Document of The World Bank COPY FOR OFFICIAL USE ONLY FILE Report No. P-2789-TU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR THE KARAKAYA HYDROPOWER PROJECT April 25, 1980 This document has a restricted distribution snd may be used by recipients only in the performance of I their official duties. Its contents may not otherwise be disclosed without World Bank authorization. TURKEY CURRENCY EQUIVALENTS Currency Unit Calendar 1978 July 1979 Jan. 1980 /1 US Dollar 1 TL 24.28 TL 47.10 /2 TL 70.00 /3 TL 1 = US$ 0.04 US$ 0.02 US$ 0.01 /1 Since January 1980 the rate is being adjusted for the differential inflation between Turkey and its major trading partners. TL70/$1 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 is TL55 = US$1.00. WEIGHTS AND MEASURES kW = kilowatt One kilogram (kg) MW = 1,000 kW (1,000 grams) = 2.2 pounds kWh = kilowatt hour One tone (metric ton) GWh (Gigawatt hour) = 1,000,000 kWh (1,000 kg) = 2,205 pounds kV (kilovolt) = 1,000 volts One kilocalorie (kcal) One meter (m) = 3.28 feet (1,000 calories) = 3.968 BTU One kilometer (km) = 0.624 miles Cumecs (m3/second) = 35.31 cubic feet per second FISCAL YEAR March 1 to February 28 GLOSSARY AND ABBREVIATIONS CEAS - Cukurova Elektrik A.S. (Cukurova Power Company) DSI - Devlet Su Isleri (State Hydraulic Works) EIB - European Investment Bank EIE - Elektrik Isleri Etut Idaresi (Electric Studies Institute) IETT - Istanbul Elektrik, Tramway, Tunel Isletmeleri (Istanbul Electricity Tramway and Tunnel Company) MTA - Mineral Research Institute SEE - State Economic Enterprise SIB - State Investment Bank SPO - State Planning Organization TEK - Turkiye Elektrik Kurumu (Turkish Electricity Authority) TKI - Turkiye Komur Isletmeleri Kurumu (Turkish Coal Enterprises) TPAO - Turkiye Petrolleri Anonim Ortakligi (Turkish Petroleum Corporation) FOR OFFICIAL USE ONLY TURKEY KARAKAYA HYDROPOWER PROJECT Loan and Project Summary Borrower: Republic of Turkey. Amount: US$120.0 million equivalent in various currencies. Terms: Seventeen years including four years of grace, with interest at _ percent per annum. Project Description: The project will add 1800 MW of additional capacity to the Turkish power system, with an average yearly generation of 7750 GWh of relatively low-cost hydropower, thus contri- buting to reduced dependence on more expensive energy sources and savings in foreign exchange. It comprises a 173 metres high, concrete arch-gravity dam which will create 5.62 km3 live storage reservoir (9.6 km3 total storage) on the Euphrates river, a power house contain- ing six 300 MW turbo-generator units and appropriate accessory equipment. It also includes resettlement of population, estimated at 17,000 living in 34 villages, and relocation of existing railway lines (33 kms), roads (35 kms) and two bridges. In addition to help meeting growing power demand in Turkey, the project, together with the existing Keban dam (16.3 km3 of live storage) will result in a better regula- tion of Euphrates river-flows, thereby benefitting power and irrigation projects downstream. The project faces no special risks, although realization of benefits will depend heavily on adequate and timely coordination of activities during project implementation, including adequate financing. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. - ii - Estimated Costs: About $1,160 million equivalent, (excluding interest during construction of $138.2 million) broken down as follows: - US$ Million------- Local Foreign Total Preliminary Works 32.1 12.4 44.5 Civil and Hydraulic Works (Contract No. 1) 81.1 205.6 286.7 Turbines and Generators (Contract No. 2) 2.3 119.5 121.8 Electromechanical Equipment (Contract No. 3) 1.6 55.9 57.5 Engineering Services 6.0 9.5 15.5 Land Appropriations 59.9 - 59.9 Resettlement 113.6 - 113.7 Subtotal 296.7 402.9 699.5 Physical Contingencies 47.6 52.2 99.8 Price Contingencies 94.3 25.3 119.6 Total 438.5 480.4 918.9 Expenditures up to 1979 120.0 121.5 241.5 TOTAL PROJECT COSTS 558.5 601.9 1,160.4 Physical contingencies are estimated at 20 percent for civil works and related equipment, and 5 percent for turbo-generators. Price contingencies where applicable have been calculated in dollar terms, for both local and foreign costs as follows: CY 1980 1981 1982 1983-85 1986-87 ---------------(percent)-------------- 10.5 9 8 7 6 Financing Plan: ---US$ Million--- (including expenditures made up to end 1979) Local Foreign Swiss Financing 295 World Bank 120 European Investment Bank (EIB) 110 Italy 20 Abu Dhabi Fund 26 Turkey 558 31 558 602 Turkey will meet the financing charges during construction, estimated at about $138 million. - iii - Estimated Disbursement: ------------------US$ Million----------------- FY 1981 1982 1983 1984 1985 1986 1987 1988 Annual 22 19 17 14 17 13 12 6 Cumulative 22 41 58 72 89 102 114 120 Rate of Return: 15 percent. Appraisal: Report No. 2848-TU, dated April 25, 1980 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TURKEY FOR THE KARAKAYA HYDROPOWER PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Turkey for the equivalent of US$120 million, to help finance part of the foreign exchange costs of the Karakaya hydropower project. The loan would have a term of 17 years including 4 years of grace, with interest at 8.25 percent per annum. Besides Swiss export financing already arranged, the European Investment Bank (EIB) proposes to cofinance the project with a loan of $11% million. Italy has agreed to provide $20 million, and Abu Dhabi Fund, $26 million. PART I - THE ECONOMY 2. A Special Economic Mission visited Turkey in April/May 1979 to evaluate the Fourth Five-Year Plan (1979-83). Following discussion with the Government in mid October 1979, 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. A Postscript to the Special Economic Report was distributed to the Board on March 24, 1980. Their find- ings are reflected in this Part. Annex I contains the Basic Country Data. Development Trends-and Policies 3. As the result of a strong commitment to rapid growth and moderniza- tion, 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 (1968-72), and Third Plan (1973-77) periods. This compares favorably with the experience of 55 "middle income" developing countries, whose GDP grew on an average 6.0 percent per annum between 1960-70 and 6.1 percent per annum between 1970-77. 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 at 2.5 percent per annum, rapid GDP growth nevertheless allowed substantial advances in per capita income. However, rising income levels were not accompanied by better income distribution and significant sectoral and regional inequalities in income exist, although basic needs have been satisfactorily met. 5. The public sector has played a key role in Turkey's development. Between 1963-77, its share in total fixed investment fluctuated around 50 percent, and its share of fixed investment in manufacturing increased from 21 - 2 - to nearly 49 percent. The public sector dominates basic industries. Never- theless, 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 1967-77 compared to an average annual increase of only 4.8 percent between 1963 and 1967. 6. Turkish development between 1963-77, 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 percent 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-70s to a relatively high level of external borrowing, and domestic inflationary pres- sures emanating from excess demand and deficit financing. Third, a relatively high proportion of the labor force is still in agriculture, reflecting signif- icant disguised unemployment and the need for accelerated job creation in non-agricultural activities; that in industry 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 inflationary 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 increas- ing 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 up to Mid-1979 7. These economic, 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 - 3 - played a key part in the deterioration of the Turkish economy. However, the politically weak governments, their policies in response to these factors and their efforts to pursue high growth policy despite the worsening international environment with increasing reliance on short-term external financing, together created forces that brought about the economic crisis that began in mid-1977 and still continues. The detailed analysis of the causes of this crisis and the government's attempts to stabilize the economy in the short-run up to mid-1979, is provided in the above-mentioned Special Economic Report and in paras. 8 through 15 of the President's Report (dated February 29, 1980) for the Structural Adjustment Loan approved by the Board on March 25, 1980. 8. The new IMF Standby, which replaced the one arranged in April 1978, was negotiated after the government took the following overdue measures in March/April 1979, to reverse the continuing adverse economic trends: (a) to improve the balance of payments, the TL was devalued in several steps until June, when a new buying rate of TL 47.10 per US$1 was established for most foreign trade and all invisibles; the new rate represented a depreciation in export-weighted terms of nearly 75 percent since the end of 1970, and more than offset the differential inflation rate during the course of 1978-79 between Turkey and its major trading partners; (b) to further stimulate exports of industrial and mining products, exporters were allowed to retain 50 percent (up from 25 percent) of their foreign exchange earnings to finance their imported inputs or those of their local suppliers; (c) to improve the financial position of SEEs, further substantial price increases (34 percent to 110 percent) were announced for a number of products, raising them above world prices at the new exchange rate; these increases were estimated to yield an additional TL 80 billion in FY1979, to help reduce the overall borrowing requirement of the public sector; and (d) to ensure more effective mobiliza- tion and allocation of resources, interest rates for deposits and loans were increased substantially, from up to a maximum of 16% p.a. to over 24% p.a.; repatriated savings of migrant workers were allowed an additional interest premium. 