Document of The World Bank FLE COPY FOR OFFICIAL USE ONLY Report No. 3390-TU TURKEY STATE INDUSTRIAL ENTERPRISE FINANCE PROJECT STAFF APPRAISAL REPORT April 20, 1981 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. TURKEY STATE INDUSTRIAL ENTERPRISE FINANCE PROJECT CURRENCY EQUIVALENTS January 1980 January 1981 US$ 1.00 = TL 70.0 TL 91.0 TL 1.00 = US$ 0.014 US$ 0.011 ABBREVIATIONS AND ACRONYMS DFC Development Finance Company DYB Devlet Yatirim Bankasi OED Operations Evaluation Department (IBRD) KBI Karadeniz Bakir Isletmeleri A.S. (Black Sea Copper Corporation) KDC Karabuk Demir Ve Celik Fabrikalari (Karabuk Iron and Steel Works) PERT Project Evaluation and Review Technique SPO State Planning Organization TSF Turkiye Seker Fabrikalari A.S. (Turkish Sugar Factories Corporation) t Tonne (Metric Ton) TBD Tonnes beet per day tpy Tonnes per year FISCAL YEARS Republic of Turkey March 1 - February 28 DYB January 1 - December 31 KBI January 1 - December 31 KDC January 1 - December 31 TSF January 1 - December 31 TURKEY FOR OFFICIAL USE ONLY STATE INDUSTRIAL ENTERPRISE FINANCE PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. CHAPTERS I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . 1 A. Background .1.. . . . . . . . . . . . . . . . . . . I B. Project Concept . . . . . . . . . . . . . . . . . . . 2 II. THE INDUSTRIAL SECTOR AND SEES . . . . . . . . . . . . . . 3 A. The Industrial Sector in Turkey . . . . . . . . . . . 3 B. State Economic Enterprise (SEE) System . . . . . . . 4 C. Performance . . . . . . . . . . . . . . . . . . . . . 5 D. Recent Policy Changes .5.. . . . . . . . . . . . . . S III. DYB: PERFORMANCE AND PROSPECTS . . . . . . . . . . . . . 6 A. Institutional Aspects . . . . . . . . . . . . . . . . 6 B. Operational Aspects ... . . . . . . . . . . . . . . 7 C. Impact of Policy Changes . . . . . . . . . . . . . . 8 D. Corrective Measures ... . . . . . . . . . . . . . . 8 IV. SUBPROJECT FEATURES. . . . . . . . . . . . . . . . . . . . 10 A. Overview.. . ........ 10 B. Turkiye Seker Fabrikalari A.S. (TSF): Ankara, Ilgin and Susurluk Sugar Factory Projects . . . . . . . . . . . . . . . 14 C. Karabuk Demir Ve Celik Fabrikalari (KDC): Karabuk Iron and Steel Plant Blast Furnaces Modernization Projects . . . . . . . . . . . . . . . 24 D. Karadeniz Bakir Isletmeleri A.S. (KBI): Murgul Copper Concentrator Rehabilitation, Balancing and Modernization Project 32 V. LOAN FEATURES . . . . . . . . . . . . . . . . . . . . . . 39 VI. RECOMMENDATIONS . . . . . . . . . . . . . . . . . . . . 41 This report is based on the findings of an appraisal mission which visited Turkey in November/December 1980 and was composed of Messrs. Abhay Deshpande, Shyamiadas Banerji, George C. Maniatis and Turgay Ozkan of the Europe, Middle East and North Africa Regional Projects Department and Messrs. S. lzgiz, P.B. James, A.H. Yazan (Consultants). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Table of Contents (Continued) ANNEXES Annex 1: DYB: Approvals, Commitments and Disbursements of Term Loans (1977-1979) Annex 2: DYB: Income Statements (1978-1980) Annex 3: DYB: Balance Sheets (1978-1980) Annex 4: DYB: Resources (1978-1980) MAP IBRD No. 15709 - Project Locations TURKEY STATE INDUSTRIAL ENTERPRISE FINANCE PROJECT I. INTRODUCTION A. Background 1.01 This report appraises a project to finance the completion of six industrial projects aimed at balancing, modernization and expansion of selected industrial establishments. The projects are sponsored by three State Economic Enterprises (SEE) producing sugar, iron and steel and copper. The Bank loan, in the amount of $70 million will be made to Devlet Yatirim Bankasi (DYB)--the State Investment Bank, which will onlend the proceeds of the loan to the SEEs concerned to meet the foreign exchange requirements of the selected projects. In the context of the loan, measures aimed at ensuring efficient project implementation and operating efficiency will be introduced in the three SEEs. The Government will be asked to develop performance indices to monitor the operational efficiency and financial performance of the SEEs concerned. With regard to DYB, the Bank's institution building efforts, which began in 1974 with its first loan to DYB, will be continued. 1.02 From its inception in 1964, DYB's role in the system of financing SEE projects has been rather ineffective, as DYB has been overshadowed by the State Planning Organization (SPO) and the Treasury. In order to strengthen the position of DYB and thereby to enable an objective examina- tion of SEE investment proposals based on rational economic criteria, the Bank extended two loans to DYB (Loan No. 1024-TU in June 1974 and Loan No. 1379-TU in March 1977). In the course of these loans, DYB's appraisal and supervision capacity was to be strengthened and improvements brought about in the project implementation performance and operational efficiency of SEEs under the influence of DYB. It was therefore ensured that the pro- ceeds of the Bank loans would go to smaller projects of SEEs, where DYB, through its loans, could have the greatest influence. The two loans did enable financing of a number of small SEE projects which otherwise could not have been supported by the Bank, but the Bank's institution building objectives have remained largely unattained. l.03 The Bank's operations in the industrial sector, including the loans to DYB, have been reviewed by the Operations Evaluation Department in its report entitled "Sector Operations Review: Industries and DFCs Program in Turkey" (Report No. 3077 dated July 18, 1980). The report concluded that progress towards the achievement of the objectives of the DYB loans had been constrained by the "characteristics of the institutional sit- uation, environment and practices prevailing in Turkey." It noted that DYB had not built up a position of an independent financier, it was not being consulted on choice of investments although it had the right to reject individual proposals, its project appraisals, though having shown improve- ments, did not come up to Bank standards, and it did not exercise the rights of a financier to ensure efficient management of the enterprise - 2 - to which it lent. The report also noted that DYB's subprojects tended to follow the Turkish pattern of excessive capital intensity and slow imple- mentation. A sample of five DYB subprojects was reviewed; while the economic returns were below those estimated by DYB initially, they ranged from 8 to 17 percent. 1.04 It has become evident that in order for DYB to function in an effective manner, its role in the selection of SEE projects for implemen- tation and their subsequent financing will have to be delineated by modifying and formalizing its relationship with the Treasury and the State Planning Organization (SPO), and its overall lending criteria will have to be formalized. DYB's capital structure, appraisal and supervision capabilities will have to be strengthened and it will have to be accorded greater flexibility to determine its borrowing and lending rates in order to enable it to raise resources from the market instead of being dependent on budgetary allocations, as at present. Finally, DYB will have to be accorded greater managerial autonomy to enable it to recruit and retain capable staff to sustain a higher level of operations. The necessity of carrying out these changes, fundamental as they are, has been underscored by the changes announced by the Government during 1980 in the system of financing bEE projects, as part of overall reforms of the SEE sector. It is now envisaged that, starting with FY1981, all investment loans to be made available to bEEs by the Government would be channelled through DYB if the SEEs are profitable. For projects of non-profitable SEEs, and in order not to affect DYB's financial position adversely, funds would be would be provided directly from the budget, but only after DYB scrutinizes the projects and undertakes to supervise them. All foreign currency loans contracted by the Goverrnment would be made available to SEEs only through DYB. In sum, a much greater responsibility and a more crucial role is envisaged for DYB. The broad changes in DYB's relationships with Government agencies and measures for institutional strengthening mentioned above, while being urgent, will require careful and detailed study by the Government and time to implement. In the meantime the proposed project seeks to meet a part of the urgent foreign exchange requirments of ongoing projects, and enables the continuation of the Bank's institution building role with respect to DYB. The concept of the proposed project takes into account the findings of the OED report as well as the above changes in the system of SEE financing that have been announced since then. B. Project Concept 1.05 The proposed loan will be made to DYB, which will onlend the loan proceeds to finance the foreign exchnge costs of a group of high priority, ongoing SEE projects in three industries, sugar, iron and copper. A list of projects was drawn up by the Government and the six projects were jointly selected from that list by DYB and the Bank with the agreement of Government. The process of selection of the SEE projects was initiated in June/July 1980, when the Governent selected, out of more than 70 industrial projects included in its 1980 Annual Investment Program, 24 medium sized projects for Bank financing through DYB. The 24 projects were examined by - 3 - a preparation mission on the basis of available information and macro- economic criteria, and 11 projects were tentatively preselected for detailed evaluation by the appraisal mission. The appraisal mission, on the basis of more detailed and updated information supplied by DYB, evaluated the projects in depth with the help of Turkish consultants, to establish that they have adequate subsectoral justification, yield accept- able financial and economic rates of return and are either ongoing projects or projects which involve balancing, modernization or expansion of existing enterprises. The energy efficiency of the projects, the timing of com- pletion and their suitability for the public sector were additional con- siderations. An important part of the evaluation of the projects was an assessment of the technical capability and financial performance of the sponsoring SEEs to ensure their ability to generate a substantial propor- tion of the local currency requirements for the proposed projects. As a result of the above evaluation, six projects were selected for financing under the proposed loan. Draft appraisal reports on the six selected projects were prepared by DYB and submitted to the Bank prior to loan nego- tiations. The reports will be finalized by DYB after Bank review of the drafts. Submission of a final appraisal report for each subloan satisfac- tory to the Bank will be a condition of disbursement of that subloan. This approach, requiring substantially greater Bank input in the selection of prospective subprojects than in the case of a typical DFC line of credit operation would result in provison of Bank funds to clearly defined high priority industrial projects in the bEE sector which are described in Chapter IV. At the same time, routing the loan through DYB enables the continuation of the Bank's institution building efforts by close involve- ment of DYB in the selection, detailed appraisal and subsequent supervision of the projects proposed for financing. 1.06 With regard to DYB, as mentioned in para 1.04 a definitive delineation of its lending criteria, role and function is necessary, and the need for such definition and for consequential corrective measures is greatly increased by the additional responsibilities cast on DYB as a result of the Government's recently announced economic reforms for the SEE sector. During negotiations, agreement was therefore reached regarding the project appraisal techniques and lending criteria to be applied by DYB in its future lending operations and it was agreed that the Government would undertake a study of DYB's future role and responsibility within the system of selection and financing of SEE projects (para. 3.09). II. THE INDUSTRIAL SECTOR AND SEES A. The Industrial Sector in Turkey 2.01 Industry, especially manufacturing, has been the leading sector in the Turkish development strategy. Until 1977, the industrial growth rate (7% p.a.) was significantly above the average for middle income developing countries. About 26% of total investment went into manufacturing during the last 5-year development plan and manufacturing now accounts for about - 4 - 35% of total merchandise exports. A substantial amount of import substitu- tion has been achieved, albeit at high cost. Increasingly, Turkey has moved into capital intensive industries producing intermediate goods. 2.02 For the future, the industrial sector is expected to play a key role in extricating Turkey from its current economic crisis, mainly through a structural reorientation towards exports, which accounted for only 10% of industrial output in 1979. The private sector, with its emphasis on light industries, is expected to take the lead, although the public sector would be relied upon to provide the capital and intermediate goods and to con- tribute to exports where possible. Although an array of export incentives was introduced last year, the present inward orientation of industry will change only gradually. In addition, shortages of foreign exchange, short- ages of fuel oil and electricity, strikes in key industries, and working capital constraints have resulted in a low industrial capacity utilization (45% in 1979), and a decline in production and exports. 