Turkey - Sumerbank Cotton Textile Rationalization Project

Document of The World Bank FILE COPY FOR OFFICIAL USE ONLY Report No. 2887-TU TURKEY STAFF APPRAISAL REPORT SUMERBANK COTTON TEXTILE RATIONALIZATION PROJECT April 30, 1980 Industrial Projects Department This document has a restricted distribution and may be used by recipients only in the performance ofi their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  INTERNATIONAL BANK FOR RECONSTRTJCTION AND DEVELOPMENT TURKEY SUMERBANK COTTON TEXTILE RATIONALIZATION PROJECT STAFF APPRAISAL REPORT CURRENCY EQUIVALENTS Except where otherwise indicated, all figures are quoted in Turkish Lira (TL) and US Dollars (US$) (Exchange rate as of January, 1980) 1/: TL 1.0 = US$0.0142 TL 70.0 = US$1.00 TL 1,000,000 = US$14,285.70 Previous rates were: From June 1979 to January 1980 TL 47.1 = US$1.00 From April 1979 to June 1979 TL 26.33 = US$1.00 From March 1978 to April 1979 TL 25.25 = US$1.00 From September 1977 to March 1978 TL 19.443 = US$1.00 ABBREVIATIONS AND ACRONYMS ASM = Alim ve Satim Muessesse - Sumerbank's Sales Division BCE = Base Cost Estimate CTD = Sumerbank Cotton Textile Division to be formed under the Project DPF = Dyeing, Processing and Finishing Sector DYB = Devlet Yatirim Bankasi O.A. (State Investment Bank) EEC = European Economic Community FTA = Financial Technical Assistance GHERZI = Gherzi Textile Organization JSC = Joint Stock Company OTA = Operational Technical Assistance OP = Operating Profit PAT = Profit After Tax PPF = Project Preparation Facility of the Bank RMP = Rationalization and Modernizatic,n Program SB = Sumerbank SEE = State Economic Enterprise SPO = State Planning Organization STTRC = Sumerbank Textile Training and Research Center SYKB = Sinai Yatirim ve Kredi Bankasi A.O. TL = Turkish Lira TSKB = Turkiye Sinai Kalkinma Bankasi A.S. UNDP = United Nations Development Program UNIDO = United Nations Industrial Development Organization 1/ Since January 1980, the rate is being adjusted for differential inflation between Turkey and her major trading partners. The rate of TL7O=US$1.00 is used for this report.  FOR OFFICIAL USE ONLY TURKEY APPRAISAL OF SUMERBANK COTTON TEXTILE RATIONALIZATION PROJECT TABLE OF CONTENTS Page No. I. INTRODUCTION ........................................... ....... 1 II. THE TURKISH TEXTILE INDUSTRY .............................. 2 A. Economic Background ......................... . 2 B. The Textile Industry ... ........... ......... . . . .............. . 3 C. Textile Consumption ........................ . 5 D. The Cotton Textile Industry ........................ 6 E. Exports ......*7 F. Development Strategy for the Textile Sector ........ 8 III. THE MARKET AND MARKETING OF COTTON TEXTILES IN TURKEY ... 8 A. Past Supply and Consumption of Cotton Textiles....e. 8 B. Supply and Demand Projections of Cotton Textiles ... 9 Co Supply of Raw Cotton ....o...o .... - o.. 12 D. Marketing of Cotton Textiles o..oo..... 12 Eo Pricing o..o.oo.. 13 IV. THE COMPANY .....o...o.oo ......13 A. Sumerbank Holding Company (The Beneficiary)c.....o.. 13 1. History, Objectives and Role of Sumerbank o... 13 2. Organization and Management ... 14 3. Financial Structure and Performance 15 B. Sumerbank Cotton Textile Operations 18 1. Organization and Reorganizational Concept 18 2. Management and Labor 19 3. Production Facilities,Technology and Operations 20 4. Marketing and Reorganization 22 5. Pricing ....o....... 25 6. Past Financial Performance and Future Prospects 26 7. Rationalization and Modernization Program (RMP) 27 This Report was prepared by 0. de Bruyn Kops, J.C. Duvigneau, A. Sandig and Y. Suzuki of the Industrial Projects Department. This document hs a mtricted distribution and may be used by recipients only in the performance of their omcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - TABLE OF CONTENTS (Continued) Page No. V. THE PROJECT ............................... ...... 28 A. Project Objectives .... ...... . .... .... ............ 28 B. Scope and Location ... *ooo.........o ..o . .....* 29 C. Machinery, Equipment and Buildings .o ........... 30 D. Technical Assistance ... o ........ ... ........ 31 E. Project Management and Implementation .............. 32 1. Project Management .......*....... ............. 32 2. Implementation Schedule ....... ................ 33 3. Recurring Action Programs ..oo ............ .... 33 F. Employment and Training ............................ o 35 G. Ecology ..oo .........o.o...... ...... ...... ..o 36 VI. CAPITAL COSTS. FINANCING PLAN AND PROCUREMENT ....o....... 36 A. Capital Cost Estimates .........o ..............o...o 36 B. Financing Plan ..o.................................... ..... o.oo .o.*... 39 C. Procurement o................................ .o........ o .... o. ..o.... 41 D. Allocation of Bank Loan and Disbursement .... o ...... 41 VII. FINANCIAL ANALYSIS. .. ....... o . . ... . . .o ............. . .. 42 A. Projected Production Build-up and Sales .... .. o.. 42 B. Operating Cost Estimates ........................... 43 C. Financial Projections and Financial Covenants....... 44 D. Financial Rate of Return .... o*.o...o. ....... .. . .. 46 E. Audit and Reporting . . ....... o......... . .......... .o... . 46 F. Major Risks ................. o...................*... 47 VIII. ECONOMIC ANALYSIS ......... . . . . . . . . .................. ... .... . ....... . 48 A. Economic Costs and Benefits ............ 48 B. Economic Rate of Return ...... 49 C. Other Benefits ..................................... 50 IX. AGREEMENTS .............................................. 50  - iii - LIST OF ANNEXES ANNEX 2-1 Textile Fiber Consumption in Turkey, 1970-78 2-2 Number of Spindles, Looms and DPF Capacity in the Turkish Cotton Textile Industry, 1972-77 3-1 Historic Textile Consumption in Turkey 1. Cotton Woven Fabrics: Production, Exports and Domestic Consumption, 1970-78 2. Cotton Yarn: Production, Exports and Domestic Consumption, 1970-78 3-2 Supply/Demand Balance of Cotton Textile Products, 1978-85 4-1 Organization Chart: Sumerbank Holding 4-2 Organization Chart: Typical Sumerback Cotton Textile Mill 4-3 Organization Chart: Sales and Purchasing Establishment (ASM-Istanbul) 4-4 SB Financial Statements 4-5 Financial Projections - SB Non-Cotton Operations 4-6 Projected Organization of CTD 4-7 List of SB Cotton Textile Plants and Activities 4-8 SB Cotton Textile Product Mix, 1977 4-9 SB Cotton Textile Operations - Financial Data 4-10 SB Cotton Textile Operations - Financial Projections without the Project 5-1 Production with and without Project 5-2 Terms of Reference for Technical Assistance 5-3 Staffing of Project Implementation Unit 6-1 Estimates of Capital Cost and Working Capital Requirement 6-2 Annual Financing Requirements and Financing Plan 6-3 Projected Disbursement Schedule 7-1 Sales Projections 7-2 Assumptions for Financial Projections 7-3 Financial Projections with Project 7-4 Incremental Financial Projections for Project 7-5 Financial Rate of Return 8 Economic Rate of Return MAPS 1. IBRD No. 14576 - Sumerbank Production Units 2. IBRD No. 14575 - Sumerbank Cotton Textile Plants and Project Activities 3. IBRD No. 14577 - Sumerbank Retail Network of ASM   SELECTED DOCUMENTS AND DATA AVAILABLE IN THE PROJECT FILE Referred to Reference Title and Date Under Para A Sumerbank Macroplan 1976 4.47 B Terms of Reference, Feasibility Study, 1977 4.47 C GHERZI Contract for Feasibility Study, 1978 4.47 D Diagnosis Report I to III, June 1979 4.47 E Recommendation Report I to III, June 1979 4.47 F Mr. Ferber's Report on Financial Situation, July 1979 4.47 G Updated Recommendation Report, Nov. 1979 4.47 H GHERZI Contract OTA, Stage I Sept. 1979 5.12 I Terms of Reference FTA, Stage I Nov. 1979 5.13 J Fourth Five Year Plan, Section on Textiles, 1978 2.19 K Textile Fiber Consumption in Selected Countries, 1974 and Domestic Consumption and Use of Manmade Fibers in Turkey 1973-1978 2.11 L Supply and Demand: Garments and Household Articles, 1977-83 3.01 M Supply and Demand Projections of Cotton Textile Products in Turkey, 1978-85 3.06 N SB Procedures for Budgeting and Investment Planning 4.07 0 Assumption for Financial Projections for SB Non- Cotton Operations 1979-86 4.15 P New Spinning Plants at Adana, Diyarbakir and Karaman, February 1980 4.28 Q Details of Cost Estimates 6.01 R CTD - Wage and Salary Earners 1979-83 7.04   I. INTRODUCTION 1.01 The Government of Turkey has requested the Bank to help finance the first phase of a Rationalization and Modernization Program (RMP) for the cotton textile manufacturing operations of Sumerbank (SB), which is one of the most important State Economic Enterprises (SEE) in the country and which is also active in the manufacture of wool textiles, leather, chemicals, ceramics, in the marketing of its products, and in banking. SB, with total employment of over 40,000 (in its wholly owned entities alone) and annual net sales of about TL 30 billion, consists of 30 wholly owned and seven majority owned (over 80%) companies and holds numerous minority interests in different branches of industries. 1.02 SB owns all public sector cotton textile operations in Turkey, consisting of 13 fully and 6 majority owned plants, located throughout the country (Maps IBRD 14576/7). SB's cotton textile operations contribute about 60% of SB's sales, account for between 15% and 20% of the Turkish cotton teltile industry's production capacity, and produce annually about 200 million m of cotton fabric (mostly dyed or printed, mass-produced fabrics consumed in rural areas and by the urban poor). 1.03 Capacity utilization, productivity and product quality in SB's cotton textile operations has been declining over the past years, resulting in poor profitability. To a large extent these growing problems have been caused by the well-known deficiencies inherent in the Turkish SEE system. Therefore, to rehabilitate its operations, and to make them again viable, SB will under- take, in addition to the physical rehabilitation of plants, action programs that are to implement reorganization, reorient its operational and marketing philosophy, and improve staffing and management systems. 1.04 A feasibility study, executed by GHERZI Textile Organization (GHERZI) of Switzerland, in close cooperation with SB and the Bank, recommended the RMP which would increase SB's effective production capacity of cotton fabric from the present 207 million m (1979) to about 300 million m by 1986. The pro- posed Sumerbank Cotton Textile Rationalization Project (the Project) will cover the first phase of the investments under the RMP to 1983 2and will increase SB's effective cotton textile capacity to about 250 million m . This will be achieved through (i) overdue rehabilitation measures (provision of spare parts and machine assemblies); (ii) replacement or modernization of obsolete machin- ery and equipment; (iii) addition of a garment plant (employment generation and export potential); and (iv) organizational, operational and managerial improvements to be supported through the provision of technical assistance. 1.05 The Project is to help modernize, rationalize and rehabilitate, in a comprehensive and well controlled way, the entire public sector cotton textile industry to restore production levels already achieved in the early 1970s, and to make it competitive domestically as well as internationally. It is in line with Turkey's attempts to reorganize and rehabilitate the State Economic Enterprise System along sound business principles as spelled out under the fourth Five Year Plan (1979 to 1983) and the Economic Policy Package of January 25, 1980.  1.06 Total financing required for the Project, including working capital and financial charges during construction are estimated at US$150.5 million, of which US$104.0 million would be in foreign exchange. The proposed IBRD loan of US$83 million 1/ will cover 94% of the estimated foreign exchange requirements for fixed assets, including technical assistance but excluding US$2.3 million local taxes, and represents 56% of the Project's total finan- cing needs including additional working capital requirements for existing operations. Foreign exchange requirements for working capital and interest during construction (US$18.0 million equivalent or 12% of total financing) will be met by SB's own export receipts. The local costs (US$44.5 million) 2/ are proposed to be met 40% by equity, and 60% through internal cash generation. 1.07 The Bank has previously been involved in the Turkish cotton textile subsector in various ways. In the public sector this included two SB projects (Erzincan and Karaman Maras) costing together US$24 million equivalent, partly financed from the proceeds of a loan (1024-TU of 6/28/1974) to Devlet Yatirim Bankasi O.A. (DYB). To date these two projects have only shown a limited success. The second loan to DYB (1379-TU of 3/23/1977) is financing two SB cotton textile projects (Izmir Printing and Izmir Garments) costing about US$15 million; these two projects have been modified recently within the framework of the RMP preparation and will benefit from technical assistance under the proposed Project. In the private sector, loans to Turkiye Sinai Kalkinma Bankasi A.S. (TSKB) have contributed about US$30 million since 1971. Under loans 1734/55-TU of 9/17/1979 the Bank extended creditlines of US$80 million to TSKB and Sinai Yatirim ve Kredi Bankasi A.O. (SYKB) to modernize the private textile sector through provision of technical assistance, training, institution building, modernization of existing and addition of new capacity. Finally, IFC has contributed about US$11 million to the textile sector and has recently approved another project (MENSUCAT Sanayi ve Ticaret A.S.). 1.08 Missions consisting of Messrs. Duvigneau (Chief), Sandig, Suzuki, de Bruyn Kops of the Industrial Projects Department and Mr. Makowitzki (Consultant) visited Turkey in September and November/December 1979 to appraise the Project. A post-appraisal mission visited Turkey in March 1980 to confirm with SB's new management various understandings previously reached. II. THE TURKISH TEXTILE INDUSTRY A. Economic Background 2.01 Over the last decade (1967-78), the Turkish economy has grown at 6% per year, and has undergone marked transformation. As a result of 1/ Including US$1.0 million from Project Preparation Facility (PPF) Funds (P-013/018-TU). 2/ Including US$19.8 million equivalent for working capital for existing operations.  - 3 - strong Government incentives, supplemented by protection against competition from imports, the share of industry in GDP increased from 14% in 1962 to 23% in 1978, while the share of agriculture declined from 34% to 21%. Reflecting a gradual structural change, the share of consumer goods in industrial output declined from 57% to 42% during 1967-78, with that of intermediates and capital goods rising from 43% to 58%. However, the economic progress has been punctuated (in 1958, 1970 and 1977) by severe balance of payments crises, mainly because of the country's over-emphasis on import substitution, and an inability to develop a strong export base. 2.02 The Government has generally been involved in basic industries where private capital has hesitated to enter because of long gestation periods, heavy capital requirements, or high risks. While the primary purpose of State Economic Enterprises (SEEs) is production, they have also been charged with social goals, such as the development of backward regions, provision of employment and maintenance of price stability, which all have contributed to their generally poor financial performance. Low salaries, political pressures and otherwise limited autonomy, and overstaffing have affected the quality of their management and operating efficiency. The private sector has invested mainly in profitable consumer goods and durables, and has only recently entered into intermediate and capital goods production. It carried out 57% of industrial investment during the last decade and now accounts for about 50% of value added in manufacturing. However, as a result of the recent eco- nomic crisis, private manufacturing investment stagnated from 1974 to 1977 and fell 11% in real terms in 1978. 2.03 Industry in Turkey faces several problems. The immediate ones are low capacity utilization, low productivity, and the low level and rate of growth of manufactured exports. SEEs have deliberately been oriented towards the domestic market. Export incentives have not been sufficient to outweigh the advantages of effective industrial protection which, in a climate of growing domestic demand, have made domestic sales more profitable than exports. Therefore, also the private sector has been concentrating on the local market. In 1977, exports accounted for only 7% of the gross output of the manufacturing sector, and about 75% of these exports were concentrated in textiles, leather products and processed goods. 2.04 The immediate objective in the industrial sector must be to improve the utilization of existing capacity. Over the longer term, substantial improvements in structure, efficiency and international competitiveness will be needed in many of the existing industries, particularly in the SEEs, to enable them to use resources effectively and compete successfully at home, as well as provide some of the thrust for increased exports. The proposed Project fits well into this strategy as it aims at increasing capacity utilization, efficiency, productivity and product quality of SB's cotton textile operations through a program of rationalization, modernization and technical assistance. B. The Textile Industry 2.05 Turkey, as the sixth largest producer and the third largest exporter of cotton in the world, has a good raw material base for expansion of its textile industry. At present, it produces about 500,000 tons of cotton per  - 4 - year, of which almost 60% is locally processed into textiles. However, Turkey's production of other fibers has been lagging behind demand and it presently imports annually 10% (10,000 tons) of its artificial and synthetic fiber requirements and 9% (5,400 tons) of its woolen consumption. 2.06 After food processing, textiles is the largest manufacturing in- dustry in Turkey. The organized textile industry's 1/ value of production, employment, investment, exports and its respective shares in manufacturing industry are shown below. Turkey - Textile Industry, 1967-78 /a 1967-78 Annual 1967 1972 1974 1978 Growth %/b (%)/b (%)/b (%)/b Investment (constant 1978 TL billion) 3.3 (16) 8.5 (18) 19.0 (28) 5.8 (9)/c 5.3 Value of Production (constant 1978 TL billion) 55.3 (17) 71.8 (16) n.a.(15) 99.5 (14) 5.5 Employment ('000) 126 (12) 138 (10) 159 (11) 200 (12) 4.3 Exports (current US$ million) 3 (4) 55 (23) 148 (25) 322 (52) 52.5 /a Organized sector only, including garment making. /b Share in manufacturing industry. /c Estimate based on 1977. Source: State Planning Organization. Investment in the organized sector, fueled by generous incentives (certifi- cates of encouragement) and growing domestic and export markets, reached a peak of TL 19.0 billion in 1974 (1978 prices), when it accounted for 28% of total manufacturing investment. It has since tapered off because of excess capacity in spinning and adverse economic developments in the country. Capital intensity also increased dramatically, reflecting the heavy investment in modern equipment, particularly in spinning. One of the most striking developments in the textile industry has been the rapid growth of exports (US$321.6 million in 1978), from only 4% of manufacturing exports in 1967 to 52% in 1978 (para 2.17). 2.07 The industry's growth has been realized through an increasing number of large, fully integrated units. Large enterprises (here defined as employing 200 or more workers), while representing 13% of the number of firms, 1/ Defined as establishments employing 10 or more workers.  -5- account for 73% of employment in the organized sector. The nature and degree of integration (spinning, weaving and finishing) of production units vary widely. The number of large and fully integrated units, which account for an estimated 20-25% of employment in the textile sector, are increasing. The organized garment sector has also been growing fast, from 25 registered establishments in 1963 to about 600 at the present time, although large firms in the garment industry are very few and their total employment does not exceed 5,000. About one half of the textile enterprises in the organized sector are located in the Istanbul area. 2.08 In the unorganized textile sector there are an estimated 8,000 small establishments, employing about 100,000 persons, of which 60% are engaged in garment making and knitting activities. The balance (40%) consists mostly of small weavers with obsolete equipment. 2.09 The cotton textile industry accounts for the bulk of textile produc- tion, with about 83% of total volume output. In the organized cotton segment, an estimated 155,000 workers are employed in spinning, weaving and finishing, and about 25,000 in the garments/making-up and knitting segments. The output of the cotton segment, mainly geared towards the domestic market, has been growing at an average of 5% per year during 1970-78. Knitting output has been growing at an even faster rate, estimated at around 17% per year. The woolen segment, including carpets, accounts for 17% of production and employs an estimated 20,000 workers. Although the Turkish consumption of wool has been relatively stagnant, the wool sector has been growing at 6-7% a year, using an increasing percentage of man-made fibers to meet the highly income-elastic demand for worsted fabrics. 2.10 Although the public sector, under SB's management, pioneered - starting in the early 1930's - the large integrated production units in the Turkish textile industry, its role has gradually diminished and about 80% of the industry is now in private hands. SB, in the late 1970s, accounts for 19% of investment in the textile sector, 14% of production, 17% of value added and 13% of employment. Unlike the private sector counterparts, SB sells most of its textile production through its own retail network to low income groups in urban and rural areas. Consequently, enhanced by the present situation of undersupply of textiles in Turkey (para 3.01), there is little competition between SB and the private sector. The organization and performance of SB cotton textile operations are further described in Chapter IV. C. Textile Consumption 2.11 Textile consumption in Turkey, at 7.7 kg per capita in 1978, is considerably higher than in countries with a comparable per capita income while much lower than in industrialized countries (Annex 2-1 and Project File, Item K). The relatively high consumption is mostly due to the existence of a sizeable domestic textile industry based on local cotton and a climate with a considerable temperature range. The consumption of cotton fibers is 59% of total fiber requirements, while synthetic fibers account for 30%, and wool and cellulosic fibers for the remaining 11%. But while cotton and wool consumption grew by 4% and 2% per year in the 1970's, the annual increase  -6- for synthetics was 25%. However, the increase for synthetics consumption is expected to slow down because of import tariffs and high domestic prices produced by a protected local industry of limited capacity. D. The Cotton Textile Industry 2.12 The rapid expansion of the private organized cotton sector since 1970 has been accompanied by increases in labor productivity of about 14% per year. This is higher than for manufacturing as a whole and reflects a heavy program of investment in modern textile equipment, particularly in spinning. Individual segments of the industry (spinning, weaving, finishing) differ greatly in structure and degree of sophistication and efficiency, and are discussed in some detail below. 2.13 In Spinning, the industry recently underwent a program of rapid expansion and modernization in which the number of spindles more than doubled from 1.3 to 3.0 million, between 1972 and 1977 when capacity stabilized (Annex 2-2). But actual yarn production in 1978 amounted to only about 288,000 tons, of which 81,000 tons were exported, as compared with an available capacity of about 427,000 tons, reflecting a low capacity utilization rate of 67%. Capacity utilization has been constrained by: (i) the limited domestic weaving capacity, which can only absorb about 60% of yarn output at full capacity; (ii) import restrictions imposed by the EEC, to which about 90% of Turkish yarn exports go; (iii) poor planning and control of production; and more recently (iv) power shortages which may have accounted for 10-20% of underutilization in 1979. Despite its modern vintage, labor productivity in spinning in Turkey ranges from 42% to 64% of European standards. A large portion of this difference could be corrected without additional investments through improved maintenance, job scheduling, working methods and load assign- ments, with the result of increased yarn output estimated at 10-15%. 2.14 Turkey's cotton weaving capacity is concentrated in 40-50, mostly integrated, mills. Available capacity is now largely being utilized and most of tye fabrics output is consumed locally. C pacity increased from 960 million m in 1972 to an estimated 1,190 million m in 1979, mainly because of the replacement of narrow looms by wider and faster automatic looms (Annex 2-2). Still more new looms are required to replace worn-out equipment (esti- mated to be 12-18% of capacity) to narrow the present imbalance with available spinning capacity in the country and to meet the growth of demand (para 3.03). Labor productivity in Turkish weaving plants ranges from only 35% to 57% of their European counterparts. A large portion of this difference would be correctible without additional investment through improved operations with the result of increased weaving output of about 20%. 2.15 Despite excess capacity for the dyeing, printing and finishing seg- ment as a whole, there are regional shortages of capacity for certain types of fabrics. This segment is dominated by the private organized sector which operates nearly 85% of installed capacity, mostly as a service industry that finishes fabrics on commission basis. In 1976, production of this segment was about 910 million linear meters, at a capacity utilization of 70% (Annex 2-2). It is estimated that about 25-30% of existing dyeing equipment and possibly 70% of printing equipment are obsolete.  - 7 - 2.16 The garment/making-up industry has mostly modern equipment, but its labor productivity is only some 40% of European standards (except for a few firms with technical assistance from foreign marketing partners). This is mostly due to uneconomically short production runs, unsuitably cramped premises, poor plant layout, organization and work methods. Cost control is practically nonexistent and there is, therefore, scope for considerable improvement in performance in areas of industrial engineering and production management. E. Exports 2.17 Production and marketing of Turkish textiles, with the recent exception of yarn, has traditionally been geared to the local market, which consumes about 92% of total production. This domestic orientation is caused by: (i) a relatively inefficient textile industry (largely prompted by the severe restrictions of textile imports); (ii) trade restrictions imposed by the EEC, the main trading partner for Turkish textiles; and (iii) a domestic market which is partly undersupplied, but at the same time of sufficient size to sustain a sizeable local textile industry. Until recently, only yarn exports were marginally profitable since production tax on yarn (35% of production cost) is not levied on exported yarn; that exemption is not applic- able to exported fabrics or garments. Yarn exports (valued at US$180 million in 1978) have increased four-fold since 1970, and as noted before, in 1978, 81,000 tons, representing about 28% of yarn production, were exported. This growth pattern is not expected to continue, largely on account of import restriction imposed by the EEC. 2.18 The export of cotton woven fabrics, 2,700 tons in 1978, of which about one-third were grey fabrics, have been fluctuating in the 1970's at low levels. In 1978 only 1.5% of total Turkish fabric production was exported. Exports of woven and knitted garments and made-up goods on the other hand, have been developing quickly and grew from a very small base in the early 1970's to 5,800 tons in 1978, or US$58 million. This represents about 15% of the Turkish garment output and about 18% of the textile sector's export value. About 80% of total Turkish textile exports go to the EEC where the share of imports from Turkey ranges from 22% for yarn to about 1% for fabrics and garments, the remaining 20% being distributed widely. Turkey's share of the neighboring Middle Eastern textile markets is small because of competitive local industry. The capability to export garments has been constrained by inadequate styling, marketing, a lack of accessories and a limited range and quality of local fabrics of acceptable prices, administrative difficulties in Turkey in importing foreign fabrics for re-export, and high prices for fabrics using non-cotton fibers.  - 8 - F. Development Strategy for the Textile Sector 2.19 The Fourth Five Year Plan (1979-83) (Project File, Item J) emphasizes renewal and rehabilitation of existing facilities and expansion of capacity, mainly to debottleneck and balance the various segments in the industry. For SB the need for modernization, reorganization and specialization of production of its textile operations is stressed; the proposed Project meets these objectives. Investment in spinning in both the public and private sectors aiming at further capacity expansion will be discouraged, until the sector approaches full capacity utilization. On the other hand, investment in intermediate goods and auxiliary materials used as inputs in garments and knitting, now in short supply, will be fostered. Local production of textile equipment (mostly spare parts) will also be promoted. Finally, exports of finished goods, such as made-up articles, woven and knitted goods, carpets, will be supported. Though the quantitative targets are high, the Plan's objectives are reasonable and point in the right direction. 2.20 Sector performance can be improved through: (a) modernization in selected segments (especially dyeing, printing and finishing where there is substantial obsolete equipment), and through (b) increased efficiency of the productive facilities which can be furthered by the extension of technical assistance and training. The industry's major objectives should be (i) to continue to expand exports because of the foreign exchange earned, the stimu- lating effect in communicating export standards of price and quality to the rest of the industry, and because the most promising exporting sector (gar- ments) will expand urban employment; and (ii) to meet growing domestic demand. III. THE MARKET AND MARKETING OF COTTON TEXTILES IN TURKEY A. Past Supply and Consumption of Cotton Textiles 3.01 Since 1970, domestic consumption of cotton fabrics including cotton blends, has been rising it an average annual rate of 4.5%, or 2% on a per capita basis from 21.3 m in 1970 to 23.4 m in 1978. This implies an income demand elasticity of 0.5 1/ as per capita income grew by 4.1% per year. Com- paring the growth of per capita income in Turkey with the actual textile con- sumption, it appears that in recent years the growth of textile demand has been faster than increases in production (Annex 3-1). The stagnating domestic supply of cotton fabrics is the result of a slowdown of expansion in weaving capacity and the import restrictions on textiles in Turkey. Therefore, based on recent consumption trends, it is estimated thit, in 1978, unsatisfied demand exceeded supply of fabrics by about 60 million m or 6% of domestic demand (para 3.02). Production, exports and consumption for cotton yarn and woven fabrics are shown below: 1/ 0.6 for 1970-77: due to supply constraints, 1978 figure is lower.  9 - Turkey - Production, Exports and Consumption of Cotton Textiles Annual Growth Rate 1970 1973 1976 1977 1978 1970-78/ 1976-78 Production Yarn ('000 tons) 2 167 210 290 290 288 7.0 (0.3) Woven Fabrics (million m ) 773 882 1,030 1,060 1,060 4.0 1.5 Exports Yarn ('000 tons) 2 17 33 79 58 81 21.5 1.1 Woven Fabrics (million m ) /a 21 34 51 58 48 10.8 (0.3) Apparent Domestic Consumption Yarn ('000 tons) 152 177 212 220 220 4.8 1.7 Woven Fabrics - total (million m ) 753 848 979 1,002 1,012 3.8 1.7 - per capita (m 2) 21.3 22.3 23.9 23.8 23.4 1.3 (1.1) /a Including fabric requirements for garment and made-up goods exports. Sources: TSKB and IBRD. Little information is available on garment and made up goods production because of the importance of the unorganized sector; it is estimated that in 1977, the organized sector production met only 11% of domestic demand (Project File, Item L). B. Supply and Demand Projections of Cotton Textiles 3.02 Supply and demand projections for cotton textiles are summarized below and shown in detail in Annex 3-2.  - 10 - Turkey - Supply/Demand Balance of Cotton Textiles 1978-85 Annual 1978 1979 1980 1983 1985 Growth (act.) (est.) Domestic Demand Yarn ('000 tons) /a 2 220 206 210 270 295 4.3 Woven Fabrics (million m ) 1,070 1,100 1,130 1,253 1,342 3.3 Production Yarn ('000 tons) 2 288 288 293 361 391 4.5 Woven Fabrics (million m ) 1,060 971 987 1,243 1,338 3.4 Exports Yarn ('000 tons) 2 81 82 83 91 96 2.5 Woven Fabrics (million m ) /b 48 50 51 63 72 6.0 Available for Domestic Market Yarn ('000 tons) 2 220 206 210 270 295 4.3 Woven Fabrics (million m ) 1,012 921 936 1,180 1,266 3.3 Supply Surplus/Deficit Yarn ('000 tons) 2 - - - - - n.a. Woven Fabrics (million m ) (58) (179) (194) (73) (76) n.a. Apparent Consumption Per Capita (m /capita) 23.4 20.8 20.7 24.2 24.7 0.8 /a Including requirements for weaving of fabric and for knitting. /b Including fabric requirements for garment exports (annual growth rate 7%); direct woven fabric export to grow at only 3% annually. 3.03 Demand for cotton woven fabrics is estimated to increase by 3.3% per year until 1985, and it is expected that the situation of undersupply of textiles in Turkey will continue through the forecast period. Domestic demand projections are based on an average per capita income growth of 2% per year (Bank estimates), a population growth rate of 2.5% per year, and an income elasticity of 0.5. This is lower than the average 0.7 for all developing countries, but justified as Turkish consumption level is higher. The produc- tion estimates for fabrics are based on the assumption that existing large private weaving mills will operate at about 80% of capacity during 1979-81 due to power shortages and thereafter at a rate of 95%. For 1981-85, production is expected to increase by an additional 1% per year as a result of increases  - 11 - in labor productivity. It is further assumed that no expansion of capacity will occur during 1980-81 due to foreign exchange constraints and adverse economic conditions, and that only investment for replacement of obsolete machinery will take place. Thereafter weaving capacity2in the organized private sector is projected to increase by 40 million m per year. Production from the proposed Project is included in the estimates. The projections show that, unless a significant further investment in weaving occurs, by 1985 2 demand for cotton fabrics will exceed domestic supply by about 76 million m or 6% of domestic demand. 3.04 Domestic demand for yarn, including cotton blends, is expected to increase by 4.3% per year, as a function of yarn requirements for weaving and knitting. Knitting is expected to increase its share in yarn consumption from 10% in 1978 to 16% in 1985, as a result of a continued high demand for knitted goods. This demand would absorb expected increases in yarn production result- ing from improved efficiency and capacity utilization (increase to 391,000 tons in 1985 without corresponding spinning capacity expansion, assuming that capacity utilization will increase to 92% by 1985). Present spinning capacity should, therefore, be sufficient to meet the yarn requirements for the domestic market during 1980-85. There is need, however, for additional capacity in combed yarns, double yarns and sewing thread. 3.05 The projections of textile exports for the near future are dominated on the one hand by trade restrictions in Turkey's principal market area (EEC), especially for yarn and to a lesser extent for garments and made up goods, and on the other hand by the growing domestic demand, particularly for woven fabrics. Furthermore, Turkish textile producers need to upgrade efficiency and quality to become competitive with other major textile exporters. Given these constraints it seems, therefore, that the expectations embodied in the Fourth Five Year Plan (1979-83), that textile exports can nearly be tripled by 1983, are unrealistic. 3.06 Garment production in the organized sector is expected to grow by 10% per year on account of economies of scale, relatively small investment requirements and favorable export prospects. As a result the organized sector penetration of the domestic garment market is expected to increase from presently 11% (para. 3.01) to about 16% in 1985. Garments and made up goods hold out the main promise for increasing exports, since Turkey's lower wages give it a clear advantage over developed countries, as its production technology is relatively labor intensive and provided that productivity can be improved. Furthermore, Turkey's proximity to Europe allows transit times of only 2-3 days and at 5-10% of total production costs. A Government sanctioned Exporters Union has been established recently to assist garment manufacturers in quality control, production management and export marketing. Greater availability of a wider selection of fabrics and accessory inputs would further facilitate export expansion. On the basis of these expectations, cotton garments (woven and knitted) and made up goods are estimated to grow by 7.2% per year during 1978-85 (Project File, Item M), i.e. to about 9,200 tons by 1985. In recogni- tion of continuing import restrictions in the EEC and a limited potential for trade-expansion in other export markets it is estimated that yarn exports  - 12 - would only grow by 2.5% annually. Fabric production will remain geared to the local market to fulfill as far as possible domestic demand, and only a 3% annual export growth rate has been assumed for direct woven fabric exports despite the low base. 3.07 Under the proposed rationalization and modernization Project, SB's share in Turkish cotton textile production is expected to remain stable, i.e. at 16% for spinning and 19% for weaving. No significant increase in SB's spinning and weaving capacity will take place under the Project. However, due to an improvement in the utilization of existing capacities from about 50% to 70% and an increase in labor productivity by about 35%, yarn production will rise from 41,000 tons in 1979 to 52,000 tons in 1984.2 Likewise, production of cotton woven fabric will rise from 207 to 250 million m in the same period. Given the general Turkish textile supply deficit and SB's improved product quality to be attained under the Project, SB should have little difficulty to market this increase in production at a level already substantially reached in the early 1970s. C. Supply of Raw Cotton 3.08 Turkish supply of raw cotton should be more than sufficient to meet the requirements of the domestic textile industry. Cotton production, which grew annually by 3.5% on average since the early 1960's, is expected to grow by 3% per year from 495,000 tons in 1978 to 609,000 tons in 1985. This, after the requirements for cotton textile production have been met, would leave an estimated export surplus of 220,000 tons of cotton in 1985. Such production increase should be achievable as already in 1975 a cotton production of 598,000 tons was realized. Also, international price developments for cotton appear to be attractive for domestic growers to increase production. Further- more, the Turkish Government seems determined to use its raw cotton for domes- tic manufacturing rather than export. Domestic use of cotton is encouraged through an export levy on cotton ranging from TL 36 to TL 41 per kg. The domestic supply of man-made fibers is expected to be constrained for the next few years by a high priced domestic industry of limited capacity and import restrictions on raw materials and finished fibers. D. Marketing of Cotton Textiles 3.09 Fabrics produced by private sector firms generally move from the factory to the market through large wholesalers and small regional wholesalers. Some 20-25 large wholesalers, located in Istanbul, function as first line intermediates and keep in close contact with the design and production planning units of the mills, thereby effectively performing the marketing function for the manufacturer. Furthermore, the large wholesalers are in a strong financial position and finance the working capital needs of the manufacturer. The large wholesalers sell the fabrics to small regional wholesalers, with an average markup of 12%, which in turn apply the same level of mark-up. The mark-up at the retail level is about 20-25%, indicating an overall mark-up of over 40%, as compared to one of 10-15% for SB's products. Exports of yarn are usually handled by agents and only in a few instances do Turkish textile firms have their own office or representative in the different EEC countries.  - 13 - 3.10 Textile sales are concentrated in the urban areas, and even more so for the more expensive fabrics produced by the private sector. Three large cities -- Istanbul, Ankara and Izmir, with 20% of the population -- account for 36% of total textile sales, and there are indications that the concentra- tion is increasing. As part of the proposed Project, SB, initially assisted by consultants (para 5.11), will closely monitor evolving market trends to assess these buying patterns and to respond with an appropriate product mix as a basis for rationalization of SB's cotton textile production. E. Pricing 3.11 There are no price controls on textiles produced by the private sector nor, at least in theory, on products of the public sector. But, until recently, prices for SB textile products were subject to survey and unofficial control by the Ministry of Industry and Technology, and there was strong political pressure on SB not to raise its prices above levels 10-15% below private sector prices. In a recent major policy shift, however, the Turkish Government has decided that in future the Board of Directors of the SEE's, including SB, will set their own prices depending on market condi- tions, so as to generate enough profit, not only to cover their production costs, but also help contribute to their investment expenditures. Export prices for yarn are determined by Export Unions, according to European market prices. Exports are encouraged through a set of export incentives, including export tax rebates, as a percentage varying with export earnings. At present, given the attractiveness of the local market and supply constraints, the most important incentive is an export retention scheme by which 50% of foreign exchange earnings by the exporting mill are retained to meet their operational import requirements. IV. THE COMPANY A. Sumerbank - Holding Company (The Beneficiary) 1. History, Objectives and Role of Sumerbank 4.01 SB was founded in 1933 as one of the first SEEs in Turkey comprising banking, industrial manufacturing and the marketing of its products. SB's main emphasis has always focused on textile manufacture, cotton as well as wool. Today textiles account for about 80% of SB's total sales revenues and for about 15% to 20% of total Turkish textile production. SB's cotton textile operations are discussed in detail in Section B of this chapter. 