9. The July 1979 Standby covered a twelve month period, and foresaw total purchases of SDR 250.0 million in four tranches - SDR 70.0 million initially, and SDR 60 million each after November 1979, March 1980, and June 1980. It provided for a series of specific performance targets to strengthen the public finances, reduce inflation and improve the balance of payments situation in the short term. These measures were expected to prevent further deterioration in the balance of payments during 1979, with essential imports projected at $5.0 billion, about the same level as the previous year in real terms. A substantial increase in workers' remittances to a level of $1.2 billion was expected to compensate for the increasing interest payments on foreign debt. At the same time, disbursements of medium- and long-term foreign aid (including the Bank's Program Loan) were expected to increase markedly in 1979, thus reducing the need for renewed short-term borrowing. 10. In 1978, short-term debts continued to grow. However, 1979 wit- nessed the completion of a major Turkish effort to alleviate the primary - 4 - external debt issue through: (a) slowing the growth of short-term liabilities; (b) debt relief arrangements; and (c) efforts to pursue new sources of credits, especially M< 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< debt, as well as amounts due over the 13-month period May 21, 1978 to June 30, 1979. A second such major rescheduling took place in July 1979 involving about $1.02 billion of the 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 tescheduled was about $5.5 billion. This is perhaps the largest debt rescheduling operation anywhere. 11. Turkey also succeeded in 1978 and 1979, though to a limited extent, in diversifying the sources and increasing the level of M< 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< bilateral credits and export credits, besides $407 million of medium-term credits from commercial banks (finalized in September 1979). Agreements for all these funds were expected to be finalized before the end of 1979. By that time, about $750 million of this was estimated to be disbursed. Economic Situation As Of End 1979 12. The economic crisis still continues. The measures taken in the context of the July 1979 Standby Arrangement have essentially succeeded in arresting further economic deterioration. Since it came into effect only in July 1979, it was recognized that the stabilization objectives which could be realized within one year were necessarily limited, and the progress towards them within the remaining six months of 1979 would also be quite modest. 13. After a surge up to mid 1979, worker remittances slowed down; nevertheless, they totalled about $1.7 billion, against $983 million in 1978 and the Standby's target of $1.2 billion. Industrial exports rose quite strongly in the first half of 1979 in response to the changes in the parity value of the TL in April and June 1979; but they subsequently slowed down, presumably, partly due to severe shortages of imported inputs and partly due to the anticipation of further devaluation in the second half of that year. Overall, exports totalled about $2.3 billion in 1979, against the Standby's target of $2.7 billion. As a result of higher prices and the necessity of purchasing oil on spot markets, the 1979 oil bill rose from the projected $1.7 billion to nearly $2.5 billion. While imports in 1979 were contained at $5.1 billion, marginally higher than the Standby's target of $5.0 billion, the large oil bill necessitated more than anticipated reductions in essential imports. The problem was compounded by a much lower inflow of new capital than that envisaged in July 1979, because a significant part of the $900 million committed by bilaterals in May 1979 at the OECD meeting had not been made effective up to December 1979; besides, only a portion of what was made - 5 - effective was available to finance imports in 1979. Disbursements were also lower than expected against the $407 million of new commercial bank financing, because of its linkage with the November 1979 tranche of the Standby Arrangements which could not take place in time due to a change of government in Turkey in late 1979. Consequently, while the estimated current account deficit of $1.6 billion in 1979 was more or less in line with the target in the Standby Arrangements, the volume of imports declined by about 15 percent in 1979, following a decline of about 30 percent in 1978. Overall, GNP growth in 1979 was about 1.5 percent. Under the great pressure imposed by extremely limited supplies of vital imported inputs and products, including oil, the resulting shortfalls in export earnings, the shortages of a wide variety of consumer goods, and much stronger pressure on wages than antici- pated at the time of the Standby, the rate of inflation reached 64 percent in 1979. January 1980 Economic Program and Policy Objectives 14. Despite the difficult stabilization measures adopted since 1978 and those reflected in the July 1979 Standby Arrangements, the economic crisis persisted throughout 1979. Following elections in October 1979 a new govern- ment was formed. It obtained a vote of confidence in late November 1979. Bold and far-reaching measures to reverse the economic situation were announced on January 25, 1980. These are summarized in Annex II and more fully discussed in Part II of the President's Report (No. P-2725-TU) for the Structural Adjustment Loan approved by the Executive Directors on March 25, 1980. The announced economic policy objectives underlying these measures represent a basic departure from the past planning objectives. Turkey has undertaken, through this program, the essential first steps to initiate major structural and institutional changes in the key areas summarized in para 6, so as to foster medium-term economic development on a stable basis. 15. Following the announcement of this program, the IMF approved a modification of the terms of the July 1979 Standby Arrangements, and the release of a larger second tranche on February 21, 1980. On March 24, 1980, it approved the release of an increased third tranche. Thus, of the balance of SDR 180 million remaining in their July 1979 Standby, only SDR 20 million remains for release by end June 1980. In addition, compensatory financing of SDR 71.6 million has been provided on February 21, 1980 together with the modification of the Standby. Together, this results in the provision of $301 million (SDR 231.6 million) now with $26 million (SDR 20 million) to be provided in June 1980. In addition, Germany took the lead in organizing the provision of sizeable external assistance, as well as a further debt relief operation. Also, in meetings sponsored under OECD auspices on March 26 and April 15, $1.16 billion of bilateral aid was pledged. The success of the January 1980 measures is clearly dependent not on Turkey's own further efforts alone, but also on the willingness of the international economic and financial community to provide adequate and timely assistance in the period immediately ahead. The alternative for Turkey would be to cut back on imports, already pared to the bone; this, in turn, would postpone the possibility of economic recovery even further, jeopardize its efforts to curb inflation, and hamper the success of the bold structural changes it has initiated. - 6 - 16. The new economic policy objectives underlying the Government's stated goal of "bringing about a major reorientation of the economy," can be summed up as follows: (a) Greater reliance on market mechanisms and forces by both the public and private sectors, and lesser reliance than hitherto on planning up to micro-levels and on administrative fiats to realize planned targets and objectives. (b) Reduction in the rate of inflation and improved management of balance of payments and external debts have the highest priority; in the process, Turkey may have to accept temporarily a lower GNP growth. (c) Import substitution and protection oriented policies, on which Turkish development policy hitherto relied and which resulted in a bias favoring production for the domestic markets, must give way to policies encouraging the public and private sectors to be efficient and internationally competitive. (d) In future, reliance must be placed on exports and foreign currency earning activities to finance Turkey's economic needs; the implementation of rational exchange rate policies and of measures encouraging exports are essential to achieve this objective. (e) The SEE sector must be reformed, by exposing it to market forces, by allowing it to set its own prices and by improv- ing its management; through such actions, it must generate its own resources to cover operating costs and investment expenditures. (f) Domestic resource mobilization efforts, unlike the past, must be substantially augmented through increased tax efforts, the banking system, increased savings and the development of financial markets; the elimination of deficits of the public sector is an important objective of budgets from 1980 onwards. (g) Investments aiming at fuller utilization of existing produc- tive capacity and completion of those ongoing projects requiring modest inputs should have first priority; there- after, the priority should be for new investments stressing exports and employment or those removing critical infra- structural bottlenecks; in any event, investments should be tailored to scarce resources. (h) Conditions to stimulate foreign investments in oil, industry and agriculture must be created, in contrast to the past when such investments were not encouraged; prudent external debt management policies to create confidence in and flow of large external resources to Turkey should be followed. -7- 17. These are radical departures from past Turkish economic policy. Considerable effort will be required to implement the new policies and com- plete the structural and institutional changes which Turkey has begun. The difficulty of the task should not be underestimated. The key policy areas are: (a) a rational exchange rate policy; (b) policies ensuring increased export earnings and encouraging foreign investments; (c) reform of the SEE sector, and the use of market forces to improve its efficiency and output as well as that of the private sector; (d) policies to improve domestic resource mobilization; and (e) formulation and pursuit of rational external debt management policies. 