2.03 In the medium-term, the main tasks facing the industrial sector are: (i) restoring existing capacity to full production; (ii) balancing and modernizing a number of key subsectors; (iii) improving SEE performance and pricing policies; (iv) encouraging quick-gestating, export-oriented invest- ments particularly in the private sector; and (v) undertaking a limited number of key investments where Turkey has a marked international competi- tive advantage or where substantial employment-generation prospects exist. B. State Economic Enterprise (SEE) System 2.04 A significant feature of the Turkish industrial sector is the large role of the SEEs, which accounted for 50% of manufacturing invest- ment, over 40% of value added, and 10% of non-agricultural employment in 1977. SEEs have a virtual monopoly in petroleum refining, steel, alcoholic beverages, and basic metals and have large shares of fertilizers, pulp and paper, cement, coal, sugar, machinery and chemicals. 2.05 The public sector is organized into 13 holding companies con- trolling about 400 plants. However, about 37 SEEs account for most public enterprise activity. Of these eight are in the financial sector, seven are classical public utilities or in public transport, nine are specialized agencies serving agriculture and the rest are in the industrial sector, including manufacturinging, mining and trade. SEEs generate about 9% of the GDP and provide 10% of all non-agricultural wage employment. SEE investment amounted to almost 25% of total fixed investment in the country in 1979 and 40% of total public sector investment. Total fixed investment in the SEE sector during 1978 was TL 60.4 billion and increased to TL 128.0 billion in 1979, in current prices. The manufacturing sector accounted for the largest share (45%) followed by mining and energy (36%), transport and communications (11%) and agriculture (8%). 2.06 The Government has established various social and economic policy obfectives tor S-s wichax e -Tied i p-rioity accorTdng to tne planning - 5 - period reflecting the idealogical inclinations of successive Governments; some examples are; import substitution, income redistribution, employment creation, and development of underdeveloped regions. C. Performance 2.07 With few exceptions, SEEs have recorded poor financial performance due to a combination of factors. Until the January 1980 reform, SEEs lacked the authority to take pricing decisions, and as a result were unable to meet rapidly increasing costs due to high rates of inflation. Many SEEs are also internally inefficient due to poor management and industrial rela- tions and technical problems in design and operation. SEEs do not have the authority to remunerate technical and managerial staff adequately to enable their retention. At the same time, they have been forced to employ exces- sive labor. In addition, the relationship between SEEs and various agen- cies of Government is often cumbersome leading to interference in day-to-day operations. As a result of these factors, SEEs have run up large operating deficits, financed so far by the Treasury, increasing from TI 4.4 billion in 1975 (0.9% of GDP) to TL 71.5 billion in 1979 (3.4% of GDP). In 1980, losses were reduced to TL 61.0 billion (1.5% of GDP). Because of the lack of budget resources during the last two years, new fixed investments have had to be held in abeyance and even ongoing projects left incomplete. D., Recent Policy Changes 2.08 Bold and potentially far-reaching changes in Government policy concerning the SEE sector were announced as part of an economic reform package in January 1980. These changes intend to establish a more open economy, with a shift to indirect controls and greater reliance on market forces. The announced eocnomic policy objectives which underlie these clhanges are a major departure from past planning objectives. As far as the SEiE sector is concerned, the changes proposed, and now under implementation include: (i) with only a few exceptions, SEEs are empowered to determine prices; (ii) SEEs will be expected to cover operating expenses and to raise resources for investment by setting appropriate prices; and (iii) SEE managements will have the authority to hire staff and dispense with excess staff without interference from the Government. In additon, in connection with the Bank's first Structural Adjustment Loan to Turkey, 1/a study of the system of protection is being undertaken which is expected to lead to lower levels of protection. The above package is intended to expose SEEs to market forces and, hopefully, bring about improvements in efficiency. however, having operated in a controlled environment for many years, SEEs are likely to experience difficulty in adjusting rapidly to the new situation. The Government has recognized the difficuilty and has decided to move towards these objectives in stages. The proposed project would help the managements of the SEEs involved to move in that direction and could serve as test cases for the proposed reform of the SEE sector. 1/ RRP on "A Structural Adjustment Loan to Republic of Turkey"; Report No. P-2725-TU dated February 29, 1980. III. DYB: PERFORMANCE AND PROSPECT6 A. Institutional Aspects 3.01 DYB was established in 1964 under Special Law 441 to provide long- term credits, guarantees and other services to bEEs. As a State Economic Enterprise itself, DYB is also subject to provisions of Law 440, which regulates the constitution and operations of SEEs. DYB's parent ministry is the Ministry of Finance. Its authorized capital is TL 6.0 billion ($65.9 million equivalent), of which TL 3.5 billion ($39.0 million equiva- lent) was paid in and held entirely by the Treasury as of December 31, 1980. Board, Management and Staff 3.02 DYB has a board of five members composed of its General Director, two Assistant General Directors and two outside members appointed by the Ministry of Finance. DYB management team consists of the General Director, Mr. T. Kivanc, and two Assistant Directors. At present one position of Assistant General Director is vacant. DYB has a total staff of 191 including 50 professionals. The Government has enforced a hiring freeze since September 1980 and vacancies occurring due to departures of profes- sional staff have not been filled. The staff available particularly for appraisal and supervision of projects is inadequate in both numbers and quality resulting in uneven quality of appraisals and very inadequate project supervision. Moreover, the expanded role envisaged for DYB as a result of proposed changes in the system of SEE financing (para. 1.04) will impose a greater burden on DYB's project appraisal and supervision staff. During negotiations, DYB's staffing needs pending completion of the study of its future role (para. 3.09) and its recruitment plans for 1981-82 were reviewed. An agreement was reached with DYB and the Government that DYB would recruit about 15 additional professional staff on contract basis (i.e. at a salary level higher than civil service scales) to attract suit- able persons by June 30, 1982. There is also a need to review compensa- tion levels to attract and retain highly qualified professionals. Existing management systems and procedures would also have to be reexamined, in conjunction with the study of DYB's role to be carried out by the Govern- ment, to enable DYB to function more effectively. DYB's Role and Lending Criteria 3.03 DYB takes lending decisions under guidelines laid down in Law 441, which are basically indicative. DYB functions within the complex adminis- trative procedures for provision of investment funds to SEEs. The SEEs submit their projects and financial requirements to SPO in July every year. SPO consults the Planning Council and the Ministry of Finance and by the end of the year the Government approves the Annual Investment Program. DYB participates in the deliberations in an advisory capacity. The SEEs can then approach DYB for funds within the allocation made under the Annual Investment Program and submit their project feasibility studies, etc., for appraisal. DYB is empowered to reiect or modify projects it finds unac- ceptable, but until 19S0 such projects could be implemented by the SEEs - 7 - from funds made available by the Government through the budget. This direct access to the Treasury by SEEs, and possibility of bypassing DYB if necessary, coupled with the fact that DYB does not have resources to finance more than a small proportion of the SEEs' investment programs, has diminished DYB's role in SEE financing and has prevented DYB from exercis- ing real influence over its borrowers. B. Operational Aspects 3.04 Lending Operations and Resources: DYB's loan disbursements were TL 8.5 billion in 1978, TL 13.7 billion in 1979 and TL 17.5 billion in 1980, a substantial decline in operations over the period in real terms. DYB's resources are provided entirely by the Government either through budgetary allocations or by Government direction to the Social Security Organization to buy a specified amount of DYB bonds bearing an interest rate of 20% p.a. DYB's operations have been therefore hampered by recurring budgetary constraints and the issue of DYB's ability to mobilize adequate resources independent of the Government, which would enable DYB to plan its lending over a longer term, will be considered in the study of DYB's role to be carried out by the Government. 3.05 Financial Position, Portfolio and Results: DYB's condensed balance sheets and income statments for 1978, 1979 and 1980 are shown in Annex 3. As of December 31, 1980, DYB's total equity was TL 8.2 billion composed of capital: TL 3.5 billion and reserves: TL 4.7 billion. Its total long term debt was TL 79.4 billion, resulting in a long term eebt:equity ratio of 9.7;1. DYB has no debt:equity ceiling and is empowered to borrow by issue of bonds without reference to its capital. Its loan portofolio was TL 88.1 billion, including loans from managed funds of TL 8.6 billion and working capital loans of TL 0.3 billion. Foreign currency loans outstanding amounted to TL 14.1 billion. Arrears on DYB's loans increased in 1980 due to poor performance of SEEs in general and also as DYB's lending rates are fixed well below commercial bank rates, thus encouraging its borrowers to default on their dues to DYB in order to reduce their borrowing requirements from other sources. Arrears were TIL 4.9 billion as of December 31, 1980, affecting loans with total princi- pal outstanding amounting to TL 16.6 billion equalling 19% of DYB's total loan portfolio. While the level of arrears is not unacceptably high, the repayment capacity of DYB's borrowers cannot be judged by the level of arrears as the Treasury has been regularly making good the defaults. During 1980 DYB generated a surplus of TL 2.4 billion, a return of 34% on its equity, after provisions for doubtful debts but before taxes. Accumulated provisions for possible bad debts were TL 1.3 million as of December 31, 1980 (1.6% of term loans portfolio). The adequacy of these provisions also cannot be judged in absence of a detailed risk analysis of DYB's portfolio. 3.06. Although DYB was created, inter alia, to examine investment pro- posals from an objective standpoint and thus to assist the Government in allocating resources in a rational manner, the system of SEE finance (para. 3.03) has not enabled DYB to exercise any real influence in project selec- tion and financing. This has generated an essentially uncritical attitude reflected in DYB's project appraisals which do not identify and discuss substantive issues arising from each project and are a rather mechanical process largely based on information supplied by the sponsor and optimistic assumptions. Moreover, DYB confines its appraisal to the specific invest- ment project under consideration and does not attempt an evaluation of the managerial, operational and financial performance and financial position of the sponsor iEE. DYB's project supervision is confined to checking project expenditures in order to monitor disbursements. After completion of the project, DYB does not make a real effort to regularly evaluate the perform- ance of the SEE and has thus been unable to build up a healthy client/ banker relationship with its borrowers. The above situation requires correction to enable DYB to improve its performance and to contribute to successful implementation of the reforms of the SEE sector in accordance with Government policies. C. Impact of Policy Changes 3.07 The Government's announced intention to channel all loans to SEEs through DYB, and more important, its intention to cut off SEEs from direct access to the Treasury for meeting operating deficits could affect DYB profoundly when the changes are fully implemented. DYB's responsibility, level of operations and its share in the financing of SEE investments would increase very substantially. As the intention is that the Treasury would no longer make good the defaults of SEEs to DYB, arrears on DYB's portfolio could grow rapidly. In fact DYB will be exposed to real lending risk, an unprecedented situation, and will have to make an assessment of the likely risk involved while approving an SEE project. Further, its loan supervi- sion will have to be greatly strengthened to constantly analyze the risk element and to identify likely problem projects. DYB will have to formu- late policies to diversify its portfolio, limit its exposure to high risk subsectors and to build up provisions for meeting likely bad debts out of its profits. D. Corrective Measures 3.08 DYB does not have a lending strategy statement specifying criteria for project selection, maximum exposure to a single client, portfolio diversification, policies with respect to clients in arrears, etc., as DFCs are normally expected to adopt and observe. In the light of the crucial role that the Government now envisages for DYB (para. 1.04), it is essen- tial that DYB develop and formalize its lending criteria. Agreement was therefore reached during negotiations regarding DYB's project appraisal techniques and lending criteria (e.g., rates of return, subsectoral priority, DYB's existing exposure to client, overall past and projected performance of the sponsoring SEE, etc.). These criteria would form the basis of a comprehensive statement of lending strategy which would be prepared