Turkey - Kayraktepe Hydropower Project

DOCUfMen of The World Bank FOR OMCIAL USE ONLY Rewpt N. P-4179-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 USt2OO MILLION TO THE REPUBLIC OF TURKEY FOR THE KAYRAKTEPE HYDROPOWER PROJECT January 31, 1986 s docemeu hun a reutffleftd d*l.d. m- =my be ued by recdplust ody o the performce dof tdeir .U,id dudb lb lsa tem may na .tberwie be dsdcmi wt Weed Bunk _atheriza. |  CURRENCY EQUIVALENTS Currency Unit Jan. 1980 /1 Jan. 1982 Jan. 1983 Jan. 1984 Jan. 1985 Oct. 1985 US Dollar - TL 70.00 TL 139.60 TL 191.15 TL 309.20 TL 451.0 TL 540.80 TL 1 - US$ 0.014 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 inflation between Turkey and its major trading partners. Fiscal Year January 1 to December 31 WEIGHTS AND MEASURES kVA = kilovolt ampere kWN kilowatt kWh = kilowatt hour GWh (Gigawatt hour) = 1,000,000 kWh WV = High Voltage kV (kilovolt) = 1,000 volts MUV Index = Unit value index of Manufactured Exports in US$ SW (Megawatt) = 1,000 kW MVA (Megavolt-ampere) = 1,000 kVA MVAR (Megavolt-ampere reactive) = 1,000 kVAR One meter (m) = 3.28 feet One kilometer (km) = 0.624 mile One kilogram (kg) (1,000 grams) = 2.2 pounds One ton (metric ton) (1,000 kg) = 2,205 pounds One kilocalorie (kcal)(l,000 calories) = 3.968 BTU toe = tons of oil equivalent GLOSSARY AND ABBREVIATIONS CEAS - Cukurova Elektrik A.S. (Cukurova Power Company) DSI - Devilet Su Isleri (State Hydraulic Authority) EIB - European Investment Bank EIE - Electric Power Resources Survey Administration Eltem TEK - Electric Tesisleri Mishen Dislik Hizmetteri ve Ticaret Anonim Sirketi EPDC - Electric Power Development Company (Japan) KEPEZ A.S. - Kepez Electric Company KfW - Kreditanstalt fur Wiederaufbau LRMC - Long-Run Marginal Cost MENR - Ministry of Energy and Natural Resources MTA - Mineral Research Institute PEE - Public Economic Establishment PPF - Public Participation Fund SAL - Structural Adjustment Loan SEE - State Economic Enterprise SPO - State Planning Organization TEK - Turkiye Elektrik Kurumu (Turkish Electricity Authority) TKI - Turkiye Komur Isletmeleri Kurumu (Turkish Lignite Enterprise) TPAO - Turkiye Petrolleri Anonim Ortakligi (Turkish Petroleum Corporation)  FOR OMCIAL USE ONLY TURKEY KAYRAKIEPE HYDROPOWER PROJECT Loan and Proiect Summary Borrower: Republic of Turkey Beneficiaries: State Hydraulic Authority (DSI) Ministry of Energy and Natural Resources (MENR) Amount: US$200.0 million equivalent Terms: Seventeen years including four years of grace, with interest at the standard variable rate. Proiect The objective of the proposed project would be to Description: support the Government's strategy of developing Turkey's indigenous energy resources through financing of the 420 MW Kayraktepe Hydropower Station on the Giksu river and to provide technical assistance to DSI in cost accounting and to MENR in carrying out a national ranking of hydroelectric resources. Project Benefits The project would help in developing economically and Risks: Turkey's indigenous energy resources. The project would also provide flood protection for the rich Silifke plain and the city of Silifke. Geological investigations for the Kayraktepe dam were comprehensive and appropriate expert geological supervision would be provided during construction. This document has a resticted distribution and may be used by recpients only in the performance of their official duties. Its contents may not otherwise be disdosed without World Bank authorkation.  Estimated Project Cost: US$ Million Equivalent Local Foreign Total Hydropower Project Road Relocation 10.6 1.2 11.8 Construction Camp Facility 2.7 - 2.7 Civil Works 115.9 96.9 212.8 Hydraulic Equipment (gates & penstocks) 3.2 18.0 21.2 Electro Mechanical Equipment 7.7 54.1 61.8 Engineering & Administration 26.0 6.0 32.0 Land Acquisition & Resettlement 34.5 - 34.5 Sub-Total 200.6 176.2 376.8 Technical Assistance Inventory & Ranking of Hydro Resources 1.0 2.0 3.0 Technical Assistance in Cost Accounting 0.1 0.4 0.5 Data Processing 0.1 1.4 1.5 Base Cost (7/85 prices) 201.8 180.0 381.8 Physical Contingencies 16.9 13.4 30.3 Price Contigencies 69.1 61.1 130.2 Total Project Cost 287.8 254.5 542.2 Interest during Construction Bank Financed - 72.2 72.2 Other - 101.9 101.9 Total Financing Required 287.8 428.6 716.4 Financing Plan IBRD A-loan - 200.0 200.0 1/ Participation in cofinancing - 50.0 50.0 2/ Cofinancing (B-loan) 223.3 76.7 300.0 Government 64.5 101.9 3/ 166.4 Total 287.8 428.6 716.4 1/ including $55 million for interest during construction. 2/ including $17.2 million for interest during construction. 3/ balance of interest during construction.  - iii - Estimated Bank Disbursements US$ Million Equivalent IBRD FY 1987 1988 1989 1990 1991 1992 1993 1994 Annual 7.0 25.2 39.0 42.2 35.5 28.2 19.6 3.3 Cumnulative 7.0 32.2 71.2 113.4 148.9 177.1 196.7 200.0 * Economic Rate of Return: 11.3 percent Appraisal Report: No. 5820-TU dated January 29, 1986 Map: IBRD 19012  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR THE KAYRAKTEPE HYDROPOWER PROJECT * 1. I submit the following report and recommendation on a proposed loan to the Republic of Turkey for the equivalent of US$200 million to help finance the foreign exchange cost of the Kayraktepe Hydropower Project- The loan would have a term of 17 years including 4 years of grace, with interest at the standard variable rate. A B-loan is also being arranged for this project. PART I - THE ECONOMY I/ 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 50 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 compared to the European average for middle income countries. 1/ Parts I and II are substantially the same as Parts I and II of the President's Report on the Elbistan Operation and Maintenance Assistance Project (P-4114-TU1) dated January 8, 1986.  