Turkey - Elbistan Operation and Maintenance Assistance Project

Document of The World Bank FOR OMFCIAL USE ONLY i t X ; G6 AZ -7 : ! Repot No. P-4214-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 EQIJIVALENT TO UStIO.0 MILLION TO THE TURKISH ELECTRICITY AUTHORITY WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR AN ELBISTAN OPERATION AND MAINTENANCE ASSISTANCE PROJECT January 8, 1986 tlib ocmumst ha redOid dlsbiEO. and may by reciien ouin the perfme of  CURRENCY EQUIVALENTS Currency Unit Jan. 1980 /1 Jan. 1982 Jan. 1983 Jan. 1984 Jan.1985 Oct. 1985 US Dollar - TL 70.00 TL L39.60 TL 191.15 TL 309.20 TL 451.400 TL 540.80 TL 1 - US$ 0.014 US$ 0.007 US$ 0.005 US$ 0.003 US$ 0.002 US$ 0.002 IL 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 kW = kilowatt kWh = kilowatt hour GWh (Gigawatt hour) = 1,000,000 kWh HV = High Voltage kV (kilovolt) = 1,000 volts MW (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)(1,000 calories) = 3.968 BTU toe = tons of oil equivalent GLOSSARY AND ABBREVIATIONS CEAS - Cukurova Elektrik A.S. (Cukurova Power Company) DSI - DevLet Su Isleri (State Hydraulic Authority) EdF - Electricite de France EIB - European Investment Bank Eltem TEK - Electric Tesisleri Mishen Dislik Hizmetteri ve Ticaret Anonim Sirketi KEPEZ A.S. - Kepez Electric Company KfW - Kreditanstalt fur Wiederaufbau LRHC - Long-Run Marginal Cost MANTRUST - Manufacturers Hanover Trust MENR - Ministry of Energy and Natural Resources MTA - Mineral Research Institute PEE - Public Economic Establishment PPF - Public Participation Fund SEE - State Economic Enterprise SPO - State Planning Organization STEAG - Steinhohlen Energie A.G. TEK - Turkiye Elektrik Kurumu (Turkish Electricity Authority) TKI - Turkiye Komur Isletmeleri Kurumu (Turkish Coal Enterprise) TPAO - Turkiye Petrolleri Anonim Ortakligi (Turkish Petroleum Corporation)  FOR OMCUL USE ONLY TURKEY ELBISTAN OPERATION AND MAINTENANCE ASSISTANCE PROJECT Loan and Proiect Summary Borrower: Turkish Electricity Authority (TEK) Guarantor: Republic of Turkey Amount: US$10-0 million equivalent Terms: Seventeen years including four years of grace, with interest at the standard variable rate. Project The proposed project would provide for the Bank's Description: continued presence in a key thermal power project in Turkey. The main objective of the project would be to help finance the completion of Units 3 and 4 at the Elbistan Power Station and to ensure the station's adequate operating availability and efficient operation. Project Benefits The project is part of the least cost program to assist -~ and Risks: TEK in meeting the growing demand for electricity after 1988. The only remaining project risk would be the uncertainty regarding the mine's ability to meet the lignite needs of the power station beyond 1986. The Government has confirmed that it will continue to take all measures necessary to ensure an adequate supply of lignite for the efficient operation of the Elbistan power station. I This document has a restricted distribution and may be used by recipients only in the performance or their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Estimated Project Cost: US$ Million Equivalent Local ForeiRn Total Power Station Plant and equipment (incl. spares) 7.9 33.1 41.0 Civil Works 11.9 - 11.9 General Erection Contract 62.3 32.7 95.0 Engineering .4 13.7 14.1 Administration 56.6 - 56.6 Base Cost (early 1985 prices) 139.1 79.5 218.6 Physical Contingencies 3.7 2.7 6.4 Price Contingencies 7.4 5.4 12.8 Total Project Cost 150.2 87.6 237.8 rnterest during Construction on Bank Loan - 1.0 1.0 Other Loans - 9.0 9.0 Total Financing Required - 150.2 97.6 247.8 Financing Plan IBRD - 10.0 10.0 EIB - 14.5 14.5 KfW - 30.7 30.7 US EXIM Bank/MANTRUST - 30.0 30.0 Government/TEK 150.2 12.4 162.6 Total 150.2 97.6 247.8 Estimated Bank Disbursements: US$ Million Equivalent - IBRD FY FY86 FY87 FY88 Annual 2.0 4.2 3.8 Cummulative 2.0 6.2 10.0 Economic Rate of Return: 11.3% Appraisal Report: No. 5774-TU dated December 31, 1985 Map: No. 19045  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AMD RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TURKISH ELECTRICITY AUTHORITY FOR AN ELBISTAN OPERATION AND MAINTENANCE ASSISTANCE PROJECT 1. I submit the following report and recommendation on a proposed loan to the Turkish Electricity Authority (TEK) with the guarantee of the Republic of Turkey for the equivalent of US$10.0 million to help finance the foreign exchange cost of an Elbistan Operation and Maintenance Assistance Project. The loan would have a term of 17 years including 4 years of grace, with interest at the standard variable rate. PART I - THE ECONOMY 1/ 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 Small and Medium Scale Industry Project (P-4148-TU) dated December 12, 1985.  -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, 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 import.;, 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 1980 - November 1983, and has since been carried out by an elected government. 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).  -3- 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 (5.6 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 percent in 1980, the average annual rate of increase in thte 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 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 fru_ts and vegetables), and an overall siackening 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 L986, 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  -4- consolidated government revenues ag a percentage of GNP, l/ 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 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 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 1/ Although total government revenues (inclusive of extra-budgetary funds introduced in 1984) have not declined as sharply.  -5- preferential and non-perferential credits: in particular, the perferential interest rate for export credits was discontinued in 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 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. Projections for 1985 indicate a further strong improvement of the current account situation. Merchandise exports, after a sluggish start in 1985, have grown by 13 percent (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 expor_s 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  -6- 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. 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 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 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 40 percent in 1985 to around 18 percent in 1990. Key economic variables in the Bank's projecticis for the period 1985-90 are presented in Table 1: 1/ 1/ The Bank's estimate for 1985 may differ slightly from the Government's latest estimates for 1985 discussed above.  Table 1: TURKEY - SELECTED ECONOMIC INDICATORS, 1984-90 Reml Growth Rate Average Reil Growth Rate 1984 1SBS 19990 () CZ) Units MACc.) (EIst.) UProj.) 1984 1985 1985-90 tWu Ia L985 TL bil 25b72.5 2092U.2 354bb.8 5.t 4.9 5.7 irLcuLture 4"XI.9 4728.2 5481.3 3.0 2.3 3.0 Industry 7138.1 7b05.6 l02U.4 9.3 b.b 7.3 Services 12443.2 13U4U.5 1715b.4 4.7 4.8 5.6 Consomption 21578.3 22389.b 29274.5 6.9 3.7 5.5 -IXed Lv.stLWe.kt ".b82.3 4921.b b742.1 2.0 5.1 6.5 Exports of goods Ifob) Curr S miL 7389.0 7982.0 18127.b 34.b 12.1 8.5 Lmports ot 0ouds i(ub) 1U331.0 1081U.9 Z1507.7 18.0 5.3 7.8 Trade balance -2942.0 -2828.9 -3440.1 -lurkers' remttances 179S.U z191.0 2741.8 Lurrent account balance -142b.U -75U.5 -bU9.0 K3Li08 LnVCstmen.t/l;DP ZU.2 L9.8 2U.5 Oumestic savings/GDP 1 15.5 L6.0 15.3 xports Ot OuL dad3:UP 14. 15.0 17.1 Current acct. deficit/lDP lb Z -2.7 -1.4 -0.8 enL ser.ce ratio /c A 2b.0 11.3 21.2 Puulic fixed ituvestment/ LotaL taxed itveatment 59.0 58.D 51.8 rlemo item: Uross capital required Gaurr S mil 4b27.J 3894.8 45U7.4 l AL mrket prices. %..mponents are expressed at factor cost. lb 'ased on cunstaunt TL. Tc lotal debt service lexcLudLn4 short-teru)/exports ut guods and NFS plus workers remictances.  -8- 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 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 i'ownside 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 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 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 comnercial 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 IMF 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 IMF'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 11 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, 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 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 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 manufacturinF subsectors. Other sectors where sectoral adjustment loans are likely to ae developed include energy and transport, and it is expected that there wo'Ad be a follow-up loan in agriculture. 31. This would be the third loan to Turkey presented to the Executive Directors this fiscal year. Other projects being processed include Kayraktepe Hydropower, 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 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 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 resources, 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 1983 production was about 2.3 million tons, equivalent to 13 percent of total consumption. Proven recoverable gas reserves are about 400 billion standard cubic feet. Domestic gas will, however, 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 1983 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 1983 was about 20 million tons, equivalent to about 4.6 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 38 million toe in 1983, of which commercial energy consumption amounted to 30 million toe. Petroleum made up the most significant share of primary commercial energy (58 percent), with lignite (20 percent), hydropower (9 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-commercial energy production (primarily fuelvood, but also other biomass) was an important energy source, accounting for 37 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. The growth in demand for petroleum will be moderate due to the much higher price of imported oil and petroleum products and its substitution by other energy sources. Organization of the Energy Sector 39. The energy sector in Turkey is characterized by the dominance of Government 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. Identification, 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 now give greater encouragement to private sector participation in the development and production of energy (para. 42). 