after the completion of the study of DYB's future role (para. 3.09). -9- Basic Study of DYB's Future 3.09 The Government's new policies regarding the financing of 6EE pro- jects have provided broad guidelines regarding DYB's future responsibili- ties and functions. The operational and financial implications of these guidelines for I)YB will have to be studied in detail in the light of the actual evolution of the bEE system. It is therefore proposed that a basic study of DYB's future role be carried out in two phases. Phase I should address in particular the following issues: (i) DYB's role in the selection of SEE projects for implementation; (ii) its relationships with the Treasury and SPO: (iii) its relationship with its SEE borrowers, and (iv) its financial structure, resources and lending rates. Such a study would most appropriately be carried out by a committee to be set up by the Gov- ernment on which the ministries concerned and SEEs would be represented. TMe study would be initiated by beptember 30, 1981 and completed by March 31, 1982. The findings of this phase would be reviewed by the Bank and discussed with the Government before Phase II is initiated. Phase II would examine the institutional, operational and financial implications of the future role of DYB as detailed under Phase I. The specific items to be studied under Phase II would include, but need not be limited to (i) DYB's organizational structure, (ii) staffing needs, (iii) salary structure, and (iv) operational policies and procedures. This phase could be undertaken with the help of local management consultants who would be more familiar than foreign consultants with the legal and administrative rules and regu- lations governing DYB's internal management, and would be completed by December 31, 1982. The completion of the study would be followed by a final review by the Bank before the implementation of its findings. Agree- ment has been reached with the Government during loan negotiations on the terms of reference, administrative arrangements, timetables for both phases and arrangements for a joint Bank/Government/DYB review of the conclusions. 3.10 The above corrective measures are clearly necessary although ambi- tious. If they are successfully implemented, DYB's role will be clearly defined for the first time since its establishment, its position in the system of financing SEE projects would be strengthened, and DYB's institu- tional, operational and financial capabilities would be improved. However, this approach has its risks. The institution building objectives of the previous two loans were not achieved firstly because DYB operated in a policy framework which diminished its influence and secondly because it could not mobilize resources independently of Government and thus acquire real autonomy. While the Government's recent policy pronouncements are encouraging, it must be clearly recognized chat the present system can change only gradually and DYB's development into a fully autonomous and effective DFC can only be an evolutionary process fraught with uncer- tainty. A relatively long period is proposed for completion of the study in recognition of these uncertainties. On balance, while the risk of failure is high, the effort is worth making. Whatever the outcome regarding this aspects of the project, the six subprojects proposed for financing under the loan are clearly suitable for Bank financing, having been selected after careful screening and evaluation under predetermined criteria (para. 1.05). - 10 - IV. SUBPROJECT FEATURES A. Overview Subproject Objectives 4.01 The recent economic crisis has severely affected the Government s ability to provide funds, particularly foreign exchange, to new investment projects in the public sector and even to complete ongoing projects. As a result, high priority projects have suffered lengthy delays in completion. The proposed project will; (i) provide $67 million equivalent to meet foreign exchange needs of a group of six high priority industrial subprojects in the manufac- turing SEE sector of which five are aimed at rehabilitation/ balancing/modernization/expansion of existing facilities to optimal scales of operation; (ii) provide $3 million to meet the foreign costs of technical assis- tance services likely to be required by the three SEES in the areas of project implementation, staff training, improvement of plant management and development of standard cost accounting system; (iii) introduce measures to improve the financial and operational performance of the beneficiary SEEs, in particular by adoption of appropriate pricing policies; and (iv) Initiate actions by the Government to carry out in depth studies of the beneficiary bEEs' operations in order to develop a set of performance indices which could be regularly monitored. (i) Subprojects Proposed for Financing 4.02 Basic features of the six proposed subprojects which fall into three industrial subsectors are given below: (i) Sugar: Three subprojects sponsored by Turkiye Seker Fabrikalari A.S. (TSF) are proposed for financing. Two are for expansion of existing sugar factories at Anakara and Susurluk from 1,500 TBD to 3,000 TBD and from 3,000 TBD to 6,000 TBD respectively. This would result in an increase in sugar production by 29,000 tpy and 30,000 tpy respectively. The third is for a new factory at Ilgin with a capacity of 6,000 TBD corresponding to a sugar output of 110,000 tpy. All of these are ongoing projects. The ERR and FRR of the projects range between 19-26% and 12-23% respectively (paras. 4.30-4.31). (ii) Iron and Steel; Two subprojects sponsored by Karabuk Demir Ve Celi_ & MWAiai (W5C , ioT paTtial modeTrnzation oi tne Yara'urni steel plant are proposed. The first is for installation of raw material crushing, screening and sizing facilities to improve - 11 - blast furnace feed preparation, and has been under implementation since 1976. The second is for replacement of refractories in the blast furnace stoves to raise blast temperature from 7500C to 11500C. Modernization will reduce the specific coke consumption in the blast furnaces, raise output of hot metal from 600,000 tpy to 900,000 tpy and result in coke savings of 173,000 tpy. The ERRs of the two projects are 33% and 58% and the FRRs are 21% and 33% respectively (para. 4.54). (iii) Copper: One subproject, sponsored by Karadeniz Bakir Isletmeleri (KBI) for modernization and expansion of the copper mining and concentration complex at Murgul is proposed. The project would raise the capacity from 50,000 tpy to 168,000 tpy of copper con- centrate and from 15,000 tpy to 133,000 tpy of pyrites. The increase in concentrate supply would enable the copper smelter at Samsun to operate at near full capacity, increasing the output of blister copper from 13,000 tpy to 33,700 tpy. At the same time, due to greater availability of sulfur dioxide, the sulfuric acid plant which is part of the smelter complex would be able to operate continuously and increase its output from 60,000 tpy to 240,000 tpy. The ERR and FRR of the project are both over 100% (para. 4.71). 4.03 Capital Costs and Financing Plans: The total capital cost of the six projects, including physical and price contingencies, working capital and interest during construction but excluding technical assistance costs, is $295.6 million equivalent in 1980 prices, including a foreign currency component of $88.1 million equivalent. A summary of the investment costs of the six projects is provided in Table 1. Out of the total funds requirement of $295.6 million, the three SEEs sponsoring the projects, being among the profitable SEEs in Turkey, are expected to be able to provide $152.0 million equivalent in local currency from equity contribu- tions and internal generation of funds. suppliers' credits and commercial borrowings for working capital will total $14.2 million. The remaining local currency requirements ($63.5 million equivalent) will be provided by loans from DYB. During negotiations, an assurance was obtained from the Government that funds will be provided to DYB for the purpose. The foreign currency requirements excluding interest during construction on foreign currency borrowings will be met substantially by the Bank loan to the extent of $67 million. Imported equipment for which firm contracts have already been signed and advance payments made will be financed by the Government. Total borrowings (local and foreign) will amount to $133.5 million. The proportion of funds requirements to be raised by loans from DYB and the Bank is 45% of the total investment cost which is acceptable. (ii) Technical Assistance 4.04 During the implementation of the subprojects, the three SEEs will need assistance of foreign consultants for (a) erection and commissioning of new equipment and (b) training of staff in use of new equipment. In TURKEY: STATE INDUSTRIAL FINANCE PROJECT INVESTMENT COSTS AND FINANCING PLAN (US$ Million) Means of Financing Investment Costs Internal Funds Loans 5.i,sector/Project Status Local Foreign Total Locall_ Foreign- Total Local Foreign Foreign Total (DYB) (DYB) (IBRD) ,SUCAR Anlcara Sugar Factory (Expansion) Ongoing 32.7 7.4 40.1 28.5 2.1 30.6 4.2 0.2 5.1 9.5 Ilgin Sugar Factory (Completion) Ongoing 79.1 13.3 92.4 57.1 4.8 61.9 22.0 - 8.5 30.5 Susurluk Sugar Factory (Expansion) Ongoing 42.3 11.1 53.4 38.5 3.0 41.5 3.8 _ 8.1 11.9 Technical Assistance 0.5 1.0 1.5 0.5 - 0.5 - _ 1.0 1.0 TOTAL SUGAR 154,6 32.8 187.4 124.6 9.9 134.5 30.0 0.2 22.7 52.9 IRON AND STEEL Karabuk Steel Plant Raw Material Preparation (I4odernization) Ongoing 27.0 16.6 43.6 12.4 5.7 18.1 14.6 - 10.9 25.5 Blast Furnace Stoves ($odernization) New 14.1 12.9 27.0 2.9 0.1 3.0 11.2 2.2 10.6 24.0 TecInical Assistance 0.3 0.8 1.1 0.3 - 0.3 - - 0.8 0.8 TOTAL IRON AND STEEL 41.4 30.3 71.7 15.6 5.8 21.4 25.8 2.2 22.3 50.3 ,COPIER Mur9ul Copper Concentrator (gehabilitation/ podernization/Expansion) New 12.3 26.8 39.1 7.0 3.0 10.0 5.3 _ 23.8 29.1 Technical Assistance 0.3 1.2 1.5 0.3 - 0.3 - - 1.2 1.2 TOTAL, COPPE~R 12.6 28.0 40.6 7.3 3.0 10.3 5.3 - 25.0 30.3 TOTAL INVESTMENT COSTS 208.6 91.1 299.7 TOTAL FINANCING 147.5 18.7 166.2 61.1 2.4 70.0 133.5 1/ Includes short-term loans for working capital. 2/ Includes interest during construction on foreign currency loans - and suppliers' credits. - 13 - addition, to improve the efficiency of their overall operations, the SEEs would need assistance of foreign consultants for (a) improving plant management including development of preventive maintenance and industrial safety programs; (b) development of an incentives system and (c) improve- ment of budgetary controls systems including inventory control and intro- duction of standard cost accounting systems. The need for technical assistance services would vary among the SEEs according to the degree of complexity of the proposed subprojects and differences in existing capab- ility in these areas. The services would be provided by individual consul- tants/firms to be selected by the SEEs under DYB's supervision, in accordance with Bank guidelines. The total requirement of technical assis- tance services is estimated at 300 man months at an average cost of $10,000 per man month. The total foreign exchange cost would total $3.0 million divided as follows: TSF--$1.0 million, KDC--$0.8 million and KBI--$1.2 mil- lion. Any savings effected in these allocations would be reallocated for financing cost overruns in equipment imports for the six subprojects if necessary. Otherwise the uncommitted balances would be cancelled. The local cost of technical services is estimated at $1.1 million equivalent in local currency, and will be borne by the beneficiary SEEs. During negotia- tions, a commitment was obtained that DYB will require the beneficiary SEEs to meet the necessary local costs by inclusion of an appropriate condition in its subloan agreements. The findings of all the consultants' studies would be reviewed by DYB and the Bank before implementation. (iii) Measures to Improve Operational and Financial Performance 4.05 Measures to be introduced to bring about improvement in efficiency in the beneficiary SEEs will be incorporated in the subloan agreements between DYB and the SEEs. During negotiations assurances were obtained that the Government will permit KDC and KBI to set prices 1/ for their products based upon the full cost of production under conditions of effi- cient operation, to provide an adequate return on equity, enable generation of resources for financing the projects and for replacement of equipment as necessary and with reference to market conditions. The prices would be reviewed by the High Control Board as part of its annual audit. The long- term debt:equity ratio of the SEEs concerned will be maintained below 60:40 and the current ratios above 1.1:1 during the life of the loan. The SEEs will carry out a review of their pay scales to develop a competitive salary structure to enable recruitment and retention of adequately qualified and experienced staff. While the hiring freeze currently in force should result in reduction of the present degree of overmanning over the next few years, skills would have to be built up in the staff to compensate for loss of more experienced workers through attrition. 1/ As sugar prices are controlled by the Government, a separate assurance relating to sugar prices to be charged by TSF has been obtained (paras. 