Turkey - Public Financial Management Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6645-TU MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED U.S. DOLLARS SINGLE CURRENCY LOAN IN AN AMOUNT EQUAL TO US$62.0 MILLION TO THE REPUBLIC OF TURKEY FOR A PUBLIC FINANCIAL MANAGEMENT PROJECT AUGUST 29, 1995 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS (as of July 31, 1995) Currency Unit = Turkish Lira TLI = US$0.00002 US$1 = 44,889 AVERAGE EXCHANGE RATES per US$1 CY 1991 CY 1992 CY 1993 CY 1994 CY 1995 Jan-July 4,172 6,872 10,985 29,609 42,447 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS CAS - Country Assistance Strategy Customs - Undersecretariat of Customs EU - European Union FLS - Financial Ledger System GDBFC - General Directorate of Budget and Fiscal Control GDPA - General Directorate of Public Accounts GDR - General Directorate of Revenues GFS - Government Finance Statistics IMF - Intemational Monetary Fund IRS - Internal Revenue Service (United States) IT - Information Technology MOF - Ministry of Finance PFMP - Public Financial Management Project PMSS - Project Management Support Services PMU - Project Management Unit PSAL - Public Sector Adjustment Loan SBA - Stand-by Arrangement SEE - State Economic Enterprise SPO - State Planning Organization TCA - Turkish Court of Accounts Treasury - Undersecretariat of Treasury TURKEY - FISCAL YEAR January I - December 31  FOR OFFICIAL USE ONLY REPUBLIC OF TURKEY PUBLIC FINANCIAL MANAGEMENT PROJECT Loan and Project Summary Borrower: Republic of Turkey Implementing Agencies: Ministry of Finance and Undersecretariat of Customs Beneficiaries: Ministry of Finance and Undersecretariat of Customs Poverty Category: Not Applicable Amount: US$62.0 million equivalent Terms: The loan is proposed to be a fixed rate single currency loan in U.S. dollars, with a maturity of up to 15 years. Each semester's disbursements would have a maturity of nine years from the rate fixing date, including three years' grace. The interest payment dates are March 15 and September 15, with the first expected rate fixing date on March 15, 1996. Financing Plan: Local Foreign Total ---------- US$million ----------- Government 23.0 9.2 32.2 IBRD /a 0.1 61.9 62.0 Total Financing 23.1 71.1 94.2 /a Excludes taxes and duties Economic Rate of Return: Not Applicable Staff Appraisal Report: 14656-TU Map: IBRD No. 24903R Project ID Number: TR-PA-35759 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwisc be disclosed without World Bank authorization.  I  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR A PUBLIC FINANCIAL MANAGEMENT PROJECT 1. I submit for your approval the following memorandum and recommendation on a proposed loan to the Republic of Turkey for the equivalent of US$62.0 million to help finance the Public Financial Management Project. The loan would be a fixed rate single currency loan in U.S. Dollars, with a maturity of up to 15 years. Each semester's disbursements would have a maturity of nine years from the rate fixing date, including three years' grace. The Republic of Turkey is eligible for single currency loans as it has no unconverted VLR82 loans. The proposed loan of US$62 million represents 19 percent of the FY96 lending program of US$327 million for the Republic of Turkey. Country/Sector Background 2. During the last few years, there has been a resurgence of high fiscal deficits and inflation in Turkey that has overshadowed the gains attained through the broad-based liberalization of the economy in the 1980s. In 1993 the internal imbalances spilled over into the external accounts, culminating in a severe currency crisis during the early months of 1994. There were successive downgradings of Turkey's credit rating by the international rating agencies, and access to external financing virtually severed. 3. The Government's Reform Program. The growing macroeconomic imbalances led the Government to introduce some reform initiatives in late 1993, notably in the area of tax. However, an overall approach to the country's economic problems was adopted only in April 1994, when the Government launched a broad program of stabilization and reform measures. The main objectives of the April 5 Program are to: (a) achieve a substantial and durable reduction in the fiscal deficit and inflation; (b) reduce the external payments deficit and restore foreign exchange reserves; and (c) establish a structural framework for more sustainable rapid growth, chiefly through a considerably reduced role of government in economic activities. Early support for the Government's program was provided by the IMF, which approved a 14-month Stand-By Arrangement (SBA) for SDR509.3 million (approximately US$715 million) in July 1994. 4. Some of the initial results of the April 5 Program have been very encouraging. The budget deficit was reduced substantially in 1994, largely through a number of special taxes and real cuts in spending on personnel costs and subsidies. As a result, the overall public sector borrowing requirement fell from 12.6 percent of GNP in 1993 to 8 percent in 1994. The external current account registered a sizable surplus of about US$3 billion in 1994 and foreign currency reserves are now well in excess of the levels prevailing before the crisis. Despite these achievements, there has been slow and uneven progress in implementing the structural reforms that would provide the basis for a durable adjustment. While important reform measures have been introduced to strengthen tax policies and administration, and some areas of government expenditure policies, reform in the rest of the public sector is lagging. Inflation is still running at an annual rate of over 100 percent and real interest rates remain very high. Recovery from the deep economic recession in 1994--real GNP declined by an estimated 6 percent--is apparently underway, but its sustainability is uncertain. The situation is complicated by persistent political uncertainty and difficult national security issues.  5. Challenges for Public Sector Reform. The primary economic challenges facing Turkey at this juncture are to establish the foundations for a sustainable fiscal adjustment and to bring about a rapid and durable reduction in inflation. Fundamental reforms of the public sector are urgently needed for both, including: (a) privatization or closure of state economic enterprises (SEEs); (b) a substantial rationalization of the public administration; (c) reductions in the costly government interventions in investment, production and marketing decisions; and (d) action to stem the financial losses of the main pension funds, followed by comprehensive medium-term reforms of health and social security financing. 