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, and 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 regimes, 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 L980 - November 1983, and has since been carried out by an elected government. The Structural AdLustment Program_-- 1980-85 7. The Turkish economy has shown an imoressive response to the structural adjustment program and actual outcomes met or exceeded the Government's own targets through L982. The overall performance deteriorated in 1983 due to a combination of toctors (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 was 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 198.4 to S.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, according to the latest estimates, the growth rate of the economy was about 4.9 percent, as against the program target of 5.5 percent. The slowdown of growth is apparent across the board, but was most significant in agriculture (2.2 percent growth) and manufacturing (5.5 percent), due respectively to less favorable climatic conditions and slackening domestic demand. On the expenditure side, the average annual 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 Dercent 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 worsening 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 vegetable3, 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 oL a slowdown in the growth of revenues. 10. Inflation declined to about 43 percent in 1985. This average annual inflation rate has been 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 1/ Although total government revenues (inclusive of extra-budgetary funds introduced in 1984) have not declined as sharply.  - 4 - 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 curtailment of personnel expenditures and government 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 tz.e 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 have improved 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 and '5 percent depending upon the term of the deposit. Positive deposit interest rates have resulted in a steady increase in deposits: in 1984 pri-rate 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 took a number of steps in 1985 to reduce the interest rate differentials between preferential and non-preferential credits: in particular, the preferential interest rate for export credits was discontinued in January 1985, while interest rates for agricultural short-term loans and for loans to SEEs were 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  - 5 - 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 2.5 percent in dollar terms to reach $7.4 billion. Remittances, too, registered a higher than expected increase, reaching $1.8 billion (up by 20 percent over 1983). Merchandise imports, fueled by high growth as well 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. Estimates for 1985 indicate a further strong improvement of the current account situation. Merchandise exports, after a sluggish start in 1985, grew by 13 percent (in dollar terms) in the first ten months of 1985, while merchandise imports grew at a moderate 6 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 6 percent per annum. The current account deficit is now estimated in 1985 at $650-800 million (about 1.7 - 1.9 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 r-'-tive 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 subjected 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.  -6- 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; (ii) an average annual real rate of growth of merchandise export- ef 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 commensurate 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 43 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: l/ 1/ The Bank's estimate for 1985 may differ slightly from the Government's latest estimates for 1985 discussed above.  -7- Table 1: TURKEY - SELECTED ECONOMIC INDICATORS, 1984-90 Real Growth Rate Average Real Growth Rate 1984 1Y85 1990 (2) (2) Uaitc (Act.) (Ecat.) (Proj.) 19t4 1985 1985-90 cLP la 1985 TL bil 25672.5 26920.2 35466.8 5.8 4.9 5.7 Agriculture 4621.9 4728.2 5481.3 3.0 2.3 3.0 Industry 7138.1 7605.6 10820.4 9.3 6.6 7.3 Services "12443.2 13040.5 17156.4 4.7 4.6 5.6 Consumption 21578.3 22389.6 29274.5 6.9 3.7 5.5 Fixed investment 46823 4921.6 6742.1 2.0 5.1 6.5 Exports of goods (fob) Curr S ail 7389.0 7982.0 18127.6 34.6 12.1 8.5 Imports of goods (fob) ' 10331.0 10810.9 21567.7 18.0 5.3 7.8 Trade balance -2942.0 -2828.9 -3440.1 Workers' refittancea 1791.0 2190.0 2741.8 Current account balance -14?6.0 -750.5 -09.0 Rat io lnveat.ent/GDP 2 20.2 19.8 20.5 Domestic savings/Gp 2 15.5 16.0 15.3 Exports of goods/CDP ; 14.0 15.0 17.1 current acct. deficit/GD /b 2 -Z.7 -1.4 -0.8 Debt service ratio Ic 2 26.0 31.3 21.2 Public fixed invcescent/ cotal fixed investent 59.0 58.8 51.8 M.o itmea Goss capital required Curr S ail 4627.3 3894.8 4507.4 /a At mrket prices. Components are expreased at factor coat. /b Based on constanrt I.. 7c Total debt service (excluding short-teru)/exports of goods and NFS plus workers' remictances.  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 determination 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 investment (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 countries. 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 cowmunity, 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  - 9 - 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 the 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 Government 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 have reached 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 from 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 growth in the stock of short-term debt is due to the inflows associated with the Dresdner Bank scheme 1/. At end-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 1/ 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 and pays an interest rate commensurate with the Euro-market rate.  - 10 - 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 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 $1.8 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 'jy the INF through a series of standby arrangements during 1980-84. The Gr.vernment did not ask 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 IMF's program and that the IMF presence through Article IV consultations should suffice for purposes of maintaining international confidence. PART IT - BANK GROUP OPERATIONS IN TURKEY 28. Thro'igh 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 rFC. Annex II provides a summary statement of Bank loans, IDA credits and IFC investments as of September 30, 1985. 29. Bank lending is aimed at supporting Turkey's medium-term 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 completed in June 1984, and more recently the sectoral adjustment lending program. Significant progress has been achieved in the lasL *ive 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 1/ Net of cancellations.  - 11 - 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. 30. A series of sectoral 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. This would be the fourth loan to Turkey presented to the Executive Directors this fiscal year. Other projects being processed include a loan for drainage and on-farm development, and a financial sector adjustment loan. 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, telecommunications 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. Turkey's debt burden is projected to remain manageable throughout 1986-89 (paras. 25 and 26). The Bank Group's share of Turkey's total external debt was 13.4 percent in 1983, is estimated at L4 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 L989. The Bank group's share of total debt service payments is projected to increase from about 12 percent in 1983 to an estimated 13 percent in 1984, and to about 18 percent in 1989. 34. 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.  - 12 - PART III - THE ENERGY SECTOR AND THE POWER SUBSECTOR Energy Resources 35. Turkey has substantial untapped lignite and hydropower resouLces, as well as more limited, but still important, oil, gas and coal resources and geothermal potential. Hydropower with potential economic viability is estimated at about 29,500 MW under average hydrological conditions and corresponds to an annual production of about 100,000 GWh. Only 15 percent has been developed so far, but this is projected to rise to about 30 percent by 1990. Proven recoverable reserves of oil are about 16 million tons; however, potential reserves that may become economically recoverable, using enhanced oil recovery techniques currently being tested, could be as high as 30 million tons. Oil production has been declining over the last decade, as few discoveries have been made in recent years; in 1984 production was about 2.2 million tons, equivalent to 12 percent of total consumption. Proven recoverable gas reserves are about 400 billion standard cubic feet. Domestic gas is to be supplemented, beginning in 1987, by large scale imports of natural gas from the U.S.S.R. 36. Total known reserves of hard coal are estimated at about 1 billion tons, all located in the north of Turkey. Coal production has been declining as operations move to deeper, less accessible seams; in 1984 production was 3.5 million tons (2.2 million toe). Proven and probable lignite reserves are about 8 billion tons, but about half of this is of extremely low quality (950-1,000 kcal/kg). Lignite production in 1984 was about 23 million tons, equivalent to about 6.9 million tons of oil. There is potential for geothermal development, for both space heating and electricity generation, and a review of promising geothermal sites is under way. Energy Consumption and Supply 37. Total gross energy consumption was about 40 million toe in 1984, of which commercial energy consumption amounted to 32 million toe. Petroleum made up the most significant share of primary commercial energy (57 percent), with lignite (21 percent), hydropower (11 percent), coal (11 percent), asphaltite and imported electricity making up the balance. Overall, about 23 percent of final commercial energy consumption was in the form of electricity. Non-comnercial energy production (primarily fuelwood, but also other biomass) was an important energy source, accounting for 23 percent of total domestic energy production. The most notable change in the pattern of energy consumption over the past two decades has been the decrease in the relative share of hard coal in the total. This was accompanied by a rapid growth in consumption of petroleum until the mid-1970s, peaking at over 50 percent in 1977/78; and a rapid rise in the share of lignite (primarily for thermal power production) and hydroelectric power consumption starting in the second half of the 1970s. During this period, hard coal consumption stayed relatively constant in absolute terms, while traditional biomass energy sources increased slightly in absolute terms but decreased steadily as a percentage of total energy consumed.  - 13 - 38. Trends observed in the growth and pattern of energy consumption during the latter part of the 1970s are expected to continue during the 1980s and 1990s. The most important factor in the growth of energy demand will be the growth rate of the economy as a whole and the growth of the relatively energy-intensive industrial sector. The demand for lignite is expected to grow rapidly, both for direct consumption by households and industry and, even more importantly, for the power sector. Organization of the Energy Sector 39. The energy sector in Turkey is characterized by the dominance of Goveroment owned enterprises and agencies. The Ministry of Energy and Natural Resources (MENR) is responsible for the development of energy resources in Turkey. The Turkish Hard Coal Enterprise (TTK), the Turkish Lignite Enterprise (TKI), the Turkish Petroleum Company (TPAO), and the Mineral Research Institute (MTA) have responsibility for the extraction of fossil fuels and radioactive minerals. Design and construction of hydroelectric projects is entrusted to the State Hydraulics Authority (DSI). The Turkish Electricity Authority (TEK) is responsible for the generation, transmission and, since November 1982, the distribution of almost all the electricity sold in Turkey. TEK is also responsible for the implementation of the Government's program for rural electrification and the construction of all public sector generating and transmission facilities, with the exception of public sector hydroelectric plants for which DSI has responsibility. 