4.18, 6.01(ii)). - 14 - (iv) Development of Performance Indices 4.06 The Government is endeavoring to improve the performance of SEEs by exposing them to market forces and granting management greater autonomy to run their establishment without interference from parent ministries. There is a need, however, to develop a set of indicators by which the Government (as the owner) and DYB (as the financier) could monitor and evaluate the overall performance of individual SEEs inluding that of its management. This could be the basis for rewarding management as well as for taking strategic decisions on the future development of the SEE. At the same time, the indicators could be used by SEE managements for evalua- tion of operational efficiency. In addition to the standard financial performance criteria, there is a need to develop physical performance indices, including those relating to labor and plant productivity, selected on an industry specific basis as they are likely to vary significantly from industry to industry. For meaningful performance monitoring and evalua- tion, targets and standards would have to be established correspondoing to these indices, taking into account plant operating conditions even within a particular industry/SEE. The introduction of adequate cost accounting and budgetary control systems based on standard costs and physical targets (para. 4.04) should provide the basis for the selection of the indices and corresponding targets and standards. These physical performance indices could be monitored on a quarterly or semiannual basis by the High Control Board and DYB to gauge the performance of the SEE. Similarly financial targets and standards appropriate to the specific industry would also need to be developed in order to carry out a meaningful financial evaluation. Agreement was therefore reached during negotiations with the Government that such indices would be developed and monitored including designation of the agencies responsible for development of the indices and for monitoring the indices after introduction. This is a task which has not been success- fully undertaken in Turkey in the SEE sector but is vitally necessary to bring about meaningful improvements in performance of SEEs. Considerable study will be necessary and it was agreed that the system be developed by September 1982 and introduced from January 1, 1983 after a joint review between the Government, the concerned SEEs and the Bank. B. Turkiye Seker Fabriklari A.S. (TSF): Ankara, Ilgin and Susurluk Sugar Factory Projects 1/ Objectives 4.07 The Turkiye Seker Fabriklari A.S. (TSF), a public sector joint stock company established under Law 440, operates thirteen sugar factories with a total rated capacity of 35,000 tonnes of beet per day (TBD). There are also five factories in the private sector with a total rated capacity of 16,800 TBD. TSF has embarked on a long term plan of expanding its beet sugar production capacity to meet the growing sugar demand in the domestic IA detailed analysis of the sugar industry, the a%ricultural situation, the market, and the three projects is available in project files. - 15 - market. The company's plans which have been approved by SPO call for the expansion of five existing factories and the construction of four new factories by 1985 which would expand total sugar production capacity by about 37%. The Government has requested the Bank to finance the imported machinery required to expand the factories at Ankara and Susurluk and establish a new factory at Ilgin. All these are on-going projects, ini- tiated in 1976, whose completion has been delayed due to financial resource constraints. The proposed projects are scheduled to be completed by 1982. The Market 4.08 Total domestic sugar consumption 1/ has increased steadily from 298,000 tonnes in 1960 to 1.15 million tonnes in 1979 or at an annual average growth rate of about 7%. This increase corresponds to a change in per capita consumption levels from 10.7 kgs in 1960 to 26.0 kgs in 1979. The present per capita consumption level is substantially lower than that of industrialized countries (50 kgs). Even though the current per capita consumption level is low, the income elasticity of demand is quite high (1.14) indicating prospects for rapid demand growth with rising income over the medium term. Future sugar demand is projected to increase to 1.36 million tonnes in 1985 and to 1.6 million tonnes in 1988 at an annual average growth rate of 6% which is slightly lower than historical trends. Supply-Demand Balance 4.09 Domestic production of sugar increased from 501,000 tonnes in 1969 to 982,000 tonnes in 1979 with some annual fluctuations due to weather conditions. Between 1960-73, Turkey was a net sugar exporter but the trend has been reversed since 1974 when the country started to import sugar. Imports had been held down until 1979 by drawing down sugar stocks which are currently at a very low level. During the past year, the Government has increased sugar prices to more realistic levels in an effort to curb consumption and reduce subsidies to consumers. In 1980, imports amounted to 205,000 tons. 4.10 The present sugar production capacity of the industry is 1.027 million tonnes per year. With the implementation of all the projects in- cluded in TSF's present investment plans, total sugar production capacity will increase to about 1.4 million tonnes per year by 1985 and to 1.6 million tonnes per year by 1988. The supply-demand projections indicate a supply shortfall of about 130,000 tonnes until 1983 which will need to be met through imports. Thereafter, there will be a small surplus (75,000 tonnes per year) during 1984-88 which would help restore depleted stocks. Domestic demand and supply will be in balance beyond 1988. This analysis confirms that TSF's investment program including the three projects being considered by the Bank for financing is realistic and consistent with the market outlook. 1/ About 25% of the sugar consumption is in cube form, the balance in crystal form. - 16 - The Agricultural Situation 4.11 Most areas of Turkey with the exception of the south and south western regions are suitable for the cultivation of summer sugar beet. However, there are a variety of climates and micro-climates caused by the parallel ranges of mountains which significantly affect cultivation and factory operating conditions. 4.12 In 1979, sugar beet was cultivated in 265,590 hectares of land, an increase of 115% over the 1970 acreage. The crop size in the 1979/80 campaign was 8.75 million tonnes of which only 8.17 million tonnes were processed because of fuel shortages. The number of farmers growing beet has increased from 170,200 in 1970 to 302,500 in 1979 indicating rapid adoption of beet cultivation by small farmers. While overall acreage has grown rapidly, there has been a problem of matching factory capacities with the available beet supply leading to longer than desirable campaign lengths (para. 4.18). 4.13 Beet yields have risen significantly since the inception of the industry and have averaged 30-35 tonnes per hectare over the past ten years. Sugar yields are currently 3.5 tonnes per hectare after peaking at 5.0 tonnes per hectare during the early 1970's. These figures compare adversely with Greece, which has a similar climate, where yields of beet and sugar have averaged 57 tonnes/hectare and 6.6 tonnes/hectare respec- tively. Most probable causes for the lower performance are deficient agronomic practices, as well as deficiencies in transportation, storage and procesing of beet. There is a need to critically review the agronomic situation with a view to improving existing practices. Thereafter, TSF should help introduce improved agronomic practices to farmers through its extension services. Extension Services 4.14 TSF and the private companies assist farmers by providing all equipment for ground preparation and drilling of the crop. TSF supplies seed and pesticides and provides an advance to farmers for purchase of fertilizers on an interest free basis. In some instances, TSF also assists with harvesting. Farmers provide beet to the factories under contract which enables TSF to plan and secure an adequate beet supply for each factory. TSF has established beet collection stations up to a radius of 100 kms from each factory location to reduce farmers' haulage problems, thus stimulating beet cultivation. Income from Beet Cultivation 4.15 The Government's agricultural product pricing policy has been to set beet and competing crop prices at levels which would yield an equiva- lent income per hectare to the farmer. Net cash revenue to the farmer per hectare of sugar been was estimated as TL 6,590 in 1979. However, farmers receive additional non-cash income (estimated at TL 7,500 per hectare) in the form of free services provided by TSF and free animal feed which has undoubtedly encouraged sugar beet cultivation. - 17 - The Company 4.16 Ownership, Management and Staffing: TSF was established in 1935 as a result of the amalgamation of four private sugar companies. It is a public sector joint stock company operating according to Law 440. The authorized share capital of TL 9 billion, as of end of 1980, is subscribed by six institutions with the Treasury's share being the largest (86.7%). The Ministry of Industry appoints the General Director, Assistant General Directors and other key officers and reportedly exerts considerable influence over the company's operations. Because of political interfer- ence, TSF's management suffers from the same problems which afflict the management of SEEs in general (high turnover, low pay, low morale, etc.). There is a definite need to upgrade the caliber of management and manage- ment functions, particularly in the areas of production and finance. This could be best achieved through the development and implementation of appro- priate training programs for all levels of technical and administrative staff. TSF also is grossly over-staffed employing over 22,000 personnel. It needs to develop a long term program of staff rationalization which should also limit the hiring of new personnel only to highly qualified technologists and managers who are required to correct existing deficien- cies. There is need to revise compensation levels to attract and retain highly qualified engineers and managers. At the factory level, the compen- sation package should be designed to include incentives to induce greater productivity. Sugar Pricing Policy and the 'Sugar Law' 4.17 TSF's and the private companies' financial performance and pros- pects are determined by the Sugar Law which limits the annual net profits after taxes to an amount equivalent to a 10% return on the paid-in capital of the company 1/. Profits in excess of this limit are transferred to a Sugar Fund in the Central Bank. In case any of the companies are unable to achieve the guaranteed minimum level of net profit from operations, the Sugar Fund compensates the companies to increase net profits to the guaran- teed level. The ex-factory price of sugar and by-products is independently established by the Government. In 1978 and 1979, revenues from sales of sugar and by-products covered only about 67% of the costs of production. The deficit including the allowed margin is covered by the Fund. This has resulted in increasing claims on the Sugar Fund. 4.18 The above policy results in TSF being paid a fixed profit margin per tonne of sugar produced, thus inducing factories to maximize production by excessively lengthening campaign durations. This results in high operating costs, lower conversion efficiency and insufficient time for carrying out preventive maintenance of plant and equipment. An assurance was therefore obtained during negotiations that the Government would adopt a pricing policy for sugar which covers full production costs including 1/ This translates into a fixed margin per tonne of sugar produced based on the rated sugar production capacity of the factories. - 18 - depreciation and financial charges and provides an adequate return on equity reflecting market conditions. This will obviate the need for Government to provide large subventions from the Sugar Fund as consumers will bear the full cost of production. In fact the need for a Sugar Fund under these circumstances is questionable and the matter should be studied further with a view to eliminating it over the next 2-3 years. To safe- guard consumers and promote efficiency, production costs should be based on a system of standard costs which should reflect efficient plant operations and optimal campaign durations for each factory. There is also a need to review the pricing policy for cube sugar, molasses and animal feed (produced from dry beet pulp and molasses). Molasses prices should be set at international levels. Cube sugar and animal feed prices should reflect full processing costs and provide an adequate return on the additional investment. There is an immediate need to review animal feed prices, particularly since part of the production is provided free to the farmers and the revenue from sale of the remainder is insufficient to cover production costs. Financial Operations and Results 4.19 TSF's consolidated gross revenue for 1979 was TL 17.2 billion of which sales of sugar and by-products accounted for TL 16.1 billion. This included an amount of TL 5.7 billion due from the Sugar Fund. Net income after taxes for the entire operations of TSF increased from TL 103.5 mil- lion in 1978 to TL 123.3 million in 1979. The contribution of sugar and by-products to after tax income was TL 82 million in 1978, and TL 103 mil- lion in 1979. Return on equity was very low at 5.7% in 1978 and in 1979. The overall liquidity position of the company was satisfactory as measured by a current ratio of 1.1 for 1979, the same as that in 1978. However, TSF had a highly leveraged financial structure with long-term debt-equity ratio of 7.7 in 1980, though lower than that of 1979 (10.1). There is a need to reduce this high leverage to a more reasonable level (e.g. 2:1) within the next three to four years. Existing Facilities and Operations 4.20 The basic operations of TSF involve the production of crystal and cube sugar, molasses and animal feed produced from dried beet pulp and molasses. There are also three units producing alcohol (1979 production was 34 million litres) from molasses at Turhal, Eskisehir and Malatya. In addition to these basic production items, the company has five machine shops capable of manufacturing 85% (in value terms) of plant required for beet sugar factories and all plant for cement works. In addition, TSF operates a small confectionary plant at Ankara, several farms, a research institute and a seed plant. It has also interests in banking, transporta- tion, insurance and consultancy. Evaluation of Operations, Plant and Production Management 4.21 Operations: During the 1979/80 campaign, TSF and the private com- panies processed 31,257 tonnes and 14,741 tonnes of beet per day respec- tively or at 87% of rated capacity in both cases, which is a satisfactory - 19 - level of performance. The average sugar extraction and sucrose recovery for the public factories were 78.4% and 11.98% respectively 1/. The figures for sucrose recovery and extraction indicate considerable room for improvements in operating efficiency. This could be achieved partly through improvements in agronomic practices and in beet transport and storage and partly through improved control of campaign lengths and processing operations. 