18. The actions taken by Turkey since 1978 in these areas, including measures in the January 1980 program and those planned for implementation in the medium-term, are summarized in the Table in Annex II. Progress in implementing them so as to foster economic recovery in the medium-term will be the focus of two reviews in July 1980 and December 1980, under the recently approved Structural Adjustment Loan. While all the issues listed in the Table are important, two of them merit further discussion: (a) external debt management and (b) public sector investment program. 19. Turkey's external debt management policy has to grapple with several difficult issues. First, the large overhang of debt, and the relatively hard terms of the recent debt reschedulings, together raise a question regarding the need for further rescheduling in the near-term. A substantial improvement in the repayment profile of the rescheduled debts and the containment of Turkey's short-term indebtedness over the medium-term to no more than the present level of about $3.8 billion is necessary to alleviate the heavy debt servicing burden over the next 5 years; a critical element here is the likely posture of commercial creditors, which cannot be easily anticipated. Second, it is important that Turkey obtain sizeable external credits on as long-term and concessional a basis as possible, to complete ongoing projects and under- take new ones in accordance with its stated investment criteria (para. 20). Recognizing the importance of these issues and the longer-term concerns regarding its creditworthiness that its creditors have, Turkey has been focussing its attention on evolving a balanced and prudent policy for external debt management. The Government has already initiated a comprehensive study of external debt, which it expects to complete before October 31, 1980. This study should help Turkey to further improve and refine its present external debt management policy; that should also assist Turkey in exercising greater control over the level and terms of new external financing it would seek from various external sources over the next five years. 20. As discussed earlier, the overall size and quality of the public investment programs until 1977 have contributed to the economic crisis. Actions taken over the last several months provide some evidence that given the severe domestic and foreign exchange constraints, public investment expenditures are being channelled towards projects meeting strict investment criteria. However, the January 1980 program and the policy announcements accompanying it go beyond that. They emphasize that since control of inflation is more important at present than the past Turkish strategy of concentrating only on higher growth, the projected level of annual investments - 8 - must be rigorously tailored to meet the availability of scarce resources each year. Investments in fiscal 1979 were lower in real terms than those in fiscal 1978. The Government proposes to continue that trend for fiscal 1980. Priority is to be accorded first to investments designed to utilize existing productive capacity more fully and to complete ongoing projects which can yield attractive returns with modest additional investments. Thereafter, the priority for new investments is for productive projects either contributing to exports or employment, or for those which remove critical infrastructural bottlenecks. A new Incentives and Investment Department has been established, whose purpose is to review which ongoing investments should be stopped, deferred or completed on an accelerated basis. 21. Successful implementation of the economic reorientation begun in January 1980 will take time, require persistence and courageous action on the part of the Government and call for substantial support from the inter- national community. In the medium term, it will strengthen the basis for Turkey's creditworthiness and reestablish a path of stable economic growth. Turkey's Medium-Term Economic Prospects 22. The Fourth Five-Year Plan (1979-83), approved by Parliament in November 1978, was in many essential ways an extension of the traditional Turkish development planning. It set out to complete the unfinished tasks of the Third Plan, and continued to emphasize a high growth rate, a large investment allocation for import substitution in basic and intermediate goods industries, and reliance on administrative controls rather than on market incentives. But it also attempted to address some development issues which came to the fore during the economic crisis, i.e. export growth and increased savings. Consequently, an export growth target of 18 percent p.a. in real terms and a marginal savings ratio of 34 percent were set, and priority was also accorded to export-oriented investments. But investment allocations provided mixed signals, favoring import substitution. In view of the continua- tion of the economic crisis, the unattainability of the targeted marginal savings ratio, and the difficulties that Turkey is facing currently, the Fourth Plan targets of investment and growth are clearly not going to be achieved. 23. Against this background, the Bank has made its own prognosis based on a general equilibrium model of the economy which permits quantification of alternative policies and a detailed and consistent examination of Turkey's medium-term prospects. Given the accumulation of economic problems of the last three years, the political difficulties besetting the country, the addi- tional resources needed to cover the significantly increased cost of imports (including oil), and the limitations which Turkey is likely to encounter over the medium-term in significantly increasing the net inflow of capital, GDP growth in real terms may average around 4 percent p.a. with a real growth of exports about 12 percent p.a., during 1980-85. These growth rates appear attainable, assuming continuation of appropriate economic policies (including those announced in January 1980), and taking into account the low export base and present underutilization of capacity. 1/ The international oil situation, following the recent substantial oil price increases at end-1979, has a major impact on future prospects. Even if Turkey allows only a marginal increase in oil imports during 1980-1985 to sustain a lower level of growth, the oil import bill is estimated to increase to $3.2 billion in 1980 and $6.1 billion by 1985, which as a percentage of merchandise exports and non-factor services reached 78.1 percent in 1979 and is likely to remain at a level of about 68 percent until 1985. The pressure this will exert on Turkey's already difficult balance of payments position is obvious. Although in constant dollars the ratio appears manageable, in current prices the projected current account deficit as a percent of GNP increases from 3 percent in 1979 to about 5.3 percent in 1980 and remains at a level of about 4 percent thereafter until 1984. Considering the limitation on the gross inflows of available external assistance and given the need for sound external debt management, Turkey can sustain an average annual current account deficit of the order of $2-2.2 billion annually over the next 5 years. 24. Taking into account international inflation and the growing obliga- tions for debt amortization, this situation necessitates a large and sharply increasing gross annual average inflow of foreign capital, rising from the current relatively low levels to about $5.2 billion during the next five years, implying an annual average of about $2.3 billion of net capital inflow for the same period. Such major inflows of foreign capital can only be sustained on the basis of prudent external debt management. In any case, debt service obligations are likely to remain very high over the coming 5 years. In 1978, total debt service payments had risen to 26.7 percent of exports of goods, non-factor services and workers' remittances after making allowance for the rescheduled service payments. In 1980, the ratio is projected to reach close to 37 percent, and is likely to peak in 1985 at a high level of about 48 percent, before declining. This, however, should represent the culmination of the financial consequences of the present crisis and the debt burden should remain manageable, provided the new policies are successfully implemented and the export drive is sustained. PART II - BANK GROUP OPERATIONS IN TURKEY 25. A large lending program for Turkey essentially began following the introduction of its 1970 Stabilization Program. To date, the Bank/IDA have lent $2,320 million through 56 projects. Agriculture accounts for 30 percent of funds lent, industry and DFCs for 34 percent, power for 14 percent and urban development, transportation, education and tourism for the rest. Annex III contains a summary statement of Bank loans, IDA credits and IFC invest- ments as of March 31, 1980, with notes on the execution of ongoing projects. 