40. Private sector participation in the supply of electricity was, until 1983, confined to two small private utilities (CEAS and KEPEZ) and industrial companies which generated power for their own use. However, recent changes in Government energy policy give greater encouragement to private sector participation in the development and production of energy (para. 41). The Government is actively seeking ways to encourage both local and foreign private sector participation in geothermal development, lignite mining, hydroelectric projects and the construction and operation of power plants fired by imported fuels. Energy Sector Policy 41. To meet its energy requirements, Turkey launched a massive program in the late 1970s to increase the domestic production of electricity and lignite. This program tended to stretch the implementation capabilities of the State energy agencies, and spread resources too thinly over too many projects, with resulting long delays in completion schedules. This has, in turn, resulted in an energy deficit which is likely to remain a feature of the Turkish economy at least through the 1980s. MENR and TEK are in the process of improving their energy planning capabilities; and MENR has produced Turkey's first energy policy paper. Furthermore, the recent Five Year Development Plan (1985-89) contains some broad objectives relevant to the energy sector including the following: - Priority is to be given to domestic sources of energy, especially hydro and lignite, provided that they are economically justified;  - 14 - - Imported energy including, but not limited to, oil will be considered; - Renewable and nonconventional resources such as geothermal, solar and biogas will be supported; and - Private sector financing, both local and foreign, will be sought for participation in energy development. 42. Two features of Government policy appear to represent a departure from previous energy policy. The first is that Government policy is now quite clearly to encourage private sector participation in the energy sector. There are no longer constraints to private sector electricity generation, and existing private utilities like KEPEZ and CEAS have plans to increase their capacities. In addition, the Government is currently negotiating with private consortia who would assemble financing, and construct and operate for a specific period (10-15 years) thermal plants based upon imported fuels. The second shift in policy focus is increased concern that indigenous resources be developed only when economically justified. Improving efficiency in the lignite mining subsector, at least to levels at which marginal production costs are competitive with imported coal, or conversely abandoning mining ventures if such economies cannot realistically be achieved, has become a major energy policy objective for the Government. 43. A less explicit but no less important component of the Government's energy policy relates to the pricing of energy products. Regular increases in the prices of petroleum products to maintain them at economic levels have been a feature of the Government's pricing policy for the past five years. Electricity tariffs have been increased sharply since early 1984. As of April 1, 1985 bulk power tariffs were roughly at the level of long run marginal cost. Prices of petroleum products are being maintained at international levels. Lignite prices, which had shown a threefold increase in real terms in the seven years preceding 1983, declined slightly in real terms in 1984. However, they are being increased in real terms. 44. The Government is also in the process of developing a program for the conservation of energy by encouraging more efficient use in existing and new industrial enterprises. Energy efficiency programs and legislation have been evaluated by both the MENR and SPO, and legislation has been passed which allows for tax credits for various types of investments in energy efficiency improvements. The Bank included financing of energy audits in selected manufacturing facilities under Loan 1916-TU. These audits have been completed and are under review. TEK has engaged consultants to assist in the development of an energy conservation and load management program. MENR has requested Bank assistance in the development and implementation of a comprehensive energy conservation program. Electricity Supply and Demand 45. The present installed power capacity in Turkey is about 7,600 MW of which 3,500 MW (50 percent) is thermal and the balance hydro. The share of hydroelectric power has increased over the past ten years from 33 percent in 1972 to about 50 per cent in 1984. On the thermal side, lignite has made an  - 15 - increasing contribution to the production of electricity. Total gross generation in 1984 was about 30,000 GWh, of which TEK accounted for almost 90 percent. Imported electricity from Bulgaria and the U.S.S.R. accounted for about 2,500 GWh. Total availability was less than the potential effective demand, estimated at 35,000 GWh. There is considerable evidence that power shortages have caused cutbacks in production in industries such as cement, textiles anC paper. In addition to the capacity constraint, the high level of total system losses (technical losses plus energy unaccounted for), estimated at about 20 percent, contributed to the supply shortages. 