Turkey - Structural Adjustment Loan Project (supplement)

Document of FILE COpy The World Bank FOR OFFICIAL USE ONLY Report No. P-2888-TU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENI TO THE EXECUTIVE DIRECTORS ON A STRUCTURAL ADJUSTMENT LOAN (SUPPLEMENT) TO-THE REPUBLIC OF TURKEY October 30, 1980 This document bas a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise -be disclosed without World Bank athoriation.  TURKEY CURRENCY EQUIVALENTS Calendar 1978 July 1979 Jan. 1980 /1 Oct. 1980 US Dollar 1 = TL 24.28 TL 47.10 /2 TL 70.00 /3 TL 82.70 /3 TL 1 = US$ 0.04 US$ 0.02 US$ 0.01 US$ 0.01 /1 Since January 1980 the rate is being adjusted for the differential I inflation between Turkey and its major trading partners. TL82.7/$1.00 was used for this report. /2 Except for imports of crude oil, petroleum products and fertilizer raw materials, and exports of agricultural products benefitting from official price supports, for which it was TL35 = US$1.00. /3 Except for imports of fertilizers and insecticides/pesticides, as well as raw materials and inputs for their manufacture, for which the rate was TL55 = US$1.00 from January 1980 and is TL70 = US$1.00 as from October 1980. FISCAL YEAR Republic of Turkey March 1 to February 28 ABBREVIATIONS EEC European Economic Community LIBOR London Inter Bank Offer Rate M & LT Medium and Long Term SEE State Economic Enterprise SPO State Planning Organization TSKB Turkish Industrial Development Bank The Structural Adjustment Loan (Supplement) was appraised by a mission consisting of Mr. D. Berk and Ms. K. Saito.  FOR OFFICIAL USE ONLY TURKEY - STRUCTURAL ADJUSTMENT LOAN I (SUPPLEMENT) LOAN SUMMARY Borrower: Republic of Turkey Amount: US$75 million equivalent in various currencies Terms; Seventeen years including four years grace, at 9.25 percent per annum. Description: The loan will be in further support of Turkey's January 1980 program of structural adjustment policies, and measures initiated and being implemented since then in areas critical to begin restoring viability to the economy, which provided the basis for the Structural Adjustment Loan I (Loan No. 1818-TU). These policy measures are aimed at; (a) export promotion, through a rational exchange rate policy and financial and institu- tional incentives; (b) improved domestic resource mobil- ization efforts, through an increased tax effort, gradual reform of the SEE sector and interest rate liberaliza- tion; (c) formulation and pursuit of rational public investment policies; and (d) improved external debt management. The loan will finance high priority imports to assist fuller utilization of productive capacity in agriculture and industry. For agriculture; plant protection chemicals and raw materials and fertilizer raw materials ($45 million). For industry: steel and inputs for the steel industry, copper, aluminum, petrochemicals and other chemicals ($30 million). Private sector firms will receive at least $25 million from the loan. The main risks relate to possible political developments in Turkey which might impede the Government's determina- tion and efforts to carry out the stringent structural adjustment programs designed to enable the economy to be first nursed to normalcy and then to resume viable growth. Estimated Disbursements: US$ Millions Bank FY 1981 Annual 75.0 Cumulative 75.0 I This document has a restricted distribution and may be used by recipients only in the performance of | their official duties. Its contenst may not otherwise be disclosed without World Bank authorization.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN I (SUPPLEMENT) TO THE REPUBLIC OF TURKEY 1. I submit the following report and recommendation on a proposed Structural Adjustment Loan I (Supplement) to the Republic of Turkey, for the equivalent of US$75 million to help finance essential recurrent imports to assist with the fuller utilization of industrial and agricultural capacity. The loan would have a term of 17 years, including 4 years of grace with interest at 9.25 percent per annum. PART I - THE ECONOMY 1/ 2. A Special Economic Mission visited Turkey in April/May 1979 to evaluate the Fourth Five-Year Plan (1979-1983). Its report entitled "Turkey. Policies and Prospects for Growth" (No. 2657a-TU dated December 12, 1979) was distributed to the Executive Directors on December 26, 1979 and its Postscript on March 24, 1980. A small mission visited Turkey in May 1980 to update information and Bank analysis of the country's economic prospects. Its findings are reflected below. Annex I contains the Basic Country Data. Development Trends and Policies 3. As the result of a strong commitment to rapid growth and modernization, GDP increased at an average annual rate of 6.4 percent, 6.7 percent and 7.2 percent respectively, during the First Plan (1963-67), Second Plan (1968- 1972), and Third Plan (1973-1977) periods. This compares favorably with the experience of 55 "middle income" developing countries, whose GDP growth averaged a little under 6.0 percent per annum between 1960-1978. Moreover, the relatively high growth rate in Turkey was achieved without significant deposits of oil or other important natural resources. 4. Growth was accompanied by significant social changes. Although population grew annually at 2.5 percent, rapid GDP growth allowed substan- tial advances in per capita income. However, rising income levels were not accompanied by better income distribution. Although basic needs have been met, significant sectoral and regional inequalities in income continue. 