Turkey - Istanbul Power Distribution Project

CIRCULATtNG COPY s TO BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use CDP , Report No. P-1226-TU REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR A POWER DISTRIBUTION PROJECT IN ISTANBUL April 12, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit Turkish Lira (TL) US$ 1 TL 14.00 TL 1 US$ 0.07 TL 1,000 3US$ 71.40 TL 1,000,000 U US$ 71,429 Tur-kish Fiscal Year - March 1 to February 28  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR A POWER DISTRIBUTION PROJECT IN ISTANBUL 1. I submit the following Report and Recommendation on a proposed loan to the Republic of Turkey for the equivalent of USS14 million to help finance a project for power distribution in the Istanbul Metropolitan area. The loan would have a term of 20 years, including 3-1/2 years of grace with interest at 7.25% per annum. The proceeds of the loan would be relent to the Istanbul Electricity, Tramway and Tunnel Company (IETT) on the same terms. PART I - THE ECONOMY 2. A report entitled "Current Economic Developments and Prospects of Turkey" dated September 18, 1972 was distributed to the Executive Directors on October 25, 1972 (R72-236). A country data sheet is attached as Annex I. 3. Following a lone period of stability, internal political tensions have appeared in the last two years. Student disturbances and unrest among workers occurred in 1970 and early 1971, and the armed forces called in March 1971 for the resignation of the Demirel cabinet and for the implementation of the land, tax, educational, administrative and other reforms prescribed by the 1961 Constitution. An "above-party and reformist" government was formed under Prime Minister Erim, and martial law was introduced. In its eight months in office, the Government largely re-established law and order, and introduced some administrative changes. It also raised prices charged by several State Economic Enterprises and presented several reform bills to Parliament. However, it was not able to translate its long-range economic policies into detailed measures and decrees. Growing opposition from Par- liament to some of the administrative changes and reform proposals brought about the resignation of a large group of ministers in December 1971, and a new coalition government, headed again bv Prime Minister Erim, was then formed. 4. The second Erim government had greater political party representation but its attempt to push through modified reform measures again met with oppo- sition in Parliament. A mining reform bill and a moderate land reform bill were introduced in Parliament, but little was done to further educational re- form or to reorganize the State Economic Enterprises. Prime Minister Erim resigned in mid-April after his request for "government by decree", intended to speed up the process of reforms, was turned down by the political parties. A new government drawn from three parties and non-parliamentarians and headed by Prime Minister Melen was formed in Mlay 1972. It declared its aim to pursue  - 2 - the reform measures and prepare for national elections in the fall of 1973. During 1972, despite the attempts of the Melen Government little progress has been made in passing the reform bills in Parliament. The underlying ten- sions between some of the political parties and the armed forces came to the fore in March 1973 in connection with the end of the term of the President of the Republic and the election of a new President. After some delay, agree-- ment was reached and former Admiral Fahri Koruturk was elected President April 6, 1973. 5. While long-term economic policy issues have recently become one of the main causes of political tensions, growth in Gross National Product in the last decade has been high and continuous, averaging about 6.8 percent per year in the period 1962-1971. In the same period, gross investment in- creased substantially, with its share in GNP rising from 15 to 21 percent. Although total consumption increased considerably, gross national savings increased at a much faster rate, their share in GNP rising from 11 to 20 percent. However, in 1970 and 1971, in spite of a big jtimp in workers' re- mittances, the share of gross national savings has not risen substantially due to relatively poor public savings, and the share of investment also in- creased more slomly due to pressure on public resources (para. 8). 6. The main growth sectors in the last decade have been industry, power and construction. This reflected the development strategy during the first and second five-year plans (1962-67, 1968-72), which gave highest priority to industrialization. Industrial output grew by about 10 percent per annum with textiles, machinery and equipment, steel and chemicals providing the main impetus. But this rapid growth, mainly to meet domestic demand and replace imports, was insulated from foreign competition. Otlher rapidly growing sectors were transport, trade and financial services. The impact of large investments in agriculture was slow, however, and agricultural production had a trend growth rate of about 3 percent per annum only, with large fluctuations from year to year depending on wqeather conditions. As a result of the relative growth rates, the shares of industrv and trade in GDP rose to 23 and 10 percent lespectively, and that of agriculture dropped to 27 percent, compared to 17, 8 and 37 re- spectively in 1962. Growth in the last two years has been above average. In 1971, GNP increased by 9, in real terms, with value added in agriculture in- creasing by more than 9% thanks largely to an excellent hlarvest, a sharp rise in workers' renittances and continued industrial growth. In 1972, GNP in- creased by about 7.5%, with value added in agriculture remaining at about the record 1971 level but an estimated 12% growth in industry, fast growth ill transport, construction and trade and another sharp rise in workers' remittancess. 