46. Growth in demand for electricity averaged about 9 percent per annum over the period 1965-1983. Between 1970 and 1983, the percentage of population with public electricity supply rose from 51 percent to 78 percent. Per capita consumption of electricity is currently about 550 kWh. TEK's latest long-term generation plan (1987-2005) is based upon a projected overall growth in energy demand of about 11 percent per annum, with peak demand increasing at about 9 percent per annum. 47. For more than two decades the Turkish power subsector has been confronted with major problems. Electricity supply has been insufficient to meet demand in every year since 1971, resulting in high costs to the economy as imports increased and supply interruptions continued. Many of the issues facing the subsector can be traced to institutional problems in the public sector agencies responsible for planning and implementing the subsector's investment program. This has resulted in project delays, consequent substantial cost escalations, power shortages, frequent and protracted plant breakdowns due to inadequate maintenance, and relatively high system losses, especially in the urban networks. The shortage of qualified staff in TEK resulted in resources, human and financial, spread too thinly over too many projects in the investment program. 48. The Government agrees that closing the supply gap will require a sustained coordinated effort by the major agencies in the subsector. It plans to emphasize increased supply in parallel with managing demand and improving efficiency of existing facilities. To illustrate the magnitude of the task, it should be noted that Turkey would have to bring on stream three times more power generating capacity in the 1980s than in the L970s and that the momentum would have to be sustained throughout most of the 1990s. Also, scarce resources will be tied up in technologies new to the country, such as nuclear, and in projects of an unprecedented size. TKI and DSI will have to meet their respective production targets commensurate with TEK's plans. Even if a lower growth rate in electricity demand is assumed, and optimistic assumptions are made about the sector's implementation capacity, except for 1986 and 1'87 some power shortages are likely to continue throughout the 1980s. Bank's Role in the Power Subsector and Experience with Past LenAing 49. The proposed project would be the nineteenth Bank operation in the power subsector in Turkey. The Bank has made fourteen loans and a technical assistance grant (total $931-7 million), and IDA has granted three credits (total $55.7 million) for four hydroelectric projects, two thermal power stations (oil- and lignite-fired), a lignite mine, and several transmission and distribution networks. The technical assistance grant helped reorganize Turkey's power subsector.  - 16 - 50. A Project Performance Audit Report (PPAR) distributed to the Board in November 1981, 1/ on the Keban Transmission (Loan 568-TU) and the first TEK Power Transmission (Loan 763-TU) projects, found that these projects had met their physical objectives despite implementation delays and cost overruns. A Project Completion Report on the Istanbul Power Distribution Project (Loan 892-TU), distributed to the Board in December 1982, 2/ also reported physical completion of the project after considerable delay. Major problems identified were the shortage of local counterpart finance and, in the case of Loan 892-TU, late preparation of bidding documents. The PCR on Loan 1194-TU commented on the need for improvement in the monitoring and coordination of the project. The report recommended the establishment of a project implementation unit within TEK. Such units are now regularly used in Bank financed power projects in Turkey. Implementation of the Third TEK Transmission Project (Loan 2322-TU) is satisfactory. A fourth TEK Transmission Project was signed on June 27, 1985. The Power System Operations Assistance Project, which was signed on July 8, 1985, is the first project to focus directly on improving the efficiency of existing facilities for producing, transmitting and distributing electricity. 51. Through its lending the Bank has been able to assist the Government in the consolidation of the power sector and in the establishment of TEK. The Bank has also provided advice and supported efforts to bring about other institutional reforms. Considerable progress has been made in areas such as TEK's system planning and procurement procedures. The Bank has also assisted in attracting funds from other bilateral and international financing agencies (e.g. EIB, German Aid (KfW), US EXIMBANK). Planned Strategy for Assistance to the Sector 52. Sector policy discussions, which recently have been held twice a year with the Government and energy sector agencies, have provided a valuable forum to discuss the issues and constraints facing the sector. Detailed agency by agency action programs are being prepared and will be discussed with the Bank during the first half of 1986. Current and future Bank lending in the sector would be based on these action programs. 53. For the electric power subsector the Government intends to focus on investments which yield quick returns, such as completion of priority ongoing investments, upgrading of existing facilities, reduction in losses, and improvements in maintenance procedures and efficiency; programs to ensure a balanced electric power development program through appropriate investment in generation, transmission, distribution and general plant; improved demand management including identification of energy saving investments and 1/ No. 3695, dated November 23, 1981. 2/ No. 4264, dated December 29, 1982.  - 17 - enactment of energy conservation legislation; technical assistance to strengthen capabilities in planning, financial management and manpower development; investment in new generation options such as those based upon imported coal and natural gas; and an increased role for the private sector in the production of electricity. 54. The Government and the Bank have jointly identified a series of investments which would address the above medium-term issues. The size and structure of Turkey's 1986 power sector investment program and the investment strategy proposed for subsequent years seem consistent with the goal of meeting Turkey's electricity needs economically. The Bank will have opportunities to express its views cn detailed future energy sector investment programs. PART IV - THE PROJECT Project Setting and Objectives 55. The proposed project has been designed to take full account of lessons learned (para 49). It consists of a 420-MW hydropower plant at Kayraktepe on the Giksu River in South Central Turkey, and represents an important element in the Government's plan to develop Turkey's indigeneous energy resources. The Kayraktepe plant would generate on average about 990 GWh per year of electric energy. It would also help protect the rich Silifke plain and the city of Silifke from destructive floods. In addition, under the proposed project, technical assistance would be provided to DSI and MENR. The project was identified in February 1985. Loan negotiations were held in Washington during December 1985 and January 1986. The Turkish delegation was led by Mr. Hikmet Ulugbay, Chief Counselor for Economic and Commercial Affairs of the Turkish Embassy in Washington and included representatives of the Treasury and DSI. A Staff Appraisal Report entitled "Kayraktepe Hydropower Project" (No. 5820-TU), dated January 29, 1986 is being circulated separately to the Executive Directors. The main features of the project are given in the Loan and Project Summary and Annex III. Project Description 56. The Kayraktepe dam would be located in a gorge 15 km upstream of the Silifke plain. The proposed dam would be 199 meters above its foundation and would be constructed of rockfill with an impervious core. Its volume would be about 17 million m3. The power plant would be built immediately downstream of the dam and would be equipped with two 200 MW main generating units, and one 20 MW unit to utilize water released for irrigation when the main units are shut down. Power generation would benefit not only from the 4800 million m3 reservoir created by the dam, but also from the regulation afforded by the Gezende reservoir upstream. Power generated at Kayraktepe would be fed into Turkey's national power grid by means of 380-kV transmission lines to Adana and possibly Seydisehir. These two lines are not included in the proposed project. The capacity of the Kayraktepe plant would be used in part (75 percent) to supply peak demand and in part (25 percent) to cover base-load in the Turkish power system.  - 18 - 57. The project would also include financing of a study, to be carried out by MENR, to rank Turkey's hydroelectric resources, and assistance to improve DSI's cost accounting practices and data processing facilities. Project Implementation 58. DSI, which is responsible for planning, constructing and putting into effective operation hydroelectric projects in coordination with TEK, would be responsible for the execution of the project. Other agencies involved in the project would be the General Directorate of State Highways of the Ministry of Public Works, and the Resettlement Department of the Ministry of Agriculture, Forestry and Rural Affairs. The former would be responsible for the relocation of affected roads and the latter for the resettlement of inhabitants in the project area. 59. DSI is administered by a Director General and has a field organization consisting of 25 Regional Directorates and Operating Groups. It has about 25,000 employees, of whom about 3000 are engineers or technicians. About 2000 employees are located in Ankara. Nearly all DSI expenditures are financed from the national budget. DSI has substantial and extensive experience in hydropower plant construction and management, procurement, and in dealing with environmental concerns. The Bank has provided assistance to DSI for several other hydropower projects which have been successfully completed. Power plants completed by DSI are transferred as an equity contribution to TEK for commercial operations. In the case of the proposed project, the transfer is likely to occur in 1994. TEK employs a staff of about 55,000. TEK has executed several Bank financed projects and is considered capable of operating the proposed project effectively. 60. The Ministry of Energy and Natural Resources would manage the proposed study to evaluate and rank Turkey's hydroelectric resources. To coordinate this effort a steering committee under the chairmanship of MENR will be established by December 31, 1986. 61. Detailed designs and technical specifications for all works and supplies for the project have been completed. As a result of Bank recommendations, certain details of the design were improved to enhance the dam's safety. The acquisition of land for the project would be handled under Turkey's General Expropriation Law, which provides a procedure through which DSI may expropriate reservoir lands with the approval of MENR. Agreement has been reached on a timetable for the acquisition of land and land rights required for the construction and the operation of the project. It has also been agreed that the Government would submit to the Bank a satisfactory resettlement program prior to December 31, 1986. An engineering consultant recruited in accordance with Bank guidelines would be employed to assist DSI in the implementation of the project. Environmental Impact 62. At the request of DSI, Cukurova University has