prices freely - and higher import prices resulting from the nominal depreciation of the Turkish lira. In addition, inflationary pressures stemmed from a larger than anticipated budget deficit in 1984 as a result of a slowdown in the growth of revenues. 10. Inflation is expected to decline to 43-44 percent in 1985. This average annual inflation rate would be the net result of a period of high inflation during the first quarter of the year, followed by a period of deceleration starting in April 1985. Deceleration occurred despite significant increases in prices of goods produced by SEEs; it was rendered possible by the maintenance of high real rates of interest, a decline in the prices of a number of agricultural goods (mostly fruits and vegetables), and an overall slackening of domestic demand. The slowdown of inflation in the second half of 1985 reinforces the expectations of a further decrease in the average rate in 1986, bringing it close to the Government's target of 25 percent. 11. In the fiscal area, the progress achieved between 1980 and 1982 (during which time the budget deficit declined from 5.3 percent to 2.1 percent of GNP) was not sustained in 1983 and 1984. Due to a steady decline in consolidated government revenues as a percentage of GNP, 1/ the budget deficit increased to 3.2 percent of GNP in 1983, and reached almost 5 percent of GNP in 1984. The somewhat disappointing performance in the raising of revenues was accompanied, however, by significant improvements in the control of public expenditure. Overall, government expenditures decreased from 22 percent of GNP in 1983 to an estimated 16 percent in 1985, essentially due to a 1/ Although total government revenues (inclusive of extra-budgetary funds introduced in 1984) have not declined as sharply.  - 4 - curtailment of personnel expenditures and goveroment transfers to SEEs, with the latter declining from 2.5 percent of GNP in 1983 to an estimated 0.8 percent of GNP in 1985. However, the fact that improvements in the area of government expenditures were not matched by commensurate gains in the reduction of the budget deficit highlights the urgency of mobilizing additional public resources. As a step in this direction, the Government introduced a Value Added Tax in January 1985, replacing previous indirect taxes based on the value of output. The new tax has resulted in raising the share of taxes on goods in total government revenues from around 12 percent in 1983-84 to an estimated 20 percent in 1985. As a result of these measures, the budget deficit is expected to improve to about 2.5 percent of GNP in 1985. 12. Progress has also been made in rationalizing interest rates and reforming the banking system. Commercial bank deposit interest rates, which were deregulated in July 1980, are positive in real terms. Time deposits have been yielding a positive real return since early 1984, with interest rates presently ranging between 45 to 55 percent depending upon the term of the deposit. Positive deposit interest rates have resulted in a steady increase in deposits: in 1984 private non-commercial deposits grew by 8 percent in real terms, and in 1985 the growth has continued at a rate of about 10 percent. Improvements in incentives for savings were accompanied by administrative reforms of the banking system. A new banking law was enacted in June 1983. It included many of the recommendations made in the Bank's report on the Financial Sector (No. 4459-TU), including measures to reduce the undercapitalization of banks and the interlocking between banks and corporations. The legal basis of the banking reform was strengthened with the enactment of a revised banking law in April 1985, which introduced standardized accounting for banks and specified improved procedures for handling of non-performing loans. The Government also took a major step towards reducing the cost of bank intermediation by reducing in December 1983 the financial transactions tax from 15 percent to 3 percent. Other important developments in the financial sector include measures undertaken to revitalize the capital markets, for which IFC has provided technical assistance, and the sale of revenue-sharing certificates linked to the income from selected public infrastructual facilities (e.g. the Bosphorus bridge, and two dams). 13. While positive real interest rates have provided an incentive to save, they have also meant high borrowing costs. Effective nominal interest rates range from 60 to 80 percent on non-preferential credits, in part because of the high intermediation costs of the commercial banks and the prevailing practice of requiring compensating balances. The Government has taken a number of steps in 1985 to reduce the interest rate differentials between preferential and non-perferential credits: in particular, the perferential interest rate for export credits was discontinued ;n January 1985, while interest rates for agricultural short-term loans and for loans to SEEs have been increased in 1985 to 30 percent (from 28 and 24 percent respectively). The narrowing of the gap between interest rates on preferential and non-preferential credits, together with the decrease in the amount of preferential credits, is expected to increase the general availability of credit and exert a downward pressure on non-preferential interest rates. 