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 turu, 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 current Five Year Development Plan (1985-89) contains some broad objectives relevant to the energy sector including the following:  - 14 - - Priority is to be given to domestic sources of energy, especially hydro and lignite, provided that they are economically justified; - Imported energy including, but not limited to, oil will be considered; - Renewable and nonconventional resources such as geothermal, solar and biogas are to 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 now no legal constraints to private sector electricity generation, and existing private utilities like KEPEZ and CEAS have plans to increase their capacities. In addition, the State Planning Organization (SPO) is currently undertaking, with assistance from consultants, preliminary studies to assess whether private finance could be sought for the construction and operation of thermal plants based upon imported fuels (coal, nuclear) and geothermal sources. 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 such mining ventures if such economies cannot realistically be met, 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 has 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 had caught up roughly with 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 up to 1983, declined slightly in real terms in 1984. 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 recommendations are expected to be implemented. 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.  - 15 - 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 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 a further 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 and 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. This represents a considerable sustained annual increase in demand, particularly as the base from which the demand is extrapolated (1987) appears to be high. 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, being 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 capacity in the 1980s than in the 1970s 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 1987 some power shortages are likely to continue throughout the 1980s.  - 16 - Bank's Role in the Power Subsector and Experience with Past Lending 49. The proposed project would be the eighteenth Bank operation in the power subsector in Turkey. The Bank has made thirteen loans and a technical assistance grant (total $921.7 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. The first five loans/credits were for projects in the CEAS concession area. All these projects were completed successfully, although often with long delays. The Bank has made six previous loans to TEK, for the First, Second, Third and Fourth Power Transmission Projects, a Power System Operations Assistance Project and the power component of the 1974 Elbistan Thermal Power Project (Loan 1023-TU). 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 constraints to timely project completion were identified as shortage of local counterpart finance and, in the case of Loan 892-TU, late preparation of bidding documents. A major conclusion of the TEK II (Loan 1194-TU) Project Completion Report was the need for improvement in the monitoring and coordination of the project. The report recommended the establishment of a single unit within TEK to be accountable for project implementation. 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. The loan for the fourth TEK Transmission Project (Loan 2586-rU) was signed on June 27, 1985. The Power System Operations Assistance Project (Loan 2602-TU 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. The Bank has been able to assist the Government in the consolidation of the power sector and in the creation of TEK. The Bank has also supported efforts to bring about other institutional reforms. Considerable progress has been made in areas such as TEK's accounting system, 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). 1/ No. 3695, dated November 23, 1981. 2/ No. 4264, dated December 29, 1982.  - 17 - 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. The Bank is generally in agreement with the Government's strategy for the energy subsector. Detailed agency by agency action programs have been prepared and will be discussed with the Bank. Current and future Bank lending would be based on these action programs. For the electric power subsector, it has been agreed that attention be given to a selected number of high priority issues. The strategy includes focus on (a) 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; (b) programs to ensure a balanced electric power development program through appropriate investment in generation, transmission, distribution and general plant; (c) improved demand management including identification of energy saving investments and enactment of energy conservation legislation; (d) technical assistance to strengthen capabilities in planning, financial management and manpower development; (e) investment in new generation options such as those based upon imvorted coal and natural gas; and (f) an increased role for the private sector in the production of electricity. 