4.02 The other manufacturing operations of SB (Map IBRD 14576)--leather, leather products; building materials (cement, bricks, tiles, and hardboard); ceramics, refractories; chemicals (dye stuff, tanning products); vegetable oil-- have had less impact on the Turkish economy. Likewise, banking (36 branches throughout Turkey) is comparatively small in the national context and serves essentially to provide (i) banking facilities to SB personnel and the  - 14 - population in low density rural areas and (ii) low costs credits to SB manufac- turing facilities. SB's sales division Alim ve Satim Muessesse (ASM), with 23 warehouses and about 430 retail shops throughout Turkey (Map IBRD 14577), was established to sell SB's consumer products but is now also intended to include retailing of consumer goods purchased from outside firms. 4.03 SB has to satisfy a number of sometimes conflicting objectives (paras 2.02 and 2.10). In addition to profit-maximization, it is called upon to (i) provide mass-consumption fabrics to the rural and urban poor throughout Turkey; (ii) stabilize prices in the domestic market; (iii) generate employment, particularly in less-developed regions; and (iv) train textile industry personnel beyond its own requirements. These conflicting objectives have tended to exacerbate management problems of this diversified industrial concern and have made performance more difficult to assess. 2. Organization and Management 4.04 SB, a 100% government owned public sector enterprise, operates under the control of the Ministry of Industry and is subject to laws and regulations applicable to SEEs. SB's activities and financial position are reviewed and audited by the High Control Board which reports directly to parliament. SB's investment plans and activities are approved annually by the Ministry of Industry and the State Planning Organization (SPO) in consultation with the State Planning Council (representatives of various government agencies and Ministries of Finance and Industry) in accordance with the Government's budget constraints, development priorities, and other policies. 4.05 SB is headed by a six-member Board of Directors comprising the General Director, two Deputy Directors and representatives of the Ministry of Industry, the Ministry of Finance and labor. The Board has limited policy making functions; it essentially is the operational decision making organ of SB, meeting weekly. Through its headquarter's organization (Annex 4-1) in Ankara, the Board controls operational units throughout Turkey. Manufacturing entities, as well as ASM, are legal entities called establishments. Annex 4-2 shows the organization of a typical cotton textile plant and Annex 4-3 that of ASM. 4.06 SB management, both at headquarters and in the plants, was changed in December 1979. The new General Director of SB is Mr. Suku Akgungor, a capable administrator with a financial background, and formerly the General Manager of DYB. The new management fully supports the Project and its con- cepts and strives to provide continuity in finalizing Project preparation and in early Project implementation. 4.07 The performance of SEEs including SB has increasingly suffered from a number of deficiencies inherent in the Turkish SEE system; the most important of which are: (i) frequent top management changes and their disruptive effects on operations and investments (para 4.22); (ii) inadequate management compensation and incentives systems in comparison with the private sector (paras 4.23 to 4.25); (iii) overstaffing coupled with relatively generous wages and lack of adequate incentive systems (paras 4.24, 4.25); (iv) an  - 15 - overly centralized organization and a lack of clearcut definitions of respon- sibility and authority (para 4.18); (v) Government's deliberate policy of keeping prices low (paras 4.39 and 4.40); and (vi) a rigid, cumbersome and time-consuming annual investment approval system (Project File, Item N), as well as misallocations of scarce financial resources and delays in execution of investments. 4.08 The new Government, which has been considering a number of ways to correct these problems, has recently decided, as a first step, that SEEs will be freed from Government intervention in pricing decisions. At the same time, they will also gradually lose their privileged access to the Treasury or the Central Bank for funding of their investment programs or for covering their deficits. It is hoped that these new policies will eventually also lead to increased autonomy of SEEs in investment and employment policies, as well as personnel compensation and incentive systems. The Bank will continue to monitor the developments of SEE reforms. 3. Financial Structure and Performance 4.09 The financial structure and performance of Sumerbank as a holding company is given in Annex 4-4, and key financial data is summarized in the table below: Sumerbank - Key Financial Data /a (TL Million) 1973 1974 1975 1976 1977 1978 1979 (Preliminary) Sales /b 5,155 7,474 8,624 11,859 12,837 18,325 26,626 Gross Profit 684 1,076 947 1,475 2,007 3,149 5,661 Net Profit 136 208 51 2 174 441 1,025 Internal Cash Generation /_ 496 760 553 638 841 1,151 1,605 Gross Profit (as X of sales) 13.3 14.4 11.0 12.4 15.5 17.1 19.1 Net Profit (as X of sales) 2.6 2.8 0.6 0.0 1.3 2.4 3.5 Total Assets 9,272 11,551 13,637 18,191 22,322 27,164 36,422 Current Ratio (times) 1.7 1.2 1.3 1.3 1.2 1.1 1.2 Debt/Equity Ratio 25/75 24/76 41/59 51/49 56/44 52/48 28/72 Debt/Service Coverage (times) 1.2 1.7 1.1 1.0 1.4 1.4 1.9 Inventory Turnover (times) 2.6 2.5 2.3 2.6 2.5 2.9 2.8 /a Excluding seven Joint Stock Companies (JSCs). JSCs include six cotton textile plants and one non-cotton plant under SB management, with SB owning more than 80% of outstanding shares of these companies. /b Due to the inadequate consolidation practices of financial statements and resulting double counting of intercompany accounts, sales figures are considerably overstated. The net sales are estimated to be approximately 60% of these amounts. The majority of intercompany transfers occurs between individual plants and ASM. /c Including interest expenses incurred.  - 16 - 4.10 Sumerbank's sales in value terms have increased by about 5.7 times between 1973-79. This increase, however, is largely on account of rising prices, since production has been stagnant despite the substantial additions to production capacities. As a result, net profit as % of sales has decreased from 2.6% in 1973 to zero in 1976, but has since recovered to 3.5% in 1979. Similarly, cash generation was barely sufficient to service debt in 1975 and 1976 on account of deteriorations in the Company's financial performance and structure. Sumerbank's debt/equity ratio has changed from 25/75 in 1973 to 52/48 in 1978, mainly due to increasing long-term liabilities vis-a-vis the Treasury and the Central Bank. At the same time, the current ratio has fallen from 1.7 to 1.1, since a large portion of SB's investments were financed by short-term debt. 4.11 To partly correct this situation and to improve Sumerbank's finan- cial structure, the Government has, in December 1979, increased the nominal capital of SB from TL 2.25 billion to TL 8.0 billion. Moreover the Treasury has converted approximately TL 4.6 billion of outstanding SB debt to the Treasury into paid-up capital as of December 31, 1979. This has resulted in a marked improvement of current ratio, debt/equity ratio and debt service coverage. Of this amount, SB has allocated TL 2.49 billion in the aggregate to its cotton textile plants which already held TL 1.2 billion of paid-up capital (para 4.45). 4.12 A grouping of SB's net profit between 1973-78 for its different operations is shown in the table below, with detailed background in Annex 4-5: Sumerbank - Net Profit by Operations /a (TL Million) 1973 1974 1975 1976 1977 1978 SB-Cotton Textile Plants /b 67 174 102 (112) (64) 45 SB-Woolen Textile Plants 52 52 66 68 98 147 SB-Chemical Plants 29 21 (28) (11) (28) 4 SB-Soils Operations (15) 18 (4) 58 47 72 SB-ASM (Sales Organization) 4 (10) (41) (40) 34 102 SB-Banking (1) (47) (44) 39 87 71 Total SB 136 208 51 2 174 441 7 Joint Stock Comp. (JSC) 65 25 (56) (3) (70) (227) Total SB + 7 JSCs 201 233 (5) _j) 104 214 Total Cotton Textile Operations /c 131 202 80 (9) 07) ) /a 1979 data not available. /b SB-Cotton Textile Plants, excluding six cotton textile Joint Stock Companies (JSCs) under SB management but including Hemp mill at Taskopru, a non-cotton plant. /c These include all fully owned SB cotton textile plants as well as six JSCs forming together the cotton textile operations.  - 17 - 4.13 With the exception of Woolen Textiles, all of SB's operations have incurred losses occasionally during the past seven years. However, the cotton textile operations (both, fully owned plants and joint stock companies) have been the primary cause of SB's declining profitability; the major reasons are explored in Section B of this chapter and appropriate measures are to be taken under the Project to improve their profitability and cash generation. 4.14 While the Banking Division has shown substantial improvements in its profitability over the last five years, it cannot, on its own be consid- ered a significant source of local funds for the proposed Project. In the financial sense it acts as a holding company, channeling the short-and long- term debt from the Government to SB's establishments, mostly in the form of intercompany receivables. Only 12% of its funding sources are customer deposits; less than 10% of its assets are outside SB with other Bank customers. 4.15 Profitability and cash generation from SB's other non-cotton opera- tions (with the exception of woolen textile operations) has been erratic. To determine SB's operational prospects and future cash-flow situation, financial projections were prepared for SB's non-cotton operations (Annex 4-5; key assumptions in Project File, Item 0). Throughout the 1980-83 period, the implementation period of the proposed Project, the net cash flow of the non-cotton operations is expected to improve on account of the recent price increases for SB products and an assumed future policy of regular price adjustments in line with market- and production cost developments. However, due to large increases in working capital needs during the highly inflationary period, that cash generation would only satisfy the financing requirements of non-cotton operations; thus it is not expected that SB non-cotton operations could contribute significantly to the financial requirements of the proposed Project. 4.16 In the past, any unforeseen cash shortfall or sudden replacement investment could be financed through SB's easy access to low-interest Govern- ment funds. Under the new economic policy towards SEEs, SB cannot count in future on Government financing other than equity. Unless, therefore, equity were to be forthcoming in a timely fashion to meet SB's additional financing needs, SB investment projects presently planned or under execution might be delayed for want of funds, including the proposed Project. Assurances were, therefore, obtained that (i) the Government will meet the early cash equity requirement of the Project according to an agreed timetable and (ii) SB will not, during project execution, transfer profits, generated within cotton textile operations, to SB non-cotton investments, unless the requirements of the Project have been met. Provision by the Government of an initial portion of cash equity (TL 400 million) is a condition of effectiveness of the Bank loan (para. 6.08). 4.17 A major recurring cost item for SB is the payment of retirement severance benefits. Based on Turkish tax laws, only payments during a current year are considered tax deductible; no reserves are being established for subsequent years. However, due to substantial increases of the retirement benefits during the last few years, future payments to beneficiaries will have a substantial impact on the evolving financial situation of SB. The actual payment in 1978 amounted to TL 292 million, while accumulated future payments would amount to TL 3.3 billion as of December 31, 1978. To show the importance of this item, SB will indicate in its financial statements, actual and pro- jected payments for a rolling five year period.  - 18 - B. Sumerbank Cotton Textile Operations 1. Organization and Reorganizational Concept 4.18 Sumerbank's cotton textile operations, 1/ consist of 13 fully owned plants (establishments) and six joint-stock companies (JSCs) under SB manage- ment (MAP IBRD 14575), and are controlled by SB headquarters, whose organiza- tion chart is shown in Annex 4-1. Cotton textile operations have suffered from the typical public sector problems (para 4.07) particularly given their size, complexity and the fact that coordination and control functions at SB headquarters are scattered throughout the headquarters organization. Moreover, although on paper the production units are supposed to be quasi-autonomous profit centers, they have to refer even minor issues to the headquarters for decision, with resulting delays. Therefore, individual plant managements have come to concern themselves almost exclusively with day-to-day operations and hesitate to take responsibilities or initiatives for medium or long-term improvement of operations. 