26. Since mid-1975 the implementation of private sector projects has been satisfactory. Political uncertainty, limited coordination amongst 1/ See "Turkey: Postscript Special Economic Report", Attachment 1, Report No. 2918-TU, dated March 20, 1980, circulated to the Executive Directors on March 24, 1980. - 10 - ministries and staffing problems resulted in uneven and delayed project implementation in the public sector. Therefore, a system of joint project reviews between Turkey and the Bank was instituted in June 1975. This resulted in distinct, but modest, improvements up to end 1977. The situation was again reviewed with the Government in March 1978, and further discussed with the then Prime Minister in April 1978. Subsequently, Turkey established a new high-level coordination team. This team set up procedures for monitoring and achieving realistic implementation and disbursement targets. As of December 1979 disbursements increased to 69 percent of appraisal estimates against 51 percent in June 1975. The last joint review was held in April 1979. The encouraging progress that is now manifest allows cautious optimism that performance will gradually improve further. 27. Bank lending is now aimed at supporting Turkey's efforts to improve its: (a) capacity to earn foreign exchange, through promotion of industrial and agro-industrial exports; (b) income distribution, employment opportunities and living standards, through rural and urban development projects; (c) lagging public sector savings, through the encouragement of improved management and financing of the investments of key SEEs; and (d) infrastructure posing critical bottlenecks for development. The Bank has begun discussions with the new government on how its lending can best contribute to the government's medium-term objectives, especially export promotion, without being handicapped by past policy and institutional obstacles. Meanwhile, agriculture and industry remain the key sectors for lending. In agriculture, projects empha- size livestock, exports, and rural development; in industry (including DFCs), the emphasis is on promotion of exports and employment, as also the gradual strengthening of the SEEs. Projects for urban development, public utilities and transportation supplement these efforts. We propose to maintain a close macroeconomic and sector dialogue with Turkey. The economic and sector work planned over the next few months includes an updating economic mission and completion of sector memoranda on industry and energy. In addition, the progress made in fostering the structural adjustments initiated by the Govern- ment through the January 1980 program will be discussed in the context of the disbursements of the Structural Adjustment Loan. 28. A thirteenth TSKB loan designed to stimulate investments in export projects of the private sector, loans for a Private Sector Textile Project and an engineering loan to assist the alleviation of air pollution in Ankara, were approved by the Board in the first four months of FY80. A loan for Structural Adjustment was approved on March 25, 1980. The Sumerbank Textile and the Fifth Livestock Development Projects are scheduled for Board considera- tion later this fiscal year. Projects being processed for future fiscal years include those for pilot enhanced oil recovery and oil exploration, fruit and vegetables, livestock products, rural development, fertilizer production, employment generation in selected cities, pulp manufacture, seed production and sewerage disposal in Istanbul. 29. The Bank Group's share of the estimated total external debt (includ- ing short-term obligations) was 5.9 percent in 1978, and is expected to grow to 10.0 percent by 1981 and to 12.5 percent by 1985. The Bank's share of - 11 - service payments is projected to fall slightly from its level of 7.7 percent in 1978 to 6.4 percent in 1981, thereafter increasing to 7.6 percent by 1985. 30. IFC has invested in synthetic yarns, pulp and paper, glass, aluminum, iron and steel products, motor bicycle engines, piston rings and cylinder liners, and tourism. It has also invested in TSKB. As of March 31, 1980, gross IFC commitments totalled about $208 million, of which $96 million were still held by IFC. New investment opportunities are being pursued. PART III - THE POWER SUB-SECTOR AND ENERGY SECTOR Power and Energy Resources 31. The spiralling cost of imported oil and the current serious fuel and power shortages make energy supplies a critical constraint on Turkey's growth. Turkey's main indigenous energy resources are hydropower and lignite. Other resources consist of coal, bituminous schist, oil, uranium and geothermal energy. The total hydropower potential is estimated at 100,000 GWh p.a., with a corresponding installed capacity of 25,000 MW; of which nearly 30 percent is developed or under construction. Lignite reserves, estimated at about 5.5 billion tons, are sufficient to provide fuel for about 10,000 MW of thermal power plants. The estimated oil reserves are in the order of 60 million tons, but intensive prospecting for oil and gas has not yet been done. The known reserves of uranium totals 4,500 tons of uranium oxide (U 0 8). Geothermal energy resources, thought to be fairly abundant have not been adequately evaluated so far. The first geothermal power plant is currently under con- struction. Non-commercial energy sources, wood and wastes, which contributed more than half of Turkey's energy supply in 1960 have declined to less than 20 percent by 1978. 32. Imported oil meets over 50 percent of Turkey's commercial energy needs. The principal domestic alternatives for producing electric power are low-calorific lignite, hydropower, plus reserves of geothermal energy. At present, the development of lignite and water as energy sources is being emphasized. Capacity and Demand 33. Turkey's installed public generating capacity at the end of 1978 totalled 4,125 MW; of this, 92 percent was owned by Turkiye Elektrik Kurumu (TEK) and 7 percent by Cukurova Elektrik A.S. (CEAS). In addition, munic- ipalities and self-producers have a combined capacity of 742 MW. The annual growth rate of electricity sales during 1965-78 was about 11 percent, and would have been higher but for constraints in generating capacity. Industrial users predominate and have maintained a relatively constant share of about 73 percent in total electricity consumption over the past 15 years. 34. The national load forecasts for the period 1979-1986 show an annual growth rate in sales of 14 percent until 1986 and 9 percent thereafter. - 12 - The maximum demand would increase from 4,060 MW in 1979 to 11,240 MW in 1986. The 1979-86 development program would add 5,542 MW of hydro plant and 6,695 MW of thermal plant to the power system, and the installed capacity is expected to grow from 4,867 MW in 1978 to 15,976 MW in 1986. Most of the thermal plants will be fuelled with lignite. Major projects intended to meet the projected demand are: Keban hydro-power (1,260 MW), partly commissioned; Elbistan lignite (1,200 MW), under construction and partly financed by the Bank (Loan No. 1023-TU); and the proposed Karakaya hydropower project (1,800 MW). Major power generation will be concentrated in eastern and central Turkey, and most of it will have to be transmitted an average of 700-800 km, to the main consumption centers in the western part of the country. Transmission network construction will include 5,670 km of 380 kV, 45,000 km of 154/60-kV and 30-kV lines, and 22,360 MVA in substation capacity. This development program for 1980-86 is estimated to cost about $22 billion in early 1980 prices, and the Karakaya project represents 4 percent of this total. However, it is clear that this program is rather optimistic in light of Turkey's financial con- straints in the medium-term period; nor is such a level of investment likely to be necessary because the rate of GNP growth in this period, for reasons discussed in Part I, can be expected to be below the high historical rate of growth achieved during 1962-77. The Government is therefore reviewing its Fourth Plan targets. Given the severe domestic and foreign resource constraints, the level of annual investments in the power subsector, as in other sectors, are proposed to be vigorously tailored to available resources each year, and these limited resources are being channelled towards projects meeting strict investment criteria. Therefore, appraisal has been based on an alternative load forecast, with an annual trend growth rate of 11 percent. Nevertheless, in view of the present serious energy situation, Turkey must speedily augment power generating capacity, especially that based on cheaper hydropower, to reduce its dependence on expensive imported oil. Indeed, Turkey's present economic difficulties, combined with the high costs of imported oil, has led to even existing oil-fuelled generating capacity not being fully utilized, resultant drastic power cuts, and consequent loss of production to the economy. Energy Policy 35. Against the setting described above, a major objective of Turkey's energy policy is optimum utilization of indigenous resources to restrain the growing dependence on imported oil. Turkey is therefore trying to develop its own energy resources, particularly hydropotential of the Euphrates River and lignite deposits at Afsin-Elbistan. The hydropower potential and lignite reserves could cover power generation needs almost to the end of this century. Although not economically justified before 1994, the first nuclear power plant is planned for 1988 to obtain required experience in construction and operation. 