Turkey - Corporate Sector Impact Assessment Report

Report No. 23153-TU Turkey Corporate Sector Impact Assessment Report March 2003 Private and Financial Sector Development Europe and Central Asia Region Document of the World Bank  Currency Equivalents Currency Unit = Turkish Lira (TL) US$1 = TL 1,694,915 (as of March 19, 2003) Acronyms and Abbhrev4aflons ASO - Ankara Sanayi Odasi (Ankara Chamber of Industry) ATO - Ankara Ticaret Odasi (Ankara Chamber of Commerce) BOTA$ - Boru Hatlari ile Petrol Tagima A$ (Petroleum Pipeline Corporation) BRSA - Banking Regulation and Supervision Agency CDRAC - Corporate Debt Restructuring Advisory Committee CIS - Commonwealth of Independent States ERDEMIR - Eregli Demir ve (elik Fabrikalari T.A.$ (Eregli Iron and Steel Works Company) FDI - Foreign direct investment FIAS Foreign Investment Advisory Service IAC - Investment Advisory Council IAS - International Accounting Standards IMF - International Monetary Fund ISE - Istanbul Stock Exchange ISO - Istanbul Sanayi Odasi (Istanbul Chamber of Industry) KOSGEB - Kuc uk ve Orta OlIekli Sanayi Gelistirme ve Destekleme Idaresi Baskanligi (Small and Medium-size Enterprises Development Organization) NGO - Nongovernmental organization PETKIMv - Petkim Petrokimya Holding A.$. POAS - Petrol Ofisi A. , (Petroleum Distribution Company) REIT - Real Estate Investment Trust SDIF - Savings Deposit Insurance Fund SSK - Sosyal Sigortalar Kurumu (Social Insurance Agency) TBA - Turkish Bankers Association TEA$ - Turkiye Elektrik Uretim ve Iletim A.$. (Turkish Electricity Generation and Transmission Company) TEDA$ - Tirkiye Elektrik Dagitim A.$. (Turkish Electricity Distribution Corporation) TL - Turkish lira TOBB - Union of Chambers of Commerce, Industry, Maritime Trade, and Commodity Exchanges of Turkey (Tuirkiye, Ticaret, Sanayi, Deniz Ticaret Odalari ve Ticaret Borsalari Birligi) TSKB - Tirkiye Sinai Kalkinma Bankasi (Industrial Development Bank of Turkey) TUPRA$ - Tiirkiye Petrol Rafinerileri A. $. (Turkish Petroleum Refineries Corporation) TUSLAD - Tirk Sanayicileri ve I,adamlari Dernegi (Turkish Industrialists' and Businessmen's Association) VAT - Value Added Tax YASED - Foreign Investors Association of Turkey (Yabanci Sermaye Demegi) Vice President: Johannes Linn Country Director: Ajay Chhibber Sector Director: Paul Siegelbaum Team Leader: Ira Lieberman  Acknowledgments This report is truly a World Bank Group effort. It could only have been prepared with the support of the International Finance Corporation team in Istanbul, of World Bank staff in Ankara-who have been besieged by the demands of Turkey's recent economic crisis-and of various Bank staff with years of corporate and related experience. In addition, the authors were supported with great dedication, professionalism, and expertise by local Turkish consultants and by two corporate advisers in Turkey-Deloitte & Touche and McKinsey & Company. The report was written by Ira Lieberman (Task Manager/Sector Manager, ECSPF), Robert R. Gourley (Senior Private Sector Development Specialist, PSASP), Zeynep Kudatgobilik (Consultant), Leonid Koryukin (Research Analyst, AFTM1), Yasuo Izumi (Sector Manager, ECSPF), William Peter Mako (Senior Private Sector Development Specialist, EASPS), Gurhan Ozdora (Senior Operations Officer, ECSPF), Tunc Uyanik (Senior Financial Specialist, ECSPF), Michele Shuey (Investment Officer, CSET1), Can Pamir (Investment Officer, CSETR), Sena Sancakli (Team Assistant, CSETR), Suha Satana (Consultant), Caglar Ergun (Consultant), and Erkan Ozcelik (Consultant). Sophia Cox and Meral Gokcek are the Program Assistants who assisted with the report. The report team appreciates the time taken by senior managers of the many Turkish companies interviewed directly and through surveys during the crisis. They were invariably gracious and accommodating. The team also appreciates the time taken by senior managers of private commercial banks, private development banks, and state-owned banks. In addition, the team is grateful to Turkey's various chambers of commerce and industry-especially the Ankara Chamber of Commerce, Ankara Chamber of Industry, and Union of Chambers of Commerce, Industry, Maritime Trade, and Commodity Exchanges of Turkey, which surveyed more than 10,000 enterprises throughout Turkey. The Industrial Development Bank of Turkey and the Turkish Industrialists' and Businessmen's Association worked with the team throughout the crisis and assisted with our many requests-setting up interviews, organizing corporate and financial sector roundtable discussions, and conducting their own analysis of the crisis. More recently, the report team has worked closely with the Turkish Bankers Association on its proposal for a resolution strategy. The team thanks the association for its openness and willingness to consult with us on this issue. Finally, the team greatly appreciates the support of public officials and other institutional representatives who, despite being under great stress due to the crisis, were always available to meet with and assist us. These include representatives of the Treasury, Central Bank, Banking Regulation and Supervision Agency, Institute of Statistics, State Planning Organization, Privatization Administration, Istanbul Stock Exchange, and Small and Medium-size Enterprises Development Organization.  I  TABLE OF CONTENTS EXECUTIVE SUMMARY ...................I 1. INTRODUCTION .1 2. OVERVIEW OF THIE CRISIS .3 The Govemment's Economic Growth Program-and Recent Developments . 3 A Deeper Crisis Than Before .4 3. CORPORATE PERCEPTIONS OF THE CRISIS .12 Summary ....... 29 4. ANALYSIS OF CORPORATE DISTRESS .30 Losses in Listed Companies .33 Prospects for Export-led Growth .35 Financial Indicators for Listed Companies .37 Strategies Used to Protect and Increase Cash Flows .43 Corporate Borrowing .46 Sumary .49 5. RESOLUTION STRATEGIES .51 Segmenting Problem Companies .52 Monitoring Large Corporations and Groups in Distress .53 Implementing a Voluntary Workout Program .55 Easing Tax, Legal, and Regulatory Impediments to Crisis Resolution .60 Improving Financial Reporting and Accounting Standards .65 Enhancing Corporate Goverance .66 6. OTHER STRUCTURAL REFORMS THAT AFFECT THE CORPORATE SECTOR . 69 Financing the Real Sector .70 Attracting Foreign Direct Investment .71 Accelerating Privatization .73 BIBLIOGRAPHY ............ 76  Tables Table 1. Macroeconomic Projections, 2001-02 ................................................................... 4 Table 2. Changes in GNP by Sector, January-December 2001 .......................................................5 Table 3. Exports, Imports, and the Trade Deficit, July and January-December 2000-01 ...............6 Table 4. Annualized Changes in Industrial Production, July and January-December 2000-01 ......6 Table 5. Capacity Use Rates in Manufacturing, January-December 2000-01 .................................7 Table 6. Changes in Electricity Demand, January-September 2001 ...............................................8 Table 7. Employment and Unemployment Indicators, 1998-2001 ..................................................8 Table 8. Changes in Production-related Labor in Manufacturing, January-August 2000-01 ..........9 Table 9. Number of Companies Opened and Closed, July and January-July 2000-01 ...................9 Table 10. Foreign Direct Investment, 1996-2001 ................................................................. 10 Table 11. Findings from the ISO Survey .................................................................. 28 Table 12. Review of FY2001 Earnings-Industrials and Services ................................................. 31 Table 13. Net Profitability by Sector, 2000 Q1 and Q2-2001 Ql and Q2 ..................................... 31 Table 14. Financial Indicators for Listed Companies, 1997-2001 ................................................. 32 Table 15. Exports by Sector and Sector Contribution to GDP, 1999 ............................................ 35 Table 16. Export Revenues as a Share of Total Revenues in Selected Sectors, 1999 ................... 35 Table 17. Export Orientation and Profitability by Sector, 2000-01 ............................................... 36 Table 18. Key Recommendations for Corporate Resolution ......................................................... 52 Table 19. Key Recommendations to Complement Corporate Resolution ..................................... 69 Table 20. Interest Rates, 1995-2000 ................................................................. 70 IFigures Figure 1. Change in GNP in Constant Prices, 1999-2001 ...............................................................5 Figure 2. Changes in Public and Private Investment, 1997-2001 ....................................................7 Figure 3. TOBB and ATO Survey Questions on Overall Distress ................................................ 13 Figure 4. TOBB and ATO Survey Questions on Financing .......................................................... 14 Figure 5. TOBB and ATO Survey Questions on Exports .............................................................. 15 Figure 6. TOBB Survey Questions on Distress, by Firm Size Ql 2001 ........................................ 16 Figure 6a. TOBB Survey Questions on Distress by Firm Size Q4 2001 ....................................... 17 Figure 7. TOBB Survey Questions on Workforce QI 2001 ......................................................... 18 Figure 7a.TOBB Survey Questions on Workforce Q4 2001 ......................................................... 19 Figure 8. Did You Borrow from Banks in the First Quarter of 2001? ........................................... 20 Figure 9. Do You Expect Export Sales in 2001 to Be Greater than in 2000? ............................... 21 Figure 10. If You Think Exports Will Increase, What Will Be the Approximate Level of the Increase? ................................................................. 22 Figure 11. ASO Survey Findings in Q4 2000, QI 2001 and Expectation for 2001 .................... 23 Figurel la. ASO Survey Findings Q3, Q4 and Expectation for 2002 .......................................... 24 Figure 12. Average Plant Capacity Use in Ankara, 2000 Q4-2001 Q2 ......................................... 25 Figure 13. Exports as a Share of Sales for Firms in Ankara ......................................................... 26 Figure 14. Financing Indicators for Firms in Ankara .................................................................. 27 Figure 15. ATO Survey Findings on Sales and Equity Capital .................................................... 28 Figure 16. Ratios of Liabilities to Equity and Interest Coverage in Various Economies .............. 33 Figure 17. Profitability for Export- and Domestic-oriented Industries .......................................... 37 Figure 18. Interest Coverage for Export and Domestic-oriented Industries .................................. 38 Figure 19. Short-term Liabilities for Export and Domestic-oriented Industries ............................ 39  Figure 20. Bank Borrowing for Export and Domestic-oriented Industries ................................... 40 Figure 21. Does Size Matter? ................................................................. 41 Figure 22. Distressed Companies, 1998-2001 Ql ................................................................. 42 Figure 23. Ages of Receivables and Inventories for Services and Industry, 1999-2001 Q2 ......... 45 Figure 24. Age of Payables for Services and Industry, 1999-2001 Q2 ......................................... 46 Figure 25. Institutional Structure for the Istanbul Approach ......................................................... 57 Figure 26. Process for the Istanbul Approach ................................................................. 58 Boxes Box 1. Why Exports Are Not a Complete Solution ................................................................. 44 Box 2. Legal Framework for Creditor Rights and Enforcement ................................................... 62 Annexes Annex 1. Comparative Analysis of Recent Corporate Crises Annex 2. Survey Data Analysis Annex 3. Analysis of Istanbul Stock Exchange Data Annex 4. Interpreting Turkish Financial Statements Annex 5. Organizations and Companies Interviewed   Executive Summary I. Introduction 1. In February 2001 Turkey was hit by its deepest economic and financial crisis since World War II, prompting a severe decline in business activity. The adverse effects of the crisis were felt throughout the economy-starting in the public sector, spreading to the financial sector, and causing increasing distress in the real sector. To restore growth and return companies to profitability, Turkey urgently needs to implement a comprehensive corporate restructuring program. Moreover, simultaneous resolution efforts are needed in cases where corporate distress is creating distress for financial institutions. II. Overview of the Crisis 2. In 2001 Turkey's real GNP fell 9.4 percent. The crisis has hurt all sectors-industry, construction, trade, and services. Industrial production fell 6.9 percent in the first half of 2001 and 9.9 percent for the year. During 2001 plant capacity use in the private sector ranged from 62 percent in March and May to 68 percent in the fourth quarter, suggesting that the crisis may have bottomed out. Still, capacity use remains below the break-even point for most manufacturers. Lower domestic demand is the most important factor undermining growth. Increased exports in a number of sectors-such as automobiles and textiles-helped mitigate corporate losses but even these sectors suffered significant losses in 2001. 3. The downturn forced most firms to reduce their workforces throughout 2001. Efforts have also been made to control wage costs, with shorter work weeks, strict controls on overtime, accelerated vacation and maintenance schedules, and temporary furloughs. Although Turkish firms have been agile in responding to the crisis, corporate and worker distress is considerable. At the end of 2001 some 2.3 million workers-10.6 percent of the workforce-were unemployed, and another 6 percent of the workforce was underemployed. 