carried out an investigation of the possible ecological impact of the proposed project. Its report has been reviewed by the Bank. The project is not expected to have an adverse environmental impact; on the contrary, the overall effect of the  - 19 - reservoir on the environment is expected to be positive. The report also states that there are possibly three sites with archeological significance in the area to be flooded. These sites are to be examined in detail and excavations may be made as appropriate. Proiect Cost and Financing 63. The total cost of the proposed project, including physical and price contingencies but excluding interest during construction, would be about $542 million, of which about $254 million would be in foreign exchange. $34.5 million have been allocated for land acquisition and resettlement. DSI is exempt from import taxes and customs duties for projeLts under construction. The project cost is based on estimates prepared by the Electric Power Development Company of Japan (EPDC) in late 1985. Quantities of work computed by the consultants have been reviewed by the Bank and been found to be generally satisfactory. Design adjustments recomnended by the Bank to enhance the safety of the dam have been quantified and added to the civil works cost. Engineering and Administration expenses represent 8.5 percent of the direct construction cost of the project. This is in line with DSI's relevant experience. Overall physical contingencies have been provided for in the project cost at the rate of 10 percent for civil works, road relocation and construction camp facilities, and 5 percent for hydraulic and electro-mechanical equipment, in addition to appropriate allowances included in the base cost for items such as drilling and grouting where prediction of quantities is inherently difficult. These are considered sufficient to cover eventual differences in quantities or unit prices. Price contingencies have been computed assuming an impiementation period of 7-1/2 years and with specific annual increases in domestic and international prices as follows: 1985 1986 1987 1988 1989 1990 1991-94 ----in percent per annum--- Local Inflation 43.2 30 25 20 20 18 18 Int. Inflacion -0.5 7.0 7.0 7.5 7.7 7.6 4.5 64. The Turkish authorities are arranging a B-loan to finance part of the foreign and local currency needs of the Project. The following financing plan is proposed. An A-loan of $200 million plus the Bank's share ($50 million) of a B-loan of $350 million would cover the foreign cost of the civil works contract, the hydraulic equipment, the engineering services and technical assistance plus a portion of the related interest during construction. Because of heavy cash flow needs for financing the investment program in the power subsector in the next few years and resulting resource constraints, financing of interest during construction is justified. The balance of the B-loan would finance the foreign cost of the road relocation contract and of the electromechanical equipment and some of the local currency needs of the project. The remainder of the project cost and interest during construction, about $166 million, would be financed by the Government.  - 20 - Power Subsector Finances 65. Wh.le DSI would have the responsibility for implementing the proposed project, upon completion of construction (in about 1994) the assets constructed under the project would be transferred to TEK under terms and conditions satisfactory to the Bank. TEK is a revenue earning public sector agency. Part of its investment program is financed from the budget, but it is the Government's intention that an increasing share of the cost of ThK's and DSI's power investment program should be financed from TEK's own revenues. 66. To increase the self financing level of the subsector, bulk electricity tariffs were increased by about 40 percent in real terms in 1984, which more than made up for real decreases in the previous two years. Following further real increases in bulk power tariffs in 1985, as of April 1, 1985 they were roughly equivalent to long run marginal cost. While tariffs were again increased on December 1, 1985, they have not kept up with inflation since April 1985. Retail tariffs have also been increased in parallel with bulk rates since 1983. The Government has indicated continued commitment to the goal of increasing the self financing level in the subsector. The Government and TEK have confirmed that increases in bulk power tariffs would continue to be passed through to the retail level and that tariffs would continue to be adjusted automatically for increases in TEK's fuel costs. 67. As a result of the tariff adjustments and TEK's takeover of the distribution function, TEK's finances have improved markedly since 1983. In 1984 the combined investments for power of TEK and DSI amounted to TL 522 billion ($1.5 billion equivalent). The principal sources of financing for the two entities combined were estimated as follows: internal cash generation (16 percent); Government equity (41 percent); foreign borrowing (42 percent); and local borrowing (1 percent). The approved subsector investment program for 1985 was TL 600 billion ($1.13 billion equivalent), including TL 400 billion for TEK and TL 200 billion for DSI, was to be financed as follows: Government equity (21 percent); foreign borrowing (41 percent); local borrowing (2 percent); and internal cash generation (36 percent). For 1986 and subsequent years, it is expected that TEK's contribution to TEK's and DSI's power investment program will at least be equal to the target of 35 percent agreed under previous loans. Agreements under the Fourth TEK Transmission Project (2586-TU) provide for continued monitoring of the situation through a joint review by TEK, the Government and the Bank by October 31 of each year of the proposed annual investment program for the power subsector for the following year and the planned power subsector investments for the next five years with the related financing plans. 