Turkey - Antalya Forest Utilization Project

eq - 7 -7 / FILSCOP DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1361-TU REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO TURKEY FOR THE ANTALYA FOREST UTILIZATION PROJECT January 2, 1974 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 It may not be published, quoted or cited without Bank Group authorization.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 US$ 71.40 TL 1,000,000 US$ 71 ,429 Turkish Fiscal Year = March 1 to February 28.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOI1MENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR THE ANTALYA FOREST UTILIZATION PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Turkey for the equivalent of US$40.0 million to help finance a project for (a) the development of modern forest management practices in the Antalya forests, (b) the construction of an integrated saw mill and pulp and paper mill by the State Pulp and Paper Enterprise (SEKA) near Antalva, and (c) further forest industries sector studies. The loan would have a term of 16 years, including 5 years of grace, with interest at 7-1/4 percent per annum. Part of the proceeds of the loan ($29.9 million) would be relent through the State Investment Bank (SIB) to SEKA and its Antalya Establishment for the in- dustrial part of the project on the same terms as the Bank loan, plus a fee of 1-3/4 percent per annum on the outstanding amount, bringing the cost of this portion of the loan to SEKA and the Establishment to 9 percent per annum. The loan would be made jointly with a $24.4 million loan from the European Investment Bank (EIB). The EIB loan would have a term of 30 vears, including 8 years of grace, with interest at 4-1/2 percent per annum. PART I - TIIE ECONOMY 2. A report entitled "Current Economic Developments and Prospects of Turkev" dated September 18, 1972, was distributed to the Executive Direc- tors (R 72-236). A country data sheet is attached as Annex I. A basic economic mission visited Turkey in April/May 1973 and the report will be distributed to the Executive Directors in early 1974. Some preliminary conclusions of the mission have been incorporated below. 3. Following a long period of stability in Turkey during the 1960s, internal political tensions appeared at the beginning of the present decade. Student disturbances and unrest among workers occurred in 1970 and early 1971 and since March 1971, when the armed forces called for the resignation of the Demirel cabinet and for the implementation of the land, tax, educa- tional, administrative and other reforms prescribed by the 1961 Constitution, there have been four Government changes. The "above-party" and reformist Government formed under Prime Mlinister Erim in March 1971 introduced several reform bills in Parliament. But the tensions between the armed forces and the political parties and opposition from Parliament to some of the reform proposals and administration changes have led to successive coalition Govern- ments with increasing political party representation. The continued political uncertainties have meant that although law and order were largely restored, planned reforms have on the whole not progressed very far. The underlying tensions 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, agreement was reached and former Admiral Fahri Koruturk was elected President in April 1973. A new Government under Prime Minister  - 2 - Talu was then formed, xjhichl announced its intention to speed up the process of legislating reforns and Drepare for national elections, which took place in October 1973. The Republican People's Party under Mr. Ecevit gained the largest number of seats but failed to get an absolute majority. Discussions are now being held to explore the formation of a coalition government. 4. While long-term economic policy issues have recentlv become one of the main causes of political tensions, growth in gross national product in the last decade has been high and continuous, aver-aging about 6.9% per year in the period 1962-72. In the same period, gross investment increased substan- tially, with its share in GNP rising from 15% to 20%. Although total consump- tion increased considerably, gross national savings increased at a much faster rate, their share in GNP rising from 11% to 19%. Iiowever, since 1970, in spite of a big jump in workers' remittances, the share of gross national savings h1as not risen substantially due to relatively poor public savings, and the share of investment also increased more slowly due to pressure on public resources (paragraph 7). 5. The main growth sectors in the last decade have been industry, power, transport 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% 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, which led to high- cost industrial production. Other rapidly growing sectors were trade and financial services. Agricultural production had a tren(d growth rate of about 3.5% per annum, with fluctuations from year to year depending on weather conditions. As a result of the relative growt:h rates, the share of industrv in GDP rose to 23% in 1972 and that of agriculture dropped to 28%', compareci to 17% and 39% respectively in 1962. Growth in the last two years has heen above average. In 1971, GNP increased by 10 percent in real terms, with value added in agriculture increasing by more than 11%, thanks largely to an excellent harvest, a sharp rise in workers' remittances and continued industrial growth. In 1972, GNP increased by 7.7%, with value added in agriculture not increasing over the 1971 level, but with a 12% growth in industry, fast growth in transport, construction and trade and another sharp rise in workers' remittances. 