4. The effects of the crisis on companies vary significantly by sector, reflecting the contraction in domestic demand, the February 2001 devaluation of the Turkish lira, and the share of exports in production. However, a highly volatile exchange rate in the first half of 2001 made it extremely difficult for manufacturers in all sectors to estimate costs and potential revenues. Such uncertainty has forced many companies to scale back operations, slash investments, and even close manufacturing operations, preferring the safety of liquid assets. In 2001 private investments fell by nearly a third. Although operating results worsened in the fourth quarter of 2001, the appreciation of the lira relative to the euro and the U.S. dollar led to a slight improvement in corporate earnings-the result of reduced foreign exchange losses and financial charges.  m. Corporate Perceptions of the Crisis 5. To assess corporate performance in the first and second and fourth quarters of 2001 as well as expectations for the rest of the year, more than 10,000 firms were surveyed by the Union of Chambers of Commerce, Industry, Maritime Trade, and Commodity Exchanges of Turkey (TOBB), Ankara Chamber of Commerce (ATO), Ankara Chamber of Industry (ASO), and Istanbul Chamber of Industry (ISO). (See Annex 2 for a summary of the various surveys.) Among the key findings: * About four out of five respondents to the TOBB and ATO surveys indicated that business was worse in the first quarter of 2001 than in 2000, and about one-third of TOBB respondents and three-fifths of ATO respondents expected conditions to deteriorate further during the rest of the year. * Some 56 percent of TOBB respondents and 65 percent of ATO respondents cut staff in the first quarter, and 41 and 56 percent expected further cuts before the end of 2001. * About 70 percent of TOBB and 50 percent of ATO respondents did not borrow from a bank in the first quarter, and 74 and 80 percent did not expect to borrow during the rest of the year. * Expectations that the devaluation of the lira would boost exports were validated: 25 percent of TOBB and 36 percent of ATO respondents indicated that exports increased in the first quarter, and 31 percent of TOBB respondents expected exports to increase at least 20 percent over the rest of 2001. e Size is an important determinant of distress. Firns of all sizes have been hurt by the crisis, but microenterprises and small firms were hit earlier and harder than medium-size and large firms. * The ASO survey found that many firms around Ankara cancelled orders in the first quarter-60 percent cancelled orders of raw materials, 77 percent intermediary goods, and 84 percent investment goods. * The ISO survey of manufacturers around Istanbul found that small and medium-size enterprises reduced their workforces by 19 percent in the first half of 2001. Among the complete ISO sample (including large firms), 8 percent of the workforce was cut during that period. o Nearly three-quarters of ISO respondents faced financing difficulties, and 7 in 10 were in contention with banks over outstanding loans. o A second ATO survey found that in the first half of 2001 about a third of firms had lost 60 percent or more of their capital, and half had lost 40-60 percent. Overall, the surveys found corporate distress that is both broad (affecting all types of firms) and deep (with many finns facing the possible loss of all their equity). By mid-2001 there was a clear need for a corporate resolution program to complement bank restructuring.  - iii - 6. Less extensive follow-up surveys were conducted by TOBB to assess results for the fourth quarter of 2001 and expectations for 2002, and by ASO for the third and fourth quarters of 2001 and expectations for 2002. Among the key findings:' * The ASO survey found that most firms saw production, domestic sales, international sales, and new orders fall in the third and fourth quarters and anticipated continued declines in 2002. * The TOBB survey found that 62 percent of small and medium-size firms and 40 percent of large firms saw their situation worsen in the fourth quarter, while things improved for 8 percent of small firms and 15 percent of large firms. Looking to 2002, 26 percent of small firms expected conditions to improve, 42 percent expected no change, and 32 percent expected things to continue deteriorating. Large firms were more optimistic, with 41 percent expecting improvement, 28 percent expecting no change, and 31 percent expecting continued deterioration. * Among TOBB respondents, 70 percent of small firms andA49 percent of large firms saw sales fall in the fourth quarter. For 2002, 63 percent of small firms expected sales to decline or not to change. Large firms were more optimistic, with 48 percent expecting sales to increase. * A majority of firms in the ASO survey experienced no changes in employment in the third and fourth quarters and anticipated the same for 2002. But almost 40 percent of firms indicated that employment had decreased during the second half of the year and expected employment to continue decreasing. The TOBB survey, in contrast, found that 62 percent of small firms and 46 percent of large firms had cut workers in the fourth quarter. For 2002, 47 percent of small firms anticipated no change in their workforces, while 27 percent of large firms expect to hire. However, 37 percent of small firms and 40 percent of large firms expect to continue reducing their workforces. * About three-quarters of small firms and half of large firms in the TOBB survey indicated that capacity use had fallen in the fourth quarter. The ASO survey had slightly different results, with capacity use rising from 44 percent in the second quarter of 2001 to 48 percent in the fourth quarter-well below the national averages. * The TOBB survey confirmed expectations about borrowing-88 percent of small firms and 69 percent of large firms did not borrow in the fourth quarter, and about the same ratio did not expect to borrow in 2002. Among firms that did borrow, 13 percent of small firms and 14 percent of large firms were required to increase collateral, 23 percent and 31 percent paid higher interest rates, and 39 percent and 41 percent experienced no change in lending conditions. * The ASO survey found that 24 percent of firms had used commercial bank loans, 8 percent used Eximbank resources, and 7 percent used leasing facilities (with some overlap among these categories). Of the firms that borrowed, 13 percent were required to repay their loans in full during the fourth quarter of 2001. When asked about financial constraints, 30 percent of firms cited high credit costs, 21 percent a rapid increase in The follow-up surveys are considerably smaller than the surveys conducted in the first half of 2001. But the TOBB survey appears to be reasonably representative of small, medium-size, and large firms, and together the two surveys sample some 330 firms. Nevertheless, caution should be used in drawing conclusions from these survey results.  - iv - working capital requirements, 20 percent an inability to generate cash flow, 15 percent insufficient credits, and 15 percent declining support from financial institutions. * The ASO survey found that 50 percent of firms had cancelled capital investments for the domestic market and 70 percent for the international market. * Finally, TOBB respondents said that the most difficult problems they faced in 2002 were taxes (22 percent of small firms and 20 percent of large firms), depressed domestic demand (14 percent and 20 percent), high operating costs (28 percent and 8 percent), difficulties in repaying or finding financing (15 percent and 9 percent), and collection of receivables (13 percent for both). 7. The follow-up surveys clearly indicate that there was no turnaround in operating performance in the third and fourth quarters of 2001 (a finding confirmed by analysis of Istanbul Stock Exchange data; see below). The employment situation was more mixed-the surveys seem to confirm a bottoming out of layoffs by the end of the year. Still, many firms remain in distress, and developments in the second half of the year did nothing to alleviate it. For 2002, small firms were more pessimistic than large firms about prospects for a turnaround: 41 percent of large firms anticipated a better year. IV. Analysis of Corporate Distress 8. Data for nonfinancial companies (industry and services) listed on the Istanbul Stock Exchange (ISE)-a sample representative of Turkey's mid-cap and large companies-show worrisome trends. Previous crises (in 1998, 1999, and November 2000) lowered company profits and increased financial fragility. Although economic conditions improved during much of 2000, many firms remained in poor financial health and have had trouble surviving the current crisis. Net profitability declined steadily between late 1997 and late 2000, then turned into major losses in the first half of 2001 in every manufacturing sector except cement and glass. Losses totaled $1.021 billion at the end of the second quarter of 2001, down from profits of $1.567 billion in the same period in 2000. Interest rate coverage on a EBITDA basis dropped below one beginning in the first quarter of 2001 and stayed that way until the fourth quarter. Debt coverage ratio was consistently above one through 1999-2000. In addition, financial expenses rose sharply as a percentage of revenue in the first quarter, hitting 27 percent. 9. By the end of 2001 there was some optimism about corporate performance because of better earnings in the fourth quarter, with listed nonfinancial companies becoming marginally profitable. As noted, earmings were aided by the strength of the Turkish lira relative to the euro and the dollar, which lowered companies' financial charges and foreign exchange losses. However, sales and earnings from operations were actually lower than in any other quarter of the year, partly reflecting seasonal patterns. Thus the hoped-for turnaround or bottoming out in operating performance did not occur. In 2001 sales of listed companies were down 13 percent from 2000, earnings before interest, taxes, depreciation, and amortization (EBITDA) were down 11 percent, and net earnings were down a staggering 80 percent. 10. Many companies were agile in their response to the crisis. For example, they took advantage of export opportunities, with exports up 30 percent for the year. However, financial charges on foreign-denominated debt and foreign exchange losses overwhelmed firms' operating  performance, leaving many in deep distress. The automotive industry, consumer durables, food and beverages, electronics and communications, media, and retail sales were the most adversely affected sectors. Only the cement, building materials, glass and ceramics, and airline and ground handling sectors saw better performance in 2001. 11. The recent crises have put a larger share of listed companies at medium or high risk of default. Between the first quarters of 1999 and 2001 the share of listed companies at medium risk rose from 63 to 69 percent-while those at high risk jumped from 2 to 11 percent. Together these companies accounted for 58 percent of listed companies' sales, 56 percent of employment, and 89 percent of bank liabilities. 12. Distressed companies have few opportunities for a turnaround in the short term. Lower domestic demand, the appreciation of the lira, price-sensitive export customers, and the soft global economy may constrain any significant increase in sales. Companies have cut production costs through import substitution and payroll reductions. They have also tried to improve management of working capital, but a general lengthening of receivables and inventories demonstrates the difficulty of doing so in a systemic crisis. As noted, companies have also significantly cut investments, with private investments down nearly a third in 2001. A few companies and banks have made rights offerings to increase equity capital, but the depressed stock market discourages equity financing. In addition, Government borrowing has crowded out the corporate bond market in recent years, and banks have limited lending to blue-chip customers. 13. It is difficult to assess corporate distress from reported financial data. Turkish accounting standards fall far short of International Accounting Standards (IAS), especially in terms of accounting for leases, inflation accounting, requirements for consolidation or equity accounting for investments, and rules on disclosing and provisioning for impaired assets and contingencies. These shortcomings are particularly troublesome for large groups (conglomerates), many of which own financial institutions. 14. Although Turkey's crisis is largely attributable to public debt and the investment activities of domestic banks-rather than, as was the case in East Asia, excess leveraging and defaults by large corporations-the spillover of financial sector distress threatens the real sector. New loans and extensions of old ones are increasingly concentrated in large blue-chip companies, and financing is becoming scarce for small and medium-size companies-especially those with no export orientation. But while the supply of credit is severely constrained, so is the demand. With real interest rates on lira-denominated loans averaging 30 percent, few corporations can afford new bank loans. 15. Bank assets contracted significantly in 2001. Factors contributing to a credit crunch for all but blue-chip borrowers include lending constraints on state banks, the exit of intervened banks from new lending, the need for banks to repay syndicated loans in the second half of 2001, and credit retrenchment by small banks-many or most of which have weakened capital and rising nonperforming loans. The credit crunch will persist throughout the current period of bank recapitalization and probably well beyond.  - vi - 16. Several factors will limit the ability of Turkish financial institutions to resolve distress among corporate borrowers. Weak insolvency and foreclosure procedures may encourage a race to seize collateral, inhibiting orderly workouts of nonliquid but viable companies. Small, capital- weakened banks could be particularly nettlesome in corporate workout negotiations. In addition, the considerable power of the Savings Deposit Insurance Fund over intervened banks could work against coordinated resolution strategies. Moreover, the weakened capital positions of large private banks limit their ability and willingness to lend. Recapitalization of the banks is closely linked to corporate workouts. 