7. The balance of pavments situation was characteri',ed in 1967-70 by increasing trade deficits, and a strict systen of imoort controls leading to delays and shortages of essential imports and, consequently, to underutiliza- tion of production capacitv. The overvalued official exchange rate was changed in August 1970 from TL 9 to TL 15 per US$, revised to TI 14 in December 1971 and has remained at TL 14 after the February 1973 dollar devaluation. This, tog,ether with associated stabilization measures and a rapid rise in workers'  - 3 - remittances helped to imorove the situation dramatically. Workers' remittances increased sharply, from about $140 million in 1969 to $470 million in 1971. Commodity exports and tourism receipts also increased markedly. These im- provements led to better availability of essential imports of investment goods, raw materials and parts, and to rebuilding of stocks. The improvement in the balance of payments continued in 1972. Commodity exports increased by about 30 percent reaching $885 million due to agricultural exports (main- ly tobacco, hazelnuts, raisins and fruits and vegetables) increasing by over 20 percent, and industrial exports increasing by about 65 percent, from $145 million in 1971 to about $240 million. The large increases in industrial exports were in food and beverages, textiles, cement, hides and leather pro- ducts and petroleum products. Imports also rose by over 30 percent to reach about $1560 million, leading to a substantially larger trade deficit than 1971. However, workers' remittances jumped by about 55 percent, reaching about $730 million and the overall result has been a continuing increase in gross official foreign exchange reserves, which stood at $1485 million at the end of January 1973. Net foreign assets, which were negative in 1966-68, had risen to almost $600 million in November 1972. 8. The budgetary situation has been dominated in the last decade by the need to control the rapid growth of public expenditures. Although tax revenues have grown faster than GNP, their share rising from 12.9 percent in 1962 to 17.6 percent of GNP in 1971, the increases in tax revenues have been more than offset by the rise in current expenditures and transfers. The over- all budget deficit has grown since 1968 and was particularly large in 1971 when the full impact on current expenditures of public salary increases under the 1970 Personnel Reform Law was felt. The Treasury had to have growing re- course to the Central Bank for short-tern adlvances and to other short-term borrowing. The difficulties facing public mobilization of resources led to public investment expenditures falling short of targets, and to an actual decline in public fixed investment in real terms in 1971. The pressure on puthlic resources has continued in 1972, anld lthe growth of public development expenditure probably suffered as a result. 9. The financial results of the more than 100 Staite Economic Enter- prises (SEE's) have beeni consistently poor. The SEE's now account for about 20 nercent of the fixed investment in the economv and about 10 percent of value-added, however, in each vear since 1966 a third of the 28 major produc- ing SEE's on average have lost money. Since 1969 the average rate of return on investment for these largest producing SEE's has been less than 3 percent despite subsidized interest rates averaging about 4 percent. The low profits of the SEE's have necessitated increasing budgetary transfers, which amounted to TL 3.5 billion in 1971. The railways, by far the biggest loser, accounted for about a third of that amount. 10. In the period 1967-70, while available resources increased, a more ranid growth of expenditures led to inflationary pressures in the economy,  - 4 - resulting in an average increase in wholesale prices of about 6 percent per annum. Inflationary pressure became particularly strong in 1971 when whole- sale nrices rose 16 percent and cost of living by 20 percent. The pressures came mainly from the demand side due to substantial increases in public salaries and industrial wages, higher remittances from abroad and larger agricultural incomes in a year of record output. At the same time controlled prices of public industrial enterprises and support prices of major agricul- tural products were also raised, and prices of imported goods increased sharp- ly as a result of both devaluation and the rise in world export prices. The pressure on prices has continued in 1972, fueled by a continued rise in receipts from remittances and exports, as well as by the resumed growth of investment, both private and public. Wholesale prices rose by 15 percent in 1972. In these circumstances, better mobilization of resources by the public sector, a balance between the claims of the public and private sectors on investment funds, further liberalization of imports and avoidance of short term borrowing by the Treasury from the Central Bank are needed, among other measures, to contain the inflationary pressure. 11. For the longer term, the continued political uncertainties have meant that the planned reforms, e.g. administrative, tax, educational and land reforms, and reorganization of SEE's have on the whole not progressed very far. In July 1972, a "preliminary measures law" for land reform was passed which provided for preparatory measures, but the land reform bill itself has yet to be passed by Parliament. Administrative reform of the SEE's and upgrading their executive and labor skills have still to be achieved. This is particularly important to prepare Turkish industry for competition that will arise from association with the EEC. In agriculture, although sub- stantial irrigation investments have been made in the past and the government rightly gives high priority to completing on-going projects., several long-term problems remain. The Anatolian plateau and the eastern part of Turkey are considerably less developed than the coastal regions and land tenure problems are serious in some regions. Surplus stocks of tobacco, tea and hazelnuts have accumulated and there is need to modify price support and other policies to divert resources from those surplus crops for which Turkey has no compara- tive advantage. Some progress has already been made in shifting land from sugarbeet to sunflower, feedgrains and other crops and recent high export demand has also helped to somewhat reduce the stocks of other products. 12. The employment situation is also a matter of growing concern. Despite rapid industrialization and with the leveling off in agricultural employment, Turkey has not been able to absorb the increasing labor supply in the last decade. The labor force grew by about 420,000 a year between 1965 and 1970, of whom about 57,000 emigrate i nd 240,000 found employment on the domestic market, mostly in services and iniustry, leaving about 124,000 more unemployed each year. In the medium term, labor supply is expected to con- tinue growing by about 2.8 percent per year while demand outside agriculture is projected at about half the increa