6. The balance of payments situation was characterized in 1967-70 by increasing trade deficits, and a strict svstem of import controls leading to delays and shortages of essential imports and, consequently, to under- utilization of production capacitv. The overvalued official exchange rate was changed in August 1970 from TL 9 to TL 15 per US$, revised to TL 14 in December 1971 and has remained at TL 14 after the February 1973 dollar devaluation. This, together with associated stabilization measures, rising world demand and prices and a rapid rise in workers' remittances (from $140 million in 1969 to $740 million in 1972) helped to improve the situation dramatically. Commoditv exports increased by about 23% per annum in 1971 and 1972, due to agricultural exports (mainly cotton, tobacco, hazelnuts, raisins and fruits and vegetables) increasing by about 22% per annum and  - 3 - industrial exports by an unprecedented 55%, The large increases in Industrial exports were in food and beverages, text!les, hides and leather products and petroleum products. The improved foreign exchange position also led to a high import growth of 28% per annum, mainly in investment goods and raw materials (machinery and equipment, transport, steel and other metals, chemicals and fertilizers), Tourism receipts also doubled between 1970 and 1972. The improvement in the balance of payments continued into 1973 with exports and imports in the first half of the year increasing by 44% and 32% respectively over the first half of 1972. Workers' remittances are expected to have been about $1 billion in 1973. The overall result has been a continuing increase in gross official foreign exchange reserves, which stood at $241 billion at the end of August 1973. Net fereign aose;s, which were negative ifn 1966-68, had risen to over $900 million in July 1973, ie. about 6 months of imports. One of the contributory factors to the rising foreign exchange reserv-es has been the inflow of 'hot' money with conrertible lira accounts rising from $70 million at the end of 1970 to $480 million in April 1973. 7, The budgetary situation has been dominated in the last decade by the rapid growth of public expenditures, Although tax revenues have grown faster than GNP, their share rising from 12.9% in 1962 to 17.9% of GNP in 1972, the increases in tax revenues ha-e been more than offset by the rise in current expenditures and transfers, The overall budget deficit has grown and was particularly large in 1971 when the full impact on current expendi- tures of public salary increases under the 1970 Personnel Reform Law was felt. The Treasury had to have growing recourse to the Central Bank for short-ternm adrances 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. In 1972, the need for Central Bank financing of the Treasury declined as a result of a strict control of current expenditure and a sharp increase in the sale of Government bonds to TL 4 billion (0.8 billion in 1971). Public 3Cvestment also recovered, increasing by 19% over 1971. 8. The overall f,.nancial results of the more than 100 State Economic Enterprises (SEEs) have been consistentlv poor, but there are sharp differ- ences among SEEs, with railways and coal being the major losers and manufac- t^oring showing improving profits. The SEEs now account for about 20'% of the .fred investment in the economy and about 10% of value-added; however, in eac1a year since 1966 a quarter of the 28 major producing SEEs on average hx-re lost money, Since 1969 the average rate of return on investment for the 28 largest producing SEEs has been less than 3% despite subsidized interest rates avieraging about 4%. The low profits of the SEEs have necessitated in- creasing budgetary transfers, which amounted to TL 3.5 billion in 1971 and over TL 6 billion in 1972. The railways have been by far the biggest loser, although the measures agreed upon in connection with Loan 893-TU have begun to lead to improvement in their financial situation. 9. In the period 1967-70, while available resources increased, a more rapid growth of expenditures fueled by fa3t monetary expansion led to infla- tionary pressures in the economy, with the GNP deflator increasing by about 6% per annur.. Inflationary- pressures have been particularly strong in the  - 4 - last two vears, with the GNP deflator increasing by 18% and 14% in 1971 and 1972 respectively. Excess demand has been fueled in this period by accumula- tion of foreign exchange reserves, due to rapidly rising workers' remittances and convertible lira accounts; substantial deficit financing of the public sector, mainlv to finance the Treasury and agricultural commodity purchases in 1971, and rising private investment demand. At the same time, prices of imported goods have risen as a result of the devaluation, depreciation of the lira and rising world export prices and, furthermore, the prices of SEE