5. The public sector has played a key role in Turkey's development. Between 1963-1977, its share in total fixed investment fluctuated around 50 percent, and its share of fixed investment in manufacturing increased from 21 to nearly 49 percent. The public sector dominates basic industries. 1/ This Part is identical to Part I of the President's Reports on the Bati Raman Enhanced Oil Recovery (P-2886-TU) and Petroleum Exploration (P-2887-TU) Projects, dated October 30, 1980.  Nevertheless, the private sector has emerged as an increasingly important and dynamic element in the economy and is beginning to shift its orientation from consumer goods to intermediate and investment goods, and from the domestic market to exports. Private sector investment increased at nearly 11.5 percent per year in real terms during 1967-1977 compared to an average annual increase of only 4.8 percent between 1963 and 1967. 6. Turkish development between 1963-1977, however, exhibited a number of structural characteristics which are of considerable relevance for future development policy. First, for a country of Turkey's size and per capita income, it has a very low level of exports relative to GDP--about 4 percent in 1977--as against a more or less "normal" import level of around 20 per- cent for middle income countries; this highlights the vulnerability of the balance of payments and the importance of export development to sustain the needed inflow of foreign exchange resources. Second, while the level of investment relative to GDP increased rapidly and compares favorably with other developing countries, mobilization of domestic savings has lagged; the ratio of domestic savings to GDP, is well below the average for middle income countries; the growing gap between domestic savings and investment led in the mid-1970s to a relatively high level of external borrowing, and domestic inflationary pressures emanating from excess demand and deficit financing. Third, a relatively high proportion of the labor force is still in agriculture, reflecting significant disguised unemployment and the need for accelerated job creation in non-agricultural activities; that in indus- try is low compared to other large middle income countries; furthermore, the relatively inadequate generation of additional employment has become more serious following the near cessation of workers' migration to Europe since 1974. Fourth, despite the growing dynamism of the private sector, the industrial scene is dominated by inefficient State Economic Enterprises (SEEs) which have not been exposed to market forces and serve not only economic but social goals; their growing deficits have imposed an infla- tionary burden on the budget, while their ambitious investment programs were financed through Central Bank borrowings, since their controlled prices have, until recently not enabled most of them to generate sufficient cash to cover costs or investment expenditures. Fifth, due to the successes achieved since the early sixties through economic planning, there has been an increasing tendency to plan to a micro-level and seek to achieve changes through administrative fiat; however, the economy has reached a stage where such excessive reliance on this becomes counter productive; planning needs to be increasingly geared towards setting a framework in which market forces could secure the desired economic results in both the public and private sectors. The Economic Crisis and Stabilization Efforts 7. These institutional and structural characteristics of the economy made it particularly vulnerable to the sharp increase in import prices (including oil) in 1974 and the simultaneous occurence of recession, inflation and rising unemployment in the industrial countries. These factors played a key part in the deterioration of the economy. However, the politically  weak governments, their policies in response to these factors and their efforts to pursue a high growth policy despite the worsening international environment through increasing reliance on short-term external financing, together created forces that brought about the economic crisis in mid-1977 which is still continuing. The detailed analysis of this crisis, and of Turkey's attempts to stabilize the economy in the short-run up to late 1979, is provided in the above-mentioned Special Economic Report and Postscript, as well as in paras. 8 to 15 of the President's Report (dated February 29, 1980) for the Structural Adjustment Loan approved by the Board on March 25, 1980. 8. Despite domestic and international efforts, 1979 was another diffi- cult year for the economy: production stagnated, unemployment increased, inflation accelerated, the balance of payments position remained tight, export performance was poor, severe import rationing continued and the external debt positio ---'inPd prF' ario-,. Poliry initiatives taken till then proved inadequate to reverse tue tie, as political and ecofloidic uncertainties continued to erode the impact of the measures taken. 9. Compared to a growth of 3 percent in 1978, GDP stagnated in 1979. Value added in agriculture increased by 2.5 percent, and in services by about 1 percent, but in industry value added declined by about 2 percent. In agriculture, further growth was held back by a sizeable decline in production of industrial crops, mainly cotton, and a bad olive crop; the area cultivated declined, due to shortages of fuel and fertilizers. In industry, worsening shortages of imported raw materials and energy, espe- cially oil, led to a decline in production of about 3.5 percent. Production of manufacturing SEEs declined by about 2 percent, and was manifested by decreases of 28 percent in cement production, 9 percent in steel production and 51 percent in certain petroleum production and processing operations. In contrast, the construction and transport sectors grew modestly, but insufficiently to overcome the decline in other sectors. This stagnation was accompanied by unprecedented inflation of about 65 percent in 1979. 