4.22 Plant and Equipment: TSF uses plant and equipment designed to standards prevailing twenty years ago in Western Europe. There is very limited use of automatic process control instrumentation. Moreover, TSF has licensed technical know-how for domestic manufacture of key equipment e.g. diffusers, centrifugals, etc. suitable for factories of low rated capacities (1,500 TBD). The quality of the equipment produced in its machine shops is satisfactory. TSF has been installing multiple units of these smaller capacity equipment in plants of larger capacities (e.g. 6,000 TBD) instead of larger capacity individual units of equipment. This results in higher capital costs, losses in operating efficiency and much higher staffing levels. TSF should consider licensing modern designs and technical know-how on machinery and equipment for larger factories in the future. In this connection, TSF should obtain the advice of an independent sugar technologist. 4..23 Production Management: A review of production control operations in several TSF factories revealed deficiencies in the operations of the purification and refining sections, leading to low sugar quality and high operating costs. The pulp drying facilities operate with high moisture content pulp which results in excessive use of expensive fuel oil. There is also need to strengthen preventive maintenance practices. TSF should employ consultants (probably from outside Turkey) to fully investigate production control procedures and suggest remedial actions. 4.24 Cost Accounting and Budgetary Control; A review of TSF's finan- cial planning and control procedures indicate the absence of standard cost accounting and budgetary control systems, which are essential for monitor- ing and controlling the performance of of individual factories. There is nD systematic procedure for setting production targets for each factory geared to the changing operating conditions over the campaign period. The introduction of such standard cost accounting and budgetary control systems is essential to improving financial management in TSF. Given that the in- troduction of such systems for the beet sugar industry poses special problems, it is recommended that TSF recruit an experienced financial con- sultant to develop and implement such systems, including training of finan- cial managers on these procedures. 1/ The corresponding figures for the private factories were slightly higher at 79.12% and 12.16%. - 20 - The Projects 4.25 The key design parameters of the three sugar projects at Ankara, Susurluk and Ilgin are summarized below: The Ankara project; The project involves expansion of the rated capa- city of the sugar factory from 1,500 TBD to 3,000 TBD as well as con- struction of a unit to manufacture animal feed from dried pulp and molasses. The proposed sucrose recovery is 13.5% based on beet sugar content of 16.4% and an extraction rate of 82%. These estimates, which take into account past operating conditions, are considered reasonable and can be consistently achieved with efficient operations. The as- sumed standard campaign length of 145 days is satisfactory for the area. The Susurluk Project; The project involves expansion of the rated capacity of factory from 3,000 TBD to 6,000 TBD as well as correspond- ing increases in the capacity of the animal feed unit. No increase in the capacity of the cubing plant is envisaged. The proposed sucrose recovery is 10% based on a beet sugar content of 13% and an extraction rate of 78%. The assumed standard campaign length of 100 days is con- servative. Although the sugar content of beet in the factory catchment area is relatively low, with improved factory operations, the projected sucrose recovery level should be easily exceeded. The Ilgin Project; The project involves the construction of a new fac- tory at Ilgin with a rated capacity of 6,000 TBD which would produce 110,000 tonnes of sugar per year (14,000 tonnes in cube form) and 62,400 tonnes of animal feed. The proposed sucrose recovery is 14.1% based on sugar content in beet of 17% and an extraction rate of 82%. These estimates take into account the performance of the neighboring factory at Konya and are considered reasonable. The assumed standard campaign length of 130 days is satisfactory and may be increased some- what if needed. Capital Costs 4.26 All three projects are on-going projects whose implementation com- menced in 1976. Progress of implementation has been slow because of the shortage of local and foreign currency resources available to TSF. The capital costs of each project are summarized in Table 2: 4.27 The capital cost per tonne of beet sliced per day for the three projects are as follows: Ankara - $18,985; Susurluk - $13,100 and Ilgin - $13,500. The unit capital cost for the Susurluk and Ilgin projects are about 65% of the unit cost of a comparable capacity plant with modern auto- mated process control systems in an industrialized country. The unit costs of the Ankara plant are, however, considerably higher both because of the smaller scale and the fact that the investment includes the renewal of the purification and filtration plants for the whole factory. the overall lower unit capital costs reflect partly the conservative designs adopted 'by 'ISF and lower levels of automation employed. These capital costs are reasonable. TSF CAPITAL COSTS AND FINANCING PLANS I/ ($ million - 1980 prices) Ankara Ilgin Susurluk Total Colts Local Foreign Total Local Foreign Total Local Foreign Total Local Foreign Total Ba4e Costs 22.6 5.7 28.3 51.0 9.2 60.2 28.6 8.1 36.7 102.2 23.0 125.2 PhMsical Contingencies 2/ 2.4 0.2 2.6 3.3 0.8 4.1 2.0 0.6 2.6 7.7 1.6 9.3 P'tlce Contingencies 3/ 3.2 0.8 4.0 8.8 1.6 10.4 4.9 1.4 6.3 16.9 3.8 20.7 tubtotal 28.2 6.7 34.9 63.1 11.6 74.7 35.5 10.1 45.6 126.8 28.4 155.2 Interest During Construction 2.5 0.7 3.2 8.6 1.7 10.3 3.3 1.0 4.3 14.4 3.4 17.8 Total Investment Costs 30.7 7.4 38.1 71.7 13.3 85.0 36.8 11.1 49.9 141.2 31.8 173.0 WO%king Capital 2.0 - 2.0 7.4 - 7.4 3.5 - 3.5 12.9 - 12.9 TeOhnical Assistance 4/ - - - - - - - - 0.5 1.0 1.5 Total Financing Required 32.7 7.4 40.1 79.1 13.3 92.4 42.3 11.1 53.4 154.6 32.8 187.4 Internally Provided Funds 26.5 0.9 27.5 49.7 4.8 54.5 34.9 3.0 37.9 111.6 8.7 120.3 DYb 4.2 0.2 4.4 22.0 - 22.0 3.8 - 3.8 30.0 0.2 30.2 1%aD - 5.1 5.1 - 8.5 8.5 - 8.1 8.1 - 22.7 22.7 Other 2.0 1.2 3.2 7.4 - 7.4 3.6 - 3.6 13.0 1.2 14.2 a Total Loans 6.2 6.5 12.7 29.4 8.5 37.9 7.4 8.1 15.5 43.0 24.1 67.1 Total Financing 32.7 7.4 40.1 79.1 13.3 _92.4 42.3 11.1 53.4 154.6 32.8 187.4 TL costs have been converted into $ at TL 79.65 $1.00. 2/ Physical contingencies are provided at varying rates for each project depending upon extent of completion and average TL. 3/ Price contingencies for both foreign and local costs are based on the Bank's forecast of international inflation rates in dollar terms: 1981 - 9%, 1982 - 8.5%, 1983 - 7.5%. 4/ The technical assistance component relates to the company as a whole inclusive of assistance needed by the three projects. - 22 - Financing Plan 4.28 The financing plan for the three projects is satisfactory. TSF plans to provide $119.8 million equivalent (64%) of the investment costs from its own resources and borrow $67.1 million equivalent. The Bank's share in the package is $22.7 million (18% of the total investment costs) and slightly over 66% of the total foreign exchange costs. The remaining foreign exchange needs are proposed to be met from TSF's own resources, a supplier's credit of $1.2 million (Siemens) and other sources available to DYB. However, given the large amount of local currency resources to be raised by TSF, during negotiations, an assurance was obtained that in the event of any shortfall the Government (the Shareholder) will provide or cause to be provided, funds necessary to complete the projects, either as share capital or loans through DYB and/or commercial banks within an over- all debt/equity ratio of 60:40. Financial and Economic Analysis 4.29 Production Costs: Unit production costs, inclusive of financial charges, for crystal sugar production at the three factories after project implementation are estimated as follows: Ankara: TL 31,574/tonne Susurluk: TL 31,962/tonne Ilgin: TL 29,338/tonne Average: TL 30,957/tonne These unit costs are reasonable and provide an average 35% margin on the ex-factory sales prices. The costs of crystal sugar production at Susurluk are relatively higher due to the short campaign length as well as the lower sucrose recovery. Animal feed production costs are not fully covered by sales revenue in the three projects, particularly since TSF provides 25% of the feed produced free to farmers. There is a definite need for TSF to review its policy in this regard. 4.30 Financial and Economic Rates of Return: The financial and economic rates of return for the three projects are as follows: FRR (%) ERR (%) Ankara 18.1 24.1 Susurluk 12.0 19.5 Ilgin 22.6 26.1 - 23 - The financial rates of return for the Ankara and Ilgin projects are on the low side but satisfactory. The Susurluk project has a relatively low FRR. These low rates of return reflect Government's control over sugar prices which have been set at artificially low levels. However, during 1980-81 the Government has increased sugar prices on four occasions and the current price for crystal sugar and cube sugar are TL 60/kg and TL 71/kg which represent a significant increase in real terms over prices prevailing in 1977-79. It is expected that the financial performance of these projects will improve substantially as a result of this policy. However, the Sugar Law needs to be revised to improve the profitability of TSF. 4.31 The economic rate of return for all three projects, calculated on the basis of a long term price of refined sugar of $542 per tonne CIF Istanbul in 1980 prices 1/ ranges from 20% to 26% and are satisfactory. Sensitivity tests based on a 10% reduction in the long term sugar price and 5% and 10% increases in operating costs have been undertaken to assess the impact on the ERR. These results also indicate satisfactory ERRs for all three projects. Project Implementation 4.32 The projects are being implemented by the Projects Division of TSF which has a small core of qualified and experienced technical staff. The Division draws on experienced staff of different factories on an ad-hoc basis to implement individual projects. This arrangement has worked reasonably well in the past but with the growing volume of plant construc- tion, it appears that there is a need to reorganize and strengthen this Division. There is a need to introduce more systematic techniques of pro- ject management including project activity and cost control systems (e.g. PERT). 2/ There is also a need at the commissioning stage to provide factories with experienced technical staff to ensure that all equipment is functioning properly and the plant is able to achieve expected performance targets. TSF will be required to prepare a plan by September 30, 1981, for adequately strengthening its Project's Division in terms of technical personnel and project management systems to facilitate implementation of these projects. Beet Supply 4.33 An adequate supply of beet would be available to meet projected demand for the three projects. In the case of the two expansion projects, the farmers are exerting considerable pressure on TSF to process more beet. The Ilgin site already produces about 40% of the beet requirements of the new factory and farmers are anxious to increase the acreage under beet. 1/ Based on raw sugar price projections prepared by the Commodities Division of the Bank. 2/ Project Evaluation and Review Technique. - 24 - Project Benefits 4.34 Implementation of these projects will increase sugar production and help reduce projected imports. The expansion of the Ankara and Susurluk factories should improve substantially the operating efficieny of these facilities. Beet availability is well in excess of the rated pro- cessing capacity of these factories. As a result, campaign durations have had to be substantially extended leading to deterioration of beet and lower recovery and extraction. The expansion of processing capacities would reduce the long campaign duration prevailing at present and permit higher operating efficiencies. The completion of the Ilgin factory would simi- larly help the neighboring Afyon factory to reduce its campaign length. Bank involvement in the financing of these three factories should lead to substantial improvements in TSF's organization, technical and financial systems and procedures. Project Risks 4.35 The three projects are located in areas with an assured supply of raw material. The technology employed is conventional. TSF's staff have had considerable experience in constructing and commissioning such plants although this group needs to be better organized and somewhat strengthened. Thus there are no special risks associated with these projects. Improving the operating efficiency of TSF through changes in organization and person- nel practices, introduction of new technology and improvements in produc- tion management, and in financial