14. Improvements in the balance of payments were substantial between 1980 and 1982, with the current account deficit decreasing from $3.3 billion (5.7 percent of GNP) in 1980 to $1.2 billion (1.6 percent of GNP) in 1982. In 1983 the current account deficit increased to $1.8 billion, as merchandise exports stagnated and workers' remittances fell by one-third. These developments were reversed in 1984 as exports increased by over 25 percent in  - 5 - dollar terms to reach $7.4 billion. Remittances, tco, registered a higher than expected increase, reaching $1.8 billion (up by 20 percent over 1983). Merchandise imports, fueled by high growth as vell as a more liberal import regime put in place in 1984, grew by more than 16 percent to reach $10.8 billion (or almost 22 percent of GNP). As a result of these developments, both the trade and the current account deficits declined as compared to 1983: the trade deficit by $50 million, and the current account deficit by $350 million, to reach $1.4 billion or about 2.9 percent of GNP. Projections for 1985 indicate a further strong improvement of the current account sitliation. Merchandise exports, after a sluggish start in 1985, have grown by 13 percevt (in dollar terms) in the first nine months of 1985, while merchandise imports have grown at a moderate 5.3 percent. Among the invisibles, tourism revenues and investment income from abroad have increased significantly compared to 1984 and previous years. Similarly, workers' remittances have continued to rise at a rate of about 10 percent per annum. It is now estimated that the current account deficit in 1985 would be in the range of $650-800 million (about 1.3 - 1.6 percent of GNP). 15. Merchandise export performance has been impressive throughout the 1980-85 period, during which exports registered an average annual rate of increase of about 22 percent in dollar terms. This growth has been led by the manufacturing sector and has involved a rise in the share of exports to the Middle Eastern countries. Industrial exports, composed primarily of processed foods and textiles, have risen from 36 percent of total exports in 1980 to more than three-quarters in 1985. These results were achieved by a combination of indirect (flexible exchange rate policy, import liberalization) and direct (tax rebates, preferential credits) measures to enhance the relative profitability of exports and offset the traditional bias towards production for the domestic market. Successful penetration of the Middle Eastern markets has brought their share in total Turkish exports from 17 percent in 1980 to around 40 percent in the 1983-85 period. 16. On the import side, the 1982-83 period was marked by a relative stability in the growth of merchandise imports, as prices of both oil and non-oil imports declined, and the volume rate of growth remained moderate. In 1984, however, merchandise imports increased by 16.1 percent in dollar value. The increase was most pronounced in some of the groups (e.g. raw materials and consumer goods) that have been suojected to major liberalization in terms of both a lowering of tariff rates and a significant removal of quantitative restrictions. In 1985, as domestic demand eased, and the initial effects of pent-up demand for importables released by import liberalization weakened, the rate of import growth decreased to one-third of the level recorded in 1984. Medium-Term Prospects 17. The Fifth Five Year Development Plan (1985-89), which was approved by the Grand National Assembly in June 1984, reaffirms the Government's determination to pursue an outward-oriented development strategy and to liberalize the economy by relying increasingly on market forces for allocation decisions. The public sector is targeted to play a supportive role by concentrating its investments in infrastructure rather than manufacturing, while the private sector is to be encouraged to play a leading role in the growth of manufacturing and exports. Some of the key targets are: (i) an average annual GNP growth rate of 6.3 percent;  -6- (ii) an average annual real rate of growth of merchandise exports of 10.6 percent; (iii) an average annual real rate of growth of 10.9 percent in private investment and 6.8 percent in public investment; (iv) a declining external debt service ratio, from 26 percent in 1984 to around 18 percent in 1989; and (v) a decreasing rate of inflation reaching 10 percent p.a. in 1989. 