pro- ducts were raised in 1971 and agricultural support purchases have been sub- stantiallv raised over the last two years. In these circumstances, effective demand management should be a major concern of economic policy. Policies will be needed to improve mobilization of resources by the public sector to finance growing public investments. It would be essential to develop the capital market in Turkey to supplement existing sources of long-term domestic borrow- ing. Proposals for a capital market bill are now being considered. In addi- tion, revisions in the interest rate structure to ensure a reasonable real rate of return would be needed to encourage private savings. Further liberal- ization of imports to improve the competitiveness of domestic industry and reduce the inflationary growth of foreign exchange reserves would also be necessary. 10. The emplovment situation is also a matter of growing concern. The development strategy has emphasized the growth of output and labor productiv- icv rather than employment. As a result, the labor surplus, including esti- mates of labor surplus in agriculture rose from about 1 million in 1962 to ..6 million in 1972, i.e., about 11% of the labor force. Migration has so far greatly eased the pressure on employment. Between 1965 and 1972, net emigration amounted to about 400,000 and was expected to be about 70,000 per vear during the Third Plan. The Third Plan continues to emphasize investment in capital intensive industries and projects a growth in non-agricultural labor surplus by aniother 300,000 by 1977. With the added effect of a slow- dow)n in EuroDe on employment of Turkish workers (para 14), unemployment should ae a .ador concern of economic policy. Speedy implementation of land reform an.d integra,ed ruraL development programs would help to reduce the migration :roxo cura. to urban areas. In addition, labor intensive methods need special cTph3SiS in the choic-e of projects. However, even with these measures and frster growth chan p_anned in construction and services, urban unemployment Is iirelv to remain a serious problem. The Prospects for continued high economic growth are good. The ;!;rc A ;- (1Qi _3-77) development strategy constitutes the first phase of a io.ng-t.err.sti:azegy for the period 1973-95, the ultinate objective of which is < raLse 1url i sh standards of living to those of It-aly in 1970, through fast induszrialization and decreasing dependenace on external resources. The Third Plan targets are an 8% GDP growth rate, 10.7%o fixed investment growth rate (TL 280 billion in constant prices over the Plan period, i.e., an average of aDout $4 billion per year), a marginal savings ratio of 38% on national savings (compared with about 18% in the Second Plan), commodity imports and exports growing at 9.4% and 7.1% respectively and a decline in gross inflows of official external assistance to $130 million in 1977 (compared with over $300 million in 1972). Workers' remittances are estimated at $600 million at constant prices in 1977.  12. A detailed analysis of these tf.rgets will be presented in the basic eeonoxc l report The p7eliminar -y nclusi~ns are that, though the prospects for a growth rate of 7% are g-eod, thE. PlFn projections seem to underestimate both the difficulty of raising thn savings level and that of balancing the external account at a reduced level of xtenrrial assistance. 13, Most of the increase in national savings in the Plan is expected to come from the public sector (68%) throtugh a large increase in tax revenues representing 31% of GNP increase and, SEE curpluses increasing by 33% per year. With the past performance of SEEs and delay7s in implementing reform, the expected growth in their surplus is not feasible. It will also be difficult to raise tax revenues to- tie extent impliped -y the Plan but there is scope for a smaller increase if vigorous policies are pursued, e.g., further impro.'e- ments in tax administration and effecti-ve collection now under way, widening the tax net to cover agricultural incomes, lncreases in the rates of property taxation, introduction of a value added tax and liberalization of imports to offset tax losses due to import stibstitu.tion and reductions of custom duties under the EEC agreement. The problem of domestic resource mobilization by the public sector is therefore likely to remain a constraint in the growth of public investment and aDart from improved SEE performance, higher external borrowing and policies to increase long-term domestic borrowing from the prilvaZe sector would be inecessary to achieve the ambitious investment targets. 