planning and control will require per- sistent efforts on the part of DYB and the Bank and may take some time to materialize. Given the complexities of the changes required and the dif- ficulties in implementing them in public enterprises in Turkey, this will require the full and sustained commitment of both the Government and TSF. C. Karabuk Demir Ve Celik Fabrikalari (KDC): Karabuk Iron and Steel Plant Blast Furnaces Modernization Projects I/ Objectives 4.36 The Karabuk Demir Ve Celik Fabrikalari (KDC) is an SEE operating under Law 440 and operates an integrated iron and steel plant with a capa- city of 600,000 tpy of raw steel. The objective of the proposed projects is to modernize the existing blast furnaces of the Karabuk Iron and Steel Plant to increase output of molten iron from 600,000 tpy to 900,000 tpy. Out of the incremental production of 300,000 tpy of. iron, 255,000 tpy will be supplied to the foundry sector in Turkey to meet increasing demand. The incremental output of iron will be marketed rather than processed into 1/ Details regarding the Turkish Iron and Steel Industry, foundry sector, pig iron demand, the sponsor company, existing facilities and bottle- necks, the projects, project management and implementation, investment costs and financing plans and financial and economic analysis are available in project files. - 25 - steel as the steelmaking shop of the plant has a capacity of only 600,000 tpy. The modernization will be carried out in two physically separable but operationally linked projects: (i) installation of raw material prepara- tion facilities and (ii) replacement of refractories in the hot stoves serving the blast furnaces. The implementation of the projects would increase the output of iron from the existing blast furnaces, reduce the coke consumption of the blast furnaces substantially, reduce unit cost of production and result in increased pig iron supply to the foundry sector. The first project has been under implementation since 1976, but progress has been slow due to resource constraints. Bank assistance has been sought for financing the imported equipment needs of the two projects which are scheduled for completion by 1983. The Foundry Sector and Pig Iron Demand 4.37 The Foundry Sector: The foundry industry in Turkey has made substantial progress in the past fifteen years as supplier of industrial inputs to engineering industries, serving principally the domestic market. The industry has a comparative advantage in terms of labor and transport costs and the domestic market for castings has not been overly protected. The foundry industry is predominantly in the private sector and by end 1980, the nominal capacity of the industry had reached 686,000 tonnes of castings per year over 700 units employing 12,400 workers. The major share of capacity (55%) is comprised of medium sized foundries (up to 5,000 tonnes per year). In 1976, grey iron castings accounted for 83% of the output of ferrous castings. In 1978, the total production of castings reached 341,752 tonnes but fell sharply to about 285,000 tonnes in 1979 and 1980. Average capacity utilization, particularly of grey iron foundries was only 40% during 1980 due to the deterioration of the economic condi- tions in the country and consequent lower growth and capacity utilization in the engineering industries, and by shortages of coke, pig iron and power. 4.38 The demand for all types of foundry products grew at 17% per annum during 1974-78. However, the growth in demand was arrested due to the economic crisis in 1979 and 1980. Engineering industries, whom the foundry sector is dependent for demand for castings, are expected to recover only slowly over the next two years and consequently, the rate of growth of demiand for castings is not expected to average more than 7% per annum over the period 1980-88, rising from 285,000 tonnes in 1980 to 496,000 tonnes in 1988. On the basis of the above estimate for demand for ferrous castings, pig iron demand from the foundry sector is projected to rise from 313,000 tonnes in 1980 to 546,000 tonnes in 1988, and further to 795,210 tonnes in 1995. 4.39 Supply/Demand Balance: Demand for pig iron is met by marketing a part of the iron output of three integrated Iron and Steel Plants: Karabuk (capacity 0.6 million tpy), Erdemir (1.5 million tpy) and Isdemir (1.1 million tpy), supplemented by imports. During 1976-1980 Isdemir has marketed about 200,000 tpy of pig iron as its steelmaking facilities are not yet fully functional. Karabuk supplied 65,000-95,000 tonnes and the - 26 - rest was imported. Imports reached a peak of 80,000 tonnes in 1978 and were about 35,000 tonnes in 1980. The demand/supply balance will change substantially from 1983 when Isdemir will stop marketing pig iron as all its iron output will be processed into steel thereafter, resulting in a substantial excess of demand over supply. Four alternatives can be con- sidered for meeting the excess demand for pig iron. These are; (i) to maintain supply at present levels and to import the excess required; (ii) to expand output at Erdemir and Isdemir plants; (iii) to expand output at Karabuk; and (iv) to expand output at all the three plants. Under all except the fourth alternative, sizeable imports will be required to meet demand after 1984. Alternative (i) would require large recurring outlays of scarce foreign exchange to finance imports rising from 105,000 tonnes in 1984 to 695,000 tonnes in 1995. Under alternative (ii), while the Erdemir and Isdemir plants are larger and more modern and theoretically could produce pig iron more economically, neither has operated at full capacity for a sustained period in the past and to achieve high output continuously is likely to need considerable investment in debottlenecking. Thus, increased supplies of pig iron to the foundry sector, after meeting the internal demands of these plants for steelmaking, could be difficult to achieve. Secondly, both Erdemir and Isdemir plants are based on partly imported raw materials which would be a bottleneck. Alternative (iii), which is the approach proposed, has the advantages that the modernization projects at Karabuk are already partially implemented and can be completed by early 1984 at a reasonable investment cost per tonne of additional out- put, Karabuk is entirely domestic raw material based, and has historically operated close to full capacity. Moreover, the additional investment at Karabuk would easily pay for itself, through substantial reduction in production cost of its existing output which would occur due to moderniza- tion. Alternative (iv) would result in oversupply until 1990 and is in- appropriate. In view of these considerations, it is considered appropriate to complete the implementation of modernization of the blast furnaces at Karabuk to achieve additional output and supply of pig iron. The Company 4.40 Ownership and Management and Staffing: KDC is a subsidiary of Turkiye Demir Ve Celik Isletmeleri (Turkish Iron and Steel Corporation). KDC has an authorized capital of TL 3.0 billion, of which TL 2.1 billion is paid in. KDC's management is in the hands of a Board of five members including the Chairman, who is the General Director of the plant. The other four members are three Assistant General Directors and one workers representative. KDC has experienced frequent changes in its top management in common with SEEs generally, though production has been maintained at near capacity levels as it has a stable work force and middle level manage- ment. It appears necessary to upgrade management caliber and improve productivity and cost control. This could best be achieved through imple- mentation of training programs for all levels of staff after a thorough review of existing production and management practices. KDC is also over- staffed, even after allowing for the fact that the plant is older and less - 27 - automated, with 9,936 permanent workers of whom 7,233 are engaged in steel- making. It needs to develop a program of staff rationalization including retra.ning of present workers in new trades to suit rationalized labor requirements. Hiring of new personnel needs to be limited to highly qualified technical individuals required to operate the new equipment to be installed. There is a need to revise compensation levels to attract and retain highly qualified engineers and managers and incentives to induce greater productivity need to be designed. 4.41 Operations and Financial Performance: KDC has historically oper- ated at near full capacity, a situation unusual among SEEs in Turkey. It has always operated profitably except during two years, 1977 and 1978 when it incurred operating losses due to the Government's price controls in the face of increasing operating costs. In 1979 and 1980, after product prices were raised, profitability was restored. In 1980, return on sales was 3.2%, that on equity 28.5% and on fixed assets, 44.1%. KDC's plant is sub- stantially depreciated and the company has no long-term debt. Its current ratio at 1.1 is acceptable and overall, its financial position is satis- factory. Existing Facilities and Bottlenecks 4.42 Existing Facilities; KDC operates an integrated Iron and Steel Plant with a capacity of 600,000 tpy of raw steel. It has three blast furnaces for ironmaking, supported by coke oven batteries and a sinter plant. The furnace output is processed into steel in one steelmaking shop with six open hearth furnaces and the raw steel is rolled into a wide range of products in five rolling mills. The major rolled product is 8 mm. diameter steel bar for concrete reinforcement. 4.43 Bottlenecks: The major bottleneck in achieving higher output of iron is the absence of modern raw material preparation facilities for the blast furnaces. Variation in feed size and excessive presence of fines affects furnace output and causes excessive coke consumption. The problem is accentuated by low blast temperatures obtained at present, ranging between 630'C-740'C, which are much below international standards (presently 120C0C-14000C). Operating under these conditions, the specific output of the blast furnaces is low. The result is high cost of production and excessive energy consumption. The Project 4e44 Scope and Purpose; The first stage of the modernization project will be the installation of modern raw material preparation facilities to ensure improvement of physical characteristics, and blending facilities to ensure uniform grade of iron ore charged to the blast furnaces. The capacity of the raw material preparation facilities will also be increased to support the higher level of output projected. This stage has been under implementation since 1976, but progress has been slow due to shortage of funds, particularly foreign exchange. The second stage envisages the - 28 - replacement of refractories in the hot stoves of the blast furnaces with high alumina bricks of improved design, along with replacement of burners and blast pipes and installation of instrumentation. These changes would enable blast temperatures to be raised from the existing 6300C-7500C to 11500C. The two stages can be implemented independently of each other, but their beneficial effect is additive and the projected economies can be maximized by coordinated implementation of both projects. 4.45 Technical Feasibility: The Raw Material Preparation Modernization Project was designed by Rheinstahl Huttenwerke, West Germany, after exten- sive experiments on samples of iron ore, limestone and coke used at Karabuk. Optimum grain sizes and permissible limits of size variation were determined after trials at laboratory and plant scales. The crushing, screening and blending equipment proposed was designed to achieve the recommended grain size specifications. The overall design, layout and specifications of major equipment have been verified by Rheinstahl and the Bank's consultants and are technically appropriate. The design of the Blast Furnace Stove Modernization Project was formulated at the Institute of Metallurgy of Berlin University, West Germany. The refractory bricks to be installed are according to a design developed at the Institute, tested extensively in steel plants in Europe and adopted successfully by refrac- tory manufacturers in Europe. 4.46 Production Plans and Raw Materials: Build up of pig iron output is expected to take place over the next four years. The first increase, to 660,000 tpy from present capacity of 600,000 will occur in 1983 following the completion of the Raw Materials Preparation Modernization Project. The replacement of refractories in the nine blast furnace stoves will commence from late 1982 and will be completed by early 1984, enabling the plant to produce 900,000 tonnes of iron from 1985. 4.47 Major raw materials required annually at the productior level of 900,000 tpy will be: iron ore 1,516,000 tonnes, coking coal 919,600 tonnes and limestone 12,700 tonnes. The critical material in the group is coking coal, and its availability is less certain than that of iron ore and lime- stone. However, KDC is already receiving 866,700 tonnes of coal from the Zouguldak coal mines of Turkish Coal Company. After modernization, the increment will be only 52,900 tpy--only 10% over present level. It is therefore expected that major difficulties are unlikely to occur. Investment Costs and Financing Plans 4.48 The capital costs and financing plans of the two moderanization projects are shown in Table 3. On the basis of the above financing plans, the two projects together would be financed 30% out of internally provided funds ($21.4 million) and 70% out of debt ($50.3 million). During nego- tiation an assurance was obtained that in the event of any shortfall the Government will provide or cause to be provided, funds necessary to com- plete the projects, either as share capital or loans through DYB and/or commercial banks within an overall debt/equity ratio of 60:40. KDC CAPITAL COSTS AND FINANCING PLANS 1/ ($ Million - 1980 prics) Raw Material Preparation Blast Furnace Stoves Modernization Modernization Total Copts Local Foreign Total Local Foreign Total Local Foreign Total Base Costs 13.9 12.3 26.2 4.4 8.5 12.9 18.3 20.8 39.1 Physical Contingencies 2/ 0.6 0.8 1.4 0.4 0.7 1.1 1.0 1.5 2.5 Price Contingencies 3/ 2.1 1.9 4.0 0.7 1.4 2.1 2.8 3.3 6.1 Subtotal 16.6 15.0 31.6 5.5 10.6 16.1 22.1 25.6 47.7 Interest During Construction 5.4 1.6 7.0 6.9 2.3 9.2 12.3 3.9 16.2 Total Investment Costs 22.0 16.6 38.6 12.4 12.9 25.3 34.4 29.5 63.9 Working Capital 5.0 - 5.0 1.7 - 1.7 6.7 - 6.7 Technical Assistance 4/ - - - - - - 0.3 0.8 1.1 Total Financing Required 27.0 16.6 43.6 14.1 12.9 27.0 41.4 30.3 71.7 Financing Internally Provided Funds 12.4 5.7 18.1 2.9 0.1 3.0 15-.6 5.8 21.4 Loans: DYB 14.6 - 14.6 11.2 2.2 13.4 25.8 2.2 28.0 IBRD - 10.9 10.9 - 10.6 10.6 - 22.3 22.3 Other _- - - i Total Loans 14.6 10.9 25.5 11.2 12.8 24.0 25.8 24.5 50.3 a Total Financing 27.0 16.6 43.6 14.1 12.9 27.0 41.4 30.3 71.7 1/ TL costs have been converted into $ at TL 89.71 = $1.00. 