6. These policy reforms need to be complemented by a variety of institutional reforms to strengthen public financial management and to enhance the framework for efficient private sector activities. The domestic tax system remains characterized by a relatively narrow base. This situation is largely due to deficiencies in the tax system and administration that preclude a broadening of the income tax base, effective collections and compliance activities, and better taxpayer service. Notable among these shortcomings is the authorities' limited ability to identify potential areas of non-compliance through cross-checks of information relating to financial transactions and asset holdings. Expenditure management and control is severely hampered by the complex and outdated budgetary framework and systems, the plethora of agencies and funds that are effectively outside the budgetary process, and deficiencies in cash management and public sector accounting. As a result, general government expenditures have exceeded targets by large margins in recent years, and fiscal policy has been driven by the short-term financing needs of the government. The management of personnel expenditures presents a particular problem. The public administration in Turkey is characterized by considerable over-staffing due to poor information on and controls over personnel expenditures. There are also serious problems of staff quality and performance due to the inadequate wage structure, weak career incentives and inefficient procedures. Finally, the major liberalization of external trade achieved during the 1980s has not been matched by corresponding changes in customs administration. The present customs regime is costly and inefficient and detracts from the competitiveness of Turkish exports and the country's attractiveness as a site for investment. A major impetus for change in this area stems from the requirements of the customs union with the European Union (EU) that is expected to take effect in 1996. Project Objectives 7. Since late 1993, the Government has consistently stressed its desire to introduce important changes to overcome institutional and systemic problems in public financial management, for which it urgently requested Bank assistance. The proposed Public Financial Management Project (PFMP), a technical assistance project, would help to address such problems in taxation, government spending and customs administration, and in related personnel management functions. The specific objectives to be pursued in the three components of the PFMP are summarized below. 8. The Tax Administration component would be directed at modernizing the organization and systems of the tax administration in Turkey, with a particular focus on strengthening the compliance enforcement and policy formulation capabilities of the tax authorities, and improving conditions progressively for taxpayers who comply. The underlying goal is to broaden the tax base in order to increase tax revenues while ensuring a more equitable distribution of the tax burden. 9. The Expenditure and Personnel Management component would attempt to enhance the government budget's usefulness as a fiscal policy instrument, and as the tool for managing public finances, by reducing the number of sources of government spending that now operate outside budgetary channels, and by introducing budgeting of public administration positions and payroll. It also aims to modernize the complex and outdated budgetary and accounting control procedures and systems that impede effective and efficient control over government finances.  10. The Customs Modernization component is directed at shifting the customs administration's policy from its present costly and inefficient ex ante, full coverage, sanctioning approach to a more ex post and efficiency-seeking stance, still capable of gathering appropriate revenues and enforcing relevant national and international laws, and at advancing the changes in the national customs organization required to enable Turkey to enter into a customs union with the European Union (EU) in 1996. Project Description 11. Project activities for the three components of the Public Financial Management Project can be grouped under five common heads: (a) studies to complete the details of the programs for reform and modernization; (b) advisory services and training in new procedures, organizational arrangements and analytical techniques; (c) design studies and modeling activities to determine the specifications of information technology investments; (d) pilot and nationwide information technology investments and associated training and civil works; and (e) project management support services. 12. Due to differences in the state of readiness of the various components for major investment expenditures, the time sensitivity of certain elements and the complexity of administrative arrangements, the authorities have adopted a "time-slice" approach to Bank financing of their overall public financial management reform program. The PFMP would be the first of two proposed Bank loans in support of institutional strengthening of the Ministry of Finance (MOF) and other agencies dealing with taxation and expenditure management and control. For these entities, the PFMP (Phase I) would involve advisory services, training, and information technology (IT) design studies and pilot activities. This would lay the foundations for a second phase (Phase II) of activity focusing on a broader program of IT investments and training. However, due to the urgent requirements of the forthcoming customs union with the European Union, and the relatively favorable sector policy environment and simple design issues involved, the PFMP would provide complete support to the modernization program of the customs administration. Specific project activities are summarized below for each component. 13. Tax Administration Component (base cost US$14.2 million). As noted above, the Ministry of Finance's plan is to reach its goals in two partially overlapping phases of activity. In the case of the tax administration component, the first phase is to be accomplished in approximately eighteen months. There are three basic thrusts to the activities planned for Phase I of the tax administration reform program. First, an organization study will be undertaken to provide assistance in the restructuring of the General Directorate of Revenues (GDR) in the MOF and the development of revised legislation, regulations and manuals defining the organization and its personnel administration in areas affected by restructuring and re-engineering. Three additional, smaller, studies will be conducted during the early stages of Phase I to fill known information gaps. They will report on: (a) strengthening compliance enforcement through the use of modern third-pay information sources and processes; (b) enhancing the role of the banking system in collections and other routine tax administration processes; and (c) the requirements for performing all collecting and processing of withholdings (including social security) within the GDR organization. The results of these latter studies will be fed into the main organization study, as well as the information/process modeling activities--see para. 14 below. 