14, On the external side. the Plan projections have been overtaken by events and commodity imports and exports in 1973 are likely to have been at about the level projected for 19,77. Workerst remittances in 1972 were already higher than the 1977 target. However, their future was made uncertain by the decision of the Federal Gernan Government in November to temporarily prohibit further entry of foreign wtorkers from non-EEC countries because of the energy crisis. It remains to be seen what course this policy will take over the I.onger run. The emphasis on capital intensive industrial development and the rise in the prices of imported fuel and raw materials will require a faster import growth rate, especially since the import regime is likely to be more liberal than in the past. Exports, pprticularly of industrial commodities, should continue to show good growth unless inflation continues at high rates, which would erode the competitive advantage gained as a result of the 1970 devaluation and the subsequent depreciation of the lira with the dollar vis- a-vis Turkey's main trading partners in Europe, Gross official external in- flows may be of the order of $400 million a year. 15. For the longer term, the continued political uncertainties have meant that planned reforms, e.g., tax, educational and SEEs, have on the whole not progressed very far. Administrative reform of the SEEs, upgrading their executive and labor skills and better pricing policies still need to be achieved, although administrative reform of SEEs is proceeding slowly on a case-by-case basis in connection with Bank loans. This is especially important to prepare Turkish industry for competition that will arise from the EEC. A land reform bill was passed in June 1973, but only the large holdings wi51 be subject to expropriation, and the existing land holding situation in Turkey is not clear because title to much of the land has not been registered and the cadastral survey is proceeding slowly. Other problems in agriculture  - 6 - are that the Anatolian plateau and the Eastern part of Turkey are considerably less developed than the coastal regions. Greater provision of credit to farmers for productive purposes is needed and there is a need to modify price support and other policies to divert resources from surplus crops, e.g., tea and tobacco. 16. Total external debt outstanding and disbursed was $2.5 billion at the end of 1972, of which all but 3 percent is public or publicly guarznteed. The share of the Bank Group in total debt outstanding was 8.3% in 1972 and is expected to rise; the precise extent will depend considerably on the future level of workers' remittances. The average terms of new credits have been hardening in recent years and this trend is expected to continue. Of the total gross official external assistance of about $380 million in 1972, the Consortium members provided an estimated $220 million. Of this about $58 million came from the United States, $44 million from the Federal Republic of Germany, $35 million from the Bank Group, $27 million from the European Monetary Agreement (EMA) and $22 million from the United Kingdom. The USSR dSsbursed $113 million. As a result of successive debt reschedulings and other arrange- ments for debt relief together with substantially increased workerst' remittances, the debt service ratio fell considerably from 24% in 1964 to an estimated 10% of total foreign exchange earnings in 1972. However, since the improvements in the balance of pavments have occurred recently, and have been dependent to a considerable degree on workers' remittances, Turkey should continue to exercise great care in its external debt management, including restraint in its resort to suppliers' credit financing. PART II - BANK GROUP OPERATIONS IN TURKEY 17. During the lengthy period of chronic balance of payments difficul- ties before the 1970 stabilization program and devaluation of the Turkish lira, Bank lending was only intermittent. Since then, the rapid improvement in the balance of payments and in creditworthiness stimulated by these actions has made possible a large increase and continuity in Bank/IDA lending, which in FY 71, FY72 and FY73 amounted to $114 million, $173.3 million, and $175 million respectively. In these three fiscal years sixteen lending operations were carried out, of which five were in agriculture, four in industry (includ- ing DFCs), three in power and the rest in urban development, transportation, an, :c-ational education. Agriculture accounted for 30% of the funds lent and industrv and DFCs for nearly 40%. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of October 31, 1973, and notes on the execution of ongoing projects. Implementation of projects in our private sector has been satisfactory; on the other hand, projects in the future sector - especially those breaking new grcound in agriculture - have been seriously affected by political instability and the resulting admiinistra- tive problems, and disbursements have been much slower than expected. A com- prehensive review of the problems besetting these projects will be proposed to the Government as soon as a new cabinet is formed.  -7 - 1 8. In view of the sastained improl7ement in the balance of payments situation, no further IDA lending in rontemplated. Bank lending is being increasingly directed to support of Turkish efforts: (a) to improve lagging public sector saving where financial and management reform of the State Economic Enterprises (SEEs) remains the key problem; and (b) to further improve distribution of income and living standards in an economy entering its seco1nd decade of roughly 7% yearly growth, i.e., to promote better employment policies, more concerted rural development efforts, and better urban planning. Since the strengthened balance of payments position rests in good measure on workers' remittances, future lending will also be aimed, as opportunities arise, at helping Turkey to make key structural changes to diversify long-term capacity to earn foreign exchange, for example, in tourism, if the Government decides to mount a greater effort in this sector to complement and support private initiatives, which have already begun to stimulate increases in badly lagging earnings from this source. As a first step in this latter direction a Bank tourism project identification mission visited Turkey in December 1973. 