4.19 To provide a more cohesive organization with better coordination between units and a clearer understanding of responsibility and function, consultants (provided under the project preparation facility--para 4.47) recommended consolidating and reorganizing all the functions related to cotton textile operations under a single organization. Initially, consideration was given to forming a separate company under a separate law to take over textile operations. However, this would have required lengthy legislative changes and was moreover inconsistent with the general reforms being considered for the state sector which envision creating sectoral holding companies. SB, there- fore, decided to form a division within the company, to be responsible for cotton textile operations, which would provide the needed consolidation but not preclude later, more radical reorganization. This solution is a major step towards improving the situation. The new Cotton Textile Division (CTD) will have a structure comparable to the already existing Banking Division and will bring under one umbrella all necessary functions and activities concerned with cotton textile activities including certain marketing functions, finan- cial planning and control as well as general administration. Under this setup, CTD which will maintain separate accounts and will consolidate financial statements of its 19 plants, will perform the centralized functions with respect to investment planning, project implementation, production planning, financial planning and control, marketing, centralized purchases, personnel management and administration for SB's cotton textile operations. SB will delegate to CTD all autonomy and authority necessary to carry out these functions effectively under SB's governing laws and regulations. CTD, in turn, will delegate to individual plants the powers necessary to permit them to achieve planned production targets, reduce operating costs and improve quality and mix of products in line with market demands. An outline of the agreed organizational framework and CTD's and the plants' powers and 1/ The cotton textile operations are not a legal entity (establishment), rather the individual cotton textile plants are.  - 19 - responsibilities are given in Annex 4-6. Agreements were obtained that as part of the technical assistance provided under the Project (para. 5.11) details of CTD's and the plants' functions and powers satisfactory to the Bank will be determined prior to December 31, 1980. 4.20 The new CTD which will control and direct all of SB's cotton textile operations and will perform functions as described above was established at SB headquarters in Ankara by resolution of SB's Board of Directors on March 14, 1980. The Managing Director of the new CTD is Mr. Fazli Emanetoglu, an experienced textile engineer, who knows the plants of CTD well. He recently participated as a member on SB's negotiation team. The Managing Director reports directly to the General Director of SB; he will assure that the core staff (marketing, financial and supervisory operational) will be recruited for CTD under a scheme of contractual positions (para 4.24) and that such staff will obtain initial training in a Project Implementation Unit (PIU) (para 5.15). 4.21 Individual Plants of CTD will retain their present legal status as independent establishments (Muessesse) or JSCs. Through the proposed reorganization they will become cost and profit centers. Their operational autonomy will be strengthened sufficiently within the limits of the law to include an enlarged freedom of staffing, improved incentive systems for management and labor, more ready access to outside short-term financing, and increased freedom in the purchasing of inputs. Plants will take initiative in proposing production targets, pricing of their products, as well as investment plans for replacement or expansion which CTD would coordinate. An improved information system within plants and between them will permit faster manage- ment decisions by CTD and ASM. Appropriate technical assistance (paras 5.11 to 5.14) combined with certain action programs will help bring about these changes. 2. Management and Labor 4.22 On occasion of Government changes in Turkey, top managements of most SEEs are being replaced which in turn tend to change middle management in Ankara and in the plants. For SB this has meant disruption of ongoing operations and delays in investment projects under preparation and execution. While such changes cannot fully be avoidable, Sumerbank and CTD have agreed to appoint qualified and experienced personnel and maintain personnel employ- ment policies as shall increase and promote CTD's labor productivity, which should compensate for this problem. 4.23 One root of the recent management problem in SEEs is, that manage- ment's compensation is not competitive with the private sector. Since a change of the laws governing salaries in the public sector is, however, only a distant possibility, for the purpose of the proposed Project, agreement was reached with SB and the Government that the provision of 55 contractual positions (which can pay substantially higher salaries) to SB's cotton textile operations would be an acceptable short term solution to overcome the most serious staffing problems during Project execution. Authority for 55 con- tractual positions has been provided by the Government to SB for CTD. Assur- ances were obtained that these positions will be maintained until Project  - 20 - completion. This will allow CTD to attract and recruit qualified staff on a contractual basis with adequate compensation throughout Project implementation. If improvements in staff compensation are not coming about soon, a further 40 such contractual positions might be required during 1981 and 1982 (para 5.15). Agreement was obtained from SB, that CTD will establish the staffing require- ments for the Project implementation and CTD prior to April 30, 1981 in order to determine whether and, if so, what type of additional positions will be required. 4.24 However, apart from the above temporary solution, real long-term improvements in staff compensation and particularly in management incentives are also required. SB and CTD will have to discuss with the new Government realistic incentives for the achievement of production, profit and export tar- gets. For 1979 an export incentive existed for SB but was set unrealistically high. Also the Government should expedite the intended reform of the State Personnel Law to provide SEE managements with increased flexibility in staff compensation matters. 4.25 Incentive schemes for workers will be reviewed by CTD and consultants before December 31, 1980 (para 5.12). The review is expected to result in recommendations to SB and Government for specific improvements. SB and CTD agreed to prepare those recommendations prior to April 30, 1981 for review and discussion with the Bank and will introduce steps for improvements. However, implementtion of such schemes will depend on the acceptance by SB's labor unions, which may take some time. 4.26 The entire personnel strength of SB's cotton textile operations was about 25,600 in 1979. During the same year, total staff at SB Headquarters was 1,000, and in ASM about 4,100. In fact, SB's cotton textile plants and administration are overstaffed. Labor wages are low compared to European countries but high compared to the private textile sector in Turkey. Because of the low productivity the wage bill per unit of production is sometimes even above European levels. Reasons for inefficiencies and overstaffing are: (i) difficulties in reducing the labor force other than by attrition; and (ii) labor compensation systems providing little motivation through incentives. Under the Project, increased capacity utilization will absorb a significant number of presently redundant personnel. Moreover staffing and training requirements will be reviewed on a regular basis (para 5.18 to 5.20). Agree- ments were obtained that CTD will prepare as part of recurring action programs annual staffing and training requirements for CTD (paras 5.18 and 5.20) and submit to the Bank the first Program prior to April 30, 1981. 3. Production Facilities, Technology and Operations 4.27 CTD controls 18 cotton textile plants, and one cotton ginnery in Adana (Map IBRD 14575). 11 plants are fully integrated (spinning, weaving and finishing), three are partly integrated (spinning and weaving) and four are spinning plants only. Three of the integrated plants also include printing and another four also have garment operations (Annex 4-7). The following table provides a summary of installed equipment and capacity utilization in 1977.  - 21 - SB Cotton Textile Operations - Technical Data of Plants (1977) Spinning Weaving Finishing Yarn Dyeing Garments Installed 524,000 7,805 misc. mics. misc. Equipment Spindles looms Installed 79,800 315 215 3,450 6,450 Capacity tpy million lm million lm tpy pc/day Overall Capacity Utilization /a 48% 58% 52% 44% n.a. La Technical efficiency x capacity utilization. 4.28 In Spinning, plant sizes range from 10,000 to 55,000 spindles. Except for three relatively new plants (established in the early 1970's and located in Adana, Diyarbakir and Karaman) technology in spinning mills is conventional, labor intensive, relatively slow and simple to operate. About 65% of equipment is more than 10 years old and about 38% is more than 20 years old. Use of man-made fibers is less than 5%, and airconditioning required for technical reasons is practically non existent in most plants. The widespread use of old slow cards and worn out drawframes and ringframes is an important cause of low productivity, poor quality and excessive power consumption. Moreover, in the three above mentioned new mills, some faulty equipment has never been commissioned and requires replacement (Prolect File, Item P). As a result, overall efficiency in all spinning mills is only about 50%. Inadequate rationalization of production, poor production scheduling and operating techniques and lately frequent powercuts are also contributing to low efficiency and capacity utilization. Moreover, poor yarn quality, result- ing from the above deficiencies, causes further problems in downstream depart- ments. 4.29 In Weaving, plant sizes range from 240 to 1,000 looms per plant. Technology is conventional with automatic shuttle looms of mostly narrow width (90 cm). Only 28% of the looms are less than 15 years old, and about 22% are more than 40 years old. Moreover, haphazard and piecemeal expansions within plants have led to a large variety of looms within a given mill. Thus, there is room for standardization through appropriate transfers of equipment between mills. A lack of spare parts and poor maintenance, combined with poor yarn quality, inadequate production scheduling, inappropriate product mix and a lack of quality control have contributed to low efficiency, capacity utiliza- tion and low labor productivity. Consequently the fabric quality is poor with as many as one major fault per meter as compared to five faults per 100 meters as the maximum acceptable rate in export markets. 4.30 In the Finishing sections old equipment requiring slow batch process- ing is still predominant. Certain obsolete processes and equipment (prepara- tion in rope form using kiers for caustic scoring and pits for desizing and hypoclorite bleaching) require replacement. Fixing and steaming facilities  - 22 - for printed fabrics are old and energy intensive. Only 3% of equipment is less than five years old, and about 50% more than 14 years old. Given the degree of obsolescence, it is not surprising that efficiency is low. Tradi- tionally the finishing sections permit to cover up many of the spinning and weaving faults, but inspection of finished goods for quality control and grading of the product is inadequate and provides little feedback to operating departments. 4.31 Garment production, is carried out in new plants with acceptable technology and equipment, but often lacks styling, acceptable job scheduling and quality control. Incentive systems are inadequate and qualification of management and supervisory personnel also needs improvement. 4.32 The increasing magnitude of operational problems is being brought into focus by the declining trend of production, as shown below: SB Cotton Textile Operations - Historic Production Data (1973-79) 1973 1974 1975 1976 1977 1978 1979 /a Yarn (tons) 2 52 49 42 45 39 38 41 Grey Cloth (million m ) 2 224 214 217 209 184 200 207 Finished Cloth (million m ) 154 148 150 144 130 137 152 Garments (million pc.) n.a. n.a. n.a. n.a. 1.7/a 1.7/a 1.7/a /a Estimate. The deterioration of capacity utilization and productivity (except for garment plants) (para 4.29) which is inherent in these figures is even more pronounced given the fact that additional capacity as well as labor were added during the 1970s. 4.33 From the above discussions it is evident that there is need to (i) replace obsolete machinery; (ii) modernize equipment through provision of spares and machine assemblies; (iii) transfer equipment within and among plants for purposes of increased standardization; and (iv) debottleneck facilities through provision of equipment to balance operational capacities. Given the size and condition of existing facilities, the task of bringing production facilities to a more reasonable standard, compared to Turkish private industry or, e.g. West European standards, is a long-term task, for which the Project can provide only a good beginning. However, investment in improvements of plant facilities must be accompanied by action programs to improve product mix, production planning and control, operational procedures, quality control, maintenance programs as well as training, incentive systems and management compensation. 4. Marketing and Reorganization 4.34 As shown in the table below, between 65% and 75% of SB's cotton fabric production (Product Mix in Annex 4-8) is sold to ASM, an additional  - 23 - 15% is sold directly to governmental institutions, and the rest is either sold directly to the public (5%), exported (5%) or used in own garment production (5% to 10%). SB Cotton Textile Operations - Fabric Sales by Customer (000 lm) 1973 1975 1978 ASM 124.8 (64%) 131.2 (65%) 146.2 (72%) Public /a 27.2 (14%) 33.7 (17%) 35.9 (17%) Private /b 10.7 (6%) 15.2 (7%) 10.3 (5%) Export 14.4 (7%) 3.5 (2%) 2.6 (1%) Other SB Plants 17.2 (9%) 18.4 (9%) 9.4 (5%) Total 194.3 (100% 202.0 204.4 (100%) /a Public customers include institutions such as military, postal service, hospitals, etc. /b Mostly second quality - sold to wholesalers. Yarn is mostly used internally and the remainder is exported or sold directly by the plant to the private sector. Up to 50% of garments is exported and the remainder is sold through ASM stores. 