14. Second, a comprehensive information/process model for the tax administration system will be developed for modernizing the core business processes of audit, collections and returns processing, as well as overall management of the GDR. The modelers will draw upon information already available through the reports of a number of recent studies, as well as the results of the proposed new studies mentioned above. A development laboratory will be established in Ankara, which will provide the facilities required to: (a) model and demonstrate new/changed processes, local tax offices and regional office concepts, including proposed tax intelligence centers; (b) model the centralized intelligence research operation;  (c) test computer configurations and communications interconnections; and (d) develop and conduct demonstrations and training sessions for IT specialists and operational staff. 15. Project-specific technical training of GDR IT staff will also commence under the PFMP, so as to be ready for the intense development efforts planned for Phase II. Using the completed model, noted above, a small and highly technical group of IT specialists will develop the IT Framework for Phase II. This will consist of: (a) a strategic planning section, which will select the set of technologies that are appropriate to meet the business needs of the organization, building on already installed technologies; and (b) technical specifications that support the procurement of the hardware, software and communications infrastructure for Phase II activities. 16. Finally, the tax policy formulation capability of the GDR would be strengthened through: (a) the design and establishment of a Policy Analysis Unit within the GDR, including a detailed training program; (b) analysis of the current tax system with a view to providing recommendations for legislative change that would broaden the tax base and enhance the fairness and efficiency of the tax system, notably through the rationalization of deductions, exemptions and other preferences; and (c) development of a set of tax policy models suitable for the design of tax policy changes and for revenue forecasting and monitoring, with appropriate training for a small team of GDR staff in the manipulation and maintenance of the new tools. 17. Implementation of component activities would be facilitated by an in-house technical advisory team, who will assist the GDR in the planning, coordination and monitoring of the other activities proposed to be carried out under the component. The GDR has selected the Internal Revenue Service (IRS) of the United States to provide the in-house advisory services, in order to continue a technical assistance program initiated in 1992. In addition to the foregoing, the IRS advisors will assist the GDR to carry out a number of initial reforms that can be introduced within the existing organizational and IT constraints. In view of its limited experience with project implementation, the GDR has also decided to contract for professional project management services to help its project management team to negotiate and determine contractual arrangements, effect payments, maintain financial accounts and to give other administrative support to the full range of consultants employed under the component. 18. Phase II (1996-2001) would see an expansion of the advisory services program, notably in the areas of audit, collections, returns processing and modern tax administration management. As has been noted, a number of the Phase I studies will establish the detailed requirements for hardware, systems software, and communications design and the choice of appropriate hardware, systems software and application development tools for the GDR. At this stage, it is envisaged that Phase II activities in the IT area would cover the introduction of a comprehensive national taxpayer identification system (building on an ongoing effort to modernize the citizens' registry in the Ministry of Interior), upgrading of existing central and regional IT assets of the GDR, acquisition and installation of IT products at a number of new regional offices, development and delivery of a broad-based training program for GDR staff and computers and ancillary equipment for a restructured and rationalized local tax office network. The main remaining cost elements for Phase II would be: (a) site preparation; (b) a management consultancy to assist the GDR in its reorganization and the rationalizing of the network of local offices; and (c) expanded project management support services. World Bank support for the Phase II activities is envisaged through a follow-up loan. 19. Expenditure and Personnel Management Component (base cost US$10.4 million). Activities in the Expenditure and Personnel Management Component would be targeted to: (a) strengthen budgetary system control by reducing substantially the number of off-budget spending entities, tightening the relationship between planning and budgeting processes, and improving the links between current and investment budgets; (b) make spending agencies more accountable and rationalize the Budget and  Accounting Office systems, and remove ex ante controls while improving ex post audit capabilities; (c) strengthen budget decision-making by introducing a more appropriate budget code structure for economic analysis; (d) install streamlined procedures to govern commitment authorizations and monitoring and a simplified model compatible with the proposed computerized Financial Ledger System (FLS); (e) modernize budgeting and accounting functions, payments processes and treasury management; (f) integrate management of public administration personnel with financial management through initiation of position ceilings, a centralized data base on the civil service and establishment of a payroll system confining personnel expenditures to authorized positions; and (g) enhance capability of core agencies to perform their expenditure management responsibilities through upgrading information systems and staff skills, and realigning the systems on a functional basis in an integrated financial management system for budget, accounting and payroll transactions. 20. As in the case of tax administration, the activities listed above are to be carried out in a phased manner over the course of the next five years. Phase I, which is to be supported by the PFMP loan, involves the definition and introduction of new processes. procedures and organizational arrangements for bud2eting. accounting and pavroll. as well as the development and testing of a prototype for the proposed FLS. This phase is expected to last for about two and a half years. 21. Preparatory studies for Phase I are either ongoing or planned to be conducted by inter-agency Working Groups with the assistance of external consultants. These studies will variously: (a) define a detailed reform strategy for improving budget coverage through the rationalization of non-budget entities; (b) introduce a new budget and chart of accounts more suitable for economic analysis, consistent with international classification structures and which can be implemented on the proposed Financial Ledger System (and utilized for both budget preparation and execution); (c) prepare an action program for rationalizing the current complex and inefficient system of controls over government expenditures, as well as the organizations involved in these processes; (d) define new regulations and procedures for budgeting of positions in the public administration and develop a detailed programn for computerization of personnel information and payroll; and (e) review banking arrangements and government accounts, with a view to developing a program for strengthening government cash management. 