19. While the focus of Bank lending is on supporting the institutional and structural changes noted above, continuation of recent levels of lending is also important at least for an interim period until the longer term stability of Turkey's external earning capacity is better established. As discussed in Part I, Turkev's Third Plan goals of an 8% growth rate and increasing competitiveness with the EEC in preparation for eventual full membership require further import liberalization and higher external borrow- ing in the near term. 20. In pursuit of the two broad objectives of improved public sector saving and better distribution of welfare outlined in paragraph 18 above, it is planned to continue concentrating the bulk of Bank lending (a) in industry (including mining and DFCs), where financial and management strengthening of SEEs is the key task, and (b) in aRriculture, where rural development, employment, and institution building are being encouraged. This core of the program will be supplemented by repeater loans for railways and selected loans for power (which also center on financial reform of state enterprises), follow-up lending for urban development in Istanbul and possibly in Izmir in support of the second objective, and potentially by lending in tourism. Bank lendlng has thus far been geographically focused mainly in the Istanbul region, with emphasis on urban development and industrial finance, and in the Cukurova region around Adana on the southern coast, with emphasis on power, irrigation and fruit and vegetables. This pattern is likely to broaden in pursuit of the second objective, with wider lending in the Anatolian plateau and eastern Turkev in response to the Government's efforts to widen the geographic base of development, discourage too rapid urban migration, and improve the distri- bution of income. Continued selective lending to the Turkish Industrial Development Bank (TSKB) is also contemplated, with emphasis being placed on encouraging TSKB to broaden its private sources of capital and to sten up its efforts to finance private investment in the poorer regions of Turkey. 21. With regard to public sector reforms, past Bank lending for power over the course of several years helped bring about a comprehensive reorganiza- tion of the power sector including the creation of the Turkish Electricity Authority (TEK). This year proposed Bank participation in a financing package for the Elbistan lignite mine and power plant in east central Turkey should  further help TEK to achieve it-s long-term reform objectives and establish a Bank working relationship with the Turkish CoaL Authority (TKI). The proposed Antalva Forest Utilization loan aims to strengthen the State Pulp and Paper Enterprise (SEYA) in its overall investment planning as well as to promote effective financial management in the proposed new mill subsidiary at Antalya. In addition, the State Investment Bank, the Government's main lending institution for SEEs, will on-lend that portion of the Bank's loan to the Government that is for financing of the industrial part of the project. As a follow-up to this relationship with SIB, the possibility of an industrial credit loan to SIB for public sector industrial enterprises is being explored for late FY74 or early FY75. The Bank is also considering a loan in FY75 to a public sector project for iron ore mine expansion and pelletizing at Divrigi in east central Turkey, which will be complementary to the Erdemir Steel Expan- sion (817-TU) and to modernization of the Railways (893-TU), which are heavily engaged in ore traffic. Divrigi and Elbistan also represent greater geo- graphic dispersion into lower income regions. 22. The Bank's main effort in support of the distribution objective is the twin strategy of promoting rural alternatives to urban migration and improving urban development. As a beginning in rural development, the Bank approved a credit in FY72 for the Second Livestock Project, which focuses on fodder cropping and breeding, raising and fattening of animals in Eastern and Central Anatolia. For FY75 the Government is preparing an integrated Rural Development Project in rainfed areas of central Turkey. The Forestry part of the proposed Antalya Forest Utilization Project should also make a significant contribution to rural emplovment through expanded cutting, reforestation and afforestation. Future lending for forest village development is also contem- plated. In urban development the Bank lent for Istanbtul Water Supply and Urban Studies in FY72 and for Istanbul Power Distribution in FY73. Further lending in support otf better planning and coordination of development in Greater Istanbul and possibly in other cities is anticipated, should the institutional ohiectives underpinning earlier projects in Istanbul be satis- factorilv attained. 23. As a resillt of the expanded menmbership of the Common Market and some leveling off