4.35 ASM, headquartered in Istanbul, sells SB products on a consignment basis. Although ASM's large retail network should constitute a major advantage over the private sector, given its reach and its possibility to make use of economies of scale in warehousing and distribution, the system has been costly and inflexible due to a lack of planning and control of shipments and inven- tories, an inadequate market information system, and a lack of sales promotion at the retail store level. Little feedback of market trends from the store arrives at ASM Istanbul or even less at plant level and in either case is late. This has led to a decline in SB's cotton weaving market share from 30% in 1970 to 20% in 1978, 1/ as well as to relatively high inventory levels, low turnover rates, misshipments and increasing costs of distribution and retail. 4.36 Sales to institutional customers, private wholesalers and other SB plants, as well as, though to a lesser extent, export sales of yarn and grey cloth are centrally coordinated by a marketing manager at SB Ankara, who also deals with exports of other consumer products of SB as well as with sales of intermediate products. 1/ SB's share in Turkey's cotton spinning fell from 30% to 13% during the same period.  - 24 - 4.37 Exports of yarn, fabrics and garments have been limited and erratic as is shown in the table below: SB Cotton Textile Operations - Exports of Yarn, Fabrics and Garments 1973 1974 1975 1976 1977 1978 1979 /a Yarn (tons) 2 9 3 3.8 6.6 1.4 2.2 7.3 Grey Cloth (million m ) 2 14 1 1.7 4.5 1.6 1.5 2.6 Finished Cloth (million m ) n.a. n.a. 1.4 1.6 1.0 0.9 3.1 Garments (million pc.) n.a. n.a. 0.7 1.8 1.2 1.3 1.9 /a Preliminary Exports have declined from the 1973 levels, although due to exchange rate adjustments results for 1979 have improved considerably over previous years. Export of finished cloth and garments have typically been the result of initiative of individual plants which established their own relationship with customers abroad. These plants have enjoyed relative freedom in pricing and sales of exports within certain constraints set by SB, but practically no intensive efforts for export are being made. In addition, no central export promotion has been provided by SB nor has any use been made of export agents or export promotion offices in export markets. 4.38 Under the Project, sales planning, domestic and export sales (except domestic retailing which would remain in ASM), pricing, market research and product development will be vested in CTD to improve coordination between production and marketing. CTD production planning and control will be based on annual sales plans to be reviewed and adjusted on a regular basis to respond flexibly to changing market conditions. Sales, including those to ASM, will be based on contracts that will cover critical conditions of sales such as quantity, quality, price, terms and timing of delivery. ASM will remain a major channel of distribution and a priority customer of CTD but, contrary to present practice, sales to ASM will be on an arms-length basis. Sales to institutional customers will remain under the plants' responsibility with CTD in a coordinating role. Sales to private wholesalers, coordinated by CTD, will be emphasized in order to permit CTD and individual plants a more direct feedback on new market trends in the private sector. Execution of export sales x'i 11 remain under the responsibility of individual plants. However, apart from the direct contacts between plant and customer, export sales promotion will be provided by CTD through active participation in trade fairs, regular canvassing of export markets, use of export promotion facilities provided under the Private Sector Textile Project (Loans 1734/55-TU), and, if required, through an export promotion office in an EEC country. An understanding has been reached with SB on these major principles, based on which marketing of cotton textiles will be carried out. Agreement was further obtained that CTD, supported by technical assistance will develop details of implementation of marketing principles prior to December 31, 1980, for review and discussion with the Bank, and subsequent implementation.  - 25 - 5. Pricing 4.39 As noted previously, while, according to the SEE Law, SB is free to set its price, in actual fact its prices have been subject to indirect Govern- ment control until January 1980. At that time SEEs were once more given the freedom to adjust their prices in accordance with production costs and market conditions. Domestic prices are normally proposed by ASM and agreed by SB management and government. Export prices on yarn and grey cloth are agreed with Export Associations according to export market conditions and the SB marketing manager has to abide by them with a maximum deviation of +10%. Exports of finished cloth and garments are priced either by individual plants or the SB marketing manager, depending on the degree of autonomy each export- ing plant enjoys. The following table shows past domestic and export price developments for SB's cotton textile products. SB Cotton Textile Operations - Average Ex-Factory Prices for Cotton Textile Products (in TL) 1975 1976 1977 1978 1979 Domestic Prices Yarn (TL/kg) 28.9 38.0 67.6 59.4 87.6 Finished Cloth (TL/m) 11.4 13.2 16.7 23.5 31.9 Garments (TL/piece) 47.3 46.8 72.3 139.7 143.0 Export Prices Yarn (TL/kg) 20.7 28.8 39.5 51.3 87.8 Grey Cloth (TL/m) 4.6 5.9 7.4 10.0 15.8 Finished Cloth (TL/m) 7.7 8.6 10.1 17.8 24.1 Garments (TL/piece) 32.9 43.0 58.8 84.5 139.0 Avg. Exchange Rate used: (US$1 = TL) 14.5 16.0 17.7 25.0 36.0 Although not strictly comparable in all categories due to some differences in product mix, above comparison of domestic and export prices illustrates the attractiveness of the domestic market. This has partly been due to a high textile price level in Turkey, as compared to other countries (protected market), and partly to overvalued local currency which depressed export earnings. The new exchange rate of TL 70.0 = US$1 established in January 1980 and the subsequent periodic adjustment has corrected the latter factor. 4.40 Although domestic SB cotton textile prices were adjusted from time to time they lagged behind inflation, and have remained about 10-20% below private sector prices. This was particularly pronounced from May 1979 until February 1980 when SB prices were only about 40-50% of those in the private sector. At that time SB raised its cotton textile prices by about 100%. In order to avoid such large jumps at long time intervals and to secure an adequate cash generation, the SB and CTD agreed to review and adjust CTD's prices frequently as needed to meet changing cost and market conditions and to earn a reasonable return on capital. The Government, on the other  - 26 - hand, assured that it would assist SB and CTD to meet this requirement. An understanding was reached that CTD will be permited a minimum margin of 20% above and below approved prices to provide CTD with flexibility in pricing to respond quickly to changing market conditions. 6. Past Financial Performance and Future Prospects 4.41 Summaries of historical sales revenue, net income on a plant-by-plant basis and financial statements for the whole of cotton textile operations are given in Annex 4-9 and an aggregated summary is given below: SB Cotton Textile Operations - Key Historical Financial Data (in TL million) 1973 1974 1975 1976 1977 1978 1979 /a (Preliminary) Net Sales 1,854 2,890 3,061 3,991 4,750 6,596 10,959 Gross Profit 385 574 417 624 759 1,203 2,052 Gross Profit as % of Net Sales 20.8 19.9 13.6 15.6 16.0 18.2 18.7 Profit after tax (PAT) 131 202 80 (89) (107) (128) 96 Internal Cash Generation /b 222 336 247 102 163 294 692 Shareholders' Equity 1,258 1,371 1,400 1,390 1,199 895 2,387 Net Fixed Assets 639 677 910 1,712 2,109 2,339 2,939 Current Ratio (times) 1.80 1.54 1.63 1.18 0.99 0.88 1.09 Debt/Equity Ratio 2/98 5/95 31/69 37/63 42/58 50/50 33/67 Times Interest Earned (times)/c 9.3 5.6 2.7 0.9 1.1 1.1 1.7 /a As of December 31, 1979, equity has been increased in the aggregate by the 1.39 billion through conversion of current accounts. /b Including interest expenses incurred. /c Debt service coverage ratios cannot be established because there are no definite repayment schedules for debts owed by individual plants to SB. 4.42 Since SB's cotton textile plants (fully owned and JSC's) are legal entities each plant prepares financial statements and budgets for its own operations. Consolidated statement including all 19 plants are not nor- mally prepared and, therefore, were specifically made by Bank staff from information supplied by SB's accounting department. Under the Project, the reorganized CTD will prepare consolidated statements and will establish and maintain financial planning, budgeting and control systems as a matter of regular routine. 4.43 In addition to low capacity utilization, increased cost for the pension scheme, and generally low production efficiency, another factor which depressed profits was the fact that the tax burden of profitable plants could not be offset with losses of others, since each plant is an independent establishment. Both in 1976 and 1977, cotton textile operations as a whole had an income tax burden of TL 1.5 million while its combined income statement indicated before tax losses of TL 0.8 million. This also holds true for cotton textile operations/ASM tax payments. While the former incurred a TL 128 million loss, ASM achieved TL 101 million net profit after income taxes of TL 85 million.  - 27 - 4.44 At present CTD barely generates sufficient cash to service its debt and, therefore, is unable to cover growing requirements for incremental working capital and renewal investments. Despite this constraint, SB has invested in new plant which has been financed by external debt (DYB, Central Bank, Treasury) mostly of short-term nature. Most of these projects were imposed by the Government to serve as employment generators in central and eastern Anatolia (Map IBRD 14576). These investments were carried out in place of renewal and maintenance investments earmarked for existing plants which, as a consequence, showed deteriorating operations and declining production. The new CTD will, therefore, be requested to limit non-Project investments to US$3.0 million per year during execution of the proposed Project and to maintain adequate financial ratios during the life of the proposed loan (para 7.06). 4.45 The debt/equity ratio rose from 2/98 in 1973 to 50/50 in 1978. Because of the massive infusion of short-term loans, the current ratio decreased from 1.80 in 1973 to an unsatisfactory 0.9 in 1978. Moreover, interest expenses as a percentage of sales revenue tripled from 1.3% in 1973 to 4.0% in 1978 despite subsidized interest rates. It is difficult to estab- lish a debt service coverage ratio since repayment schedules for a large proportion of government debt have not been established. However, even under the assumption that this debt would be provided on a long-term basis (Annex 4-5), the internal cash generation was barely enough to cover debt service requirements. Because of the increase in capital by TL 1.39 billion (para 4.41) as of December 31, 1979, current ratio, debt/equity ratio and debt service coverage have improved. Moreover SB confirmed that it increased CTD's paid up capital in the aggregate to TL 3.75 billion and will set CTD's aggre- gate nominal capital at TL 5.0 billion, prior to December 31, 1981. These improvements by themselves will, however, not be enough to restore the finan- cial viability for CTD unless they are accompanied by provision of technical assistance and by rehabilitation of existing facilities included under the Project. 4.46 Financial projections for CTD "without the Project" are shown in Annex 4-10. They are expressed in US dollars (para 7.01), and do include the increase in paid-up capital mentioned above, as well as the recent price increase of about 100% on all products. Projections show that without the Project CTD's profit after-tax are at best marginal even throughout the forecast period (until 1987). These projections are based on the assumption of continued price adjustments in line with inflation and allow for two recent DYB financed new projects which are expected to start-up in 1981 and would slightly improve CTD's profitability. However, the projected cash flow would be insufficient to meet rapidly growing working capital needs, and debt service requirements let alone cover needs for plant rehabilitation. This unsatisfactory financial future of CTD clearly indicates the urgency of a comprehensive rehabilitation program. 7. Rationalization and Modernization Program (RMP) 4.47 SB management had realized that rationalization and modernization of SB's plants was overdue, and had, therefore, established a physical rehab- ilitation program for textile operations under the heading of the "MACROPLAN,"  - 28 - (Project File, Item A) a technical project report prepared in 1976. In 1977, a Bank mission reviewed this document with SB as well as consultants and recommended that such modernization program should address not only the physical rehabilitation aspects of SB's textile plants but also related ins- titutional aspects of the Company to make it a success. GHERZI of Switzerland was appointed as the consultant to carry out an appropriate feasibility study (Project File, Items B and C) which was partly financed by the Bank through the Project Preparation Facility (PPF--PO13-TU). A comprehensive Rationaliza- tion and Modernization Program (Project File, Items D to G) was completed in June 1979 and is summarized in para 5.01. V. THE PROJECT A. Project Objectives 5.01 The Rationalization and Modernization Program (RMP) is to be imple- mented over the period from 1980 to 1986. It is designed to (i) increase efficiency and capacity utilization of existing plant facilities; (ii) reduce production costs; (iii) improve product quality; and (iv) improve the institu- tional and management framework of SB's cotton textile operations. The RMP will cover almost CTD's entire investment needs 1/ up to the end of 1986 and will increase CTD's production from presently about 41,000 metric t 2ns per year (tpy) to2about 62,000 tpy of yarn and from about 207 million m to about 300 million m per year of fabric. This will be achieved without engaging in any real expansion of capacity, but rather through more economic use and modernization of existing facilities through provision of spare parts and modern machine assemblies. Obsolete machinery will be replaced. Through appropriate transfer of equipment among different plants, standardization in certain plants will be increased, allowing better use of economies of scale and spares. Maintenance will be restored to a reasonable level through provision of spare parts and training of maintenance personnel. In addition, a technical assistance program to improve institutional efficiency and manage- ment effectiveness will include (i) reorganization of cotton textile operations into a functional, "quasi autonomous" division (CTD) (paras 4.19 to 4.21); (ii) improvements in incentive and recruitment systems for management and labor (paras 4.23 to 4.25); (iii) improvements in operations, quality control, financial planning and control (paras 5.11 to 5.14); and (iv) strengthening of marketing and pricing functions (paras 4.38 and 4.40). 