18. While the overall thrust of the Plan'is in accord with the goals of the structural adjustment program, the Plan targets, if viewed collectively and in the light of the developments in 1984 and 1985, appear ambitious and likely to strain domestic resources (especially in the public sector) as well as to have an adverse impact on the external balance. Accordingly, the Government is adjusting the annual programs to ensure that they remain compatible with the fight against inflation and with a growth strategy coumensurate with the Government's ability to generate resources. 19. The Bank's projections indicate that GDP growth of 5.7 percent p.a. on average for the 1985-90 period may be more realistic. In the first phase of this period (1985-87), growth might be relatively slow (5.3 percent p.a.), gradually accelerating in the outer years with an average rate of 6.0 percent p.a. in the period 1988-90. The inflation targets in the Bank's projections are also more conservative, implying a reduction from about 40 percent in 1985 to around 18 percent in 1990. Key economic variables in the Bank's projections for the period 1985-90 are presented in Table 1: 1/ Table 1: TURKEY - SELECTED ECONOMIC INDICATORS, 1984-90 Real Ctb Rae Aeg Real Gma.Ctb Rate 19" 19M5 19 (2) (0) unit. (Act.) {I:t.) (proj. 134 1963 1933-90 CW /a 1955 7L bil 25672.5 26920.2 3546t.3 5.3 4.9 5.7 Artc-Itnr. M al:. 4723.2 5181.3 3.0 2.3 3.0 zeesetty 7U63.1 7605.6 10320. 9.3 6.6 7.3 So-ice. 12143L2 13I0.5 17151.4 4.7 4.8 5.6 Cone.ptim 21578.3 22389.1 29274.5 b.9 3.7 5.5 rihd itect - 4632.3 4921.6 6742.1 z.0 5.1 6.5 8L".oct of goed (fob) Cerr 8 il 7389.0 7N92.0 18127.6 34.6 12.1 * .5 InPre at moods 1.) 10331.0 10810.9 21567.7 18.0 5.3 7.3 Trad. balace -29N2.0 -2823.9 -36w- 1 we.er. renictarce. 1791.0 21W.0 2741.3 C.rrent eccoent bIeLce - -142b.0 -750.5 -309.0 Znw.la nt_cG 7. 20.2 19. 20.5 basic .. Lfi/CW 1 15.5 16.0 18.3 Espon.- of swdeJlcV 7 14.0 15.0 17.1 C-cot ace. deiritAMP /b 2 -2.7 -1.4 -0.3 Debt ker= VatL IC 2 2b.0 31.3 21.2 P.blic fiil ineaeskr/ total fix"d ia"vteet 2 59.0 56.5 51.3 an_e it_: GrCa Capital reqeired Crsr 2 nil 4627.3 33.8 4507.4 Ia At arket pric.e. Coenp tes are aproened at facter coet. Lb Asoed - Stmt IL_ /c TetLL debt *r"sic (Ildindg h*rt-tee,)jeaepacte of goods *ad WS pla -rker.' re.ittsc.es. 11 The Bank's projections for 1985 may differ slightly from the Government's latest estimates for 1985 discussed above.  7 20. Achievement of these growth rates will depend primarily on the performance of agriculture and manufacturing. This in turn will depend to a large extent on the Government's detenmination to constrain the growth of the public sector in line with resources and to create a more favorable investment climate for the private sector. This translates into a projected real growth in public fixed investment of about 3.8 percent p.a. on average for the 1985-90 period, starting with a more modest increase of around 3.5 percent p.a. in the early years. The comparable figure for the growth of private fixed investm nt (for the Whole period) is 10.0 percent p.a. These figures are consistent with the need to meet the infrastructural requirements of the economy through the public investment program, while providing for the capacity expansion of the private sector necessary to meet the output and export targets. The projections allow for a modest increase of per capita consumption of about 3.0 percent p.a. on average over the period 1985-90. 21. Merchandise exports are projected to grow at an average rate of 8.5 percent per annum in real terms during 1985-90, while merchandise imports are projected to grow at an average annual rate of 7.8 percent. This is consistent with the import liberalization program of the Government. On these assumptions, the current account deficit is projected to decrease through 1988 as stabilization policies act to contain import growth while encouraging exports. As higher growth rates set in during the outer years of the period, the trend would reverse and the current account deficit would rise moderately through 1990. For the year 1990, the projections show a deficit of $810 million as compared to an estimated 1985 figure of $750 million. The projected capital account would remain manageable throughout the period, even in the face of some sharp increases in amortization payments arising from the debts rescheduled during 1978-80. 22. On the external front, the current expectation of lower oil prices in the next period is likely to have a positive impact on the balance of payments. The savings on direct petroleum imports could be as much as $275 million in 1986 alone. Lower oil prices will no doubt have some negative consequences for Turkey's exports to oil-exporting countries as well as on profit and workers' remittances from construction activities in these co-ntries. Nevertheless, the overall effect on the current account is likely to be positive, due to the stronger effect of the import savings. 