53. The Government has identified a series of investments which would address the above medium-term issues. The Bank agrees with the size and structure of Turkey's 1986 power sector investment program and generally with the investment strategy proposed for subsequent years. The Bank will have opportunities to express its views on detailed future energy sector investment programs. PART IV - THE PROJECT 54. The proposed project would help finance the completion of the Elbistan Power station and would help ensure its adequate operating availability and efficient operation. The project was identified in December 1984 and appraised in April/May 1985. Loan negotiations were held in Washington in November/December, 1985. The Turkish delegation was led by Mr. Hikmet Ulugbay, Chief Financial and Economic Counselor of the Turkish Embassy in Washington and included representatives of the Treasury and TEK. A Staff Appraisal Report entitled "Elbistan Operation and Maintenance Assistance Project" (No. 5774-TU), dated December 31, 1985 is being circulated separately to the Executive Directors. The main features of the project are given in the Loan and Project Summary and in Annex III. Background of the 1974 Elbistan Thermal Power Project (Ln. 1023-TU) 55. The 1974 integrated Elbistan Thermal Power Project is the first to exploit the Afsin-Elbistan lignite deposit. It accounts for a substantial share of Turkish power investment (36% and 13% in 1975-1980 and 1981-1985 respectively) and is a highly visible operation. The Project is designed to supply electric power using low grade lignite from the Kislakoy  - 18 - mine in Afsin-Elbistan as part of a balanced program of power development utilizing Turkey's fuel and hydropower resources. Other project objectives are to address institutional problems (organization, management, personnel and finances) that were apparent in TEK and TKI and which proved to be the main causes of delay in the execution of the project. The project originally included the following components: (a) a thermal power station with four 340-MW lignite-fired units delivering, after meeting the power station and mine loads, an estimated 1,048 MW and 7,030 GWh p.a. to TEK's interconnected system; (b) 380-kV transmission lines, about 540 km long, connecting Elbistan with Kayseri and Ankara by 1978 and 1979 respectively; (c) an open-cast lignite mine with a planned capacity of 20.7 Mt/a, 17.9 Mt/a for the power station and 2.8 Mt/a for processing for sale as domestic fuel; the project included the cost of land and restoration of the worked-out mining area; (d) separate permanent housing for power station and mine staff and roads between these and the works as well as Afsin-Elbistan towns; and (e) consultancy services. 56. The Bank provided about 24Z of the original foreign financing. Loan 1023-TU for $148 million, ($123 million for the power station and $25 million for the lignite mine) was approved in June 1974. Cofinancing was provided by German Aid (KfW, Hermes), European Investment Bank (EIB), US Eximbank, Japanese Eximbank, Italy and France. Loan effectiveness was delayed nearly two years largely on account of delays in implementing a tariff increase to improve TEK's finances. The loan was finally declared effective on June 1, 1976. The Closing Date of the loan was June 30, 1983. This loan was fully disbursed by September 15, 1983. Ongoing contracts under the project have been financed through 1985 by KfW, EIB and the Government. 57. Initially a mine output for a 600-MW power plant (4 x 150 MW) was planied. In an effort to achieve economies of scale TEK, with support of its consultants, decided to increase the power plant rating to 1200 MW (4x300 MW) and the mine's design output to 20 Mt/a, with most of the lignite intended for power generation. This decision proved to be critical since it overloaded TEK's and TKI's manpower and financial resources. Implementation Problems 58. TEK and TKI had difficulty in recruiting and retaining suitably qualified personnel because of the remoteness and poor living conditions of the site and the low civil service salary structure. Project site supervision ran into difficulties due to the inexperience of TEK and TKI's site managers and the limited authority delegated to the field staff. There was also a problem of coordination between the two entities. These issues led  - 19 - delays in the procurement of equipment and in payments to contractors and lack of supervision and control of civil works. Delays in the provision of local funds also af.fected the implementation of the project. Status and Operating Performance 59. The project is about seven years behind schedule but there has been no further slippage since 1983. The present situation can be summarized as follows: (a) Power Station: All the main plant and equipment for the four 340-MW units are on site. The cooling towers, chimneys and the bulk of the civil works are complete. Since July 1982, erection work has been proceeding