17. Banks need to recognize that such workouts can reduce nonperforming loans and restore their clients' creditworthiness. In addition, the Banking Regulation and Supervision Agency needs to develop policies that encourage banks to participate in voluntary workouts. The agency also needs to consider regulatory forbearance-whether in terms of not requiring full provisioning for nonperfonning loans or allowing banks to achieve capital adequacy over time. The agency's decision requiring banks to fully disclose their nonperforming loans seems correct in light of East Asia's recent bank crises. The new banking law addresses the issue of capital adequacy. Finally, the required restructuring and privatization of state banks inhibit the Government's ability to provide liquidity to small and medium-size businesses. 18. Extemal factors are also contributing to Turkey's distress, increasing the risk of a stalled recovery. From a corporate perspective, the main external risks are the soft global economy- particularly in Europe, the destination for more than half of Turkey's exports-and the flight to quality in global capital markets. These risks make it difficult for Turkey to attract foreign direct investment and portfolio investment and for Turkish banks and companies to borrow abroad. They will also delay privatization efforts, reduce the proceeds, or both. Another concem is the threat to tourism revenues for 2002 in the wake of the September 11, 2001, terrorist attacks on the United States. Finally, potential intervention in Iraq could hurt the Turkish economy in several ways. 19. The principal factor to Turkey's advantage is that the economic slowdown in OECD countries had led to lower benchmark OECD interest rates, partly offsetting the rise in spreads for Turkey caused by increased risk aversion. V. Resolution Strategies 20. Debt Resolution. The Government, working with banks and corporations, should implement a program to ease the debt burdens of several hundred mid-cap and large companies. Several thousand small and medium-size enterprises also need such assistance, but it should be provided through systemic measures rather than case-by-case workouts. Including small and medium-size enterprises in the workout process would only bog it down, as in Thailand's recent crisis. The debt resolution program should strengthen monitoring by the Banking Regulation and Supervision Agency (BRSA), introduce an out-of-court workout program geared toward mid-cap and large companies, eliminate tax, legal, and regulatory impediments to operational and financial restructuring of distressed companies, strengthen and streamline insolvency and foreclosure procedures, introduce an enhanced option for business rehabilitation, and expedite  - vii - the use of the Savings Deposit Insurance Fund (SDIF) to restructure and sell distressed business assets. 21. In addition, the Government should establish a financial analysis unit in the Treasury to monitor the financial positions of mid-cap and large corporations in distress and with major debt or equity links to local financial institutions. The East Asian crisis showed that a few key indicators could have identified firms highly vulnerable to distress well before they defaulted. 22. A voluntary, out-of-court workout program can provide temporary, financially stabilizing solutions for distressed but viable companies without clogging the courts. To avoid chaotic races among creditors to grab collateral, short-term standstill periods (lasting, say, three months) should be introduced to allow due diligence and preliminary development of workout agreements. In addition, it is essential to have mechanisms for resolving intercreditor disputes and encouraging financial institutions to share some of the losses from corporate restructuring. Rapidly consolidating the financial sector and eliminating weak or nonviable banks would help. New money should have priority status. To impose workouts on holdout minority creditors or public shareholders, it would be useful to obtain court enforcement through an expedited process such as "prepackaged" reorganizations. 23. Drawing on various models-the London approach; the programs implemented in the Republics of Korea, Malaysia, and Thailand; and Mexico's UCABE-and working with the Union of Chambers of Commerce and the Turkish Industrialists' and Businessmen's Association, the Turkish Bankers Association has made substantial progress in formulating such a workout program. Given the level of corporate distress, the program-informally known as the Istanbul approach-should be implemented as soon as possible. 24. The role of the Savings Deposit Insurance Fund and its powers relative to other creditors warrant careful review. The fund's powers should not be used to disadvantage similarly positioned creditors. In fact, the fund-which represents state banks and intervened private banks-will need to be part of any intercreditor agreement. Thus it is important to provide indemnities for executives of state banks who agree to debt reduction or workout arrangements for state and intervened banks. 25. Efforts should be made to expedite the sale of distressed assets through cooperative arrangements with the Savings Deposit Insurance Fund or an asset resolution agency. Given fiscal constraints, however, the Government should not establish a state-owned asset resolution agency. Instead, the Turkish Bankers Association should be encouraged to create one. East Asia shows that commercializing asset management efforts is the only way to moderate the large losses that have traditionally been incurred by state-owned asset management agencies. 26. There may be an opportunity to promote the formation of equity' and debt funds to recapitalize and provide long-term loans to Turkish corporations, as well as to replace short-term with long-term debt. These funds could be modeled on the experience in Korea, where the Korean Development Bank and local commercial banks invested $1.5 billion in four funds managed by Templeton, Scudder, State Street, and Rothschilds. The funds were reasonably  - viii - successful and, in at least one case, follow-on funds have been established and financed solely with offshore private capital. 27. Turkey's crisis may encourage distressed companies and banks to divest excess fixed assets or to sell and lease back primary real estate. In addition, banks will need to divest collateral (land, buildings) acquired as a result of the crisis. During its crisis Korea established a land bank so that companies could divest excess property holdings, with an option to reacquire them in the future. It did so to prevent a precipitous fall in values, as occurred in Japan. Although Korea's real estate investment trust (REIT) was owned by the state, Turkey could attract institutional investors to establish REITs. 28. Policy Measures. Some tax, legal, and regulatory impediments to corporate restructuring have already been addressed-for example, the Government has introduced tax relief for restructured debt and for corporate reorganizations and mergers. However, the banks would like to exclude value added tax (VAT) from workout transactions. 29. Insolvency and foreclosure procedures must be enhanced to facilitate the court- supervised rehabilitation of distressed but viable companies, to encourage debtors to cooperate with out-of-court workouts, and to impose reasonable solutions to corporate distress on holdout creditors and public shareholders. Key reforms include expediting procedures for seizing and selling collateral, enhancing court-supervised rehabilitation, and introducing an option for a fast- track, "prepackaged" reorganization. 30. To meet the need for increased equity and debt financing in 2002, particularly from foreign investors, Turkey should adopt International Accounting Standards for all listed companies and for unlisted affiliates and subsidiaries of large corporate groups. Better accounting standards and information disclosure are also important for companies undergoing *workouts, which typically reschedule debt over some medium-term period. The World Bank is pursuing more systematic accounting reforms with the Government, but that effort will likely take several years to complete. 31. Corporate Governance. The Capital Markets Board should adopt a corporate governance code that includes principles on transparency and disclosure. The code should also require the provision of timely, accurate information and bolster the rights of minority shareholders. In addition, Turkey should consider creating an institute of directors to train independent directors for seats on the boards of listed companies. 32. Postscript on Resolution Strategies. The Government announced the start of the workout program, known as the Istanbul Approach, as of June 1, 2002. The Turkish Bankers Association, working with Government and industry representatives, took the lead in developing a voluntary, non-judicial workout program based on the London Approach. The program, informally required the strong backing of the Treasury and the Ministry of Finance because of the policy and regulatory implications and the tax incentives required to make such a program operational. In addition, the Banking Regulation and Supervision Agency and the Savings Deposit Insurance Fund were involved in establishing clear provisioning rules in support of workouts and in coordinating workouts with intervened banks. Some 34 commercial banks and  - 1x - non-bank financial intermediaries, intervened banks represented by SDIF and state banks signed an inter-creditor agreement that governs the process. The workout program addressed the following important issues: * The willingness of creditors to pursue a non-judicial resolution to a company's financial difficulties rather than resort to a formal process of seizing collateral or an insolvency procedure such as liquidation. The out-of-court program process was time bound, with a maximum period set at 180 days for reaching agreement between the creditors and the debtor. * The process also required approval by a majority of creditors-those accounting for at least 75 percent of outstanding credit meant that the workout was approved. In the event that 55 percent of creditors by value approved the workout, but not 75 percent, the workout proposal was referred to arbitration. * Creating an arbitration panel to resolve inter-creditor disputes. * The commissioning by creditors of an independent due diligence review of each distressed company's long-term viability, drawing on comprehensive information made available by and shared between all the likely parties to any workout. * Drawing on the independent review, encouraging each company's main creditors to work together through a Creditors' Committee to reach a joint conclusion on whether a company is viable and on what terms it is worth supporting in the longer term. * During the review and negotiation of each workout, agreeing to a standstill, that is seeing whether the company's bankers will agree to maintain their credit facilities, thereby preserving the confidence of workers, suppliers, and customers by allowing the company to continue to operate normally. * Allowing companies to supplement their borrowing in case of a liquidity shortfall. New money could be provided on a pro rata basis by all existing lenders, by specific lenders with priority arrangements, or by the release of asset disposal proceeds subject to priority considerations. (Other principles underlying this critical period of financial support include recognizing the seniority of existing claims and sharing losses on an equal basis between creditors in the same category.) * If creditors agree that a company is viable over the long term, they then agreed to a formal rescheduling of the debts plus whatever other financial restructuring measures they deemed appropriate-such as an interest holiday, re-capitalization of interest in arrears, extension of loan maturities, lending of new money, or conversion of debt to equity.  o These longer-term financial changes were conditioned in a number of cases on the implementation of an agreed restructuring plan that may involve management changes, injections of fresh equity, sales of assets or divisions, or even company takeovers. o The Istanbul approach does not guarantee the survival of a company in distress. Regulatory authorities did not intervene and, because of its voluntary nature, the Istanbul Approach was only effective due to its support by the banking community. 33. Corporate iresolution results. By end January 2003, 216 companies, employing 32,000 workers and exporting goods and service in an amount of US$695 million had entered into the Istanbul Approach resolution process. Some US$3.6 billion dollars in non-performing loans were restructured in 96 different companies. Restructured loans were primarily with companies that had non-performing loans. A number of these credits had been rolled over from before the crisis. Disappointingly, there was little real restructuring to complement the workouts. Therefore, it is anticipated that a number of the re-scheduling cases will prove non-viable, as was the case in Korea. Those companies will potentially need to go through another workout round or be forced into bankruptcy or liquidation. Reform of the bankruptcy system remains an important issue. 34. The workout agreements were largely re-schedulings that ranged from 6-14 years. The banks were not prepared to provide significant new working capital to these distressed companies, but did in the end provide fresh working capital on a selective basis and non-cash support in the form of guarantees, letters of credit and construction bonds as appropriate to the workout companies. Also, debt/asset swaps, debt/equity swaps and interest rate reductions were applied to many of the agreements. In general banks were reluctant to accept a "haircut" and write-off their debts. VI. Other Structural Refoirms That Affect the Corporate Sector 35. Financing the Real Sector. Given the difficult external environment, the Government- working with banks and companies-should take an active approach to attract institutional investors to the real sector for working capital, equity infusions, trade finance, and the substitution of long-term for short-term debt. For example, domestic and international banks should restore and expand trade lines and trade guarantees. Turkish banks had to repay substantial syndicated loans in 2001, and it appears that only four or five private banks have been able to replace these loans-though at just 45-50 percent of prior levels. 