36. Apart from measures to develop indigenous energy resources and restrain oil consumption through price increases and restricted supply, the Government plans to expand petroleum exploration activities by increasing the financial resources available for this purpose, encouraging joint-venture exploration efforts in collaboration with foreign oil companies, providing increased incentives for offshore exploration and application of enhanced - 13 - recovery methods to existing oil fields. However, despite all these measures, Turkey is unlikely to accomplish its objectives of meeting 60 percent of the demand for domestic production during this decade, unless sizeable new reserves are discovered in the near future. National energy policy focusses on effec- tive energy conservation (about which much remains to be done), development of oil-shale, geothermal and solar energy, and long-range energy planning encom- passing viable supply options, together with demand and utilization patterns. Institutions 37. Under the general authority of the Ministry of Energy and Natural Resources (MOE), responsibility for electricity generation and supply is divided between: (a) The Turkish Electricity Authority (TEK), an SEE formed in 1970 with primary responsibility for electrical energy planning as well as construction and operation of thermal generation and transmission facilities; (b) The State Hydraulic Works (DSI), a semi-autonomous agency with responsibility for the planning of water resource devel- opment and for the construction of hydroelectric facilities, in coordination with TEK, which assumes ownership after such facilities are brought fully into commercial operation; (c) two concessionary utility companies, authorized to generate and distribute power in four out of a total of 67 Turkish provinces, the more important being the Cukurova Electric Company (CEAS) in the Adana region; (d) municipal authorities, most of whom purchase bulk power from TEK and distribute it within their jurisdiction. The principal institutional constraints in the power sub-sector lie in: (a) coordination and planning; (b) organization, management, and staffing; and (c) subsector financing. These are discussed below. 38. Coordination and Planning. Although the responsibility for coor- dination and planning is centralized in TEK, significant improvements in the coordination of planning and the allocation of resources among the various agencies concerned with power are still needed. Some agencies have, in practice, maintained a fairly independent role; for example, although the TEK Law requires close coordination between DSI and TEK in the planning and design of hydroelectric generating facilities, TEK is not always sufficiently involved in the identification, selection and design stages of such facili- ties. Similarly, improved coordination is needed between TEK and the Turkish Coal Authority (TKI) in the planning of coal and lignite mining development and related power generation. Moreover, all these plans need to be carefully evaluated in the light of available local and foreign resources and their relative priorities established in the context of resource constraints. As a result, there have been lags in the implementation of some new projects, which - 14 - have aggravated shortages of energy supplies. The Government has agreed to review existing arrangements, with a view to improving coordination between TEK and DSI for hydro-power development, and between TEK and TKI, in formulating medium and long-term development plans and integration of their development programs, and ensuring their timely execution (Loan Agreement Section 4.06). 39. Organization, Management and Staffing. Ever since its creation, TEK has faced problems of organization, management and staffing. The organiza- tional structure it inherited from its predecessor organization was not suited to its widened responsibilities under the TEK Law and recommendations for a reorganization were formulated in March 1973 by consultants financed under the Bank's 1967 technical assistance grant. These recommendations aimed at decen- tralization of authority for operations to regional offices and reorganization of management responsibilities at headquarters. TEK has already prepared a reorganization plan, and partially implemented it, with the establishment of some regional offices. A fuller implementation of this plan must, however, await an improvement in TEK's staffing situation. To provide TEK's management with reliable estimates of the magnitude and composition of its future staffing needs, under the ongoing TEK II project (Loan No. 1194-TU), TEK completed a detailed manpower study through its consultants, and has agreed to furnish a program of action to implement the recommendations of the study. However, in TEK, as in other SEEs, the management's ability to recruit and retain competent personnel, especially experienced engineers with senior and middle level management capabilities, has been affected by the Personnel Law govern- ing SEEs. Attempts to overcome management and staffing problems through special authority to hire outside personnel on contract, has alleviated the situation, but is by no means entirely effective. This situation can only be resolved by a basic SEE reform; though efforts to achieve such a reform did not succeed in the past, we expect that following the Government's bold and far-reaching measures enacted early in 1980 to reform the SEE's financial operations, basic reforms needed in SEE management will receive much needed attention. This matter, insofar as it relates to TEK, will therefore continue to be pursued under the on-going TEK II Transmission project. DSI's staffing is adequate, but it has to strengthen its project management and supervision capacity. Measures to strengthen DSI project management and supervision capacity have been proposed under this project (see para. 58). 40. Sub-Sector Financing. The problems of coordination and planning that face TEK, DSI and TKI (para. 38) also affect the financing of investments for generation and transmission facilities. They are characterized by a lack of coordinated policies and clear financial goals for the many institutions involved. 41. Investments in power generation and transmission are financed through two principal channels. Government budget and foreign loans are used to finance the hydro-electric facilities, constructed by DSI, a non-revenue generating agency. When fully completed and in commercial operation, they are transferred as Government equity to TEK. On the other hand, thermal genera- tion and transmission facilities constructed by TEK, are financed by TEK's internal cash generation and loans from the State Investment Bank and foreign sources. Municipalities who purchase bulk power from TEK, are responsible - 15 - for investments in distribution and related facilities in their jurisdiction. Municipal tariffs are expected to contribute a reasonable portion of future investments in the municipal distribution assets. Many municipal organizations are however involved not only in electrical power distribution, but also in other activities such as public transportation and gas supply. While municipal power distribution activities have remained generally profitable, transport, and to a lesser extent gas supply, have generally incurred heavy losses, which were met from electricity profits. Against this background, the question of adequate generation of resources for power subsector investments, especially of generation and transmission undertaken by DSI and TEK, assumes significance. 42. TEK is not immediately concerned with the proposed project, but it will be the ultimate beneficiary when the Karakaya assets are transferred to it on completion by DSI, several years from now. However, in view of its central role in the subsector, as the "generator of cash" for major power investments, it becomes important to pay attention to its financial role in the system. 43. In its past power loans, the Bank has tried to promote the concept of the "user paying for service" and TEK generating internal resources to finance part of its investments. This meant, in practice, a concern with the financial soundness of TEK as an enterprise, and with TEK's tariffs, receiv- ables and its rate of return. The loan agreements with TEK (Loan 1023-TU and Loan 1194-TU) require it to earn an 8 percent return on revalued assets. This is in line with TEK Law, which requires TEK to earn an 8 percent return on net fixed assets. However, as the TEK Law does not spell out the manner of computing the return, or explain what constitutes expenses, these matters have been clarified in the Loan Agreements with the Bank. They provided that the rate of return be calculated on the basis of revalued assets, according to a formula which realistically reflected changes in values as a result of infla- tion and exchange rate changes. 44. TEK's financial operations have however been marked by two features: (i) failure, except in 1972, to earn the minimum 8 percent return on net fixed assets; and (ii) a chronic shortage of cash, on account of continuing inability to collect its bills for electricity, mainly from municipalities. The major reasons for the former were: (i) Government's caution in increasing tariffs of a basic input like electricity, out of concern that drastic tariff increases could aggravate inflation and affect Government efforts to control it; (ii) the tariff increases being largely offset by a significant rise in operating expenses, caused by substantial increases in fuel prices and wages; (iii) the expensive generation-mix of TEK, with a large dependence on small, inefficient and fuel fired plants, as well as small distant hydro sources; and (iv) the high level of income-taxes payable by TEK (41.7 percent of income). 