5.02 The RMP will be grouped into two phases, the first of which consti- tutes the proposed Project, with base cost investments of US$77 million for Phase I, and US$115 million (1979 terms) for Phase II. Phase I is a self- contained project that addresses the immediate needs of modernization while Phase II addresses some of the longer term structural changes required, notably in finishing and garments. 1/ Excluding certain DYB financed projects in Izmir.  - 29 - B. Scope and Location 5.03 Phase I of the RMP--the Project--is to be implemented between 1980 and 1983, and encompasses the rationalization and modernization of existing machinery with special emphasis on certain plants (Map IBRD 14575) as well as all the institutional improvements of CTD described in para 5.01 above. In addition to the physical rehabilitation of certain plants the Project will specifically concentrate on the reorganization of SB's cotton textile opera- tions, the reorientation of marketing, as well as technical assistance for operations, training, and management systems. This will provide a good base for Phase II of RMP (from 1984 to 1986) designed to conclude the modernization of the remaining facilities. 5.04 In view of the severe domestic and foreign financial constraints in Turkey, the project has been scaled-down to the essentials needed to achieve its objectives of balancing existing capacity to achieve the highest return. The Project is designed to optimize the output of existing spinning facilities through relatively inexpensive modernization and rehabilitation, and to utilize practically all the yarn thus spun to manufacture fabrics (80% of which will then be finished). The production of garments will be increased, in view of the higher marketability and profitability of these products as compared with yarn. As a result of the envisaged improvements of CTD under the Project, production efficiency and capacity utilization in the various departments of CTD's plants are expected to increase significantly. A com- parison of production projections for 1984 "with" and "without" the Project is given in Annex 5-1 and summarized below: CTD - Expected Improvements from the Project by 1984 /a Spinning Weaving Finishing Garments With Without With Without With Without With Without (tpy) (million m') (million m ) (million pc.) Produc- 52,000 35,500 250 210/b 207 159 6.3 4.5 tion Overall Capacity 78/c 47/c 74/c 67/c 78/c 51/d n.a. n.a. Utiliza- tion (X) /a Excludes knitting operations at Adiyaman, not financed under the Project. /b Increases over 1979 production due to DYB financed projects. /c At 92% capacity utilization (6,637 hours/year, expressed as % of theoretical maximum). /d At 85% capacity utilization. 5.05 In Spinning, production of yarn is expected to increase from pres- ently 41,000 tpy 1/ to 52,000 tpy and will provide for significantly upgraded quality and proportions of cotton blend yarns and combed yarns (from 1,200 tons to 4,600 tons, and from 3,200 tons to 4,000 tons of yarn respectively). 1/ "Present" figures are preliminary data for 1979, projected figures are for 1985.  - 30 - In weavinF, production of gEey fabrics will increase from presently 207 million m to 250 million m , again, concommitant with a general increase in quality as well as increased volumes of wider fabrics, color woven materials, blended materials and terry fabrics in line with expected market trends for those items. In Finishing, in order to balance increased production of grey fabrics, production of finis?ed fabrics will increase from about 152 million m to about 207 million m with increased emphasis on product quality. In Garments, existing plants will be improved through technical assistance while one new plant will be installed in the phased out spinning section of SB's Bakirkoy plant. Improved quality and increased output will increase CTD's products' values, increase the potential for exports and will absorb surplus labor resulting from the streamlining of the upstream textile operations. C. Machinery, Equipment and Buildings 5.06 In the Spinning sections of CTD, investments will be focused on six plants (Map IBRD 14575), and will cover modernization of existing equip- ment (rehabilitation of some 47,000 spindles, replacement of drafting systems at ring frames and speed frames); about 63,000 obsolete spindles will be scrapped. Certain bottlenecks will be removed through addition of new machines (drawing, combing). Installation of overhead cleaners for the ring frames, addition of electronic yarn clearers to existing winders and the above modernizations are expected to remove dust and improve yarn quality in those plants where high quality fabrics are woven. Quality will further be upgraded through better use of raw materials by introducing testing instruments. In Eregli plant, manufacturing equipment for about 500 tons of sewing thread will be installed. In the new Karaman and Adana plants, certain machinery installed in 1974/75, which never became operational due to design problems, will be replaced and the remainder of equipment rehabilitated and equipped with missing components and spare parts (Annex 4-8). 5.07 With respect to Weaving the Project will focus on eight plants (Map IBRD 14575). Chosen technology will, again, be conventional; 1,439 looms will be scrapped and 817 new looms installed. 766 looms and portions of auxiliary machinery will be rehabilitated or replaced to allow CTD to produce an increased volume of wider fabrics, larger quantities of color woven materials and terry fabrics in line with market demand for such items. Spare parts for all plants will be provided to help allow rehabilitation of an adequate level of maintenance. Weaving operations in the Bakirkoy plant will be phased out by the time the Project is completed. 5.08 With respect to Finishing and Printing the Project will focus on five plants (Map IBRD 14575) where obsolete dyeing, printing and finishing equipment will be either modernized or replaced. Finishing facilities in Bakirkoy will be phased out by end 1983. Obsolete steam generating and water scouring units will be replaced. The production flow in all plants will be balanced to maximize capacity utilization and to increase the proportion of finished fabrics production as compared to grey cloth. New finishing facilities will be considered only during Phase II of RMP.  - 31 - 5.09 As noted above, the Project includes one new garment plant with a capacity of 1.7 million pieces of shirts and pyjamas per year, to be placed in the vacated spinning section of Bakirkoy. During Phase II of the RMP another garment plant may be installed after phasing out and removing the weaving and finishing facilities at Bakirkoy. In addition, technical assistance to the existing plants in Izmir, Bergama, Manisa and Adiyaman is expected to increase quality and output of these plants to allow them to participate in a rapidly expanding market. 5.10 Civil works have been kept to a minimum under the Project concept on account of the severe local funds shortage in SB and the country. Thus no new buildings are envisaged and civil works will be limited to rehabilitation and repair of floors and ceilings in the existing mills, as well as work connected with improvements of the lighting, ventilation, humidification, steam delivery and effluent disposal systems. D. Technical Assistance 5.11 In order to prepare and implement the detailed action programs (para 5.18) which form part of the reorganization, reorientation and rational- ization of CTD, the Project includes necessary technical assistance (about 480 man-months); terms of reference for such assistance are given in Annex 5-2 1/. Such assistance has been grouped into (i) operational technical assistance (OTA) to cover aspects of organization, management systems, ope- rations, marketing and training (about 360 man-months) 1/ and (ii) financial technical assistance (FTA) to cover aspects of organization, management information-systems, financial planning, budgeting and control, general and cost accounting (about 120 man-months). OTA and FTA will overlap to a certain extent and CTD staff will therefore have to coordinate the activities of financial and technical consultants. 5.12 OTA is grouped into two stages: The first stage of OTA (Project File, Item H) which is to be provided by the Swiss textile consultant firm GHERZI 2/ covers a period until about November 1980 (60 man-months financed by the second tranche of the Bank's PPF--P018-TU) and includes (i) assistance in finalizing project preparation, implementation schedules, procurement documentation, training programs and revised product mix; (ii) assistance in reorganization at headquarter (creation of CTD), reorientation of marketing and management assistance to the new CTD (revision of long-term objectives, redefini- tion of management functions, tools for corporate planning, production planning and control, and cost control); and (iii) operational technical assistance in one integrated textile plant (Eregli) and one garment plant (Manisa). Assist- ance in these plants includes improvement of plant organization, improvements in industrial engineering standards, production planning, standard costing system, workers' incentive systems, introduction of modern procedures for 1/ Man-month rates are discussed in para 6.05. 2/ GRERZI will reinforce its team with marketing experts from a local firm in Istanbul (Tubitak) and has arranged with four European textile manu- facturers to assure training of CTD personnel in European plants.  - 32 - machine maintenance, raw material management as well as operational, health, and safety procedures for supervision and machine operators and quality control. The second stage of OTA which is to be carried out between 1981 and 1983 (300 man-months to be financed under the proposed Bank loan) will shift its attention to the plant level and will be based on the experience gained during the first stage. OTA will also include assistance for supervision of erection, rehabilitation and commissioning of machinery as well as direction and supervision of CTD's training program. 5.13 The financial technical assistance (FTA) will also be grouped into two stages. The first stage of FTA will be financed by a grant from UNDP/UNIDO which is also going to be the executing agency, and will amount to about 20 man-months during 1980 (in parallel with OTA). It will concentrate on (i) establishing financial and accounting systems for the new CTD; (ii) improving financial planning and control at the plants' level; and (iii) revising information systems between plants and CTD. Terms of reference for this work (Project File, Item I) have been agreed upon between SB, UNDP/UNIDO and the Bank. A firm (Whitehead, UK) has been selected. It is expected to start work in June 1980. The second stage of FTA will be carried out between 1981 and 1983 (about 100 man-months, to be financed under the proposed Bank loan), will focus on improvements of financial planning, control and cost accounting in the individual plants under CTD. 5.14 With regard to improvements in the information system between ASM and CTD and its plants, both OTA and FTA will limit themselves to help improve inventory control systems and information flows about sales from retail shops to CTD. SB confirmed that it will retain the services of suitable consultants for OTA and FTA, acceptable to the Bank on the basis of terms of reference mutually agreed with the Bank, during the implementation of the Project. Effectiveness of a contract for the second stage of OTA is a condition of effectiveness of the proposed loan. SB further agreed to cause CTD to engage in a suitable contract with consultants for the second stage of FTA prior to March 31, 1981. E. Project Management and Implementation 1. Project Management 5.15 SB and CTD will have prime responsibility for the execution of the Project, supported by GHERZI. However, during the recent past SB's record of implementation of projects has been unsatisfactory. To assure satisfactory execution of the Project SB has established an initial core (16 persons) of a strong Project Implementation Unit (PIU), headed by a capable project manager, Mr. Mehmet Yatkin, an experienced textile engineer with managerial experience and supported by technical assistance. Given the large number of plants containing one to four different production sections (spinning, weaving, finishing, garments) it is estimated that the PIU will have to grow to about 35 highly qualified employees by mid 1980, and ultimately to 95 persons, for both, CTD at headquarters and at the plant level, with experience in financial, technical, marketing and engineering management (Annex 5-3). After completion of essential reorganizational work in a given plant in production planning and control, operations, financial planning and control, quality control and marketing, a plant team will split up and move to other plants reinforced by new PIU team members. Eventually team members will be assigned permanently  - 33 - to a plant where they will continue to carry out the recurring action programs (para 5.18). PIU will be supported by a team of consultants which at any given time will number about 10 experts hired under the OTA and FTA contracts. SB and CTD have agreed to maintain and increase PIU according to an agreed schedule, and CTD is at present actively recruiting further personnel for PIU who will work as counterparts with the consulting firms. 