36. For economic, social, and political reasons there is a need for broad assistance to distressed small and medium-size enterprises. Thus the Government should analyze the need to provide these enterprises with liquidity and working capital beyond the $400 million already provided through Halk Bank and Ziraat Bank. Any additional liquidity should be provided through budget transfers. To the extent that public banks are used to assist in intermediation, they should act as agents for the Government and not assume additional risk in financing small and medium-size enterprises. In areas lacking sufficient banking services (such as the southeast and the Black Sea coast), the Government should encourage the entry of microfinance  - xi - institutions to help create jobs and alleviate poverty. Such an effort could attract support from bilateral sources and nongovernmental organizations (NGOs). 37. Attracting Foreign Direct Investment. A study by the World Banks Foreign Investment Advisory Service (FIAS) indicates that Turkey's constraints on attracting foreign direct investment are not only legal and administrative but, perhaps more important, involve Govermment commitment. Thus the Government and the Foreign Investors Association of Turkey, working with foreign investors and major business organizations, should implement an active campaign to attract foreign investment and to counter negative attitudes-domestic and foreign. Foreign direct investment is needed to recapitalize private banks, nonbank financial institutions, and corporations in distress. The Government should also consider creating an investment promotion agency, as recommended by FIAS and in line with best practices. 38. The Government has requested World Bank Group and International Monetary Fund (IMF) support in establishing a small, high-level, private sector-driven Investment Advisory Council. The council is intended to increase understanding between the Government and private investors and to identify and accelerate Government measures to improve the investment climate, including increased productivity and employment. Thirteen chief executive officers of multinational companies with investment interests in Turkey have committed to participate in the council. 39. Accelerating Privatization. The Government should also take steps to depoliticize and strengthen the privatization process. Doing so would enable the Privatization Administration to remove saleable loss-making companies from its portfolio as quickly as possible. Finally, the Privatization Administration should do a detailed portfolio evaluation to determine potential refinancing needs based on results for 2001. Although external market conditions have delayed privatization transactions slated for 2001 and 2002, efforts to increase the Privatization Administration's independence and clean up its portfolio should take place now in anticipation of better market conditions.  - xli - Summary of Recommendations 40. The table below summarizes the recommendations offered in this report. The recommendations fall into three groups: resolution strategies to help banks and firms resolve their "mutual hostage" dilemma, policy changes for the Government to facilitate resolution and attract foreign direct investment, and financing measures to help firms overcome the credit crunch, which is expected to continue for the immediate future. The recommendations are also split between short-term measures (those likely to have an impact over the next 6-12 months) and medium-term measures (those with an impact over the next one to three years). The medium-term measures are crucial because corporate distress will likely continue well beyond the initial macroeconomic recovery. Moreover, many of these measures-such as facilitating foreign direct investment and improving the management and transparency of large corporate groups-will have long-lasting effects.  - xiii - Summary of Key Recommendations Timing of expected impact Recommendation Short term Medium term Strategies to Help Resolve Crisis-induced Problems * Establish a crisis management team and necessary X X organizational capabilities * Develop a system to assess the impact of the crisis and X X of measures taken to support the real sector - Monitor large corporations with significant debt or equity links to local financial institutions - Survey small and medium-size enterpnses regularly and consistently * Develop a corporate workout program based on the X X London approach * Commercialize asset resolution mechanisms X X * Roll over loans from state banks to small and medium- X size enterprises for 6-12 months Policy Changes * Develop an enabling legal environment for corporate X X restructuring and mergers and acquisitions * Enhance insolvency and foreclosure procedures to X X facilitate pre-packaged bankruptcies * Enact a re-drafted bankruptcy law X * Adopt IAS for listed companies to improve X transparency, compliance, and monitoring and to facilitate foreign direct investment * Strengthen corporate governance standards for listed X companies to improve management and facilitate foreign direct investment Financing the Real Sector * Expand trade finance facilities X * Provide financing to small businesses in underserviced X areas through microfinance institutions * Attract foreign direct investment to inject long-term X debt and equity into banks and companies - Encourage recapitalization of private banks through X foreign partnerships - Sell intervened banks to foreign banks X X - Privatize state banks X X - Accelerate the privatization program X X - Improve tax laws to encourage mergers and X acquisitions by foreign companies x   THE REPUBLIC OF TURKEY CORPORATE SECTOR IMPACT ASSESSMENT 1. INTRODUCTION 1. Many Turkish companies are experiencing distress as a result of the economic and financial crisis that started in February 2001. For several years companies have faced unstable political and economic conditions with high inflation, high real interest rates, and bloated state enterprises. Moreover, industry has had to deal with a series of recent crises: Turkey's 1994 crisis, the contagion effects of the 1997-98 East Asian and Russian crises, the crisis that emerged from Turkey's earthquakes in 1999, and the country's November 2000 crisis. Because previous crises lowered profits, many companies were already fragile at the onset of the current crisis. 2. Although economic conditions were favorable for most of 2000, they were not sufficient to improve the financial condition of many firms. And while Turkish firms have learned how to cope with crises, the current crisis is deeper than the previous ones and will leave in its wake many struggling companies. In addition, Turkey's economy is being hit by adverse external factors- including a weakening global economy, particularly in Europe, and the difficulty of attracting portfolio investment and foreign direct investment amid the regional turbulence resulting from the September 11, 2001 terrorist attacks on the United States. Further destabilization in the region could significantly harm the economy, particularly tourism revenues. 3. Until recently Turkey's weak coalition governments lacked the will to address deep-rooted structural problems. Reforms proceeded in starts and stops, causing considerable damage to industry. Moreover, banks are just as distressed as firms (if not more) and cannot be restructured unless their portfolio problems are addressed through a corporate resolution strategy. Ultimately, resolving Turkey's corporate distress will require political will to implement a new economic program. This report evaluates Turkey's current crisis to provide senior policymakers with an assessment of its effects on firms and to provide policy and operational recommendations to help the Government address corporate distress during and immediately after the crisis. 4. In the short term the Government's Economic Growth Program projects a recovery led by a rebound in exports, supported by strong tourism. In the medium term the program expects bank reforms-as detailed in the World Bank's Programmatic Financial and Public Sector Adjustment Loan -to lower real interest rates. The program also expects a growing role for the private sector, to be led by foreign direct investment. The timing of certain actions will depend on when the real sector starts to recover. In the first half of 2001 tourism was at its highest level in several years. However, external developments, starting with the September 11 terrorist attacks, lowered expectations for the rest of 2001 and 2002. In addition, external remittances have fallen due to Europe's softer economy, especially in Germany. Finally, it remains unclear when and to what extent growth will resume in other sectors.  - 2 - 5. The main data sources for this report are Government statistical agencies-primarily the Central Bank and State Institute of Statistics-and filings of companies listed on the Istanbul Stock Exchange. The report also uses the annual reports of some large corporate groups and corporate financial analyses prepared by brokerage firms and investment banks inside and outside Turkey. In addition, the report draws on surveys conducted by Turkish organizations and on interviews conducted by the authors. 6. A few caveats are in order. First, the report does not discuss the events that led to the crisis or include a detailed macroeconomic analysis of the crisis or of the Government's Economic Growth Program, except to the extent that these are relevant to the assessment of corporate distress. Such analyses can be found in the World Bank's revised Country Assistance Strategy (June 2001) in the report describing the Bank's recent structural adjustment loan, "Turkey: Programmatic Financial and Public Sector Adjustment Loan" (June 2001) in the Intemational Monetary Fund's country program; and in reports prepared by many associations, investment banks, and brokerage firms inside and outside Turkey. Second, the report does not address the banking sector except to the extent that banking issues affect the corporate sector. However, World Bank staff have been working with the Turkish Govermment on bank reformns since 1998. These reforms are documented in Bank reports on the "Financial Sector Adjustment Loan" (December 2000) and on the Programmatic Financial and Public Sector Adjustment Loan (see above). In addition, the Bank has provided support to Turkey's Eximbank through the Export Finance Intermediation Project (June 1999), which supplied about US$250 million in financing to eligible exporters.  - 3 - 2. OVERVIEW OF THE CRISIS 7. Companies and business associations have little confidence in Turkey's political establishment. This, together with the collapse of domestic markets, translates into a lack of business confidence-a fact clear from surveys of some 10,000 firms across Turkey (see Chapter 3). Many businesspeople had confidence in the Government's early 2000 stabilization program, established in conjunction with the International Monetary Fund (IMF). When the program failed in February 2001 over what was perceived as political infighting, businesses across the country were hurt-with many on the brink of insolvency-and business activity was paralyzed for several months. For the economy to grow and remain competitive, consumer and business confidence must return and the boom and bust cycles of recent years must end. The Government's Economic Growth Program-and Recent Developments 8. The Goyernment's Economic Growth Program aims to sharply reduce inflation by the end of 2002, stabilize the Turkish Lira (which underwent around 40 percent devaluation in February 2001, from 685 thousand TL/$ to 957 thousand TLI$ in one day on February 22, was as high as 1,639 thousand and slowly stabilized in the first quarter of 2002 to 1,356 thousand TL/$), lower real interest rates, and ease public sector borrowing requirements and the associated crowding out of financial markets (Table 1). In addition, the Government has committed to a series of structural reforms, including restructuring and privatizing state banks, divesting previously intervened banks, resuming the privatization program, and attracting foreign direct investment (FDI). However, these reforms will be slowed by the deep recession in the domestic economy and the worsening extemal environment, especially since September 11. Increasing FDI by restarting the privatization program and attracting FDI and portfolio investment to distressed corporations and banks will be especially difficult with the flight to quality occurring in international capital markets. It will also be difficult for the Government to raise funds in global capital markets-funds that it desperately needs to service debt. 9. Making matters worse, worker remittances dropped by a third in the first half of 2001 (Morgan Stanley 2001c). In addition, tourism revenues-robust through August 2001 and one of the economy's few bright spots-could suffer if there is further conflict in the region. All these developments have made Turkey far more reliant on official capital flows than was anticipated in the Government's economic program. 10. The Government has enacted important reforms in support of its economic program and by the end of 2001 macroeconomic stabilization was evident, with lower inflation and interest rates and the generation of a primary surplus. In addition, the Government has managed its debt servicing requirements and debt rollovers with agility. However, GNP growth remains a challenge, having fallen by 9.4 percent in 2001-far below the original forecast of a 3.0 percent drop and a revised forecast of a 5.5 percent drop. Moreover, Turkey remains highly indebted, leaving it vulnerable to external shocks-political or economic. In addition, corporate interest rates will remain high as long as the Government has to rely on capital markets to finance itself.  -4 - Table 11. Macroeconomlies Parameters, 1997-2002 1997 1998 1999 2000 2001 2002 Estimate Real GNP growth 8.3% 3.9% -6.1% 6.3% -9.5% 6.5% GNP TLtillions 29,393 53,518 78,283 125,596 176,484 271,406 Percentage Change 96.2% 82.1% 46.3% 60.4% 40.5% 53.8% GNP US$ biHlons 193.9 205.5 187 4 201.3 144.0 180.5 GNP deflator (average) 81.2% 75.3% 55.8% 50.9% 55 3% 44.4% CPI (average) 85.7% 84.6% 64.9% 54.9% 54.4% 45.1% Dec-Dec 99.1% 69.7% 68.8% 39.0% 68.5% 31.0% WPI (average) 81.8% 71.8% 53.1% 51.4% 61.6% 50.0% Dec-Dec 91.0% 54.3% 62.9% 32.7% 88.6% 30.0% Average interest rate on T-biIIs 105.2% 115.7% 106.2% 38.0% 99.1% 63.9% Average exchange rate TL/US$ 151,628 260,403 417,758 623,973 1,225,490 1,503,745 Percentage change (average) 87.1% 71.7% 60.4% 49.4% 96.4% 22.7% End-of-period exchange rate TI 205,110 313,707 540,098 671,765 1,446,638 1,612,106 Percentage change (Dec-Dec) 90.8% 52.9% 72.2% 24.4% 115.3% 11.4% RER (average period, 1990=100 94.0 102.0 106.2 116.7 89.6 104.2 average 6.4% 8.5% 4.1% 9.9% -23.3% 16.3% Dec-Dec 13.5% 3.9% 5.6% 13.7% -23.6% 15.6% Source: Treasury, IMF and WB. 11. The difficult external environment will continue to put pressure on the Turkish economy. Achieving the goals of the Government's growth program will require political will, political cohesiveness, and staying power. None of the resolution measures recommended in this report (see Chapter 5), either together or separately, will be as important for establishing a political and economic environment that builds consumer and business confidence. Still, those measures will provide crucial short-term assistance to firms and banks. A Deeper Crisis Than Befoire 12. Economic indicators point to a steep decline in business activity since Turkey's crisis began in February 2001. The crisis is deeper and potentially more adverse to industry than any since World War II. Instead of a V-shaped recovery led by an export surge resulting from the sharp devaluation of the lira, as in 1994, Turkey is experiencing a U-shaped recovery- potentially extending over a long period, with only modest growth in 2002 (JP Morgan 2001c).  - 5 - Private consumption fell 4.8 percent in 1994 and 2.6 percent in 1999, but in 2001 consumption fell by 9.4 percent (Morgan Stanley 2001a). 13. Sales and Demand. Consumer demand-expressed as sales-has fallen in all industrial sectors. In the second quarter of 2001 GNP dropped by 11.8 percent (Figure 1), private consumption by 11.5 percent (the largest drop since World War II), and gross fixed investment by 32.1 percent. In year 2001, as GNP declined by 9.4, industry declined by 7.5 percent, construction by 5.9 percent, financial institutions by 9.9 percent (though these losses are understated), and transportation and communication by 4.9 percent (Table 2). Figure 1. Quarterly Changes in GNP in Constant Prices, 1999 Q3-2001 Q2 (%) 10 7.2 4 2 7 6 0 3rd - 99 4U st-00 2nd-00 3=.9(0 45 1 - 01 2nd -Ot .106 -11 8 -15 Source: State Institute of Statistics, February 2002. Table 2. Changes in GNP by Sector, 2001 (%) Sector 2001 2001 2001 2001 2001 Q1 Q2 Q3 Q4 Overall Agriculture 8.5 -2.9 -5.6 -13.6 -6.1 Industry - 0.8 -10.1 8.9 -10.7 -7.5 Construction -5.2 -5.8 8.3 -3.6 -5.9 Trade 2.3 -12.1 -7.4 -14.4 -9.4 Transportation and Communication -2.3 -8.8 -4.5 -3.7 -4.9 Financial Institutions -5.3 -10.0 -9.8 -14.2 -9.9 Home Ownership 2.2 2.1 2.1 2.0 2.1 Miscellaneous Services -0.3 9.7 -7.8 -10.4 -7.4 Public Services 2.2 1.9 0.9 1.0 1.5 Private Nonprofit Organizations 1.7 -0.3 -0.3 0.0 0.2 Import Tax -10.1 -28.0 28.0 -28.4 -25.1 GNP --3.1 -12.1- -9.0 -12.3 -9.4 Source: State Institute of Statistics, March 2002. 14. Exports and Imports. Turkey's trade deficit has shrunk in line with Government expectations, with exports increasing 12.3 percent and imports falling 25.7 percent in 2001 (Table 3). However, there is evidence that the gains from the devaluation of the lira have peaked. Moreover, export growth may slow in 2002 due to the appreciation of the lira and  - 6 - adverse economic conditions in Europe (which accounts for 53 percent of Turkey's exports) and the United States (8 percent). Table 3. Exports, Imports, and the Trade Deficit, December and January-December 2000-01 (millions of U.S. dollars) December January-December Indicator 2000 2001 Change (%) 2000 2001 Change (%) Exports 2,489 2,536 1.9 27,774 31,186 12.3 Imports 4,437 3,473 -21.7 54,502 40,506 -25.7 Trade Deficit -1,948 -936 -51.9 -26,727 -9,320 -65.1 Sufficiency Ratio (%) 56.1 73.0 51.0 77.0 Source: State Institute of Statistics, Foreign Trade Statistics, February 2002. 15. Production and Capacity Use. Industrial production fell 8.9 percent in the first half of 2001 relative to the first half of 2000, with manufacturing dropping 9.9 percent (Table 4). Capacity use in private manufacturing declined to 62 percent in March 2001 but by the end of the year had rebounded to 68 percent-though this is still below the use rate many plants require to break even (Table 5). For most of 2001, capacity use exceeded 80 percent in public plants for commodity industries such as steel, oil, and petrochemicals, largely due to import substitution. Table 4. Annualized Changes in IndustriaR Production, December and January-December 2000-01 (%) lDecember Janua-December Sector 2000 2001 2000 2001 All Industry -4.1 -9.4 5.5 -8.9 Mining -10.0 -7.2 - 4.4 -7.9 Manufacturing -4.3 -10.9 5.7 -9.9 Energy (Electricity, Gas, and Water) 0.2 2.1 7.3 -1.5 Source: State Institute of Statistics, Monthly Industrial Production Index Bulletin, February 2002.  -7 - Table 5. Capacity Use Rates in Manufacturing, January-December 2000-01 (%) Total Public Private Month 2000 2001 2000 2001 2000 2001 January 73.0 71.7 78.4 76.7 69.7 68.3 February 74.0 71.0 74.8 76.6 73.5 65.5 March 74.0 71.0 78.4 87.8 71.7 61.8 April 77.2 68.0 81.3 75.0 74.8 63.8 May 77.1 70.4 76.7 84.3 77.4 62.3 June 76.7 71.3 74.4 80.5 78.2 66.3 July 76.4 71.0 78.4 82.9 75.1 65.4 August 75.8 71.4 80.6 81.7 71.8 64.9 September 73.9 72.9 66.0 82.2 79.0 66.8 October 81.3 73.9 84.0 84.6 79.6 67.8 November 79.6 74.1 82.3 84.8 77.6 67.8 December 74.5 73.6 86.7 83.3 65.4 67.6 Source: State Institute of Statistics, Monthly Manufacturing Tendency Survey, September 2002. 16. Investments. During a crisis, capital investments are usually among the first discretionary spending items to be cut-a fact reflected in Turkey's statistics. In constant dollars, gross fixed investments (public and private) fell 32 percent in 2001 (Figure 2). Figure 2. Changes in Public and Private Investments, 1997-2002 (%) 40- 30 20 r0 X -10 Sr1997 Ecni 1999.I 2 2002; S00 -20 -30- -40J -.- Public Sector Investments ---~. Aw -Piate Sector tnvestments *Realization estimate. ** Economic Growth Program projection. Source: Economic Indicators of Treasury, January 2002; State Planning Organization, Gross Fixed Investment by Sector, December 2001. 17. Energy Production. In a normal year the demand for power grows by 8-10 percent. Even in 1994 (another crisis year) and 1999 (the year of Turkey's devastating earthquakes) electricity demand grew 4 percent a year. In 2001, however, demand declined (Table 6). Moreover, electricity prices-already subsidized before the crisis-initially failed to keep pace  - 8 - with inflation. Adjustments starting in April 2001 have since brought the tariff in line with prices agreed to in the IMF program. However, costs have risen as well, mainly because of higher oil prices and a drought that has forced TEA$ (electricity generation and transmission) to rely more on thermal production instead of less expensive hydropower. In addition, contracts with private producers have forced TEDA$ (electricity distribution) to pay as much as 12 cents per kilowatt-hour, compounding its losses. Table 6. Changes in Electricity Demand, January- September 2001 (%) January February March April May June Change 4.7 -2.4 -8.9 0.1 -1.6 -0.6 July August September Change -0.9 0.9 -2.2 - - Source: Turkish Electricity Generation and Transmission Company (TEAS) data. 18. TEA$, TEDA$, and BOTA$ (gas distribution) have accumulated a financial deficit of 3.5 quadrillion lira because of overdue accounts with each other and other public institutions. Losses in 2001 increased this deficit. It is not clear if TEA$ or TEDAa have assessed how the crisis will affect them. Large losses would lower the value of electricity distribution companies, impeding their proposed privatization. 19. Unemployment. Formal labor statistics are released quarterly in Turkey. According to the Treasury, formal unemployment rose to 10.6 percent in the fourth quarter of 2001-making for about 884,000 more unemployed workers than in 2000 (Table 7). Table 7. Employment and Unemployment Indicators, 1998-2001 Number of Number of Unemploye Unemployment Year Employed Workers Workers Rate (%) 1998 22,399,000 1,527,000 6.8 1999 23,187,000 1,774,000 7.6 2000 22,029,000 1,451,000 6.6 2001 Ql 21,031,000 1,809,000 8.7 2001 Q2 21,127,000 1,567,000 6.9 2001 Q3 21,875,000 1,907,000 8.0 2001 Q4 19,742,000 2,335,000 10.6 Source: Turkish Treasury based on State Institute of Statistics, February 2002. 20. Interviews and surveys suggest that unemployment is much higher among small and medium-size enterprises than among large manufacturers. Small companies lost an average of 19 percent of jobs in the first half of 2001, with much larger losses in transport, forestry products, and furniture manufacturing. In medium-size companies job losses ranged from 10-22 percent (ISO 2001a; see also Chapter 3). However, in large companies the real issue is underemployment. Employers are reluctant to lay off workers and so have used every means possible of cutting their hours: accelerating vacation schedules, eliminating overtime, closing plants earlier for maintenance, and informally furloughing workers with the promise of rehiring them when conditions improve. The number of production-related manufacturing workers in the  - 9 - private sector fell 11.9 percent and hours worked fell 13.8 percent in the third quarter of 2001 compared with the same period in 2000 (Table 8). Table 8. Changes in Production-related Employment in Manufacturing, 2000-0-1 Q3 (%) Number of Number of Sector Workers Hours Worked Public -10.4 -8.9 Private -11.9 -13.8 Average -11.7 -13.2 Source: State Institute of Statistics, February 2002. 21. Company Openings and Closings. According to the State Institute of Statistics, the crisis has slowed the rate of company openings and sped up closings. In 2001 company openings fell 10.5 percent, while firm openings (small businesses and sole proprietorships) fell 24.4 percent (Table 9). Meanwhile, company closings increased 30.5 percent and firm closings 13.7 percent. Table 9. Number of Companies and Firms Opened and Closed, January - December, 2000 and 2001 2000 2001 Change (%) Category Dec Jan- Dec Dec Jan-Dec Dec Jan-Dec New companies and cooperatives 3,472 33,161 2,410 29,665 -30.6 -10.5 Closed companies and cooperatives 225 1,887 298 2,464 32.4 30.5 New frms 1,863 21,404 1,415 16,171 -24.05 -24.4 Closed frnns 1,135 12,055 866 13,707 -23.7 13.7. Note: Companies are enterprises that have a corporate form4 while firms are usually sole proprietorships. Source: State Institute of Statistics, Enterprise Creation and Closure Statistics, December 2001. 22. Foreign Direct Investment. It has become increasingly important for Turkey to attract FDI to help recapitalize banks and corporations starved for new equity. In addition, the privatization program depends on attracting domestic investors, institutional portfolio investment, and FDI for shares of large firms such as POAa (oil distribution and retailing), TUPRA* (oil refining), PETKIM (petrochemicals), Turk Telecom, Turkish Airlines, and TEDA$. Finally, during bank restructuring in East Asia and Eastern Europe, institutional investors entered the market to purchase the assets of distressed banks-an urgent priority for Turkey. However, Turkey's track record in attracting FDI is poor, and external economic and political conditions will make it difficult to attract external capital in the immediate future. 23. FDI in Turkey hovered around $900 million a year in 1995-99 (Table 10), while in 2000 FDI was about $1,700 million, largely due to privatization revenues. In 2001 FDI reached $3,288 million. In 2000 per capita FDI was $20 in Turkey-compared with $200 in Hungary and $4,300 in Ireland. Increasing FDI is an urgent priority not only to attract resources, but also to improve competitiveness and managerial skills.  - 10- Table 10. Forei n Direct Investment, 1996-2001 Number of Annual Realization Year Foreign Capital Permits Inflows Outflows Net Companies 1996 3,582 3,837 937 325 612 1997 4,068 1,678 873 319 554 1998 4,533 1,647 982 409 573 1999 4,950 1,701 823 685 138 2000 5,328 3,060 1,707 725 982 2001 5,841 2,739 3,288 22 3,266 2002(l) 523 55 0 55 Total _______________ ________ 8,655 2,485 6,180 () January-Ma rch, 2001. Source: Undersecretariat of Treasury; State Planning Organization. 24. The Informal Economy. The informal economy consists of income-generating activities that are unregulated or concealed from govermment. In Turkey these activities involve tax evasion, off-the-books employment, self-employment, and illegal activities such as drug trafficking. The informal economy is quite large and will undoubtedly grow because of the economic crisis. Among the most important causes of the informal economy are the lack of job opportunities in the formal economy and high taxation and excess regulation of formal economic activity. 25. The informal economy is a problem for several reasons. First, it reduces tax revenues. Second, it makes taxes a heavier burden for honest taxpayers, creating inequalities in incomes and tax burdens. Third, the informal economy may draw resources from more productive parts of the economy. Fourth, the informal economy may make official economic statistics misleading, causing errors in government management of the economy. However, the informal economy also has some desirable features, serving as a social and political safety valve by providing income and job opportunities. 26. The so-called suitcase trade is a unique feature of Turkey's informal economy. The suitcase trade gets its name from the luggage used by traders from Commonwealth of Independent States (CIS) countries and the Balkans who transport Turkish goods to CIS and Eastem European markets. The trade, which is largely unrecorded and untaxed, is a major source of hard currency for Turkey. The suitcase trade is expected to increase as a result of the crisis. 27. Inspections by Ministry of Finance auditors indicate that the rate of tax evasion was 25 percent in 1997, 28 percent in 1998, 45 percent in 1999, and 35 percent in 2000. A total of 11.5 quadrillion lira in tax revenue was evaded in 2000 (Turkish Daily News, 30 October 2000). The Central Bank estimates that the informal economy accounts for 20-26 percent of the economy, depending on how it is calculated. In 2001 the Association of Tax Controllers estimated that unregistered transactions represent 45 percent of economic activities and that tax evasion and tax losses equal $15 billion a year.  - 11 - 28. Poverty. Per capita income was projected to fall to $2,261 in 2001, the lowest level since 1994 (Executive Digest, 15 October 2001). The crisis is having an especially adverse effect on industry, especially small and medium-size enterprises in poorer areas such as the southeast and the Black Sea coast. The crisis will worsen Turkey's income distribution and increase inflation, hitting poor people especially hard (World Bank 2001a). 