45. These difficulties led to serious differences between Turkey and the Bank and delayed the effectiveness of the TEK II Loan for nearly two years. In April 1978, following discussions with the then Prime Minister, an agreement was reached that the Government would increase TEK's bulk tariffs by January 1, 1980 to enable TEK to achieve a 5.5 percent return for 1980 on the basis of agreed principles, and increase tariffs thereafter, to achieve the 8 percent return for 1982. Effective February 1, 1980, the Government raised the TEK's - 16 - tariffs to 280 krs/kwh, nearly 130 percent above April 1979 levels, as part of the Government's comprehensive January 1980 economic program. Consequently, the Government has ensured that, in line with its commitment, TEK will achieve the agreed 5.5 percent return for 1980. Despite this salutory development, the pricing of electric power remains affected by two inter-related difficul- ties: first, the tariffs do not enable TEK to generate internally sufficient cash to make a reasonable contribution to the cost of its investment program; and second, the tariff structure is unrelated to either marginal cost or the cost of supply. To provide a basis for rationalizing the structure of tariffs and electricity pricing policies at the bulk supply and distribution levels, TEK carried out under the TEK II project, with the help of qualified experts, a nationwide study of tariffs in the power sub-sector, which is now under review by the Government, TEK and the experts. We expect to exchange views in the near future on this tariff study's recommendations for a revised power tariff structure. Nevertheless, given the continuing high rate of infla- tion and periodic substantial exchange rate changes which affect the revalua- tion of net fixed assets, it seems more appropriate to relate a rationalized bulk tariff structure to yield each year adequate level of cash towards the power investment of both TEK and DSI. The Government has therefore recently requested the substitution of a viable cash generation covenant for the rate of return covenant in Loans 1023-TU and 1194-TU. As the objectives of both the rate of return and cash generation covenants are the same, namely, adequate cost recovery and generation of internal resources to meet a reasonable part of future investments, the Bank agreed to consider the request, provided principles yielding adequate levels of cash generation are reflected in such a covenant. 46. During negotiations, agreement was reached on the principles as well as on appropriate levels of cash generation, gradually increasing over time. Since TEK's cash generation is also derived in part from assets constructed by DSI, the cash generation objective would be applied to the total generation and transmission investments in the power sub-sector, instead of only to TEK's investments. TEK's cash generation will be computed before income-taxes, but after deducting total debt service not merely on TEK's loans, but also on foreign loans incurred by the Government for DSI's hydro projects. It was agreed that beginning in 1981, TEK would generate not less than 20 percent of total TEK and DSI investments in the power subsector including interest during construction, gradually increasing to about 35 percent in 1986 and thereafter. This will be an interim arrangement, pending the completion of the subsector financing study (para. 50). The Government will furnish to the Bank by December 31 each year its total power subsector investments for TEK and DSI in the coming year, including interest charged during construction, the extent of cash generation based on TEK's financial forecasts for the coming year and its proposal for meeting agreed internal cash generation. Following approval by Parliament of the Government's Budget and the annual investment plan, including the power subsector plan by end February, the Government will take necessary tariff measures by May 31 to meet that year's cash generation requirements (Loan Agreement, Section 4.08). 47. While the arrangements described above should enable sufficient mobilization of resources from bulk power users, they will be of little avail unless TEK can collect these resources. TEK has had serious difficulties in - 17 - collecting from municipalities, to whom it sells bulk electricity. Such sales account for nearly 35 percent of TEK's sales. There are two principal reasons for the municipal defaults. First, municipal retail electricity tariffs were not promptly increased in the past, in line with increases in TEK's tariffs. Secondly, municipalities were diverting their electricity surpluses to meet losses in their other activities such as transport and gas. However, since 1977, the Government has faithfully fulfilled its first commit- ment to increase municipal retail tariffs promptly, along with increases in TEK's tariffs. However, municipalities have failed to remit their payments on time. Therefore, the Government has paid TEK from time to time the municipal overdues out of municipal taxes collected by it on behalf of the municipalities. There is an inevitable time lag in making such payments, and the Government itself recognizes that this unsatisfactory arrangement is a temporary expedient. As a long-term solution to increase municipal resources, it passed a revenue law through Parliament in 1979, which was vetoed for various reasons by Turkey's President. Thus pending further legislative measures, this problem will have to be dealt with by consolidating municipal dues and by paying them out of the budget every year. During negotiations, the Government agreed to explore administrative measures to expedite its payment of dues to TEK on behalf of municipalities, and to ensure a timely flow of funds to TEK, so that implementation of important on-going power projects is not delayed. Proposed Comprehensive Review of Power Sub-Sector Financing 48. Besides the problems of adequate cash generation and liquidity for TEK, the situation is compounded by other financial relationships between TEK and other agencies involved in the subsector. For example the pricing policies of TKI for coal and lignite it supplies to TEK, and also the policies regarding petroleum fuel, affect TEK. TKI has been suffering losses, despite price increases, and these losses have been met by Government. By fixing fuel prices at uneconomical levels in the past, the Government provided a hidden subsidy to TEK and therefore to electricity consumers in the country. The recent increases in coal and lignite prices are expected to enable TKI to cover its costs and earn a return on investments, thus obviating any indirect subsidy to electricity consumers. Certain industrial consumers of power are also directly subsidized by Government through rates lower than the prevailing tariff, for example, aluminum and ferro-chrome producers. Another matter which blurs the picture is the transfer of hydro-electric assets constructed by DSI as Government's equity to TEK. This is advantageous to TEK, as the Government remains responsible for the related debt service, although this is partially offset by TEK's liability to pay higher income-taxes; TEK does not get the benefit of the associated interest charges in computing its income-tax liability. Finally, the Government siphons away as income-taxes 41.7 percent of TEK's income. The emphasis on TEK's rate of return obscured the fact that TEK is only one of the principal agencies in the power sub-sector, and did not address directly the power subsector, its financial needs, the relationship between the various agencies operating in the sub-sector, and the total impact of pricing, capitalization and subsidy policies on the Government's budget. 49. As part of the January 1980 economic program, the Government has proposed a radical reform of SEE finances. It has removed many items, except electricity used for aluminum and ferro-chrome production, coal, lignite and - 18 - fertilizers, from the list of basic goods whose prices are subject to Govern- ment approval. SEEs are now free to determine their prices, based on market forces, so as to generate sufficient resources for their future investments. While their investments would be reviewed by the State Planning Organization to ensure conformity to Plan objectives and their viability, they are no longer expected to be financed by the Budget, except for physical infrastruc- ture. While these reforms will go some way towards resolving the problems of financing in the subsector, it is still necessary to extend the reform of power subsector financing beyond TEK and to address more directly the broader issues of power subsector investment priorities and financing. An integrated view of the subsector's needs and financing policies is needed. The invest- ment needs of the power development program will be large, even when the targets are realistically set. In addition to measures to improve coordina- tion in planning, the Bank had therefore, for sometime, urged the Government to study the broad question of the financing of power subsector investments, including not merely TEK, but also DSI and TKI, with a view to establishing guidelines for pricing of not merely electricity, but also of fuels used in power generation and for the generation of adequate funds for financing subsector investments. 50. The Government has now appointed a committee of experts to review the electricity demand and supply forecast for 1980-83, the investment programs of TEK and DSI and to make recommendations for funds to be generated by TEK and the corresponding level of its tariffs. During negotiations, agreement was reached on elaborating the Committee's terms of reference to include an analysis of the Government's fuel pricing policies, treatment of Government's income taxes, debt service associated with hydroelectric assets, finances of municipal power distribution agencies and other related matters and on dates for completing the studies and follow-up actions (Loan Agreement, Section 4.05). This study will help advance the Government's own financial objectives, as far as the power subsector is concerned. This review should assist in evaluating the financial contribution made under present arrangements by both bulk and retail customers to the total generation, transmission and distri- bution investments and will also concentrate more directly on the real issue of investment financing of TEK, DSI and the distribution agencies for meeting Turkey's power needs until 1988. PART IV - THE PROJECT Project History 51. Turkey has actively studied plans for the development of the Euphrates Basin since 1962, and formulated projects for irrigation and power development. In 1974, it completed the first stage of the Keban power proj- ect, with a total reservoir capacity of 30.7 km3, useful storage of 16.3 km3 and 1,260 MW installed generating capacity. The Bank chaired the syndicate for the financing of Keban and participated in the financing of transmission lines associated with Keban (Loan No. 568-TU). Karakaya represents the second stage in the basin development program and involves primarily reregulation of the waters released from the existing Keban reservoir for the generation of - 19 - hydropower. The