22. Most of the preparatory studies in the foregoing areas are expected to be completed by the time of loan effectiveness, and project activity will focus on implementation of the proposed changes, including broader dissemination of the Government Finance Statistics (GFS) methodology for which initial training has already been completed. The working groups responsible for implementation will be assisted by an in-house technical advisor. A number of short term consultancies will also be executed to help the MOF complete the detailed design of the reforms and to implement them. Training for IT staff is also planned to be carried out during this phase as a prerequisite for the substantial information technology investments to follow in Phase II. 23. Also as part of Phase I, a major design study will be conducted to establish the overall functional and information requirements of the information systems, the overall systems architecture and the technology architecture (including the hardware, systems software, and communications design and choice of appropriate hardware, systems software and application development tools). It is proposed that this study be carried out by a firm with extensive experience in the design and implementation of such systems. The contractor would be required to provide not only the detailed design of the FLS, but also develop related procedures and manuals as well as modules for budget preparation, the post management system, personnel information system and payroll system. Finally, the contractor would be required to test the proposed systems, applications and systems software in eight pilot sites.  - 6 - 24. Phase II would involve the installation of the hardware and systems and applications software across the nodes of the network; training of operational staff in the use of the system and commissioning the system at the different nodes; and training technical staff in the maintenance and operation of the system, and in the provision of ongoing end-user support throughout the life of the system. In Phase II, audit related activities would be separated out as a distinct component, focusing on strengthening ex post audit techniques and systems in the Turkish Court of Accounts and relevant MOF entities. 25. Customs Modernization Component (base cost US$62.4 million). Activities in the Customs Modernization Component would be geared to: (a) rid customs procedures of their present duplication, excessive paperwork and physical controls, to be replaced by self-assessment methods, selective physical inspections and document checks, stronger post-release reviews and simpler import controls; (b) upgrade present computerization to full automation of customs procedures and the capacity to enforce legislative and other EU requirements; (c) consolidate responsibilities for development and maintenance of automated information systems; (d) restructure and downsize the customs organization in line with the new operational procedures, complemented by decentralization of operations; and (e) support these changes with staff training, facility renovation, public information programs and pilot tests with brokers and other affected groups and stakeholders. 26. The work required to establish a reform/modernization strategy is largely complete. Some legislative aspects are pending the results of ongoing negotiations between the Government and the EU. A study has also been conducted to establish the functional and information requirements of the information systems, the overall systems architecture and the technology architecture. 27. The Customs administration has selected the French SOFIX system as its choice for the main (customs) application software, since it can be adapted readily to meet Turkish and EU requirements. The entire package of the SOFIX software and required technical assistance and equipment for adaptation, training and pilot implementation is being procured directly from French customs under a bilateral agreement. The contractor for the nationwide replication of the pilot, however, would be selected through a process of international competitive bidding. The contractor would be responsible for delivering a fully-functional network involving 18 regional and 45 local offices as well as training of operational staff in the use of the system, and training technical staff in the maintenance and operation of the system and in the provision of ongoing end-user support throughout the life of the system. 28. Major remaining cost elements are: (a) site preparation and other civil works; (b) development of simplified, modern procedures and training of staff in the new procedures and processes and of managers in change management with the assistance of externally-recruited advisors, including in-house advisors for customs administration and information technology who will work under the supervision of the IMF; (c) recruitment of additional IT staff and redeployment of redundant personnel; and (d) professional project management services. Project Cost and Financing 29. The total cost of the project is estimated at US$ 94.2 million equivalent, including contingencies, taxes and duties. Foreign currency costs, including contingencies, are estimated at US$71.1 million or 75 percent of total cost. A summary breakdown of costs by expenditure category is shown in Schedule A. The proposed Bank loan of US$ 62.0 million, which excludes taxes and duties but includes the repayment of a US$2 million advance from the Bank's Project Preparation Facility, would finance 66 percent of total project costs, and meet 87 percent of foreign exchange requirements and 0.4 percent of local costs. The Turkish Government will contribute US$ 32.2 million, covering 34 percent of total project cost. The Government's share of PFMP financing is much higher than that for other recent Bank-financed projects  in Turkey (24 percent in FY94-95), reflecting the importance that the authorities attach to the objectives of the project. 30. As noted above, the Government has obtained an advance in the amount of US$2 million from the Bank's Project Preparation Facility. Preparatory activities for the PFMP have also benefitted from a Japanese PHRD grant in the amount of Yen 128 million (approximately US$1.3 million). The French Government also provided a grant of about US$132,000 specifically for preparatory studies for the Expenditure and Personnel Management component. These monies have allowed the timely initiation of the most time-sensitive activities. Pro3ect Implementation 31. The borrower is the Republic of Turkey, represented by the Undersecretariat of Treasury (Treasury) in the Prime Ministry. The implementing agencies and beneficiaries are the Ministry of Finance and Undersecretariat of Customs in the Prime Ministry. Any necessary coordination between the MOF and Customs will be effected at the ministry level by the Undersecretaries, with the assistance of the Treasury. Management and implementation arrangements for each of the three components are summarized below. 