23. The medium-term scenario presented above is, of course, only one of many possibilities and is used specifically to illustrate Turkey's potential in the light of the Government's own development strategy. Given Turkey's progress in the structural adjustment program, the favorable response which this has evoked from the international financial community, and the present outlook for both lower oil prices and a strong growth of Turkish exports, the GNP growth projected in the medium-term base case scenario could be exceeded if slightly higher export growth rates were achieved and there was an improvement in the mobilization of public resources. 24. In view of the sensitivity of the projections to the assumptions regarding export growth, a downside risk case has also been developed. With Turkey's export performance heavily dependent on exogenous factors such as the world economic conditions and movements in international prices, a slower growth of merchandise exports (an average of about 6 percent p.a. over the 1985-90 period) coupled with lower mobilization of public resources (3 percent lower revenues than envisaged under the base case scenario) would  lead to a more difficult but still manageable balance of payments situation, a lower GDP growth (averaging about 4.7 percent p.a.) and a higher debt service ratio (averaging 26.7 percent during 1986-90 against 25.1 percent in the base case scenario). In such a situation the Government would have less chance of absorbing Lhe unemployed and improving tangibly the average standard of living. However, if the Government in such circumstances were to resort to a high growth strategy, then it could witness a repeat of the situation which prevailed in the 1970s, and which led to a debt crisis. It is unlikely that the Government would risk such a situation. It is therefore more probable - even if exogeneous developments are unfavorable - that the GovernmenL will continue with the structural adjustment program as implemented to date, so that the scenario of high growth fuelled by increased external borrowing seems at present unlikely. External Debt and Creditworthiness 25. At the end of 1978, Turkey had $7.2 billion in short-term debt and $7.0 billion in medium and long-term debt. Between 1978 and 1980, Turkey rescheduled some $9.2 billion of outstanding obligations through a series of rescheduling arrangements concluded with official and commercial creditors. Following the resolution of the debt crisis, inflows were mostly from official sources - OECD countries, the World Bank and the IMF. Since 1983 commitments from commercial banks have outstripped those from official sources and are likely to reach an estimated level of $2.5 billion by end-1985. Of the estimated total debt outstanding of $22.3 billion (including IMF) at end-1984, medium and long-term debt accounted for about 79 percent. Short-term debt as a percentage of total debt outstanding fell ftom 51 percent in 1978 to about 11 percent in 1982, then increased to 14 percent in 1983 and to an estimated 21 percent in 1984. Much of this 6rowth in the stock of short-term debt is due to the inflows associated with the Dresdner Bank scheme 1/. At ent-1984, the outstanding liabilities associated with the Dresdner scheme amounted to $1.8 billion, constituting 39 percent of short-term external obligations. Based on the growth scenario outlined in paras. 19 to 22, debt outstanding and disbursed as a percentage of GDP is projected to fall from an estimated 42 percent in 1984 to 37 percent in 1990. This translates into a total debt outstanding forecast for 1990 of $28.8 billion, with short-term debt constituting about 25 percent of the total. 26. The debt service ratio for medium and long-term credits increased from about 26 percent in 1984 to an estimated 31 percent in 1985, mostly as a result of large repayments of rescheduled debt falling due. Debt service obligations are expected to be on average about $4.0 billion a year during 1986-90, a quarter of which is attributable to service obligations on rescheduled debt. However, the debt service ratio is projected to decrease to a level of about 25 percent during 1986-1990, due largely to improvements in the current account of the balance of payments. The debt burden should remain 11 Under this scheme the Dresdner Bank collects deposits from Turkish workers in West Germany and automatically places these funds at the disposition of the Central Bank of Turkey, which guarantees the deposits i.nd pays an interest rate commensurate with the Euro-market rate.  - 9 - manageable provided current policies are successfully implemented, the export drive is sustained, and Turkey continues to receive support from international commercial and official sources. Confidence in Turkey's overall economic performance, its stable record in meeting debt servicing obligations and its improved debt management, encouraged commercial banks to commit about $1.3 billion in 1985. Several major American, European, Japanese and Middle Eastern banks were involved in these operations, including a $500 million syndicated loan in support of the balance of payments signed in April 1985. 