project, like Keban, would have no irrigation uses and does not involve abstraction of water from the Euphrates River, except for initial filling. While Bank consideration of the international water aspects of this and other projects on the Euphrates river in the lower riparian countries started in 1972, the Government requested Bank assistance for the project only in January 1975. Following considerable discussions, agreement was reached in June 1976 on the filling and operational principles to be applied during the construction and operation of Karakaya which would ensure that the project would not adversely affect the interests of either Turkey, Syria or Iraq, with regard to the use of the Euphrates waters. Turkey then communicated these principles to Iraq and Syria, and offered to discuss the development of a tripartite system to monitor these principles. It was only then that the project was appraised in late 1976. But, with the change of government in 1977 and its new outlook on the subsector's financial and related issues, and on the abovementioned riparian arrangements which were confirmed only in March 1979, both Turkey and the Bank agreed to defer consideration of the project. The request for financing was renewed by Turkey in mid 1979 to the European Investment Bank (EIB) and the Bank. The project was reappraised in November 1979. EIB participated in the reappraisal, and also attended, as observers, the Bank's loan negotiations held in Washington from March 26 to April 1, 1980. The Turkish delegation was led by Mr. Gunay, Assistant Director General of the Treasury. The Project 52. The proposed project involves the establishment of a reservoir having 9.6 km3 of total storage and 5.6 km3 useful storage located about 160 km downstream of the Keban hydropower plant, through the construction of (a) a concrete arch-gravity dam (173 meters high), with an overflow spillway, intakes and penstocks, (b) a power house with six 300-MW turbo-generator units, and (c) appropriate accessory equipment and a switchyard located 2.5 km from the dam. It also includes the relocation of a railway line, roads and bridges, and resettlement of about 17,000 inhabitants in the reservoir area. A Staff Appraisal Report (2848-TU) dated April 25, 1980, and entitled "Appraisal of Karakaya Hydropower Project" is being distributed separately to the Executive Directors. Project Costs and Financing 53. The estimated total project cost, excluding $138 million of interest during construction, is about $1,160 million equivalent. Of this, $602 million is in foreign exchange. Turkey has concluded agreements with Swiss banking institutions, manufacturers and consultants for S.Frs. 509 million ($295 million), which will cover all foreign exchange costs of contracts for generating units, electro-mechanical equipment and consulting services awarded to Swiss manufacturers and consultants. In addition to $19 million already spent, about $12 million will be borne by Turkey, mainly toward foreign exchange costs of locally procured material. The remainder of the foreign exchange costs will be financed, in addition to the proposed Bank loan, as follows: (a) EIB has agreed in principle to provide $110 million equivalent, as co- financing; its loan negotiations are scheduled in May and consideration by its Board in June 1980; a letter of administration will be signed by EIB and the Bank to cover the usual administrative aspects and coordination necessary to - 20 - ensure success of the cofinancing arrangements; (b) Italy has agreed to provide $20 million equivalent; and (c) the Abu Dhabi Fund has indicated to Turkey its intention to provide $26 million. Signing of the financing arrange- menLs with Italy and Abu Dhabi Fund would be a condition of the Bank loan effectiveness (Loan Agreement, Section 6.01). Local financing and financing of interest during construction, will be secured through annual governmental budget allocations in accordance with the Project implementation schedule. However, to ensure timely availability of local funds, it has been agreed that a special revolving fund will be established, with an initial amount of 500 million TL, equal to three months' estimated civil works expenditure require- ments, to be replenished monthly (Loan Agreement, Section 3.01). The establish- ment of this revolving fund will be a condition of loan effectiveness (Loan Agreement, Section 6.01). International Riparian Aspects 54. Karakaya is a non-water-consumptive project, once the reservoir is filled. It therefore does not directly raise technical questions of long-term sharing of waters with the two lower riparians, Syria and Iraq. It does, how- ever, involve the need to ensure that, during initial filling and subsequent operation of the reservoir, the interests of the downstream riparians are not adversely affected. This matter was thoroughly and very carefully studied during the preparation stages of the Project. In addition, although Karakaya is non-consumptive, its role in regulating the flow of the Euphrates river, on which a number of consumptive and non-consumptive projects are under operation or construction or planned in all three riparian countries, made its construction an appropriate occasion for assessing the question of long- term water sharing and for seeking to establish a process for addressing this question among the three riparians. Thus, the Bank's consideration of Karakaya from the beginning was based on seeking satisfactory arrangements to facilitate eventual agreement among the three riparians on long-term sharing of the waters. These arrangements are summarized in succeeding paragraphs and discussed in Annex V. 55. With a view to ensuring that the Karakaya project will not adversely affect the lower riparians, Turkey's filling and operational proposals for Karakaya were evaluated by the Bank in the model developed in the technical study which the Bank undertook in 1974, following a request by Iraq for the Bank's good offices to help achieve a just and equitable solution between the riparian countries on the division of the Euphrates waters (an issue which had become urgent because of the simultaneous filling of the Turkish Keban reservoir and the Syrian Tabqa reservoir which the Bank, incidentally, had anticipated since 1972). After discussions with all the riparians, this evaluation revealed that if Turkey maintains an average monthly discharge of water of at least 500 cubic meters per second (cumecs), as the Euphrates passes from Turkey into Syria at Birecik, this would ensure that: (a) the existing requirements of downstream riparians for power generation and irrigation needs and reason- able growth in these requirements during 1975-85, would be met; (b) the Karakaya reservoir could be filled within a period of three to seven months, depending on the date of closure and actual water flows; and (c) the Turkish power plants could be operated for maximum energy output. This operating rule is called the "Rule of 500". The study also revealed that, while Turkey's release of a minimum of 500 cumecs would ensure the lower riparians' interests, the benefits in Syria and Iraq could be further increased, if the Syrian and Iraqi reservoirs are also operated according to principles developed in the model. - 21 - 56. In 1976, in the context of the proposed project, Turkey informed Syria and Iraq that it would observe the Rule of 500 during the construction, initial filling and operation of the Karakaya Dam, until such time that any large water consumptive project is implemented in any of the three riparian countries, and also of its readiness to initiate tripartite discussions on the better use of the common waters. Iraq and Syria have yet to accept this offer, but have made their views known to the Bank, which commented thereon (Annex V). Subsequently, in March 1979 Turkey's Minister of Energy recorded an official policy statement in the Turkish Parliament that during construc- tion, initial filling and operation of Karakaya, the monthly average flow of Euphrates waters would not fall below 500 cumecs at Birecik, with shortfalls in any averaging period of not more than a month being made up in the next period. He also announced that this Rule of 500 would be applied by Turkey unless very abnormal hydrometerological conditions exist, and as long as Turkey had not developed a project involving large consumptive use of the river's waters in its territories. Turkey has also formally represented to the Bank that in considering Karakaya for financing, the Bank may rely on this policy statement regarding the international riparian aspects of the project. 