29. An increase in consumer confidence and a healthier macroeconomic environment-with lower inflation and interest rates and less government crowding out of borrowing-are crucial for resolving corporate distress, as are interrelated structural reforms such as resolving the banking crisis, attracting FDI, and accelerating privatization. However, in the interim there is a need for a resolution program so that healthy businesses hurt by the crisis can continue operations. A resolution program will also lower the social and poverty impact of the crisis. The next chapter uses business surveys to show the depth and extent of corporate distress caused by the crisis. These surveys underscore this report's overall thesis that a program for resolving systemic corporate distress is urgently needed.  - 12 - 3. COREPORATE PERCEPTIONS OF THE CRISIS 30. During 2001 several organizations in Turkey-mainly chambers of commerce and industry-conducted surveys to assess corporate distress as well as company expectations for the rest of the year or for 2002. The primary survey for the first quarter was conducted by the Union of Chambers of Commerce, Industry, Maritime Trade, and Commodity Exchanges of Turkey (TOBB), the umbrella organization for all Turkish chambers of commerce. The sample covered all of Turkey, with responses from 3,476 firms. TOBB considers this sample representative of Turkish industry. The Ankara Chamber of Commerce (ATO) conducted a similar survey of 1,720 retailers and small and medium-size enterprises in the Ankara region. Although the TOBB survey is more representative of Turkey as a whole, the TOBB and ATO survey results are presented together in the next section. 31. Thereafter, that the chapter presents the findings of several other surveys-follow-up surveys by TOBB and ATO as well as surveys by the Ankara Chamber of Industry (ASO) and Istanbul Chamber of Industry (ISO) that asked companies in Ankara and Istanbul about results for the first half of 2001 and expectations for the second half. Finally, TOBB and ASO conducted a smaller survey covering the fourth quarter of 2001 and expectations for 2002. (See Annex 2 for a summary of the various surveys.) 32. Overall Distress. A series of TOBB and ATO surveys conducted during the course of 2001, were designed to measure corporate distress in the first quarter of 2001 and expectations for the rest of the year. (See Annex 2 for the dates and other details of these surveys.) About 80 percent of respondents in the first TOBB survey and 83 percent in the first ATO survey said that their businesses were worse off in the first quarter than in 2000 (Figure 3). Moreover, 33 percent of TOBB and 58 percent of ATO respondents believed that conditions would worsen over the rest of the year. In addition, 56 percent of TOBB and 65 percent of ATO respondent firms had cut their workforces, and 41 percent and 56 percent expected such reductions to continue over the rest of the year. Lower demand had hurt nearly all the respondents-77 percent of TOBB and 86 percent of ATO respondents saw sales fall in the first quarter of 2001.  - 13 - Figure 3. TOBB and ATO Survey Findings on Overall Distress, 2001 Ql 1. Hbw was the situation of your estabishment 2. What are your expectations for the remaining In the let quarter of 2001 relative to year 2000? part of 2001 as compared to the first quarter? go - _ 60 -0 40 4 30 m a3 TOBD ATO TOBB ATO U6.B4.t,SBoo6 f3N.d1 . *W 6,.n200 | |11W8ll. b.~ a0 M..dli,,. *--Ilb. | 3. In the first quarter of 2001, what happened to 4. What are your expectations for the remainder the workforce employed at your establishment? of 2001 In the workforce employed at your establishment? 100~~~~~~~~~~~~~~~~~~~~~~~~~0 gooc 60~~~~~~~~~~~~~~~~~~~~~~~9 90 70 70 60~~~~~~~~~~~~~~~~~~~~~~~6 t1 * .86.00,.In mpln 50 - 40 - 40 30 3 00.- 10 -2 970~~~~~~~~~~~~~~~~~ T ea ATo3TOS ATO 8. How did your ealos volume change In the lst quarter ot2001 relative to the last quarter of 2000? 1001. -- - 90 90 70 _ 30 10 _ TOBB AT0 1 e0bo Cl No diftr. _ Deose |  - 14- 33. Financing. More than two-thirds of TOBB respondents and half of ATO respondents did not borrow from a bank in the first quarter, and 74 percent and 80 percent did not expect to borrow during the rest of 2001 (Figure 4). Among the 1,262 firms that did borrow in the first quarter, half paid higher interest rates than in 2000. Just 3 percent of borrowers had their loans withdrawn or additional collateral requested. Figure 4. TOBB and ATO Survey Findings on Financing, 2001 Qi 8. Did you borrow from tho banks In tho lotquartorof 2001? 100 - 90 80 O 60 = 50 U & 40 _ _ _ _ _ _ _ _ 30 10 TOBB ATO | Yes o From time to time o No 7. WUIl you borrow from any bank for tho remalndor oV 2001 ? 100 - 70- .so 30 20 10- o - TOBB ATO 34. Export Growth. The Government's economic program expects growth to resume partly as a result of a surge in industrial exports resulting from the devaluation of the Turkish lira. These expectations appear to be validated by the surveys. A quarter of TOBB and more than a third of ATO respondents said that exports had grown in the first quarter of 2001 (Figure 5). For the rest of the year, 31 percent of TOBB and 1 percent of ATO respondents expected exports to grow by more than 20 percent, 38 percent of TOBB and 30 percent of ATO respondents expected growth of 11-20 percent, and 31 percent of TOBB and 69 percent of ATO respondents expected growth of less than 10 percent.  - 15 - Figure 5. TOBB and ATO Survey Findings on Exports, 2001 Ql 9. How did your exports change In the 1st quarter of 2001 relatve to 2000? 100 90 p 80 r 70 s1 57 CS 0 nt 50 40 30 20 7 10 TOga ATO 10. Ityou think yourexports will Increase whatwill be the approximate level of this Increase? 100 80 70 5 40 0 30 20 10 0 TOBB ATO | More then 20% 0 Between 11% and 20% * Less than 10% 35. Size as a Determinant of a Firm's Condition. Firm size is usually important during a crisis, with the presumption that small firms have less capacity to weather the storm. The initial TOBB survey asked basic questions such as: Is the crisis hurting small firms more than big firms, and do big firms expect to benefit more from the economic program than do small firms? Firms of all sizes have been hurt, but a far larger share of mnicroenterprises (1-10 employees) and small firms (11-59 employees) have been adversely affected. At the end of the first quarter 42 percent of microenterprises and 32 percent of small firms expected the situation to worsen over the rest of 2001, while 37 percent of medium-size firms (60-200 employees) and 46 percent of large firms (more than 200 employees) expected conditions to improve (Figure 6). A majority of all firms expected conditions to stay the same or deteriorate, which is problematic. As for demand and sales, 84 percent of microenterprises, 76 percent of small firms, 71 percent of medium-size firms, and 61 percent of large firms saw sales fall in the first quarter of 2001 relative to the fourth quarter of 2000. 36. TOBB's second follow-up survey found that 62 percent of small and medium-size enterprises and 40 percent of large companies saw conditions deteriorate between the third and fourth quarters of 2001. These findings are supported by an analysis of Istanbul Stock Exchange companies for the third and fourth quarters. Looking to 2002, 33 percent of small and medium- size enterprises and 31 percent of large companies expected the situation to continue to  -16- deteriorate (Figure 6a). Just 26 percent of small and medium-size enterprises expected things to improve, compared with 42 percent of large companies. Figure 6. TOBB Survey Findings on Distiress, by Number of EmpRoyees, 20011 QIl How was the situation of your establishment in the first quarter of 2001 relative to 2000? 100 80- 60 U 40 20 4 _-+ I - . 7 ,1.' 0-10 11-59 60-200 >200 a Better than 2000 o No difference n Worse than 2000 What are your expectations for the remaining part of 2001 as compared to the first quarter? 50 40 30 0-10 11-59 60-200 >200 o Wil be better o No difference o Wdl be worse  - 17 - How did your sales volume change in the first quarter of 2001 relative to the fourth quarter of 2000? 100.0 80.0 600 m - . -M - M 0-10 11-59 60-200 >200 o Increased a No difference * Cecreased Figure 6a. TOBB Survey Findings on Distress, by Number of Employees, 2001 Q4 How was the situation of your establishment in the fourth quarter of 2001 relative to the third quarter? 70 60 50 40 - 30- 20 10 - 0 Small Enterprises Large Enterprises | Better than Q3 2001 IB No difference * Worse than Q3 2001 What are your expectations for 2002 as compared to the fourth quarters of 2001 ? 45 40 35 30__ _ 15 200 _| 15 10 Srrmaler Enterprises Larger Enterprises |E A- VWAII be better m B- No difference * C- Will be w orse  - 18 - How did your sales volume change in fourth quarter of 2001 relative to the third quarter? 80 70- 60- so -_ s40- 230 M 20 10 Smaller Enterprises Larger Enterprses | A Increased GS- No difference n C- Decreased 37. In the first quarter of 2001, firms of all sizes-over 40 percent of microenterprises and small firms, 40 percent of medium-size firms, and over 30 percent of large firms-cut their workforces. TOBB's second follow-up survey found that dunng the fourth quarter of 2001, workforces were cut at about 60 percent of small and medium-size enterprises and just under 50 percent of large companies (Figure 7a). About 40 percent of all firms expected to continue reducing their workforces m 2002 Figure 7. TOBB Survey Findings on Changes in Workforce, by Number of Employees, 2001 Q1 In the first quarter of 2001, what happened to the workforce employed at your establishment? 600 50 0 *30 0 20 0 10 0 0-10 11-59 60-200 1200 ao hcrease 0 No difference o Decrease  - 19- What are your expectations for the remainder of 2001 in the workforce employed at your establishment ? 60.0 50.0 ----_---- 40.0 - - fl1 _2 30.0 20.0 - | | !3 10.0 -_l . . E 0-10 11-59 60-200 >200 Eo Increase l No difference * Decrease Figure 7a. TOBB Survey Findings on Changes in Workforce, by Number of Employees, 2001 Q4 In the fourth quarter of 2001, what happened to the workforce employed at your establishment? 70 60 50 - 40 ._. -30 - 20__ 10 - ___ 0 Srraller Enterprises Larger Enterprises |IB A, Increased an B- No difference m C- Decreased]  - 20 - What are your expectations for 2002 in the workforce employed at your establishment9 50 40 30 Smaller Enterpnses Larger Enterprises o Ae Increase 3 B- No difference a C- Decrease 38. As noted, few firms borrowed during the first quarter, no matter what their size (Figure 8). Over the rest of 2001, 37 percent of medium-size firns and 46 percent of large firns expected to borrow. However, with limited credit available, borrowing m the fourth quarter followed a pattern similar to that in the first. Some 88 percent of small and 69 percent of large enterpnses did not borrow in the fourth quarter of 2001 and about the same number did not expect to borrow m 2002. Figure 8. TOBB Survey Findings on Financing, by Number of Employees, 2001 QI and Q4 Did you borrow from a bank in the first quarter of 2001? 1000 800 -m- - 40 0rr 20 0 wflME= 0-10 11-59 60-200 >200 [ n Yes GiziN  - 21 - Did you borrow from a bank in the fourth quarter of 2001? 100 80-- 60 20 20 __ Smaller Enterprises Larger Enterprises | Yes * No 39. Size matters significantly for exports-57 percent of medium-size and 68 percent of large firms expected exports to increase in 2001 (Figure 9). Moreover, more than a third of these firns expected exports to increase between 11-20 percent. Figure 9. TOBB Survey Findings on Expected Export Sales, by Number of Employees, 2001 Ql Do you expect export sales in 2001 to be greater than in 2000? 100.0 80.0 600 20.0 0-10 11-59 60-200 >200 Yes * No  - 22 - Figure 10. TOBB Survey Findings on Expected Changes in Export Sales, by Number of Employees, 20011 Qi If you think exports will increase, what will be the approximate level of the increase? 80.0 60.0 40.0 20.0 -_ 0-10 11-59 60-200 >200 13 More than 20% O3 Between 11% and 20% * Less than 10% 40. Several surveys assessed firms' responses to the crisis through the first half of 2001, along with their expectations for the second half. Among them are an Ankara Chamber of Industry (ASO) survey, for the third and fourth quarter of 2001 and expectations for 2002, of 167 large manufacturing companies in the Ankara region, an Istanbul Chamber of Industry (ISO) survey, a second Ankara Chamber of Commerce (ATO) survey of 8,170 firms, and a second TOBB survey of 2,542 firms covering all of Turkey. 41. Ankara Chamber of Industry Survey. The first ASO survey, conducted for the first quarter of 2001, provided a number of insights that the other surveys did not. It confirmed the overall decline in sales but indicated that it affected both domestic and intemational sales. This finding supports field interviews in which firms noted that their inability to set an exchange rate for dollars and euros constrained domestic and export sales-with the challenge to domestic sales reflecting the "dollarization" of the domestic economy. Two out of three of the firms surveyed reported a decline in new orders in the fourth quarter of 2000, and four out of five reported a decline in production in the first quarter of 2001 (Figure 11). In nearly every category-production, domestic sales, new orders, and employment-almost three-quarters of these firms expected the situation to worsen during the remainder of 2001. For the third and fourth quarter of 2001, ASO surveys found that most firms saw production, domestic sales, intemational sales and new orders fall and expected continued declines in 2002. 