27. Turkey's economic program has been supported by the DF through a series of standby arrangements during 1980-84. The Government has not asked for a new standby in 1985. The Government's decision seems to reflect the view that the favorable economic developments in 1985 constitute proof of Turkey having "graduated" from the INF's program and that the IMF presence through Article IV consultations should suffice for purposes of maintaining international confidence. PART II - BANK GROUP OPERATIONS IN TURKEY 28. Through September 30, 1985 the Bank and IDA have lent $6185.8 million 1/ to Turkey, through 88 projects. Agriculture accounts for 21 percent of the funds lent, industry and DFCs for 22 percent, power for 16 percent, structural adjustment and program loans for 27 percent, and urban development, transportation, education, tourism and technical assistance for the remaining 14 percent. Disbursements for all sectors combined averaged 63 percent of appraisal estimates at the end of September 1985, which compares favorably with other countries in the region. As of September 30, 1985, IFC commitments to Turkey totalled about $246 million, of which about $64 million were still held by IFC. Annex II provides a summary statement of Bank loans, IIA credits and IFC investments as of September 30, 1985. 29. Bank lending is aimed at supporting Turkey's mediumrterm objectives of restructuring the Turkish economy by placing more reliance on market forces and adopting a more outward-oriented strategy. The main vehicle for the Bank's operational discussions with the Government has been the structural adjustment lending (SAL) program, which was compleLed in June 1984, and more recently the sectoral adjustment lending program. Significant progress has been achieved in the last five years, but the task of restructuring is by no means over. The current plan involves the broadening and deepening of the adjustment process at the sectoral level. Recent economic developments have underlined the need for a continuation of the stabilization program without giving up the goals of sectoral adjustment. Hence the emphasis of Bank lending in the post-SAL period would be on striking an appropriate balance between sectoral adjustment lending designed in part to be quick disbursing and supportive of policy reforms in the major sectors, and carefully formulated project lending focussing on high priority projects principally in the agriculture, energy, industry and transport sectors. 1/ Net of cancellations.  - 10 - 30. A series of secteral adjustment loans for the major sectors is planned over the next few years. A first loan for agriculture was approved in June 1985. Further lending of this kind would support measures to address the structural problems of the financial sector and enhance the utilization of industrial capacity in the public and private sectors, keeping in view the scope for the "privatization" of publicly-held assets in the manufacturing subsectors. Other sectors where sectoral adjustment loans are likely to be developed include energy and transport, and it is expected that there would be a follow-up loan in agriculture. 31. Project lending, which would continue to make up the majority of the lending operations, would be designed to support and strengthen the adjustment process. Some project lending would be earmarked for the construction or rehabilitation of key projects in the energy sector. Other projects would be guided by the major policy objectives of the Government, which include generation of foreign exchange (including improving productivity in export industries and providing essential infrastructure for exports), improvement of institutional efficiency, non-inflationary output growth and amelioration of the social costs of adjustment (including provision of social infrastructure and employment generation, with some emphasis on the least developed provinces in Eastern Turkey). 32. The close macroeconomic and sector dialogue established with the Government in recent years is expected to be pursued. The economic and sector work currently being undertaken includes a review of the public investment program and studies of housing finance, engineering industries, transport investment, telecomaunications and electronics. Topics expected to be covered in the future include a study in domestic resource mobilization, a country economic memorandum focussing on inflation, reviews of the health and education sectors and a study of private sector adjustment to liberalization action. 33. This would be the second loan to Turkey presented to the Executive Directors this fiscal year. Other projects being processed include the Kayraktepe Hydropower Project, a loan for drainage and on-farm development, a financial sector adjustment loan and a loan for Elbistan operation and mainteuance assistance. 34. Turkey's debt burden is projected to remain manageable throughout 1985-89 (paras. 