10. The overall public sector deficit increased from TL 80 billion in 1978 to TL 132 billion in 1979. It was financed mainly by borrowing from the Central Bank (TL 70 billion). The consolidated budget and the opera- tions of the SEEs were almost equally responsible for the enlarged deficit. The deterioration in the consolidated budget was caused mainly by a sharp increase in transfers to the SEEs, which in 1979 amounted to TL 89 billion. 11. On the external account, there was a marginal decline in the value of recorded exports of goods to $2.3 billion, although in volume terms, exports actually declined by an estimated 17 percent. The value of merchan- dise imports was about 10 percent higher than the previous year at $5.1 billion; but due to substantial price increases, the volume is estimated to have declined by 19 percent. The current account deficit in 1979 was the same as in 1978, i.e. around $1.7 billion.  - 4 - 12. Turkey achieved some success in diversifying the sources, and increasing the level, of M&LT commitments, including $250 million in project credits from the Saudi Fund. Perhaps the most important arrangement arrived at was the May 1979 OECD sponsored pledging of $1.45 billion in special assistance, including about $900 million in M&LT bilateral credits and export credits, besides $407 million of medium-term credits from commercial banks (finalized in September 1979). However, actual capital inflows were about the same as the previous year. 13. Also, throughout 1979, Turkey made a major effort to alleviate the critical burden of external debt through: (a) slowing the growth of short- term liabilities; (b) debt relief arrangements; and (c) efforts to pursue new sources of credits, especially M&LT credits. The first debt relief operation, arranged through the OECD Consortium for Turkey in May 1978, involved consolidation of $1.14 billion in arrears on guaranteed short-term and bilateral M&LT debt, as well as amounts due over the thirteen month period May 21, 1978 to June 30, 1979. A second major rescheduling took place in July 1979, involving payments of about $1.02 billion on official bilateral and private guaranteed credits due between July 1, 1979 and June 30, 1980. A third major arrangement, finalized in July and August 1979 with commercial banks, rescheduled convertible lira deposits ($2.3 billion), banker's credits ($429 million) and third party reimbursement credits ($300 million). About $317 million in oil debt was also rescheduled. The total amount thus rescheduled was about $5.5 billion. This was perhaps the largest debt rescheduling operation anywhere. Even so, net arrears of about $500 million emerged given the remaining high debt service burden in 1979. January 1980 Structural Adjustment Program and Policy Objectives 14. Against this background, it was quite clear that drastic and painful stabilization measures were not enough to reverse the adverse economic tide. What was needed, was a major program of long-term structural adjustments, if the economy was first to be nursed back to normalcy and then to resume viable growth. Such a bold and far-reaching program of policies to effect structural adjustments in the economy over the medium term was announced on January 25, 1980, accompanied by initial measures to implement adjustments in certain critical areas. These were described and discussed in detail in the President's Report (No. P-272-5-TU dated February 29, 1980) for the Structural Adjustment Loan. The policy objectives underlying, the program, and the measures it initiated, represent a basic departure from past planning objectives. Turkey has undertaken, through it, the essential first steps to foster major structural and institutional changes in the key economic areas. 15. The program's stated goal of "bringing about a major reorientation of the economy" calls for: .i) greater reliance on market mechanisms and forces, by both the public and private sectors; (ii) reduction in the rate of inflation; (iii) improved management of the balance of payments and external debts; (iv) policies to encourage the public and private sectors to be efficient and internationally competitive; (v) the implementation of  - 5 - rational exchange rate policies and of measures encouraging exports; (vi) domestic resource mobilization efforts to be substantially augmented through increased tax efforts, realistic SEE pricing, and increased private savings via the banking system and the development of financial markets; (vii) an investment policy aimed at fuller utilization of existing productive capac- ity and completion of ongoing projects requiring modest inputs, and tailored to scarce resources; and (viii) conditions to stimulate foreign investments in oil, industry and agriculture. 16. Successful implementation of this program over the medium-term, will require persistence and courageous action on the part of the Govern- ment. It will also call for substantial support from the international community, without which it is unlikely to succeed. However, if Turkey implements it vigorously, and periodically makes critical in-depth reviews as to the impact of the measures and what further modifications and adjust- ments are needed to achipi7p the p-yr-ram's economic goals, it will strengthen the r