satisfactorily. Unit I went into commercial operation in January 1985. Unit 2 went into trial operation in May 1985 and is going into commercial operation in January 1986. Units 3 and 4 are to follow at one-year intervals. (b) Lignite Mine: The quantities of material moved at the mine over the past three years have been well below planned levels. However, by March 1985, the lignite seam had been uncovered for the first time, with an inventory of about 4.3 Mt available for immediate mining. Data gained from the seam showed improved geological conditions compared to those previously assumed from exploration results, resulting in more lignite available within power station specifications and a lower overall stripping ratio. No mine planning based on the new parameters has been done as yet and further verification is required. But the Bank is satisfied that the existing mine equipment is adequate to handle the required quantities of material without major overburden backlogs over the next two to three years provided, however, that corrective a-tion is taken on the following major operational constraints: insufficient managerial and skilled personnel, lack of training, insufficient spare and wear parts, inadequate maintenance arrangements, and inefficient removal of hard strata. (c) Domestic Fuel Drying Plant: In the light of the problems encountered in suppLying lignite for the power station, the lignite drying plant associated with the original project has been dropped by TKI. The Bank agreed to this decision. (d) Transmission Lines: Of the two 380-kV lines under the original project, Elbistan-Kayseri has been in operation since 1983. The other, Elbistan-Ankara, is under construction and scheduled for completion this year in time to accommodate the commercial operation of Unit 3 starting in January 1987. 60. The severe delays in the execution of the project led to a more than doubling of the original cost estimates (as shown in the table below). The following factors also contributed:  - 20 - (a) Exchange Rate Variation: The bulk of equipment was procured from countries whose currencies appreciated substantially during project implementation. (b) Increased Cost of Engineering: When the project ran into difficulties, more engineering supervision was called for; actual man months of engineering and administration are more than 2002 of the appraisal estimate. (c) Interest During Construction: The length of the execution period for the project coupled with borrowings to cover the resulting financing gap substantially increased the amount of interest during construction. Elbistan Project Cost Estimates ($ million) Appraisal Cost Revised Cost Estimates (1974) Estimates (1985) Power Station 767.8 1744.6 Transmission Lines 31.5 67.1 Lignite Mine 337.7 594.2 Total 1137.0 2405.9 Rationale for Continued Bank Involvement 61. The Elbistan Project is almost complete. Project implementation is now under control and progressing well. The mine is fully operational and construction of the fourth and last unit in the power station is scheduled for completion by the end of 1986. Moreover, the government is committed to introducing adequate measures to ensure the long term availability of lignite for the power plant. 62. Throughout the implementation of the Elbistan project, starting in 1974, the three major cofinanciers, KfW, EIB and! L;le Lank, have acted in close coordination to help bring about a more favorable turn of events. In addition to participating in the proposed project, KfW and EIB are also funding a parallel project to assist TKI carry out operation and maintenance improvements at the lignite mine. An additional remedy is provided for under the Bank loan agreement in the event that the KfW or EIB financing for this parallel project is suspended. One of the reasons why it is considered desirable to make this modest (in financial terms) loan is that it would enable the Bank to continue to work with KfW and EIB now that a solution to Elbistan's long-standing problems is in sight. Project Objective 63. The main objectives of the proposed project would be to complete the Elbistan Power Station and to ensure the station's adequate operating availability and efficient operation.  - 21 - Project Description 64. The project would include: (a) the completion and commissioning of Units 3 and 4 at Elbistan power station (4x340 MW); and (b) improvement in the Borrower's project management and operation and maintenance capabilities at Elbistan. Project Implementation 65. TEK would implement the project. To ensure adequate technical support at the power plant TEK has agreed to continue to employ a project management firm to provide supervision of construction and assistance in operation and maintenance of the power plant up to December 31, 1987 or the commissioning of Unit 4, whichever comes later. The project would be implemented over three years (1985-1987) and is expected to be completed by December 31, 1987. Project Financing Plan and Lending Arrangement 66. The proposed Bank loan of $10.0 million would be made to TEK. It would finance about 4% of the total financing required ($247.8 million) and 10% of the foreign exchange portion ($97.6 million). The remaining costs of $237.8 million would be covered from loans and credits being provided by EIB, KfW, US Eximbank, and own resources from TEK and the Government. Retroactive financing would not be required. A suimnary of the project financing plan is shown below. Details of the items that would be financed out of the Bank loan are given in para. 68. The foreign exchange risk on the Bank loan would be born by TEK. Project Financing Plan ($ Million) Local Foreign Currency Currency Total Proposed IBRD Loan - 10.0 10.0 EIB - 14.5 Li 14.5 KfW - 30.7 S 30.7 Us EXIMBANK _ 30.0 3 30.0 TEK 35.0 - 35.0 Government 115.2 12.4 127.6 Total 150 9.2 11 Released from blocked ECU 45 million loan. 72 From remaining DM 25 million in Loan No. 5 and DM 55 million in Loan No. 6. /3 From available MANTRUST facil.ty.  - 22 - Given the recent improvements in TEK's financial performance, no difficulties are foreseen in TEK meeting its share of the local cost of the project. TEK suffered a net operating loss in 1983, hut the situation improved sharply in 1984 and 1985. As of April 1985 bulk rates had roughly caught up with long run marginal cost. The Government is committed to the completion of the Elbistan complex and has agreed to make available local funds to TEK for the proposed project in a timely manner. Audits 67. TEK's financial statements are audited by the High Control Board in the Prime Ministry. TEK is required by law to submit its balance sheets and financial accounts to the Prime Ministry for auditing no later than the third month following the year they pertain to. TEK is then required to subait its annual audited accounts to the Bank no later than five months after the close of the year. However, there are shortcomings in both the scope and the timing of the present audit reports. The auditors rarely comment on the reliability of the presentation of the accounts, or on significant events which occurred during the year. The audit reports concerning 1981 and 1982 and 1983 were received more than a year after the close of the fiscal year. The report for 1984 has not yet been received. Most likely it will not be possible to meet the five month target for submission of audit reports until the 1987 report. TEK's consultants are giving priority to helping TEK improve the timeliness and accuracy of the financial statements. Furthermore, an upgrading of TEK's computer center, presently being studied. should improve TEK's ability to prepare and correct the annual financial reports. It is expected that the quality and timely submission of audit reports will improve gradually. The 1985 and 1986 reports are expected within ten and eight months, respectively, after the end of the given fiscal year, and within five months for 1987 and afterwards. Procurement and Disbursement 68. Procurement arrangements are summarized below: Total Procurement ($ millions) Project Element ICB LCB Other Total Cost Plant & Equipment - 0.5 45.6 46.1 including spares (0.5) (2.5) (3.0) Civil Works - 12.7 12.7 Installation & - 103.4 103.4 Erection - - (5.0) (5.0) Engineering - - 15.4 15.4 - - (2.0) (2.0) Administration - - 60.2 60.2 Total 0.5 - 237.3 237.8 (0.5) - (9.5) (10.0) Note: Figures in parentheses are the respective amounts to be financed from the Bank loan.  - 23 - Plant and Equipment up to an amount of $45.6 million equivalent would be co-financed by KfW and EIB and procured through extension of existing contracts with eligible suppliers under KfW and EIB rules. Spare parts to be financed by the Bank ($2.5 million) are proprietary items, obtainable only from one source and would be procured through direct contracting, in accordance with procedures satisfactory to the Bank. Installation and erection services ($103.4 million) would be procured through extension of existing contracts, awarded under ICB in accordance with Bank guidelines. Civil works ($12.7 million), which would not be financed by the Bank would be procured as an extension of existing local contracts. Contracts for miscellaneous items costing the equivalent of $50,000 or less, up to an agregate of $1,000,000 equivalent may be procured under contracts awarded on the basis of comparison of pr:ce quotations, solicited from a list of at least three suppliers, eligible under the Bank's guidelines, in accordance with procedures acceptable to the Bauk. Engineering services ($15.4 million) would be procured through extension of existing consultancy contracts, awarded under the Bank's guidelines. Administration would be done by force account not financed by the Bank. All bidding packages for goods over $250,000 to be financed by the Bank would be subject to the Bank's prior review of procurement documents, resulting in about 90% coverage of goods contracts. The balance of contracts would be subject to selective post review by the Bank after contract award. 69. Disbursement of proceeds of the proposed Bank loan would be made for: Z of Expenditures Category to be Financed (a) Goods 100% of foreign expenditures and 100% of local ex- penditures (ex- factory cost) (b) Installation & 100% of foreign Erection Services expenditures (c) Consulting services 100% of foreign expenditures The disbursement schedule takes into consideration the special nature of the proposed project as a result of which a comparison with power project profiles in EMENA as a whole is not appropriate. Special Account 70. The establishment of a Special Account in the Central Bank would permit payment of Bank-financed expenditures with a minimum of administrative delay. The initial deposit would be $2 million.  - 24 - Environmental Aspects 71. The Elbistan power station is located in a sparsely inhabited area. The power plant provides for ash removal from flue gases by means of electrostatic precipitators designed for 99Z removal efficiency. At this level, fly ash emissions are in compliance with World Bank Guidelines for dust and electrostatic precipitators. In addition, the plant will meet Bank Guidelines for sulfur dioxide and nitrogen oxides. Under Loan 1023-TU, TEK agreed to establish pollution monitoring stations and to inform the Bank of recorded pollution levels and any corrective actions taken, should they be necessary. This covenant is being complied with and the Government has agreed to take measures to ensure continued application of pollution controls. The mine site area is treeless and at best sparsely cultivated. It affords no shelter to wildlife. Moreover, TKI is carrying out, under Loan 1023-TU, necessary reclamation to allow resettlement and reuse. The lowering of the water table in the mining area has produced no ill effects and extracted water is used for irrigation. Sewage is being treated appropriately. Noise pollution does not arise. Project Benefits and Risks 72. The only remaining project risk is the uncertainty of the mine meeting the lignite needs of the power station beyond 1986. The Government has confirmed that it will take all measures necessary to meet minimum requirements of lignite for the efficient operation of the power station. The proposed project would form part of the interconnected power system operated by TEK. TEK's system is projected to expand rapidly over the next ten years in order to meet a fast-growing demand and close the still prevailing electrical energy deficit. It is very unlikely that the projected generation expansion to 1990, which includes Elbistan 3 and 4, will be able to meet the system's energy requirements, even under average hydrological conditions and with continued power imports from Bulgaria and the USSR. Any delay in commissioning of Elbistan 3 and 4 would therefore increase the projected supply gap. The proposed project is justified and necessary to meet projected incremental demand on TEK's system. 73. The remaining question is whether any other type of plant could meet the projected requirements at less cost than the project. Of the available alternatives, only combustion turbines could conceivably be installed in time to lessen the energy deficits which would prevail in 1988 and later years without the project. Other feasible options would be justified, only if they showed sufficient economic advantage over the proposed project to offset the costs to the economy in terms of unserved demand which their longer completion times would involve. Evaluation of all the alternatives shows that both the capital and operating costs of the proposed project are lower than those of any alternative. Sensitivity testing confirmed that the project would still be the least-cost option in TEK's projected system growth. Rate of Return on the Overall Sector TEK/DSI Expansions Progra' 74. The overall TEK/DSI expansion program for 1985-1990, which includes the proposed project was evaluated in conjunction with the appraisal of the Fourth TEK Transmission and the Power System Operations Assistance projects  - 25 - (Loans 2586-TU and 2602-TU respectively) and indicated a rate of return of 11.3Z, marginally below the estimated opportunity cost o.f capital of 122. This reflects that average power tariffs are near long run marginal cost of supply. However, it understates the real economic return on the program, since the measurement of benefits underestimates the willingness to pay for electricity. Recalculation of the Rate of Return on the 1974 Elbistan Project 75. The rate of return on the Elbistan project has been recalculated. The period used for the calculation was 1973-2014, covering the start of construction of the power station and mine and their estimated economic life of 30 years from the start of commercial operation in 1985. The costs are the capital and operating costs of the mine and power station together with the associated transmission facilities. The benefits comprise the revenues from the incremental bulk sales of electricity attributable to the power station. Incremental sales were valued at the average prices projected for bulk consumers (at 1985 prices), which are as follows: 1985 1986 1987 1988 1989 1990 onwards TLIkWh 26.87 28.21 29.62 31.10 33.10 36.83 Electricity tariffs were assumed to increase at regular intervals to reach and maintain LRMC, and to ensure an adequate level of self-financing for the power subsector, reflecting the Government's commitment to reduce public expenditures. Since the tariffs used in the calculation were estimated as a proxy for consumers' willingness to pay, all taxes 1/ were included. Given the large unmet demand, the willingness to pay for electricity is likely to be higher than the current average tariff, but it cannot be readily quantified. 