57. The Bank is fully conscious that the arrangements agreed upon by the Turkish Government in connection with Karakaya are but an initial step towards a broader agreement between the three riparian countries on the long- term apportioning of Euphrates and Tigris waters. The Bank has repeatedly tried since 1965, when this problem was raised in connection with the Keban Dam in Turkey, to bring about negotiations between the riparians to resolve this issue. The three riparian countries have themselves held tripartite or bilateral discussions on this project, but the long-term interests at stake as well as political differences have proved to be obstacles difficult to over- come. As a result, several projects, some of them involving consumptive uses, have been started in the Euphrates and Tigris basins without consultation, let alone agreement, between the riparians. In all cases where the Bank has been involved in the financing of such projects (Lower Khalis in Iraq, Balikh in Syria, and Keban and Karakaya in Turkey), it has carried out detailed studies to ascertain that the projects would not harm, or not be adversely affected by developments in the other riparian countries; it has also always endeavoured to use its good offices in order to bring about tripartite discussions with a view to making progress towards an agreement on water sharing. As regards Karakaya, since consumptive use is limited to initial filling, and since the "Rule of 500" agreed upon by Turkey would adequately protect the downstream riparians, the Bank considers it appropriate to participate in the financing of the Project. The Government has agreed to establish an appropriate report- ing system onthe actual operation of the Project and Euphrates river flows (Loan Agreement, Section 4.04). Project Implementation 58. DSI will be responsible for project execution. Project construction began in late 1976, but due to unavailability of adequate foreign exchange financing, only preliminary works had been completed as of end 1979. The construction and erection schedule is now phased up to 1987. DSI will con- tinue to retain consultants to assist in engineering, procurement, supervision of construction and initial operation (Loan Agreement, Section 3.03(a)). Although well-known and experienced consultants are assisting DSI in project - 22 - supervision, in view of the project size and its potential risks, DSI agreed to establish a board of experts, independent of the designers of the project, to familiarize themselves with the designs and to advise DSI in the event of unforeseen problems arising during project construction (Loan Agreement, Section 3.03(b)). The establishment of this board of experts will be a condition of loan effectiveness (Loan Agreement, Section 6.01(b)). To ensure effective supervision, the Government will establish effective project site management by October 31, 1980, with a full-time site manager with responsi- bilities, qualifications and experience satisfactory to the Bank, along with adequate technical and financial authority to solve problems at the site as they arise (Loan Agreement, Section 3.07). As several ministries and agen- cies, such as those responsible for highways, railways, resettlement, industry and customs are involved, the Government has already established a central coordinating committee, which will review progress regularly and help in resolving difficulties in project coordination and implementation (Loan Agree- ment, Section 3.08). The Government will also undertake periodic inspection of the dam to ensure its sound condition and proper maintenance (Loan Agree- ment, Section 4.07). Ecological and Resettlement Aspects 59. Intensive archaeological investigations, with the assistance of numerous foreign scientific institutions, over the last ten years, have not revealed any sites of archaeological or historical significance in the reservoir area. In view of the potential importance of the ecological aspects of a project as large as Karakaya, the Government appointed independent con- sultants to study these aspects in detail. The draft study did not identify any significant adverse environmental effects. However, it highlighted the importance of dealing adequately with the problem of resettling about 17,000 inhabitants who would be displaced by the construction works and the filling of the reservoir. Most are subsistence farmers living in 34 villages, only 3 of which have populations exceeding 1,000 persons. Turkey has legally established a comprehensive resettlement methodology, so that resettlements are carried out in a coordinated manner. While persons living on and around the dam site have already been resettled, DSI has just started addressing the resettlement of population in areas which will be flooded by the dam. Adequate funds have been included in the project cost estimates for resettlement. In addition, the owners of the land or houses in the area which will be inundated by the Karakaya reservoir will be fairly indemnified under existing law and provided with at least the same economic benefits they had prior to the flood- ing of their properties. However, in view of the importance of the resettle- ment problem, the Government presented, during negotiations, a workable resettlement plan and a tentative implementation schedule. The Government has arranged to prepare an inventory of the property which would be submerged by the project, and is initiating action for their valuation to make compensa- tion payments. A census of the families requiring Government assistance in resettlement has been completed, which indicates that only a small proportion of the population has expressed a preference for Government assistance in resettlement. Resettlement sites have been tentatively identified, and Government plans to provide them with accommodation and support services to enable them to rebuild their livelihood. Further, the Government has agreed - 23 - to furnish a detailed implementation schedule by February 28, 1981 and to ensure that its implementation is fully coordinated with reservoir filling (Loan Agreement, Section 3.06(b)). Procurement and Disbursement 60. The proposed loan would finance (i) a part of the foreign costs of the main civil and hydraulic works contract for the Karakaya dam which amounts to about $260 million including contingencies and (ii) equipment and materials relating to relocation of railways, roads and bridges. The civil works contract, which provides for some related permanent equipment, was awarded in October 1976, after international competitive bidding in accordance with Bank guidelines and in consultation with the Bank. Advance contracting of the main civil and hydraulic works is justified, in terms of the project construction schedule and the Bank's involvement in the project since 1975. The contracts for turbines, generators and other electro-mechanical equipment, totalling some $285 million have been awarded by DSI to Swiss manufacturers after limited bidding to use available Swiss financing. Swiss financing also includes $10 million for consultants. Equipment and materials relating to relocation of railways, roads and bridges would be procured through inter- national competitive bidding in accordance with Bank guidelines. Disburse- ments of the proposed Bank loan would be 45 percent of the foreign expenditures on civil works in a cofinancing arrangement with EIB and 100 percent of foreign expenditures for equipment and materials for relocating railways, roads and bridges. Disbursements are expected to begin in the first half of FY81 and the loan should be fully disbursed by the end of FY88. Retroactive financing of not more than $10 million is proposed for civil works expendi- tures from February 1, 1980. Operation and Role of DSI and TEK 61. After the project is in full commercial operation, its assets will be transferred, in accordance with sound financial and accounting practices, from DSI to TEK, in the form of a Government equity holding in TEK (Loan Agreement, Section 4.09(b)). The Government will be required to ensure that, apart from TEK operating these assets in accordance with sound public utility practices, TEK's and DSI's operation of the power plants and reservoir will be in conformity with the "Rule of 500," described in para. 55. The Govern- ment has undertaken that TEK will construct the transmission lines needed to connect the Karakaya facilities with Turkey's national inter-connected power grid system. To ensure that TEK completes these lines (which are not part of the proposed project) prior to the commissioning of the project's generating units, the Government has agreed to (i) provide the Bank with a construction schedule and a tentative financing plan for these lines by June 30, 1981 and (ii) make arrangements satisfactory to the Bank for securing the financing needed for the lines to enable their construction by the time the project's generating units are commissioned (Loan Agreement, Section 4.09(a)). Economic Justification and Project Risks 62. The project is the least-cost means of meeting Turkey's projected growth of power demand at discount rates up to 30 percent. The estimated rate of return is at least 15 percent, valuing benefits at the present electricity - 24 - tariff rates. It is likely that the incremental revenues understate the benefits, some of which will arise from assured availability of electricity supply. 63. The project site has difficult geological conditions and construction involves large excavation in an area with steep slopes. The geological investigations for the dam have been thorough and the best site chosen. The construction risks are normal for this type of project and manageable, with expert supervision provided by the consultants. The coffer dam and diversion tunnels have been designed for a flood of 25 years. The existence of a much larger reservoir in Keban will facilitate handling any floods unforeseen beyond the design levels. Other potential risks are the flow of adequate local currency funds, timely supplies of fuel, lubricants and construction materials and effective project site management. Reasonable precautions have been taken to ensure that these will be forthcoming. PART V - LEGAL INSTRUMENTS AND AUTHORITY 64. The draft Loan Agreement between the Republic of Turkey and the Bank, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement are being distributed separately to the Executive Directors. Features of special interest are referred to in para- graphs 38, 55, 57, 58, 59, 60 and 61 of this Report. Additional conditions of effectiveness would be: (i) the signing of agreements to finance the remain- ing foreign exchange costs of the Project; (ii) the establishment of a special revolving fund to meet local expenditures; and (iii) establishment of a panel of experts to advise DSI in the event of any unforeseen problems during Project construction (Loan Agreement, Section 6.01). In other respects, the draft loan documents conform to the normal pattern for loans for power projects. 65. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 66. I recommend that the Executive Directors approve the proposed Loan Agreement. Robert S. McNamara President by Moeen A. Qureshi Attachments April 25, 1980 Washington, D.C. - 25 - ANNEX I P -5
Группа Всемирного банка · Memorandum & Recommendation of the President
Turkey - Karakaya Hydropower Project
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