32. Overall responsibility for the supervision of the Tax Administration and Expenditure and Personnel Management components rests with the Undersecretary in the Ministry of Finance, who will ensure any necessary coordination within the MOF, and with other involved entities. However, the Director General in the GDR is responsible for the management of the Tax Administration Component. A Project Management Unit (PMU) headed by a Deputy Director General is responsible for coordinating component activities on a day-to-day basis. Specific tasks are to be carried out by Working Groups comprised of Ministry of Finance staff, assisted by external consultants. The Heads of the Working Groups are the members of the PMU. A professional project management support services (PMSS) consultant will assist with procurement and contract monitoring, disbursements, accounting and other administrative issues. Implementation of Tax Administration Component activities for the PFMP is expected to be completed in eighteen months. Initial activities will center on the efforts of the IRS advisory team and the PMSS contractor. These two consultancies will commence about two months before any others begin, in order to allow for appropriate planning and preparation. 33. The Undersecretary of Finance is directly responsible for management of the Expenditure and Personnel Management Component which involves a number of agencies. A high-level, inter-agency Steering Committee chaired by a Deputy Undersecretary of Finance has been appointed as an advisory body. It includes appropriate participants from the Ministry of Finance, Treasury, State Planning Organization and Turkish Court of Accounts. As in the case of the Tax Component, responsibility for day-to-day coordination and monitoring of component implementation rests with a PMU. The Expenditure and Personnel PMU is led by a Head of Department from the General Directorate of Budget and Fiscal Control (GDBFC). The PMU includes the heads of four Working Groups that are responsible for implementation of specific component tasks, as well as other MOF personnel with skills in accounting, procurement, contract monitoring and information processing. Execution of Expenditure and Personnel Management Component activities is to be carried out over a period of two and a half years. Successful implementation will depend on close coordination among several agencies in the government sector. The Steering Committee must play an effective role in ensuring the required coordination. During preparation, participation of most of the concerned core agencies in the Working Groups contributed to very good coordination at the technical level.  - 8 - 34. Responsibility for the Customs Modernization Component rests with the Undersecretariat of Customs. The management and coordination of component activities is being effected by a Customs PMU, headed by a Deputy Undersecretary. Actual development and implementation activities are being carried out by seven Working Groups. The Customs Administration has decided to engage the IMF to help it implement the technical components necessary to support the modernization plan. Central to this agreement is the appointment of two in-house technical advisers, for customs administration and information technology, who will provide specific advice related to the restructuring and modernization of the customs organization and coordinate all technical assistance. The Fiscal Affairs Department of the IMF will supervise the in-house advisers that will be appointed under the agreement as well as short term advisers assigned to provide specific technical advice. The Customs Modernization Component will be implemented over a period of three and a half years. Key upfront activities for the next few months are: (a) the drafting of new regulations and design of new customs procedures; and (b) the development and implementation of the pilot customs system. Project Sustainabilitv 35. The Government's commitment is reflected in the considerable time, resources and high-level participation that it is investing in the project, as well as in a variety of upfront actions. These have served to promote ownership at both the managerial and technical levels. Government officials have worked intensively with Bank staff and consultants to prepare detailed programs for reform in all three component areas. A number of studies have already been completed and follow-up action taken, including important changes in tax legislation and customs regulations. Implementation risks will be mitigated by: (a) the focus on the "component" as the basic unit for management and implementation, including Bank disbursements; (b) the assignment of permanent technical advisors, notably from the IMF and IRS, and professional project management experts to the implementing agencies; (c) the strengthening of the technical capabilities of government staff early in the project in order to allow for fuller participation in downstream activities; and (d) the attention given to change management, including study tours abroad for key stakeholders. Finally, and perhaps most importantly, the sustainability of the project is likely to be enhanced by the fact that the project deals with issues for which there is widespread support in Turkey--a more equitable tax burden, improved management and control over the Government's finances and closer economic ties with Europe. Lessons Learned from Previous Bank/IDA Involvement 36. Reviews of recently-completed Bank-supported public sector management projects suggest a few important lessons for the PFMP. Attempts at public sector management reform need to be focused in areas where there is a strong commitment at all levels (political, managerial and technical). Clearly identified outputs and expected impact must be incorporated in design. Successes can then serve as the basis for future assistance and reforms. Supervision by the Bank and the Borrower on a continuous and intensive basis is paramount in public sector technical assistance efforts. More specific to Turkey, project implementation is frequently constrained by weak project management capacity, rapid turnover of key officials, complexities in the Government's decision-making processes, and cumbersome and lengthy Government procurement procedures and inadequate understanding of Bank procurement guidelines. Another important constraint in recent years has been budgetary cuts. 37. In recognition of these lessons, the PFMP's development and design places emphasis on: (a) promotion of government ownership and development of effective means of gaining broad support, including through the focus on the "component" as the basic unit for management and implementation; (b) slicing of the Ministry of Finance program into two partially overlapping projects so that upfront technical studies and follow-up institutional reform decisions and pilot operations can be carried out before major investment commitments are made; (c) provision of in-house technical advisors and professional  - 9 - project management support specialists to minimize the risks associated with the borrower's implementation capacity; (d) provision for intensive supervision activity, including a formal review in each of the first three years of project execution in order to benefit from experience on the ground and facilitate any required course corrections; (e) evaluation and monitoring criteria tied directly to the objectives sought by the client; (f) use of annual work programs, and procurement and financing plans; and (g) use of World Bank standard bid documents together with translations. Rationale for Bank Involvement 38. This project is consistent with the Country Assistance Strategy (CAS) as discussed by the Board of Directors during the presentation of the Bursa Water and Sanitation Project, Report No. P-5897-TU, on March 11, 1993. 