42. Plant capacity use in Ankara fell from a low 59 percent in the fourth quarter of 2000 to a dismal 45 percent in the first two quarters of 2001 and continued to be 45 percent in the third quarter and rise to 47.5 in the fourth quarter of 2001 (Figure 12). Thus capacity use in Ankara was much lower than the national average (about 64 percent in April for private firms). In addition, most of the firms in the ASO survey cancelled orders in the first quarter-60 percent cancelled orders of raw materials, 77 percent cancelled orders of intermediate goods, and 84 percent cancelled orders of investment goods. The third figure is consistent with the large drop in private investment between January and June. Exports became more important, rising from 24 percent of sales in the fourth quarter of 2000 to 36 percent in the second quarter of 2001 (Figure  - 23 - 14). Finally, exports rose to over 30 percent in the third quarter of 2001 and fell under 30 percent in the fourth quarter of 2001. Figure 11. ASO Survey Summary Findings, 2000 Q4 and 2001 Ql, and Expectations for the Rest of 2001 ASO Survey - Evaluation of Qrt 4 2000 80 54 57 ^ O 60 41 ,40 V c22 -U s0 120t1- WWI 0 m ?VodUCt\0r porvl\stis\ siac r\ a\esa eOrdefivps rvt | Increased 0 No Change o Decreased ASO Survey - Evaluation of Qrt 1 2001 100 - ---------6------ __ 90- 8 * 70 60 50 - - - 40 -_-____ 3013- - - - 20 13- ptod wOn es"', Sas SravOas tAeNf o gePs |M Increased E No Change * Decreased Expectation for the rest of 2001 80.- - 73 _ _75 . _72 71 60 -* 537 4~0 20 - ,Mdu6o * r sd0 s Cae -deese | tB ncreased 13 No Change n Decresed  - 24 - Figure Ila. ASO Survey Summairy Findings, 2001 Q3 and Q4, amd Expectatlioms for 2002 ASO Survey- Evaluation for the Gnd of Q3 2001 70- 60-r- '50 40 l i 20 Roduction Domestic tnternatlonal New 6Tnployment Sales Sales Orders [1Increased n No Change O Decreased ASO Survey - Evaluation for the end of Q4 2001 60 so ~,40- 30- ~20- Roduction Domestic nternational New Enployment Sales Sales Orders 0 Increased El No Change El Decreased_| ASO Survey - Expectation for 2002 60 -50 N ~40 -30 a C 20in _ a.0 roduction Domestic International New Enployrent Sales Sales Orders a Increased E No Change El Decreased  - 25 - Figure 12. ASO Survey Findings on Average Plant Capacity Use, 2000 Q4-2001 Q4 Average Capacity Utilization 59.07 60 45 24 44.59 40- , 20 0. Fourth quarter of Rrst quarter of Second quarter of 2000 2001 2001 Average Capacity Utilization 60 43.72 45.81 47.56 E 20 ; , 40 Second quarter Thlird quarter of Fourth quarter of of 2001 2001 2001  - 26 - Figure 13. ASO Survey Findings on Exports as a Share of Sales, 2000 Q4-2001 Q4 ASO-Survey Share of Exports in Total Sales Average 40 -36 32 ,30 24 ~20- 10 10 Fourth quarter of First quarter of Second quarter of 2000 2001 2001 ASO-Survey Share of Exports in Total Sales Average 40- 30- ~20- 10 0 - Second quarter of Third quarter of Fourth quarter of 2001 2001 2001 43. For financing, 46 percent of the Ankara firms used commercial banks, 12 percent used leasing companies, 10 percent used Eximbank, and 3 percent used factoring (with some overlap between these categories). During the first quarter 30 percent of firms were required to repay a loan in full (Figure 14), for a third of those firms, that repayment represented 40-100 percent of external financing. Firms indicated that the number of bounced checks and rejected promissory notes they received rose substantially during the fourth quarter of 2000. Some 87 percent of firms indicated financing constraints, including (in order of importance) high credit costs, higher working capital requirements, failure to generate capital resources, and insufficient credit. (Again, these categories are not exclusive.)  - 27 - Figure 14. ASO Survey Findings on Financing, 2001 Ql Do you have a credit that you have to closed In the 1st Quarter of 2001? Yes 3A0% NoD - 70% Ranking of Constraints 4 2 High Credit Costs Rapid increasing of Not to Create Own Insufficient Credits Decreasing of Others Managemnnt Resources Supports Capital 44. Istanbul Chamber of Industry Survey. The ISO survey provided the first specific estimates of employment contraction, indicating a 19 percent reduction in workers at small and medium-size enterprises and an 8 percent reduction in the total workforce (Table 11). The survey also found that during the first half of 2001, 58 percent of companies operated at less than half of production capacity. Surprisingly, nearly 80 percent of companies were unable to increase exports appreciably following the devaluation. Nearly three-quarters of responding firms faced financing bottlenecks; to cope, they adopted strategies that included stopping credit sales, reducing employment, delaying payments, offering paid and unpaid leave to workers, and simply halting production.  - 28 - Table 11. ISO Survey Summary Findings Imidicator Share Capacity use 43 Companies facing financing bottlenecks 73 Companies facing contention with banks 70 Companies contracting production 62 Companies with reduced sales 63 Share of workforce laid off 8 Companies stopping credit sales 38 Companies reducing employment 37 Companies delaying payments 33 Companies offering paid leave to workers 25 Companies offering unpaid leave to workers 29 Companies halting manufacturing 26 Companies halting sales 10 45. Second Ankara Chamber of Commerce Survey. The ATO survey for the second quarter, with 8,170 respondents, provides specific data about reductions in company sales and equity. About a quarter of firms saw sales drop more than 60 percent, and more than half saw drops of 40-60 percent (Figure 15). Nearly a third of firns lost more than 60 percent of their capital, and half lost 40-60 percent-clear indicaiors of extreme corporate distress. Figure 15. ATO Survey IFindings on Saes and Equity Capital, 2001 Q2 Degree of Shrinkage In Sales Betw een 10-30 percent Vvbre than 18% X-60 percent 26% Betweei, 40-60 percent 56%  - 29 - Between Eroslon In Euity Capital 10-30 percent X 19% Nbre than 60 percent 30% Betw een 40-60 percent 51% Summary 46. The surveys discussed above convey an impression of a crisis that is both broad (affecting all types of firms) and deep (affecting all aspects of business)-and so support the view that the corporate sector will need help through some type of resolution program. Given the high distress among small and medium-size enterprises, any effort to resolve their problems will need to be systemic. For medium-size and large corporations, it appears feasible to take a case-by-case approach to resolving distress. The next chapter confirms that view through financial analysis of more than 200 firms listed on the Istanbul Stock Exchange.  - 30 - 4. ANALYSIS OF CORPORATE DISTRESS 47. Data for 1997-2001 for nonfinancial companies-that is, those engaged in industry and services-listed on the Istanbul Stock Exchange (ISE) indicate that: o Net profitability declined steadily between late 1997 and late 2000-and turned sharply negative in the first quarter of 2001 for a broad range of sectors and companies. These losses continued in the second quarter, leaving many listed companies in fragile condition, but in the third quarter the situation stabilized. Domestic demand grew modestly, so companies saw lower losses, were able to break even, or even showed a small profit. But the recovery in the third quarter was far too modest to relieve corporate distress. o The fourth quarter of 2001 was a setback, with industry experiencing the worst operating losses, partly due to seasonal factors and partly due to the events surrounding the September 11 terrorist attacks on the United States. However, poor operating results were obscured by the fact that reported corporate net profits were positive for the quarter (Table 12). Profits were positive only because the lira appreciated during the fourth quarter, reducing financial charges and foreign exchange losses. o In 2001 sales fell 19 percent but exports increased 31 percent, cash flow from operations (EBITDA) declined 13 percent, financial charges and foreign exchange losses increased 240 percent, and net earnings fell by $504 million. The 30 largest companies, which were more leveraged than the average listed company, lost more than $1 billion.  - 31 - Table 12. Earnings of Industrial and Service Companies Listed on the Istanbul Stock Exchange, Fiscal 2001 (millions of U.S. dollars) Cumulative YoY Quarterly 4Q-3Q WS$nu) 2001 2000 Growth 4Q2091 Growth Sales 28,427 35,149 -19.1% 6,706 -8 8% Exports 6,358 4,870 30 6% 1,480 -7 5% Operating Income 2,481 2,740 -9 5% 314 -63 5% EBITDA 4,246 4,871 -12 8% 697 -462% Financial Expenses 4,327 1,799 140% 182 -85 3% Earnings 617 1,121 -44 96% 160 - Earnings All Companies 124 1,716 -92 7% 251 - Equity 5,480 9,846 -44 3% 5,480 9 6% Sales ISE-30 16,857 20,934 -19.5% 3,925 -102% Oper.Inc. ISE-30 1,106 1,678 -34 1% 127 -68 1% EBITDA ISE-30 2,153 2,845 -24 3% 349 47.3% Earnings ISE-30 16 1,074 -98 5% 66 176 00% Source Raymond lames Secunties, Turkey, Equity Research, 2002 48. During 2001 losses were broad, affecting every sector of the economy, and deep. Sectors largely dependent on domestic demand-such as automobile manufacturing, food, retailmg, and communications-absorbed especially large losses (Table 13). But considerable losses occurred even in sectors, such as textiles, that reonented themselves primanly to export. Table 13. Net Profitability by Sector, 199S-2001 (millions of U.S. dollars) _ ~~~1998 1999 _ 2000 2004 INFOMTO TECNLG (1 59) 7 22 7.36 (2 04 CONSUMER DURABLES 225 04 _159 93 1 71 71 _(36 07 ELECRONICS AND 53 78 249.84 249 52 (533 26 ENER0Y 85.76 1641 43 56 98 (7 1690 FOOD __ =73.85 19.13 42.05 (189 2 PACKAGINGANDPAPER 21018 (40713 1056 (21.8 HE SRCA ES 675 05 845.62 56116 228.9 STATIONERY 4 40 3.22 3.20 1.4' MAHINERY EQUrPMENT5 1 71 0 08 5 52 (7 731 PUBI ISHING AND MEDIA 74 64 34.84 32 98 (5.9!M MEETAIS (110 22) 114.33 74.22 (169.95 FURNITrURE __ _ _601 2.91_ 1.31_ 1.0X AUTOMOTfVE 243.1 6 45.93 1 88.1 3 (9 124 MARKE1IING 101 81 64.03 12 43 (175.80 HEALTHISERVICES 0 97 4 80 5 24 0 8  - 32 - Compas a ,98 19 2.00 200 'FEXTILES 27.56 175.19 38.08 (180.13' GLASS-CEMDENT- CERAMVICS 249.52 210.05 152.99 152.12 TOURISM 7.67 2.25 3.89 (5.11, TRANQSPORTATION 49.24 147.69 91.41 4875 frOTA.L 1,740.74 1,127.33 839.34 (1,016.65, Source. TSKB Research, Main Financial Figures and Ratios of Industrial and Commrercial Listed Companies at ISE, 2002. O Companies' ability to service debt has declined markedly. The average ratio of liabilities to equity ranged from 124-151 percent between 1997 and 2000 but increased to 177 percent in the first quarter of 2001 (Table 14). This is much lower leverage than, for example, the 500 percent average ratio for the Republic of Korea's 30 largest chaebols at the end of 1997. Still, some sectors and companies (especially large companies) started to see leverage rise above 200 percent in the first quarter of 2001. By the end of the second quarter average leverage had fallen to 156 percent and by the end of 2001 to 149 percent. Leverage was higher for large companies (173 percent), reflecting their ability to borrow in euros or dollars prior to the crisis. Leverage also remained high in sectors such as food, beverages, metals, and textiles. o Average interest rate coverage dropped below a ratio of 1.0 in the fourth quarter of 2000 and stayed there in the first and second quarters of 2001-meaning that cash flows did not cover interest expenses. Debt is predominantly short term-up to 85 percent for many listed companies-which increases financial vulnerability because loans are repriced quarterly. The spike in interest rates during the early part of the crisis and prevailing high real interest rates since then have made it difficult for firms to service debt. By the end of 2001 average interest rate coverage had improved from second and third quarter levels, but were still below levels needed to service debts. Table 14. FinanciaR lindicators for Listed Companies, 1997-2001 Indicator 1997 Q4 1998 Q4 1999 Q4 2000 Q4 20,0;Q1 2001 Q2 2001 Q3 2001 Q4 Net Profitability 7.40% 4.80% 2.00% 3.30% -10.60% -4.0% -2.1% 0.2% Liabilities/Equity 124% 126% 147% 129% 177% 156% 165% 149% Eamings before Interest and n.a. 1.7 1.3 1.9 0.6 0.8 0.8 1.02 Taxes/Interest Expenses Source: Istanbul Stock Exchange data; World Bank staff estimates. 49. Taking pre-crisis average ratios of 131 percent for liabilities to equity and 1.6:1 for earnings before interest and taxes to interest coverage, listed Turkish companies were comparable to companies from Argentina, Colombia, and Mexico (Figure 16). Relative to East Asian companies, Turkish companies had lower ratios of liabilities to equity but similar interest coverage. Compared with companies from Westem Europe, Japan, and the United States, listed Turkish companies had similar or lower liabilities to equity but much lower interest coverage.  - 33 - 50. These data suggest that Turkish companies are vulnerable to drops in operating cash flows (such as those arising from contractions in demand) and spikes in interest expenses. During the first several months of the crisis, the debt of most listed companies rose to unsustainable levels, with the average ratio of net debt to equity (weighted by market capitalization) jumping from 13 percent at the end of 2000 to 53 percent in the first quarter of 2001-and then to 95 percent in the second quarter. By comparison, during the 1994 crisis this ratio peaked at 68 percent (Morgan Stanley 2001c, p. 15). Figure 16. Ratios of Liabilities to Equity and Interest Coverage in Various Economies V 450 400 * Kcrea 1997 C 350 ; * b~~~~~~~~~~~Idonesia 3 350 0 300 rea 1998 ._ \ * ~~~~~~~~~~~~~Thailand 250 - 200 * Korea 1999 JlPhppmes .0 PakLtan G* o t EbaKon8 er ISO * GersalawNorway 9F49ahden lo * Mexic Argcntama * U5 *N#hfflkad * Malaysa X5 * Colomb0a Pet Taiwan * Stng dMa 00 0 1 2 3 4 5 6 7 8 Interest Coverage Ratio Source. LGEconomic Researrh hlstitute, September2000;basedon World BankandAsian Devebopment Bankdata. Losses in Listed Companies 51. Financing for corporations comes from creditors, internally generated profits, or equity injections by owners. Losses consume resources and can be financed in only three ways. The first is to use the corporation's assets to finance the losses-say, by selling noncore assets or cutting investment in working capital assets such as receivables and inventories. A second way is to rely more on creditors, by delaying payments to trade creditors, negotiating extended repayment terms, failing to make statutory remittances on time, and a host of other techniques. Alone or together, both strategies increase the leverage of a corporation's financial structure and so make it more vulnerable. Both are by nature temporary; a business cannot indefinitely consume its assets or increase its leverage beyond a certain level before creditors take action to protect themselves. The third way to finance losses is for owners or new investors to inject additional equity. Businesses in Turkey have used all three techniques in their efforts to survive the current crisis. The central questions facing Turkish businesses are how long it will take them to recover profitability and whether they or their creditors (or both) have sufficient resources to finance the intervening period. 