25 and 26). The Bank Group's share of Turkey's total external debc was 13.4 percent in 1983, is estimated at 14 percent in 1984, and is expected to grow to about 17 percent by 1989. Official debt outstanding is projected to increase from $11.0 billion in 1984 to $13.4 billion in 1989 and private medium and long-term debt outstanding is projected to increase from $5.2 billion in 1984 to $7.5 billion in 1989. The Bank group's share of total debt service payments is projected to increase from about 12 percent in 1983 to an estizmated 13 percent in 1984, and to about 18 percent in 1989. 35. IFC has invested in synthetic yarns, textiles, pulp and paper, glass, aluminum, cement, iron and steel products, heavy diesel engines, motor bicycle engines, piston rings, food processing and tourism. It has also invested in the Industrial Development Bank of Turkey (TSKB) and provided guarantees for overseas contracting firms. In addition, IFC is currently providing technical assistance to the Government with respect to the development of the capital market and a regulatory framework for leasing.  - 11 - PART III - THE SECTORAL FRM&EWORK The Manufacturing Sector 36. Overview. The key objectives of Turkey's industrial development strategy are expansion of exports, broadening of the range of goods produced, greater efficiency in public and private enterprises, and employment generation. The Government recognizes that job creation must be the outcome of economically viable investments. Numerous studies of Turkey's industrial sector have shown that factor productivity is significantly higher in private than in public industry, and that small firms in the private sector offer high returns per unit of capital invested, while being more labor intensive. The Goveroment's industrial policy involves limiting public investment in the manufacturing sector to rehabilitation and modernization of existing investments and relying on private sector investment in new manufacturing industries. The small and medium-scale industrial sector, which had been somewhat neglected during the 1960s and 1970s when Turkey gave priority to large-scale capital intensive projects in the public sector, is to be encouraged through removal of disincentives and provision of technical and financial assistance. 37. The economic policies adopted since 1980 have attempted to move Turkey away from its previous import-substitution focus towards an outward-orientation and greater reliance on market forces. During 1982-84, the Government reoriented major parts of the incentives framework towards promociJng export development. Significant progress has also been made in removing quantitative restrictions and in lowering duties on imports, bringing competitive pressures to bear upon Turkish industry. Turkish firms are now expected to compete in domestic and export markets without reliance on the excessive tariff protection and fiscal incentives that characterized Turkish industrial policy prior to 1980. 38. The Government's Fifth Five-Year Development Plan (1985-89) projects favorable growth prospects for the industrial sector. The manufacturing sector's share in GDP is expected to grow to 27 percent during the Plan period. Currently, the manufacturing sector accounts for about 25 percent of fixed investment, 11 percent of aggregate employment and 65 percent of merchandise exports. The private sector, whose share of manufacturing employment and value added is approximately twice that of the public sector, is concentrated in the food processing, textiles, garments, engineering, glass, plastics and ceramics subsectors. The public sector is mainly concentrated in heavy industry (iron and steel, fertilizers, pulp and paper, cement, petroleum refining, chemicals and mining) as well as in some light industries such as textiles and electrical machinery, and certain agro-industries such as milk and meat processing. 39. The Role of Small and Medium Scale Industry. Small and mediur-scale establishments 1/ number about 6,000 units accounting for about 68 percent of 1/ There are several definitions of small and medium scale manufacturing units in Turkey. The Small Industries Development Organization defines small units as those employing 10-49 workers and medium-scale units as those employing 50-199 workers. Under IBRD Loan 1952-TU, small-scale units were defined as firms with fixed assets (including land and buildings) valued at less than $500,000 (in 1984 prices) and mediumrscale units as those with assets up to $2.5 million.  - 12 - establishments registered in the organized private sector (employing 10 or more workers). They employ about 235,000 workers or about 45 percent of the total employed. These numbers exclude units in the informal sector (para. 40). On the basis of a 1978 survey, SMI's share in total manufacturing employment was estimated at about 35 percent. SMI firms are very prominent in certain industries, notably wood processing/fu