2/ Physical contingencies are provided at varying rates for each project depending upon extent of completion and average 7/. 3/ Price contingencies for both foreign and local costs are based on the Bankts forecast of international inflation rates in dollar terms: 1981 - 9.5%, 1982 - 8.5%, 1983 - 7.5%. 4/ The technical assistance component relates to the company as a whole including the assistance needed for the two projects. - 30 - 4.49 Out of the total investment cost of $41.9 million for the raw materials preparation modernization project, $14.5 million has already been incurred out of KDC's internal funds. No expenditure has been incurred on the blast furnace stoves modernization project. The capital cost of the two projects together, fully escalated but excluding working capital and interest during construction is estimated at $47.7 million or $150 per tonne of additional output which is considered reasonable. The remaining funds requirements of $27.4 million for the raw materials preparation modernization project is proposed to be met to the extent of $2.7 million out of internally provided funds and $24.7 million by loans ($14.6 million equivalent from DYB and $10.1 million by IBRD). The funds requirements of the blast furnace stoves modernization project totalling $27.0 million will be met by internal funds equivalent to $2.6 million and loans of $23.4 million ($13.4 million equivalent by DYB and $10.0 million by IBRD). Project Management and Implementation 4.50 Project Management: Overall control of the implementation will rest with KDC. Specifically the Engineering Projects and Construction Department will be responsible for the entire civil works and structural erection. Erection of mechanical equipment will be carried out under close supervision of the suppliers. The bricks will be installed in the stoves with technical assistance and under supervision of the refractory suppliers. It may be noted that a considerable part of the Raw Materials Preparation Project civil and structural work has already been completed by the Engineering Projects and Construction Department in a satisfactory manner. There would be a need at the commissioning stage to obtain engineering services to ensure that all the equipment is working satis- factorily and the projects would result in expected output. KDC will be required to prepare a plan of adequate strengthening of the project man- agement systems to facilitate timely implementation of the projects by September 30, 1981. 4.51 Implementation Schedules: The Raw Materials Preparation Moderni- zation Project is expected to be completed by end 1982 and trials are ex- pected to commence in early 1983. The replacement of refractory bricks in the nine stoves will be carried out in one stove at a time to avoid inter- ruption of production and will be completed by March 1984. These schedules assume loan effectiveness by September 1981 and appear realistic. Training and Technical Assistance 4.52 The need for special training is minimal as no complex equipment is to be installed, and KDC has adequately experienced personnel. However, - 31 - arrangements will have to be made to obtain engineering services and tech- nical assistance from equipment and refractory suppliers. Training will be necessary to improve overall operational efficiency by improving inventory control, establishment of standard cost accounting and management informa- tion and control system. KDC has agreed to develop training programs to train its staff in use of new equipment, preventive maintenance and indus- trial safety and to submit the program to DYB and the Bank within one year from loan signing. Financial and Economic Analysis 4.53 Production Costs and Selling Prices: After implementation of the projects unit cost of iron production will decrease by 13%, from the present TL 16,067/tonne to TL 14,119/tonne based on present prices of inputs and will provide a 33% margin on ex-plant sales price of TL 19,500/tonne. KDC's pig iron selling price of $217 equivalent, is about 10% higher than CIF price of pig iron imported from Europe. However, KDC's pig iron, having a higher silicon content, is preferred by local foundries and the marginally higher selling prices does not affect its marketability. During negotiations, agreement was reached that KDC will devise and implement a system of standard cost accounting to induce operat- ing efficiency, and that the Government will allow KDC to set its selling prices so as to (i) cover full costs of production under condition of efficient operation; (ii) ensure an adequate return on equity and (iii) generate funds for meeting its share of the costs of the modernization projects and replacement of equipment as necessary and with reference to market conditions. 4.54 Financial and Economic Rates of Return: The incremental FRR and ERR for the two projects calculated separately are shown below: FRR (%) ERR (%) Raw Material Preparation Modernization 20.9 33.5 Blast Furnace Stoves Modernization 53.4 58.6 The financial and economic rates of return for both projects are high due to the nature of the projects, which would result in optimization of effi- ciency of existing facilities and increase in output at a relatively modest incremental investment. Sensitivity tests based on higher production costs, delay in project implementation, and consequent capital cost increase were carried out. The 'worst case test results in FRR of 16.1% and 40.8% for the two projects respectively. The rates of return of the two projects calculated together indicate a base case FRR of 26% and ERR of 41% which is also satisfactory. Project Benefits and Risks 4.55 Benefits: The major benefits are reduced coke consumption and higher output of iron at reduced cost of production. The reduction of - 32 - ironmaking costs will also reduce the cost of steel produced at KDC and will improve KDC's overall profitability. Major benefits to the economy will be steady pig iron supply to foundries and saving of foreign exchange due to reduced imports, and production of pig iron at internationally competitive prices based on domestic resources at a low investment cost per tonne of output. 4.56 Risks: As the proposed projects are for modernization of existing facilities without introducing any radically new technology, risks asso- ciated with start up and operation are minimal. The major risk, under current circumstances in Turkey is of delay in implementation. However, the more complex project--Raw Materials Preparation Modernization--has been under implementation since 1976 and a substantial and time-consuming part is already completed. No major delays are therefore expected. D. Karadenize Bakir Isletmeleri A.S. (KBI): Murgul Copper Concentrator Rehabilitation, Balancing and Modernization Project 1/ Objectives 4.57 The objective of the proposed project is to enable balanced and full capacity operation of the Copper Smelter of KBI located at Samsun by modernizing and expanding the copper mining and concentration complex at Murgul, which provides the copper concentrate for the Samsun Smelter. Under the project, mining equipment will be added, problems in the existing grinding and flotation units will be rectified and the grinding and flota- tion units will be expanded. It is expected that after the completion of the project, the supply of concentrate would increase to 169,000 tpy and enable the operation of the Copper Smelter on a continuous basis. The in- creased supply of sulfur dioxide from the smelter would enable full capacity operation of the sulfuric acid plant at Samsun. Market Outlook 4.58 Between 1970 and 1976, consumption of blister copper grew at 20% per annum, reaching 40,000 tonnes and resulting in imports of 12,000 tonnes. Since 1977, consumption declined precipitously, reaching an esti- mated 23,000 tonnes in 1980, following the slowdown of industrial activity during this period due to the unavailability of foreign exchange to finance required imports. Demand projections, based on slow recovery of the eco- nomic activity and GNP growth, indicate that the demand for blister copper 1/ Details on the structure, ore reserves, processing capacities, produc- tion, consumptions and demand/supply outlook of the Turkish copper in- dustry; KBI's existing facilities, bottlenecks and financial position; the design, management, implementation schedules, investment costs and financing plan of the proposed project; pricing policies, future profitability, financial and economic rates of return, and the benefits of the project; are available in project files. - 33 - would attain the 1976 level of 40,000 tonnes by 1983, growing thereafter at a modest 9% per annum to reach 72,000 tonnes by 1990. Production, on the other hand, is projected to pick up from the extremely low level of 16,000 tonnes in 1980 to 54,200 tonnes by 1986 as a result of: (a) the increased production of KBI following the modernization and expansion envisaged in the proposed project (from 10,850 tonnes in 1980 to 33,700 tonnes in 1986); and (b) improved performance by Etibank, which would enable it to reach rated capacities in its facilities of 20,000/tpy by 1986 (which may be somewhat optimistic assumption). Production would stabilize beyond 1986, necessitating increased imports which are projected to rise from token levels during 1982-86, when the KBI project would be on stream, to 4,700 tonnes in 1987 and 18,000 tonnes in 1990. Demand/supply projections of sulfuric acid, including forthcoming capacities, also indicate a shortage by 465,000 tonnes in 1986, rising to 820,000 tonnes by 1990. In 1980, imports of pyrite concentrate amounted to 200,000 tonnes. The demand/ supply gap for pyrite concentrate, which is a major input in the production of fertilizers, is expected to continue growing, necessitating higher levels of imports. Since projected demand for blister copper, sulfuric acid, and pyrite concentrate will continue to exceed domestic supply after completion of the project, and since KBI will be able to produce at inter- nationally competitive prices, KBI is not expected to encounter marketing difficulties. The Company 4.59 Control, Management and Labor Force: KBI, a public sector joint stock company, was established in 1968 and operates under Law 440. The Treasury and Etibank 1/ control 99% of the TL 2 billion paid-in capital. KBI operates according to private commercial law and is audited by the High Control Board. KBI's Board of Directors and the General Manager have been changed frequently in the past. This management instability, coupled with outside interference in day-to-day operations and the deteriorating economic conditions in the last few years, have affected KBI's operating efficiency. The General Manager and his three Assistant General Managers (Production, Finance and Projects) appear experienced and able. The middle level management team comprises mostly qualified and efficient personnel, but has been affected by high turnover. Management at the plant level is satisfactory with the exception of the plant manager at Murgul. KBI's total labor force of 2,550 is well above levels for comparable facilities in industrialized countries. However, KBI expects to reduce its labor force through attrition by at least 15% within the next four years. The Government imposed freeze in hiring should also help in reducing over- manning. 1/ Etibank is also an SEE engaged in mineral development and copper production. - 34 - 4.60 Operations and Financial Performance: Until 1978, KBI had expe- rienced annual losses because of the precipitous decline in world copper prices during 1975-78, which served as a basis for setting its prices, and the low capacity utilization due to a number of severe bottlenecks. Beginning with 1979, because of the dramatic surge in world prices and strong market position, KBI's financial performance has improved and, despite operating inefficiencies, the years 1979 and 1980 have shown considerable profits. The injection of fresh equity capital in 1979 by the Treasury has improved KBI's debt/equity and current ratios substantially which are now satisfactory. 