68. A large gap remains between the total national requirements for investments in electric power and the level of investment which can reasonably be financed and implemented by TEK and DSI. This gap would need to be financed and implemented through other sources which could include existing private utilities such as CEAS and KEPEZ, as well as local and foreign investors. The likely level of private investment in power in Turkey is still uncertain, other than for CEAS and KEPEZ, which plan to undertake investments of about $0.5 billion in the next five years. The Government has begun discussions with local parties which could serve as regional utility companies  - 21 - operating in designated regions, and with foreign companies which could invest in thermal power plants on a concession basis without requiring TEK or the Government to take on additional foreign debt. Audits 69. The Government has agreed to: (a) maintain or cause to be maintained adequate accounting records, to reflect in accordance with sound accounting practices, the operations, resources and expenditures for the project; (b) have the project accounts for each fiscal year audited by independent auditors; and (c) furnish certified copies of the report of independent auditors to the Bank within nine months after the end of each fiscal year. Furthermore, for the purposes of the annual review of power subsector cash generation, the Government would maintain adequate records of the total capital expenditures for power projects incurred by DSI, and furnish to the Bank by October 31 of each fiscal year a summary of capital expenditures incurred, or expected to be incurred, in respect of such year and the next following fiscal year. Procurement and Disbursements 70. The goods and services for the proposed project would be procured under four main contracts. All procurement of civil works and equipment financed by the Bank under the A-loan and under its share of the B-loan would be through international competitive bidding in accordance with the Bank's guidelines for procurement. Technical assistance services would be obtained in accordance with the Bank's Guidelines for the Use of Consultants in Bank-Financed Projects. The planned procurement is summarized below:  - 22 - Summary of Procurement Plans (US$ million equivalent) Procurement Method Total ICB LCB Other Cost Road Relocation - 17.1 - 17.1 Construction Camp Facilities - 3.3 - 3.3 Civil Works 309.0 - - 309.0 (140.7) - - (140.7) Hydraulic Equipment (gates and penstocks) 29.3 - - 29.3 (24.9) - - (24.9) Electro-Mechanical Equipment (turbines, generators and switchgear) - - 85.7 85.7 Engineering Services & Administration - - 42.2 42.2 - - (8.0) ( 8.0) Land Acquisition and Resettlement - - 50.1 50.1 Inventory and Ranking of Hydro Resources - - 3.5 3.5 - - (2.3) (2.3) Tech. Asst. in Proj. Cost Acctg. - - 0.5 0.5 - - (0.4) (0.4) Hardware. & Software for DSI's Data Processing Facilities - - 1.6 1.6 _ _ (1.5) (1.5) Total 338.3 20.4 183.6 542.3 (165.6) (12.2) (177.8) Note: Figures in brackets are the amounts to be financed by the Bank. 71. The disbursement of the proceeds of the Bank loan would be made against: (a) 43 percent of the expenditures for the civil works contract corresponding to a share of the foreign exchange portion; (b) 100 percent of the foreign cost for foreign consultants for engineering ser-;ices and administration, for ranking of hydropower resources, and for technical assistance in project cost accounting; and (c) 100 percent of foreign expenditures and 85 percent of local expenditures for data processing equipment and software. The Closing Date for the loan would be December 31, 1994, one year after the estimated physical completion of the Project, to allow for payment of retention monies. It has been agreed that a Special Account would be established for the project to finance expenditures with a minimum of administrative delay. The initial deposit would be $10 million. The estimated disbursement profile for the proposed loan is close to the regional standard profile for power projects and the Bank-wide profile for hydroelectric projects.  - 23 - Project Justification 72. The economic development of indigenous resources is an important component of the Government's energy strategy. The role and importance of hydro resource development has been emphasized in a Bank sector study. It is estimated that the proposed project falls well within the range of economically viable hydropower projects in Turkey. The project would provide additional benefits in the form of flood protection for the Silifke plain and the city of Silifke. The rate of economic return for the power sector investment program, including this project, is estimated at 11.3 percent. The review of all hydroelectric projects within Turkey financed under the project is expected to be of major assistance to DSI and the Government in planning the future development of the hydropower subsector. Project Risks 73. Although subsurface geological investigations for the Kayraktepe dam are comprehensive, there is a small risk that geological problems might appear unexpectedly and cause delays in the construction and an increase in costs. However, this risk is manageable as expert geological supervision would be provided by the project consultants at site during foundation excavation and grouting. Furthermore, adequate contingency provisions have been included in the project cost for those construction tasks where it is impossible to predict accurately the quantities of work required. Part V - Recommendation 74. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments January 31, 1986 Washington, D.C.  -24- ANNEX I Page 1 of 6 T A n L E 3A TUWK? - SUCiAL IfICATUES dATA SHELT TUM RlEEN GROUPS (iKLLCITEI AVERAES) /a WSIS (XSET HEGERt flTIHATLJ /b 16Eb CCT b