76. A comparison of the Elbistan's costs and benefits results in a rate of retura of about 6X. This compares with an estimate of nearly 18% in the original (1974) appraisal. The difference is due largely to the delay experienced in completing Elbistan and the resulEing lengthy period of time which has elapsed between incurring its heavy investment costs and reaping the benefits of its output. The Elbistan project is worth completing because the rate of return estimated for the proposed project is over 407,given that a large part of the costs of units 3 and 4 were incurred before 1985- 1/ VAT presents some difficulties, since it is repaid to industries which use electricity as an intermediate good. However, repayment may take up to a year, and the "effective price" to industrial consumers is therefore taken as including VAT. Excluding VAT in these cases would slightly reduce the rate of return.  - 26 - PART V - RECOMMENDATION 77. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recoumend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments January 8, 1986 Washington, D.C.  -27- ANX I Page 1 of 6 T A tb E 34 mmvvM - &tTAL uitcmf DATA ^W TnUR RF011C GROPS (WKLCI AVSAS) MMe (mur macwr KSutUwl Ab I7b lbr T7b amr RAM9O INL AUA umasa SQ. a) TMAL 7W.6 710.0 780.. AGRICUTUTIJRAL 3I6.7 361.6 360.8 GP F CUrA C) .. .. 1240.0 2144.3 l1062.9 (ULOClANS OF OIL ou UIVALHT) 170.0 362.0 570.0 11L9.5 4991.3 Marua A VRAXL sATsCs POPULATION.NIO-IDAR (TISaNDS) 27509.0 35321.0 47279.0 URBAN POPULATtON CZ OF tOTAL) 29.7 32.9 45.1 47.5 70.7 POPULATION mPJC POPUATION IN YUs 20 (ELL) 65.4 STATIOIAL POPULATION (MILL) 111.0 POPULATII unn, PER SQ. KM. 35.2 45.Z 0.6 84.7 1411. PER Sq. %K. ACR1. LAND 74.6 92.5 120.3 166.9 521.2 POPULATO EC SIRUCUrE (z) 0-14 tRS 41.2 41.0 37.6 31.2 z1.3 15-64 ns 55.2 54.3 57.1 61.5 66.6 65 AND ABOVE 3.5 4.8 4.3 7.2 12.0 POPULATIO CG I RATE CZ) TOTAL 2.1 2.5 Z.2 1.6 u.o URaN 6.1 3.6 4.S 3.7 1.3 CRUDE BIRTH RATE (PER TAWS) 13.1 37.9 30.6 23.4 13.5 CRE DEATH RATE (PER TroUS) 1S.6 12.2 8.6 8.9 8.9 r;DSS MPROSUCrION RAEn 2.9 2.6 = 2.0 1.5 o.Y EARfl PLNG AEP7ORS. AISAL (THOS) 05.6 USERS CZ OF PARRIEO WNEN) 5.3 I. 32.0 Id e 38.0 /f . 11.1 INDEX OP FOD PR0D. PER CAPITA (1969-71-1D0) 96.0 100.0 110.0 109.1 107.2 PER CAPITA SUPLTY OP CALOIES (S OF WEQUIRTHTS) 109.0 112.0 125.0 131.5 13Z.v PROTEINS (CGRAMS PER DAY) 54.0 80.0 83.0 92.4 101.0 OF MICH ANDL MULSE 25.0 23.0 25.0 15 34.5 81.' CHILD (ACES 1-4) DEAT RA;TE 62.5 27.5 8.0 4.7 0.4 LIFE EPECT. AT BIRH (tEARS) 50.5 55.9 63.2 67.2 75.5 INFArTr YOYT. MEt (pmo ius) 177.8 13h.2 62.0 53.3 9.9 ACCESS MD SAFE WATER (zpoP) TOTAL .. 52.0 75.0 lb 70.2 URBAN . 51.0 95.0 lh 89.4 RURL .. 53.0 62.0 7ir 57.0 ACCESS T EXCRETA DISPOSAL CZ OF POPULAoIN) TUTrL . . . S9.b - URA .. .. 60.1 /h 65.9 RURAL .. .. .. 47.6 POPULATON PEm pSTc 2600. 2230.0 1830.0 /h 1070.6 553.2 POP. PER HRSINp ff3505 16300.0 IL 1S80.0 1130.0 lb 769.5 166.8 PoP. PDI HOSPITAL 8ED TOTAL 60041 490.0 490.0 If 328.3 12U.9 URBA 340.0 IL 270.0 /1 270.0 ji 201.9 L13.2 URAL 5100.0/1 6510.U l 5650.0 /A 4519.7 778.d AD1SSION1S PER HOSPITAL BED .. 20.2 22.3 AL Z2.0 17.U AVERAGE bIZE OF HUSEROID TOTAL 5.7 &k 5.9 URBAN .. .. RURAL .. .. AVERAGE N0. OF PERSONS'ROtaO 'TOTAL 2.4 /h 2.2 URBAN 2.0 7F 1.9 RURAL 2.7/k .. PERCENTACE OF OCELLIS wIT ELECr. TOTAL 29.0 41.1 URL8 .- 78.2 RUL 2.0 18.0  -28 - ANEX I TASLI 3A Page 2 of 6 TUR1T SOCIAL INDICATORS MTA SHRET TUUCYT REFh881IR E WOUPS (WiECGE AVERGS L S (mlm Nzr 1s_ u) A aiCUT MIDDLE. CCSE rU L 196im( 1ig-rLb jjTji-j/b EUIOPE mA=? sco4SOHsrZ wusrED EROLUI RATIOS PRIMARY: TOTAL 75.0 110.0 102.0 101.9 101.2 MALE 90.0 124.0 10.0 106.2 102.6 VOULF 58.0 95.0 95.0 97.5 102.4 SEICOUA: TOMA 14.0 27.0 39.0 57.5 87.1 HALE 20.0 38.0 50.0 64.9 80.3 FEMAlZ 8.0 15.0 27.0 50.0 84.1 VOCATIOVAK. CZ SOCONDST) 17.7 13.7 21.9 21.0 18.4 PUPIL-TEAOCI RATIO PRIMARY 46.0 38.0 28.0 25.1 16.7 SECONDAI 19.0 28.0 19.0 19.1 11.6 PASSDIGER CARSAOUSAMD POP 1.7 3.9 11.5 11 54.2 366.3 RADIO RECErVERSITSOUSAND POP 49.1 87.7 93.0 170.7 1093.2 Ty zzczxvrnsUSAID lPOP 0.0 1.8 105.8 149.3 492.3 HISPAPU ("DAIL. GENEML IFFERIST) CIROCULAOU PER THOUSAID POPULATIO 51.3 40.6 89.1 I. 97.0 320.4 CXbA AlU.L ATTI ICECAPTA, 1.1 7.0 1.4 f 2.7 3.3 TOTAL LADOR FORCE (CT S) 13782.0 15829.0 20660.0 FEMALE (PENCIEr) 40.2 37.0 36.3 36.3 36.2 AGRICULTUE PECENT) 78.5 67.7 53.5 lh 40.8 6.2 IIUSTRT (PeCENmT) 10.5 12.1 12.8 7W 23.3 37.7 PARTICIPATION RATE (PERCENT) TOAL 50.1 "4.8 43.7 43.1 46.0 HMLa 5B.7 55.7 54.B 55.1 59.5 FEMALE 41.2 33.6 32.2 31.4 32.7 ECOIIOWC DEPEIWDICE RATIO 0.9 1.0 1.0 0.9 0.7 iNcUa DISTEIBUTEW PERCElT OF PRIVkTE INCOME RECEIVED Br HIGHEST SE OF UDUSEROLDS 33.0 Ic 32.8 Id HICIEST 2Z 0F HOUSEOLDS 61.0 77 60.67i .. .. 43.L LOWEST 201 OF lCUSlOS 4.2 Ic 2.9 Id .. '' 5.4 LOWEST 401 Or KDUSENOLS P10.6 7 9.4 d .. .. 16.4 ESTIMATED ABSOLUTE POVEl! nINCU tEEL CaSS PER CWA ) MURAl .. .. 362.0 If MRAL .. .. 27.0 7F T ESTILATO RELATIVE POVERT DINOM LEtL CBSS PR CAPITA) aR ........ RURAL .. .. 220.0 If ESTlI!MA POP. BELOW ABSOLUMT POVTT INCaM LEVEL (C) Um ........ RMUAL .. M.I AVAILALE ROT APPLICABLE . N~~~~OTES N O T E S a TMe group average for each Indicator are population-eighted aritbe tic mans. Covrage of countries amng the ludicacorx depends on avallab4licy of data and Is am un