39. The Government's Economic Program of April 5, 1994 provided the Bank with an opportunity to enhance its support of efforts to address the underlying causes of Turkey's growing fiscal imbalances. During the past year, the Bank has engaged in an intensive dialogue with the Government on the major issues in areas such as SEEs and social security, with a view to providing support through a comprehensive Public Sector Adjustment Loan (PSAL). Unfortunately, the implementation of key reforms has been extensively delayed, largely as a result of the lack of a clear political mandate for the government. Meanwhile, as noted above, Turkey's external payments situation has improved considerably. Given this situation, the Government requested the Bank to suspend preparation of the PSAL. In view of the weak state of the domestic economy and likely continued slow progress in the implementation of key reforms, the Government also requested the IMF to extend the SBA for six months to March 1996 and, in this context, to augment Turkey's access to Fund resources in order to allow for a more gradual adjustment. These requests were approved by the IMF Board on April 21, 1995. 40. Although Bank support through adjustment lending is not judged appropriate at this time, the Government's ongoing stabilization program does provide a framework for Bank assistance to strengthen the core agencies responsible for macroeconomic management. Specifically, in keeping with the priorities and graduated Bank response outlined in the March 1993 CAS, the Bank's current approach is to maintain a constructive role in the economic policy process by using more narrowly-focused lending operations like the PFMP to strengthen the institutional framework and administrative capacity for public sector adjustment. Several of the studies proposed to be financed under the PFMP are also geared to improve the understanding within Turkey of the policy issues that must be addressed eventually when the political situation clarifies. The PFMP would also complement other Bank-supported projects aimed at enhancing the infrastructure for public sector management and reform--e.g., the FY92 Treasury Data Systems Project, which is helping to improve the Government's debt management and macroeconomic policy formulation capacity, and the FY94 Privatization Implementation and Social Safety Net Loan, which aims to strengthen the capabilities of the Privatization Administration and Treasury to manage and implement privatization and an effective social safety net program for displaced workers. Agreed Actions 41. During negotiations, the Government confirmed its agreement to the following specific conditions: Condition of Loan Effectiveness: Expenditure and Personnel Component. The in-house adviser for the Expenditure and Personnel Management Component shall have been appointed on the basis of terms of reference agreed with the Bank.  - 10- Conditions of Loan Disbursements: Tax Administration Component. The General Directorate of Revenues shall have appointed an in-house tax administration adviser and a project management support contractor, with terms of reference agreed with the Bank. Customs Modernization Component. The Customs Administration shall have entered into a technical assistance agreement with the IMF, including for the provision of a customs administration adviser and an information technology adviser. Dated Covenants: Tax Administration Component. (i) By December 31, 1996, the Ministry of Finance shall present the Bank with a satisfactory plan for the reorganization of the General Directorate of Revenues (headquarters, regional and local offices) prepared on the basis of appropriate legislation and regulations, and the proposed new automated systems. (ii) By December 31, 1996, the Government of Turkey shall have communicated to the Bank its decision concerning the collection of social security, health and unemployment contributions by the General Directorate of Revenues. Expenditure and Personnel Management Component. (i) The new chart of accounts shall be put into effect by January 1, 1997 on the basis of guidelines agreed with the Bank. (ii) By December 31, 1997, the Ministry of Finance shall furnish the Bank a satisfactory plan for the reorganization and rationalization of the budget offices and accounting offices prepared on the basis of the new procedures, regulations and automated systems. (iii) The general budget submitted to Parliament for the 1997 fiscal year by January 1, 1997 shall be prepared on the basis of the new code structure, which is to include functional and economic classification of expenditures according to international standards. (iv) The general budget submitted to Parliament for the 1997 fiscal year by January 1, 1997 shall introduce the full implementation of new guidelines agreed with the Bank for budgetary posts management. (v) By February 28, 1996, the new calendar and methodology for budget preparation shall have been adopted for implementation in the preparation of the fiscal 1997 budget. (vi) By December 31, 1997, the Ministry of Finance shall have conducted successful pilot implementations of the Government Financial Management Information System and Personnel and Payroll Management Information System, with the success of implementation to be assessed on the basis of criteria agreed with the Bank.  - 11 - Customs Modernization Component. (i) By December 31, 1996, Customs shall issue new and/or revised customs regulations. (ii) By December 31, 1996, Customs shall have conducted a successful implementation of the pilot customs operation, with the success of implementation to be assessed on the basis of criteria agreed with the Bank. (iii) By June 30, 1997, Customs shall furnish the Bank a satisfactory plan for the reorganization of the Customs Administration (headquarters, regional and local offices) prepared on the basis of the new regulations and automated systems. Environmental Aspects 42. The project is classified as Environmental Assessment Category C, as defined in O.D. 4.01. It is not expected that there will be any issues related to the environment. Program Objective Category 43. The proposed loan would improve public sector management. Participatory Approach 44. The project is the culmination of an extensive joint review of the Government's needs and requirements in the area of its financial management. Preparatory activities have fully involved technical