5.16 Coordination of Project activities will take place at the divisional level in Ankara by the Project Manager of the PIU. Responsibility for, and direction of subprojects in individual plants will be vested in a Project Manager at the plant level who will report to the plant management, directing PIU members assigned to the plant, and closely cooperating with operational plant departments as well as visiting consultants. The plant's Project Manager, through plant management, will report to PIU at CTD headquarter in Ankara. Details of inter-communications and reporting will be worked out on the basis of experience gathered during technical assistance work during the first half of 1980. Plant Project Managers will prepare monthly progress reports which PIU will assemble at the divisional level for SB management. 2. Implementation Schedule 5.17 The resulting overall implementation schedule for the Project is shown on the following page. It was prepared by GHERZI and SB, and is con- sidered to be realistic by the Bank, since (a) most of engineering work regarding the type and location of equipment has been completed as part of the feasibility study, and (b) no major civil works are involved. The Project will be implemented over the period 1980-83. 1/ The consultants responsible for OTA are in place since March 1980, and those responsible for FTA are expected to start in June 1980. GHERZI will assist SB in the preparation of the detailed design, engineering, and tender documents and the evaluation of qualifications of vendors. Procurement of foreign goods will be advertised internationally on about June 1, 1980. Tenders will be issued on September 1980 and contracts for machinery and equipment awarded before February 1, 1981. Mechanical completion is estimated for June 30, 1983 and about 90% of the potential capacity utilization of the rehabilitated and expanded facilities is expected to be realized before the end of 1983. The detailed implementation schedules for each of the 19 plants will be prepared prior to December 31, 1980 by the PIU in collaboration with respective plant managers with the assistance of the consultants and will be phased according to the overall project schedule. 3. Recurring Action Programs 5.18 SB has agreed that Recurring Action Programs will be prepared annually by each mill and will be assembled by CTD before November 30 preceding I/ Completion of the Project is defined as the date on which rehabilitation, erection and installation of parts and machinery under the Project will have been completed and CTD will have reached an aggregate monthly production of at least 4,400 metric tons of yarn and 17 million m of finished fabric during a continuous period of 60 days.  - 34 - TURKEY SUMERBANK COTTON TEXTILE PROJECT IMPLEMENTATION SCHEDULE DATE 1980 1981 1982 1983 1984 0 6 12 18 24 30 36 42 48 A. MACHINERY AND BUILDINGS Detailed Engineering & Design Civil Works - Procurement Delivery of Equipment & Machinery _ Erection of Equipment & Machinery - Trial Runs Entry into Commercial Production _ B. TECHNICAL ASSISTANCE Total Man Months OPERATIONAL TECHNICAL 360 MM ASSISTANCE (OTA) 1 5M M 4 5MM 60 MM Headquarters r _ _ 40MM 401MM Eregli, Manisa Garments Other Plants 2 220MM 220MM 5MM 35MM _ 40 MM ASM 2 FINANCIAL TECHNICAL ASSISTANCE IFTA) 120 MM 8MM 17MM 25 MM Headquarte rs - - Eregli, Manisa Garments 1 OM 0M 75MM 75 MM Other Plants 2 7MM 2 8MM im ASM 10MM wA__A First Stage. Financed by PPF and UNDP/UNIDO Second Stage. Financed under the Project M.M. Man Months Industrial Projects Department Februarv 1980 World Bank - 21376  - 35 - the following fiscal year. They will include (i) production programs; (ii) maintenance programs; (iii) technical assistance programs (OTA and FTA); (iv) staffing and training programs; (v) operational budgets with targets for production costs, profits, and exports; (vi) investment programs, and (vii) five-year rolling financial projections for CTD. The above programs will be reviewed and adjusted by CTD on a quarterly basis except for the five-year projections which will be revised annually. F. Employment and Training 5.19 Poor performance of SB's cotton textile plants has been caused, among others, by inadequate training of a portion of the labor force considered redundant. The SB Textile Training and Research Center (STTRC) in Bursa has not been used to the extent possible and on-the-job training in the plants has been inadequate. Therefore, a detailed staffing and training program will be established for the Project by CTD and the Consultants by December 31, 1980. The staffing program will call for staffing targets in each plant. Broadly, the training program will include initially training of about 50 Technical Instructors (for spinning, weaving, finishing, garments, for all mills) in four textile and garment plants in Western Europe to be arranged by OTA con- sultants. In a follow-up stage those instructors will attend short seminars organized, staffed and supervised by OTA consultants at STTRC in Bursa, to discuss the organization of teaching techniques for the courses subsequently to be given in the plants. Such seminars will be repeated once every six months during Project implementation to serve as a clearing house for ideas and solving of problems connected with the training program. In a third stage, training courses for mechanics, foremen and loom fixers will be carried out by the Instructors on a continuous basis in their respective plants. Thus, altogether it is estimated that over 1,000 supervisors and operators will be retrained in textile engineering, operation and maintenance procedures for textile and garment machinery and equipment. In addition and subject to availability of potential supervisory and management personnel, at least 40 Turkish nationals with appropriate education, language abilities and experience will be selected for a special six-month training program abroad in textile technology and plant management, which should be followed by practical training programs of three months duration in appropriate foreign textile plants. 5.20 The STTRC in Bursa will be utilized essentially for purposes of supervisory training, training of instructors and, possibly, for language training. A crash language course may be required before the first group of technical instructors is sent to Europe (para 5.19). The research facili- ties should be used more extensively for quality control and industry surveys of the Turkish Textile Sector (comparison of products of public and private industry, and with foreign products). SB and CTD agreed to provide to the Bank (i) said staffing and training program prior to April 30, 1981, and (ii) progress reports on staffing and training, quality control and industry surveys on a annual basis prior to November 30 of each year from 1981.  - 36 - 5.21 Direct employment effects are small in relation to the investment and amount to about 1,680 new jobs being provided in the garment sector, offset by an attrition of about 940 redundant jobs in spinning, weaving and processing or a net gain of 740 jobs. However, this ignores the very large amount of over-employment in the present facilities and the very low produc- tivity of the present work force. The main anticipated benefit of the proposed Project is the substantially increased production from largely the same plant and labor force, achieved through a careful balance of modernizing investments, better organization and management. G. Ecology 5.22 The main sources of pollution in cotton textile plants are (a) high alkalinity (ph above 7); (b) cellulosic waste increasing the biological oxygen demand (BOD); (c) suspended solid (SS) content of the effluent generated in processing operations, as well as inside the plant; (d) dust pollution from fiber particles; and (e) noise pollution. The existing environmental standards for industrial effluents issued by the Government in 1973 are generally less stringent than current Bank guidelines. Until revised standards and a time- table for compliance is published by the Government, it has been agreed with SB management that by 3 months after Project Completion CTD will operate its dyeing, processing and finishing operations according to environmental and occupational health standards for textile plants acceptable to the Bank. VI. CAPITAL COSTS. FINANCING PLAN AND PROCUREMENT A. Capital Cost Estimates 6.01 The total financing required for the Project is estimated to be US$130.7 million including US$17.7 million financial charges during construc- tion. In addition, US$19.8 million will be required to bring up to and maintain the working capital of existing operations at acceptable levels (para 6.04). A summary of capital costs is shown below in mid-1979 terms and detailed assumptions are given in Annex 6-1 and the Project File (Item Q).  - 37 - CTD - Summary of Capital Cost Estimates ---- TL Million /a-- ------US$ Million----- Local Foreign Total Local Foreign Total % Machinery & Equipment Spinning 49 1,281 1,330 0.7 18.3 19.0 24 Weaving 196 917 1,113 2.8 13.1 15.9 21 Processing - 329 329 - 4.7 4.7 6 Garment 7 196 203 0.1 2.8 2.9 4 Spare & Components /b - 756 756 - 10.8 10.8 14 Sub-total 252 3,479 3,731 3.6 49.7 53.3 69 Freight & Insurance 7 280 287 0.1 4.0 4.1 5 Civil Works 560 105 /c 665 8.0 1.5 /c 9.5 13 Erection 7 105 112 0.1 1.5 1.6 2 Consultancy & Training Id 119 476 595 1.7 6.8 8.5 11 Base Cost 945 4,445 5,390 13.5 63.5 77.0 100 Physical Contingency (6%) 70 259 329 1.0 3.7 4.7 6 Price Contingency (32%) 245 1,456 1,701 3.5 20.8 24.3 32 Total 1,260 6,160 7,420 18.0 88.0 106.0/f 138 of Which Taxes (161) (0) (161) (2.3) (0.0) (2.3) - Financial Charges during Construction 245 994 1,239 3.5 14.2 17.7 23 Incremental Working Capital fe 364 126 490 5.2 1.8 7.0 9 Financing Required for the Project 1,869 7,280 9,149 26.7 104.0 130.7 170 Additional W.C. for Existing Operations /g 1,246 140 1,386 17.8 2.0 19.8 25 Total Financing Required 3,115 7,420 10,535 44.5 106.0 150.5 195 /a The costs expressed in TL have been calculated from the US$ costs using an exchange rate of US$1.00 - TL 70 and are therefore only notional, as changes in the exchange rate are expected (para 6.03). /b Foreign spare parts and machine components for existing production facilities. /c Represent costs for water and effluent treatment facilities amounting to US$1.5 million, all in foreign exchange. /d Includes US$1 million already financed through PPF, i.e., US$0.4 million for feasibility study and and US$0.6 million for consultancy services during early implementation period. /e Working capital incremental for the Project. Includes relevant price increases due to inflation. /f Includes US$1.0 million indirect foreign exchange. /A Incremental working capital required for existing operations. Includes relevant price increases due to inflation.  - 38 - 6.02 Equipment costs expressed in mid-1979 terms have been estimated by GHERZI based on price quotations obtained from textile machinery suppliers in April 1979, and have been revised by the Bank to reflect certain changes in scope. Imported equipment costs are based on FOB plus transportation and insurance costs, excluding Turkish customs duties of which SB is exempted as is practiced with all SB investments. Local taxes included in the cost estimates are estimated at US$2.3 million. The base cost includes estimated costs of foreign spare parts and machine components for the existing equipment, adequate to reinstate in CTD a reasonable level of maintenance. Restitution of maintenance through the supply of spare parts as well as technical assist- ance services (para 6.05) constitute major cost items in this rehabilitation Project. Civil works costs are estimated based on the preliminary design prepared by GHERZI, and price information received from local contractors in April 1)79. Existing buildings and structures are to be used with minimum modif!zation under the Project, for the purpose of minimizing local currency cost'. 6.03 The total Project cost includes provisions for overall contingencies of about 38% on base costs, including 6% for physical contingencies 1/ and 32% for price contingencies. Price escalation for foreign costs is calculated on the basis of projected international inflation rates of 12%, 10.5%, 9%, 8%, 7% per year for 1979 through 1983. The same international price inflation rates have also been used for local supplies and services expressed in US dollars on the assumption that the differences in domestic and the inter- national inflation rates will be accounted for by adjustments in foreign exchange rates. This assumption is based on the new economic policy package announced on January 25, 1980. Given the well defined project scope and small proportion of civil construction costs, the project cost estimates including contingency provisions are considered realistic. 6.04 Permanent incremental working capital for the Project is estimated at US$7.0 million, including US$1.8 million in foreign exchange necessary to finance additional raw material inventories of man-made fibers, chemicals and dye stuffs which have to be imported. Details for working capital require- ments are given in Annex 6-1. In order to improve CTD's financial structure SB converted TL 2.49 billion of its short-term debt into equity. Furthermore an additional working capital of US$19.8 million for the existing production facilities is included in the above financing requirements in order to main- tain CTD's current ratio at a level of at least 1.2 during implementation of the Project. 6.05 The feasibility study for the entire RMP (Phases I and II) and the Project (Phase I) was carried out by GHERZI and financed by PPF at the rate of US$10,800 per man-month. For technical and financial consulting services during the implementation period, the same man-month rate (US$10,800 in 1/ 7% on all items except for spares and components for existing machinery, for which no physical contingency is provided.  - 39 - mid-1979 terms) has been assumed. In addition, costs of US$3,700 per man- month to cover expenditures for international travel, subsistence as well as local transportation, local office operating expenses, and miscellaneous items, have been included, resulting in a man-month cost of US$14,500. B. Financing Plan 6.06 Annual financing requirements and a proposed annual financing plan are shown in Annex 6-2. The financing plan is summarized below: CTD - Proposed Financing Plan ----TL Million a --]-- - --US$ Million