52. This report's statistical assessment of listed companies is based on the ratios described in Annex 2 and on macroeconomic data from the State Institute of Statistics. Where possible, company data have been segmented by size, sector, and ownership. The five listed state enterprises are treated as a separate group. Listed companies that are part of a group are also treated separately, because the results reported for an enterprise in a group do not necessarily  - 34 - reflect the financial situation of the group but are not necessarily comparable to those for independent companies. The main reason is that Turkey's generally accepted accounting principles and Capital Markets Board accounting rules do not require consolidated financial statements. (though the Capital Markets Board recently introduced new requirements for consolidated statements, to take effect in 2003.) The absence of such statements means that intragroup transactions are included in the results reported for individual companies. This approach does not necessarily present a true picture of the situation for the reporting corporation because the results may contain non-arm's-length transactions with other group companies. 53. In the absence of consolidated group financial statements, interviews with many of these groups provided insights into the effects of the crisis on their operations. Although not entirely satisfactory due to a lack of factual underpinning, these interviews lead to a working assumption that large groups are sufficiently diversified, have access to a wide variety of financing (including significant economic power relative to many of their suppliers), and have not been as badly affected by the crisis as stand-alone companies. Thus large groups present fewer risks than smaller conglomerates, which appear increasingly fragile, and stand-alone medium-size companies. This assumption is supported by a review of publicly listed group companies. At the end of March and June 2001, listed companies belonging to a large group were more export- oriented than stand-alone listed companies, were slightly less leveraged, and had less short-term debt as a share of total debt. Still, all the main groups have subsidiaries that have seen their financial situations worsen considerably. 54. Many groups undertook rationalization programs during 2001. These efforts included significant reductions in wage costs, reduced production, asset sales, and injections of new equity. There is a need to rapidly expand and accelerate such efforts in a few groups. In addition, some group subsidiaries will require extensive restructuring, including debt rescheduling. The idea that large, highly complex groups are too big to fail was debunked by the 1997-98 crisis in East Asia and the 1994-95 crisis in Mexico, and there is no reason to assume that Turkish groups are immune to failure-especially given their losses and deteriorating debt service ratios. 55. Of greater immediate concern, however, are the losses that have been suffered by small conglomerates. By the end of March 2001 their losses were -$126 million (compared with profits of $38 million in the same period in 2000), and by June losses had reached -$284 million (down from profits of $48 million). Medium-size stand-alone companies have also suffered losses in sectors such as textiles, food and beverages, retailing, marketing, and distribution. 56. When reviewing the analysis of listed companies, it is important to bear in mind that their reported results are prepared in accordance with accounting principles specified by the Capital Markets Board, which depart in several major ways from International Accounting Standards (see Chapter 5 and Annex 4). Until recent changes by the Capital Markets Board, there were no comprehensive requirements for consolidated financial statements or accounting for inflation, and wide latitude was given to the treatment of depreciation and interest.  - 35 - Prospects for Export-led Growth 57. The Government's economic program anticipates that, as with past crises, recovery will be led by a surge in exports. Thus this report, using 1999 as a starting base, focuses on the recent performance of the sectors with the largest export components (Table 15). The goal is to determine the extent to which these sectors appear to be taking advantage of the improvement in their competitive position resulting from the February 2001 devaluation. It is also useful to examine export revenues as a percentage of total revenues in the most important of these sectors (Table 16). Finally, Table 17 compares the export orientation and profitability of the main export sectors. Table 15. Exports by Sector and Sector Contribution to GDP, 1999 (%) Share of Share of manufacturing manufacturing sector's contribution to Sector exports GDP Textiles 37.0 16.1 Metal Goods, Machinery, and Equipment 23.6 12.9 Chemicals, Gasoline, Rubber, and Plastic 8.7 19.4 Iron, Steel, and Castings 8.1 7.2 Food, Beverages, and Tobacco 6.0 23.5 Cement and Glass 4.1 4.3 Forest Products 2.5 4.2 Pulp, Paper, and Publishing 0.7 2.4 Other 11.8 14.2 Source: Istanbul Stock Exchange data; World Bank staff estimates. * Table 16. Export Revenues as a Share of Total Revenues in Selected Sectors, 1999 Sector Share Textiles 42 Iron, Steel, and Castings 36 Metal Goods, Machinery, and Equipment 31 Food, Beverages, and Tobacco 15 Chemicals, Gasoline, Rubber, and Plastic 8 Source: Istanbul Stock Exchange data; World Bank staff estimates.  - 36 - Table 17. Export Oirienitationm and Profitabfiity by Sector9 2000-01 (percenitage of sales) Sector 2000!Ql 2000 Q2 2000 Q3 2000 Q4 2001 !Q1 2001 Q12 2001 Q3 2001 Q4 Tei;Aes Export Orientation 28.6 30.6 26.6 29.4 36.5 38.8 36.9 37.9 Profitability 0.4 1.4 1.9 0.3 -17.2 -8.3 -5.4 -1.4 "G';c-'o s' Af.Nwbty mMfy .-nd E -n ,ma Export Orientation 43.8 47.4 39.3 34.2 46.7 34.1 46.1 46.5 Profitability -2.0 -1.7 -1.3 0.3 -3.0 -5.8 -0.3 -0.6 2 k'r.- i - Export Orientation 7.9 8.0 6.7 6.4 5.8 10.3 9.4 10.8 Profitability 2.1 3.6 3.4 2.9 -18.3 -12.6 -10.2 -1.7 rin, Stc II and C$st1Lns Export Orientation 7.9 47.4 39.3 6.4 5.8 45.6 46.1 46.5 rofitability 2.1 -1.7 -1.3 2.9 -18.3 -5.0 -0.3 -0.6 acd ; e -, Export Orientation 14.4 18.3 18.7 19.6 12.9 18.2 17.1 15.0 Profitability 3.2 2.2 3.4 1.8 -17.8 -9.0 -4.1 -3.2 ,- 5' .- . . , Export Orientation 29.4 21.5 20.1 21.4 23.2 28.1 30.5 31.8 Profitability 2.0 3.7 4.9 4.6 4.2 5.6 8.5 8.5 Export Orientation 3.7 6.1 4.4 5.7 3.5 5.8 4.8 5.4 Profitability 3.9 6.9 6.4 4.9 -8.8 -1.6 0.4 -1.6 Export Orientation 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Profitability 2.0 0.2 0.9 0.9 -12.7 -10.3 -26.0 -11.4 Source: Istanbul Stock Exchange data; World Bank staff estimates. 58. During the first quarter of 2001 the textiles and the machinery and equipment sectors were able to export a significantly larger portion of their sales than in the comparable period in 2000. All sectors except cement and glass suffered major losses in the first half of 2001. In commodity sectors such as steel and chemicals, the ability to export helped reduce losses in the sector. By the fourth quarter the rate of loss in most sectors had mitigated and the cement and glass sectors remained profitable. 59. The benefits of the devaluation should be assessed for the entire corporate sector, including sectors that do not export a significant amount of their production. Sectors that historically have been major exporters have benefited the most from the devaluation. However, the economy can be divided into sectors that import raw materials and export them after processing, those that import raw materials to make products for the domestic market, those that use domestic inputs for sales in export markets, and those that use primarily domestic inputs for sales in the domestic market. Even the main export sectors derive more than half of their revenues from the domestic market. Thus the health of the domestic market will determine when and how quickly the real sector will recover. Companies in every sector have incurred losses-  - 37 - exporters and nonexporters. Some large compames, such as automobile manufacturers and white goods producers, that mcreased exports, are far more dependent on domestic sales than on exports And traditional exporting sectors, such as textiles, remam mired m financial difficulty. Thus a restoration of busmess confidence and an mcrease in domestic demand are essential to economic recovery Financial Indicators for Listed Companies 60 A companson of the performance and status of listed compamnes for 2001 and in 2000 indicates both the damage the companies have suffered and the ways they have adapted to the Cnsis. 61 A Steep Decline in Profitability As noted, all the main sectors except cement and glass suffered losses in the first and second quarters of 2001 (Figure 17) Food, beverages, tobacco, textiles, chemicals and fuels suffered the sharpest reversals m profitability relative to both all of 2000 and the same quarters in 2000. In 1999 these three sectors accounted for nearly 60 percent of the manufacturing sector's contribution to GDP and for 52 percent of manufacturing exports (see Table 15) Figure 17. Profitability in Export- and Domestic-oriented Industries, 1997 Q4-2001 Q4 Profitability: Export Industries 150% 10 0% - 50% - - - 00% - r N -1150%7-S. S _9__ -200% - - - -Textiles Machinery & Eq - Iron, Steel, Metal Profitability: Domestic Industries 150% -50% q8q34-9q1-Oq4--Oq4 9O2-40q3-O O4-- t WQ- , q4 t-O00% -~ ------------ --.-- -- -- - - - . -20 0% - - . -Chemwicals & Fuel -Food & Beverages iPaper and Printing - Cement & Glass_ Source Istanbul Stoc Exc,hange data, World Bank sffes7tiates  - 38 - 62. llmadequate lunterest Coverage. Throughout 2001 interest coverage with cash from operations was weak in all sectors except cement and glass (Figure 18). Textiles, chemicals, fuels, food and beverages appear especially vulnerable. Because reported financial expenses can include exchange losses, it is difficult to discern the extent to which these data are distorted. But because the sectors involved are so important-in terms of exports and contributions to GDP- the duration of the weakness in the coverage of financial expenses is critical. Figure 18. Elnterest Coverage in Export- and Domzestic-oriented lindustries, 1997 Q4-2001 Q4 Onterest Coverage: Export Industries 5.00 4.00 3.00 2.00 _ - 1.00 0.00 97q4 98q1 98q4 99q1 99q4 OOql OOq2 OOq3 OOq4 01ql 01q2 01q3 01q4 -- -Te4iles -Machinery& Eq. Iron, Steel, Metal Interest Coverage: Domastic lndusMstrs 6.00 5.00 _h. 4.00--_____________________________ 3.00 - ' - 1.00 0.00 97q4 98q1 98q4 99q1 99q4 OOql OOq2 OOq3 OOq4 Olql 01q2 01q3 01q4 | - -*Chemicals & Fuel -Food & Beverages - - -Paper and Printing -Cement&Glass Source: Istanbul Stock Exchange data; World Bank staff estirnates. 63. Hligh Short-term Liabilities. Short-term liabilities as a percentage of total liabilities increased marginally in all sectors from already high levels. At the end of June 2001 short-term liabilities accounted for an average of 81 percent of the total; among the major exporting sectors the average was closer to 85 percent (Figure 19). This is an unusual, unstable financial structure, and exposes enterprises to far more risk than if their liabilities had more balanced maturities.  - 39 - Figure 19. Short-term Liabilities in Export- and Domestic-oriented Industries, 1997 Q4-2001 Q4 Short-Term Liabilities: Export Industries 1000% 80 0%6----e 60 0% - r 400% 20 0% - 00% 1 - - T- 97q4 98q1 98q4 ggql 99q4 OOql OOq2 OOq3 ooq4 Olql 01q2 01q3 01q4 - 5- --Texhles -.-M chinery& Eq - - Iron, Steel, Metal Short-term Liabilities: Dormstic Industries 100 0% 800% - 0 - 600% - - -_ _ . . . _ _ . 400% 0 __ _ _ % 20 0% -_________4._._ 97q4 98q1 98q4 98q1 99q4 OOq1 00q2 OOq3 OOq4 Olql 01q2 01q3 Olq4 | *- - -Chemicals & Fuel Food & Beverages I - u Paper and Pnnfing Cement & Glass Source Istanbul Stock Exchange data, World Bank staff estimates 64. High Reliance on Bank Borrowing. Most of the major export sectors have mcreased bank borrowing as a percentage of both long- and short-term liabilities. Textiles, machinery and equipment, and food, beverages, and tobacco not only have the largest shares of short-term liabilities, they also have high shares of bank debt in those ltabilities (Figure 20) Dependence on bank financing may pose difficulties if banks continue to resist sxgmuficantly increasing loans. At the least, the compames with the most bank debt will suffer the most from banks' hlgher pncing structures. The economic recovery will require lower real interest rates from banks, but there is no sign that these will be available in the foreseeable future  - 40 - Figure 20. Bank BTorrowing in Export- aind ID)onmestic-oriemted llmdustries, 1997 Q4-2001 Q4 3Bank Borrowing: Export IndusMres 70.0% - 50.0% - 40.0% - ___ 30.0% 20.0% --._ __-_-_-__-_ _ _ ___________ 10.0% ~- - 0.0% 97q4 98q1 98q4 99ql 99q4 OOql OOq2 OOq3 00q4 Olql 01q2 01q3 01q4 | - - -TeAiIes -I\chinery& Eq. I Iron, Steel, Metal Bank Borrowing: Donmstic Mndustrles 60 0% 50.0% <.<--- '=_ 40.0% - - - - - - ____. 30.0% ~ . - - _ __ 10.0% -_ 00% 97q4 98q1 98q4 99q1 99q4 OOql OOq2 OOq3 OOq4 Olql 01q2 01q3 01q4 | - - -Chemicals & Fuel -Food & Beverages | . -Paper and Printing -Cement & Glass Source: Istanbul Stock Exchange data; World Bank staff estimates. 65. Sma$lenr Companies, Bigger Losses. Small listed companies (these companies would be considered mid-cap companies relative to traditional definitions of small and medium-size enterprises) were hit harder by the crisis than were medium-size and large companies. In the first quarter of 2001 their profits dropped 20 percent (compared with 5 percent for medium-size and large companies), their financial expense burden was a staggering 30 percent of sales (compared with 20 percent for large companies), and their interest coverage fell to 0.5-meaning that they could not service their debt (Figure 21). Over the rest of 2001 the losses of small companies declined, averaging 5 percent of sales in the fourth quarter. The assumption is that small listed companies were able to cut costs and in many cases probably stopped servicing their debt. At the end of 2001 their average debt service ratio remained below 1.  - 41 - Figure 21. Does Size Matter? Profitability by Size 100% 50% - , -50OW --98qt- 98q4 99q -49q4--O0qt- 00q2- OOqS-G4q4 - 2 -0193 -44 -1 00% -1 50%- -200% - -25 0% | -Large Medium 4 Small Financial Expense Burden 40 0% 30 0% f_--- ____--- __ __ _ _ 20 0% - -__ _ _ _ _ ___ _