staff as well as senior managers of the implementing agencies. Project rmanagement and implementing arrangements have been designed to try and ensure that this high-level oversight and participation continues throughout project execution. Project Benerits 45. Past adjustment programs in Turkey have foundered because of failures to tackle key institutional problems. The proposed Public Financial Management Project would assist in addressing such problems in taxation, government expenditures and customs, and related personnel management functions. In these areas, the project would seek to restructure and otherwise rationalize the central agencies, upgrade their planning and controls, and modernize their processes. The envisaged changes would help deepen and enhance the sustainability of the fiscal stabilization initiated in 1994 and facilitate Turkey's successful entry into the customs union with the EU. Satisfactory progress with this project would lay a solid base for future investments to strengthen administrative capacity in the financial management agencies and for future fundamental policy reforms, for which some thorough studies are needed. 46. In addition, the project will have a financial benefit to the Republic of Turkey. Turkey's foreign exchange receipts and non-debt capital inflows are denominated predominantly in U.S. dollars. Consequently, the Government anticipates that the U.S. dollar single currency loan will help improve its external portfolio management by creating a better balance in the currency composition of its external debt liabilities and foreign exchange inflows.  - 12 - Risks 47. The major risks relate to: (a) the large overall agenda for stabilization and reform facing the Government, which may lead implementation of institutional reforms to be given lower priority; (b) the institutional diversity and complexity of the project, which may strain the administrative capacity of the Government and lead to bottlenecks in implementation; and (c) failure of the technical assistance for any of a number of systemic reasons despite the clear ownership of and political support for the project. Considerable effort will be required to ensure that the proper pace and sequence of implementation is achieved in each of the involved agencies. It is hoped that the considerable time and resources invested in elaborating the design of the various components with the project entities (including the slicing of the overall Ministry of Finance program into two projects) and the implementation arrangements will mitigate these risks. Ultimately, however, as highlighted by past Bank experience with similar operations in other parts of the world, the only way to deal with this complex of risk factors is through intensive supervision efforts by both the Government and the Bank as provided for under the PFMP. Recommendation 48. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve it. James D. Wolfensohn President by Richard H. Frank Attachments: Schedules A - D Washington, D.C. August 29, 1995  - 13 - Schedule A Page 1 of 2 REPUBLIC OF TURKEY PUBLIC FINANCIAL MANAGEMENT PROJECT Estimated Costs and Financing Plan (UN$mflilon) Local Foreign Total ESTIMATED PROJECr CosTs: Tax Administration Component Civil Works 0.0 0.0 0.0 Goods/Equipment 0.3 4.8 5.1 Training 1.4 0.4 1.8 Advisory Services 0.0 6.7 6.7 Project Support 0.2 0.4 0.6 Subtotal 1.9 12.3 14.2 Expenditure and Personnel Management Component Civil Works 0.1 0.0 0.1 Goods/Equipment 1.2 4.8 6.0 Training 0.4 0.3 0.7 Advisory Services 0.5 3.0 3.5 Project Support 0.1 0.0 0.1 Subtotal 2.3 8.1 10.4 Customs Modernization Component Civil Works 5.5 0.0 5.5 Goods/Equipment 9.9 41.3 51.2 Training 1.8 0.8 2.6 Advisory Services 0.0 1.6 1.6 Project Support 0.0 1.5 1.5 Subtotal 17.2 45.2 62.4 Total Base Costs 21.4 65.6 87.0 Total Physical Contingencies 0.8 2.4 3.2 Total Price Contingencies 0.9 3.1 4.0 Total Project Costs 23.1 71.1 94.2  - 14 - Schedule A Page 2 of 2 (US$million) Local Foreign Total FINANCING PLAN: Government 23.0 9.2 32.2 IBRD /a 0.1 61.9 62.0 Total Project Cost 23.1 71.1 94.2 /a txciucles taxes ana auties  - 15 - Schedule B Page 1 of 3 REPUBLIC OF TURKEY PUBLIC FINANCIAL MANAGEMENT PROJECT Summary of Proposed Procurement Arrangements and Disbursements (US$million) A. Procurement Procurement Method Project Element ICB Other NBF Total Civil Works - - 5.9 5.9 - - (0.0) (0.0) Equipment/Goods 57.1 0.9 9.9 67.9 (46.0) (0.5) (0.0) (46.5) Training - 1.5 3.7 5.2 - (1.5) (0.0) (1.5) Advisory Services - 11.0 0.5 11.5 - (11.0) (0.0) (I 11.0) Project Support - 1.0 0.7 1.7 - (1.0) (0.0) (1.0) Project Preparation Facility - 2.0 - 2.0 - (2.0) - (2.0) TOTAL 57.1 16.4 20.7 94.2 (46.0) (16.0) (0.0) (62.0) Note: Numbers in parentheses are the respective amounts financed by the IBRD loan. NBF Non-Bank Financed Other Includes sole sourcing, shortlisting of consulting firms and individual consultants (US$15.2 million), international shopping (US$0.33 million) and direct contracting (US$0.57 million). Differences due to rounding.  - 16 - Schedule B Page 2 of 3 B. Disbursements Percent of Amount of Loan of Expenditures Category in US$ equivalent to be Financed (1) Tax Administration Component (a) Goods 1,190,000 100% of foreign expenditures, 100% of local expenditures, (ex-factory cost) and 85% of local expenditures for other items procured locally (b) Training 500,000 100% (c) Consultants' services 6,000,000 100% (2) Expenditure and Personnel Management Component (a) Goods 4,680,000 100% of foreign expenditures, 100% of local expenditures, (ex-factory cost) and 85% of local expenditures for other items procured locally (b) Training 300,000 100% (c) Consultants' services 2,690,000 100% (3) Customs Modernization Component (a) Goods 35,250,000 100% of foreign expenditures, 100% of local expenditures, (ex-factory cost) and 85% of local expenditures for other items procured locally (b) Training 580,000 100% (c) Consultants' services (advisory) 1,560,000 100% (d) Project management support services 1,000,000 100%  - 17 - Schedule B Page 3 of 3 Percent of Amount of Loan of Expenditures Category in US$ equivalent to be Financed (4) Refunding the Project Preparation Advance 2,000,000 Amounts due pursuant to Section 2.02 (c) of Loan Agreement (5) Unallocated 6.250.000 TOTAL 62.000.000 Estimated IBRD Disbursements FY96 FY97 FY98 FY99 FY00 Annual 2.1 7.0 18.8 18.1 16.0 Cumulative 2.1 9.1 27.9 46.0 62.0   - 19 - ScheduleC REPUBLIC OF TURKEY PUBLIC FINANCIAL MANAGEMENT PROJECT Timetable of Key Project Processing Events (a) Time taken to prepare: Fourteen months - February 1994 to April 1995 (b) Prepared by: The Government of the Republic of Turkey with Bank assistance, and consultants financed under grants from the Governments of Japan and France (c) Appraisal Mission Departure: April 1995 (d) Negotiations: July 1995 (e) Planned Date of Effectiveness: November 1995 (f) List of relevant PCRs and PPARs: Turkey: Technical Assistance Project for State Economic Enterprises (Loan 2400-TU) PCR, Report No. 10326 date February 11, 1992   - 21- Schedule D Page 1 of 2 REPUBLIC OF TURKEY PUBLIC FINANCIAL MANAGEMENT PROJECT The Status of Bank Group Operations in Turkey A. Statement of Bank Loans and IDA Credits (As of June 30, 1995) Anount (Smillion) Fiscal (lc8 cancellations) Loan No. Year Borrower Purpose Bank IDA Undisbursed Ninety-nine loans, six B-loans and 14 credits are closed, 7843.60 196.15 21.29 of which SECALs, SALs and Program Loans: a/ Ia. 1515-TU 1980 Republic of Turkey SAL 200.00 0.00 Ln. 1915-TU 1981 Republic of Turkey SAL 75.00 0.00 Ln. 1987-TU 1981 Republic of Turkey SAL D 300.00 0.00 Ln. 2158-TU 1982 Republic of Turkey SAL I11 304.50 0.00 Ln. 2321-TU 1983 Republic of Turkey SAL IV 300.80 0.00 Ln. 2441-TU 1984 Republic of Turkey SAL V 376.00 0.00 Ln. 2585-TU 1985 Republic of Turkey ASAL 250.19 0.00 La. 2714-TU 1986 Republic of Turkey FSAL I 300.00 0.00 Ln. 2964-TU 1988 Republic of Turkey Financial Sector Adjustment D 299.64 0.00 La 2856-TU 1987 Republic of Turkey Energy Sector Adjustment 311.97 0.00 La. B0160-T 1987 Republic of Turkey B-Loan for FSAL I 32.90 0.00 Ln. B0190-T 1987 Republic of Turkey B-Loan for FSAL I 20.00 0.00 La. B0220-T 1988 Republic of Turkey B-Loan for ESAL 30.10 0.00 LA. B0240-T 1989 Republic of Turkey B-Loan for FSAL 11 29.85 0.00 Subtotal 2830.95 0.00 Ln. 2776-TU 1987 Republic of Turkey Non-Formal Vocational Training 58.50 32.50 Ln. 2818-TU 1987 IZSU Izmir Water & Sewerage 116.00 36.91 Ln. 2888-TU 1988 ISKI Istanbul Water Supply 218.00 43.18 Ln. 2922-TU 1988 Republic of Turkey Industrial Training U 115.80 32.04 Ln. 3057-TU 1989 Republic of Turkey Health 1 75.00 47.62 La. 3067-TU 1989 Republic of Turkey Small- & Medium-Scale Industry 11 204.50 66.99 Ln. 3077-TU 1989 Republic of Turkey Agro-Industry 150.00 99.09 LA. 3151-TU 1990 ASKI Ankara Sewerage 173.00 151.06 La. 3177-TU 1990 Republic of Turkey Second Agricultural Extension 63.00 27.78 La. 3192-TU 1990 Republic of Turkey National Education Dev. 90.20 79.21 Ln. 3296-TU 1991 Republic of Turkey Technology Development 100.00 80.93 La. 3324-TU 1991 Republic of Turkey State & Provincial Roads 250.00 87.52 Ln. 3345-TU 1991 TEK TEK Restructuring 300.00 219.98 La. 3346-TU 1991 Republic of Turkey Private Investment Credit 200.00 171.66 Ln. 3472-TU 1992 Republic of Turkey Agricultural Research 55.00 52.56 LA. 3477-TU 1992 Republic of Turkey Treasury Data Systems 9.20 3.22 Ln. 351 1-TU 1993 Republic of Turkey Earthquake Reconstruction 285.00 144.63 Ln. 3541 -TU 1993 Republic of Turkey Employment & Training 67.00 58.99 La. 3565-TU 1993 Bursa Water Supply & Sewerage Bursa Water & Sanitation 117.00 111.13 La. 3566-TU 1993 Bursa Metropolitan Municipality Bursa Water & Sanitation 12.50 10.95 Ln. 3567-TU 1993 Republic of Turkey Eastern Anatolia Watershed Rehab. 77.00 70.65 La. 3728-TU 1994 Republic of Turkey Privatization Implementation 100.00 95.25 La. 3802-TU 1995 Republic of Turkey Health Ut 150.00 149.04 La. 3893-TU 1995 Antalya Water Supply Auth. Antalya Water Supply 100.00 100.00 Subtotal 3086.70 1972.89 Total 10930.30 196.15 1994.18 Of which has been repaid 5026.47 63.16 Total now outstanding 5903.83 132.99 Amounts sold 3.55 of which has been repaid 3.55 Total now held by IBRD 5903.83 Total undisbursed 1994.18 a/ Approved during or after FY80 * SECAL  - 22 - Schedule D Page 2 of 2 Status of Bank Grout Operations In Turkey B. Statement of IFC Investments (As of June 30, 1995) Amount ($millioe) (less cancellaions) Date Borrower Purpose Loan Equity Tot 1966/69nin2 Sifas Textiles 3.15 142 4.57 1973 Akdeniz Tourism 0.34 0.27 0.61 1974 Aka Textiles 10.00 0.00 10.00 1975 Aslan Cement manufacturing 5.60 0.00 5.60 1975 Kartaltepe Textiles 1.30 0.00 1.30 1975 Sasa Resin & Plastic manufacturing 7.50 0.00 7.50 1974M Bonman Iron & Steel 3.60 0.50 4.10 1976/79 Asil Celik Machinery & equipment 12.00 4.00 16.00 1979 Ege Mosan Motorcycles & bicycles 2.15 0.00 2.15 1980 Mens Textile 4.00 0.00 4.00 1982 Man Motors Mtor Vehicles 7.89 0.00 7.89 1964167169fl2n3r75n6778 TSKB DFC 15.00 4.74 19.74 s969nons182183 Viking Paper manufacturing 2.50 0.82 3.32 1975sns818113 Dodtas Iron & Steel 7.50 1.53 9.03 1984 Pinar Et Slaughtering 10.90 0.00 10.90 1985 Manas Motor Vehicles 6.47 0.00 6.47 79/80/82/83/84185 Iass Metals & motor vehicles 8.00 3.19 11.19 1986 Cam Elyaf Glass mAnufacturing 7.94 0.00 7.94 1987 Guney Textiles 16.48 0.00 16.48 1988/91192 Uluslarrasi Endustri ve Financial Services 25.00 0.00 25.00 1988/93 Elginkan Mfg. Non-Metalic Minieral PR 30.85 0.00 30 85 1989 Coats Iplik Textiles Wearing Apparel & Leather 7.72 0.00 7.72 1989 Turk Dis Ticaret Bankasi Capital markets 12.50 0.00 12.50 1989 Duss Textiles 17.00 0.00 17.00 1989 Isko Textils 33.24 0.00 33.24 1989 Sanko (SKST) Textiles 6.37 0.00 6.37 1988/89 Sariville Restaurants & hotels 2.66 2.15 4.81 1981/89 Kitareli Clas manufacturing 3147 0.00 31.47 1986/89 ESaka Turizm Tourism 9.08 0.00 9.08 1990 FSP (Kamelya) Restaurants & hotels 1218 0.00 12.18 1990 Mersin Restaurants & hotels 6.50 0.00 8.50 1990 Simplot Food products 9.40 0.00 9.40 1990 Turkish Invest. Fund Merchant bank 0.00 8.86 8.86 1990/94 Yeditepe Beynelmilel Otld Tourism 25.63 4.00 29.63 71n6183189 Nasas Metal manufacturing 8.58 1.55 10.13 1986/90 Silkar Tourism 14.37 4.92 19.29 1989/90 Kiris Hotel Restaurant & hotels 13.03 0.00 13.03 1991 Kepez Electric Utilities 25.00 0.00 25.00 1991 Kula Textiles 19.40 0.00 19.40 1979/83/84/89/91 Trakya Cam Class manufacturing 55.49 9.58 65.07 1970/86/87/90/92 ACS Glass Class Manufacturing 17.50 2.25 19.75 1992 Elbo Steam&IHotWaterSupply 19.33 0.00 19.33 1992 Finansbank Small- & Medium-Scal Enterprises 10.00 0.00 10.00 1992 Heller Factoring Export Finance 0.00 0.50 0.50 1992 Korfezbank Small- & Medium-Scale Enterprises 8.00 0.00 8.00 1992 Mis Sut Sanayi Dairy Products 10.00 5.00 15.00 1992 NASCO Textiles 15.00 2.50 17.50 1989/92 Ram Dis Ticaret Other 18.25 0.00 18.25 1990/91/92 Koy Tur Slaughtering 8.60 4.13 12.73 88/90/93 IGFK Leasing 5.00 0.94 5.94 1993 Caveli Bakir Non-ferrous ore mining 30.00 0.00 30.00 1993 Eldor Radio/TV Communication 4.00 1.00 5.00 1993 Sise ve Cam Class manufacturing 10.82 0.00 10.82 1993 Medya Printing, Publishing & Allied Ind. 12.13 0.00 12.13 1994/95 Globe Securitie Investment & Merchant Bank Securiti 0.00 1.34 1.34 1994 Demirbank Sals & Export Finance Leasing 15.00 0.00 15.00 1994 Pinar Sut Manufacturer of Dairy Products 7.50 0.00 7.50 1994 Turkiye Garanti Securities Mkt Financing bIsti. 20.00 0.00 20.00 1994/95 CBS Holding Mfg. of paints, varnishes & cq. 15.00 0.00 15.00 1994 Aytac Mfg. of food, beverages & tobacco 8.00 2.00 10.00 1994 Cerrahogullari Transport & storage 10.00 0.00 10.00 1994 Assan Non-ferrous metal basic industry 15.40 0.00 15.40 1995 Caranti Leaing AS. Capital market 7.00 0.00 7.00 1995 Turk Ekn Bnk-CL Commercial banks 20.00 0.00 20.00 Total Gross Commuitments 786.32 67.19 853.51 Less Cancellations, Termination Exchanges Adjustments, Prepayments and Sales 347.95 29.66 377.61 Total Commitments now held by IFC 438.37 37.53 475.90 Total Undisbursed IFC 33.34 0.03 33.37 Total Outstanding IFC 405.03 37.50 442.53  IBRD 24903R '. BULGARIA 30' 3- S0 40 GEORGIA Z 5 _,~,0 d a - ..z < -B -')UL- ' , SZONGUuDAK " AMONOU . {, , ,, 5 2 ARIAMENIA -- GREECE- v _ 1*-=as -- MAAtA _ _NISeffu-N ,_, r 1,2D _ s //XA\_>o_; _ i) - _ d!>I -5 - sRAP NATIONAL CAPITAL -a- MAJOR ROADS - PROVINCE BOUNDARIES MILES