4.61 Existing Facilities and Bottlenecks: KBI operates a fully integrated (mining, concentration, smelting) blister copper facility, with design capacity of 40,000/tpy blister copper. The technology employed has been especially developed for low grade concentrates. The equipment is in good working condition. However, unavailability of good quality spare parts and consumables, lack of specialized equipment and proper process control instrumentation, high turnover of key technical staff, poor pro- duction management, insufficient maintenance facilities and absence of adequate preventive maintenance, have resulted in high frequency of shut- downs in the mining and concentration stages of production adversely affecting the content of the copper concentrate and metal recovery. Con- sequently, the smelting process is interrupted frequently and has resulted in low levels of production of blister copper and sulfuric acid and high cost of operations. Annual production of blister copper has been hovering around 13,000/tpy. Capacity utilization of all facilities is very low, with mining equipment operating at 20%, concentration facilities at 50%, and the smelting plant at one-third of rated capacity. The Project 4.62 Scope and Purpose: The purpose of the proposed project is. (a) to debottleneck and modernize the existing mining and flotation facili- ties at Murgul to achieve full utilization of their capacity; and (b) to balance these facilities with the available smelting capacity at Samsun. Under the project, utilization of the existing mining equipment will be improved by adding critical items (e.g. excavators, drill masters, com- pressors, etc.) and some new mining equipment will be added to expand capacity. The ore grinding and flotation units will be debottlenecked by increasing the size of the jaw crusher and by building up the inventory of consumables and spares. The flotation unit will be expanded by adding a new autogenous mill and related equipment. On completion of the project: (a) the mining capacity would increase from 1.6 million/tpy of ore (of 1% copper content) to 3.8 million/tpy; (b) the annual production of copper concentrate (17% copper content) would rise from 60,000/tpy to 169,000/tpy, while that of pyrite concentrate (45% sulfur content) from 15,000/tpy to 133,000/tpy; (c) production of blister copper (99% copper content) from 13,000/tpy to 33,700 tpy, the output of sulfuric acid from 30,000/tpy to 270,000/tpy, and that of the pyrite concentrate from 15,000/tpy to t5>tSp i}teotQwtoezst f< w<cacwrt eE - 35 - increase from 70% to the designed 90%, while sulfur content in pyrite con- centrate would increase from 40% to 45%; (e) the present severe air pollu- tion problem resulting from the discharge to the atmosphere of acid gases will be greatly alleviated. This increase in output would result in increase in capacity utilization of the concentrator to 80%, of the smelter to 84%, and of the sulfuric acid plant to 82%. The above operating rates serve as production targets to ensure a balanced operation of KBI's integrated facilities and are technically feasible. Investment Cost and Financing Plan 4.63 The capital cost and financing plan of the project is shown below. Capital Cost and Financing Plan 1/ (US$ million - 1980 prices) Costs Local Foreign Total Base Costs 4.8 18.0 22.8 Physical Contingencies 2/ 0.5 1.8 2.3 Price Contingencies 3/ 1.0 3.7 4.7 Subtotal 6.3 23.5 29.8 Interest during Construction 4.2 3.0 7.2 Total Investment Cost 10.5 26.5 37.0 Working Capital 1.8 0.3 2.1 Technical Assistance 0.3 1.2 1.5 Total Costs 12.6 28.0 40.6 Financing Internally Provided Funds 7.3 3.0 10.3 Loans DYB 5.3 - 5.3 IBRD - 25.0 25.0 Other _ _ _ Total Loans 5.3 25.0 30.3 Total Financing 12.6 28.0 40.6 1/ Lira costs have been converted into US$ at TL 89.71 = US$1.00. 2/ Physical contingencies are provided at 10%. 3/ Price contingencies for both foreign and local costs are based on the Bank's forecast of international inflation in dollar terms: 1981 - 9.5%, 1982 - 8.5%, 1983 - 7.5%. - 36 - Total Financing 4.64 Capital cost, fully escalated but excluding working capital and interest during construction, is estimated at US$29.8 million or US$14 per annual tonne of additional copper ore processed at Murgul facilities. This figure compares very favorably with the estimated cost of US$70 per tonne if new capacity were to be installed at conventional "green field" sites. The investment cost of US$40.6 million will be financed about 25% from funds mobilized by KBI from equity (US$9.3 million) and short-term bor- rowings for working capital (US$1.0 million). Loans will total US$30.3 million (US$5.3 million equivalent from DYB and US$25.0 million from IBRD) which is acceptable. During negotiation an assurance was obtained that in the event of any shortfall, the Government (the Shareholder) will provide or cause to be provided, funds necessary to complete the projects, either as share capital or loans through DYB and/or commercial banks within an overall debt/equity ratio of 60:40. Project Management and Implementation 4.65 Project Management: To ensure prompt and efficient implementation of the project, KBI will strengthen its Projects Department by recruiting additional technical and financial experts, and to engage engineering con- sultants (local and foreign) to assist its project staff. Such consultants would help in the engineering work, advise on procurement of equipment, and supervise the erection, and commissioning of the project. KBI will be required to prepare a plan detailing the steps to be taken to build up the project management team by September 30, 1981. 4.66 The Government appears determined to delink the state economic enterprises from the political influence of the parent ministry, to appoint qualified professionals to top level positions, and to insulate management from intereference in purely operational matters, e.g. recruitment of staff. In the light of the above and KBI's agreement to strengthen the project team, to develop a competitive wage and salary structure, and to make sound personnel appointments, KBI should be able to carry out success- fully the project and to improve its overall performance. 4.67 Implementation Schedule: The implementation of the debottleneck- ing phase of the project, which would enable an increase of copper concen- trate production at Murgul from 60,000 tpy to 126,800 tpy, is expected to be completed within 18 months, or by the end of 1982. The commissioning of the expanded mining and flotation facilities is estimated to take place by March 1984. This schedule takes into account the time required to procure and erect the imported machinery and the prevailing local conditions, and allows for the inherent difficulties in making changes in existing manage- ment and production practices. It is therefore considered to be realistic - 37 - and attainable. KBI will develop a more accurate and complete PERT sched- ule for implementation of the project and submit it to DYB for review by September 30, 1981. Staff Requirements, Training and Technical Assistance 4.68 The expanded project will require an estimated 98 additional staff, mostly skilled technicians. To maintain a stable and qualified work force, KBI will develop and apply a competitive salary and wage structure that would enable it to attract and retain experienced technical staff, and will follow strict personnel policies to avoid overstaffing. The need for a special training effort exists only in certain areas, given that KBI has been operating an integrated copper plant since 1973. They involve primarily the copper concentration plant at Murgul, and the areas of inventory control, costing (establishment of standard cost accounting), and management information and control systems. KBI will develop a program to train its staff in the use of the new equipment and to upgrade their skills with the help of specialized consultants possibly from outside Turkey. There is also need to strengthen and systematize preventive maintenance and plant safety programs. KBI will submit time-bound programs for staff training, preventive maintenance, plant safety, and management information systems to DYB and the Bank for review by September 30, 1982. Financial and Economic Analysis 4.69 Pricing Policies: The present pricing policy, permitted by the Government, sets the price of blister copper at a level which covers KBI's full production costs and provides a net profit margin of 20%. Considering KBI's high costs of production, in part due to social functions thrust upon it (e.g. over-manning), the widely fluctuating world prices for copper, the erosion of KBI's equity basis due to losses in the past, and the intended effort to improve performance, the prevailing price policy is acceptable. However, to guard against the operational inefficiencies that this pricing strategy may foster, and to stimulate greater efficiency and to develop an effective management tool for cost control, budgeting, and realistic price determination, KBI will, by September 30, 1982, develop and implement (with the help of consultants) a system of standard cost accounting, which would involve setting standards of performance encompassing all phases of produc- tion (mining, concentration, smelting), distribution and administration, taking into account KBI's particular operating circumstances. In light of the above, and given that KBI's unit costs of production of blister copper are expected to decline by 50% after the completion of the proposed project, from TL 189,000/tonne (US$2,105 equivalent) to TL 95,000/tonne (US$1,060 equivalent), KBI's pricing policy should ultimately aim at setting prices ensuring a reasonable return on investment, to enable KBI to cover full costs of production under conditions of efficient operations and to provide adequate funds for replacement of existing equipment. Such prices should approximate international copper prices and be adjusted in - 38 - line with the pace of inflation. Selling prices of by-products (e.g. sulfuric acid) should also be fixed to take into account import prices. Future Profitability and Financial Position 4.70 As a result of the proposed debottlenecking and expansion, KBI's unit cost of production of blister copper is projected to drop from the 1980 level of TL 189,000 (US$2,105 equivalent) to TL 121,500 (US$1,350 equivalent) in 1983 and to TL 95,200 (US$1,060 equivalent) thereafter, in 1980 prices. KBI's financial performance and position is expected to improve further in 1981 and beyond because of the confluence of a number of important factors: declining costs per unit of output, rising volume of output and significant increases in capacity utilization, and rising world prices. CIF world prices for blister copper are projected to rise from US$2,000 in 1980 to US$2,100 in 1982, US$2,440 in 1985 and US$2,730 by 1990 in real terms. 1/ Nevertheless, in order to maintain a strong financial position, a commitment has been obtained from KBI and the Government that KBI will maintain at all times a long term debt/equity ratio of 60:40 or less, and a current ratio of at least 1.1. Financial and Economic Rates of Return 4.71 The incremental financial and economic rates of return exceed 100%. These high returns reflect the dramatic impact of the debottle- necking of existing facilities and attest to the merit of the proposed project. Project Benefits and Risks 4.72 Benefits: The primary impact of the proposed project would be in substantial productivity improvements, balancing of operations, and foreign exchange savings through efficient import substitution, by debottlenecking and modestly expanding existing facilities. KBI would be strengthened as an entity and improve its operating efficiency and financial performance, through provision of special training to upgrade the skills of its tech- nical personnel, the development of preventive maintenance and plant safety schemes, and improvements in inventory control, costing, budgeting, management and information systems, and pricing policies. Finally, the country will benefit from the exploitation of a national resource and an assured steady supply of copper at internationally competitive prices, while the town of Samsun will be rid of a major source of pollution. 4.73 Risks: Technical risks associated with project technology, start-up and ordinary operations are modest, since the project entails a limited expansion of facilities, no new copper processing technology is involved, and KBI will hire contractors/consultants to assist it in the engineering work and to supervise the erection, start-up and efficient I ased on coppe- p! ece 'p'w Qregared by the Commodities Division of the Bank. - 39 - operation when the project will come on stream. In light of the above, the chance of delays in implementation appears small. However, continuous monitoring during implementation by DYB and the Bank would be required. No major commercial or economic risks are foreseen since, even under conserva- tive market estimates copper production will be less than domestic demand. Also, copper ore supplies, the pipeline system and the capacities of the regrinding ball mills, flotation cells and other related equipment and utilities meet the requirements of the expanded output envisaged in the proposed project. Geological surveys confirm the existence of substantial quantities of commercially exploitable copper deposits near the existing mine. A commitment was obtained from the Government during negotiations that the Mining Investigation and Exploration Institute would develop a 5-year exploration program in the area commencing in 1982. V. LOAN FEATURES Lending Arrangements 5.01 The loan proceeds will be onlent by DYB under subloan agreements between DYB and the SEEs concerned. The subloan agreements will be reviewed by the Bank and the signing of a subloan agreement satisfactory to the Bank will be a condition of disbursement for each subloan. The amortization periods of the subloans will be up to 15 years including an appropriate grace period up to five years, which is commensurate with the debt servicing capacity of the sub-borrowers. DYB will repay the Bank based on the aggregate composite amortization schedule for the individual subloans. DYB has submitted draft appraisal reports on the six subprojects for Bank review prior to loan negotiations. These reports need to be supplemented in some areas (e.g. projected cash flows of the sponsor SEE, rates of return of the enterprise as a whole etc.). They will be finalized by DYB after taking the Bank's comments into account. The submission of a final appraisal report satisfactory to the Bank, will also be a condition of disbursement of that subloan. The closing date will be December 31, 1986. Loan Amount 5.02 The loan of US$70.0 million will meet substantially the foreign currency requirements of the six projects (excluding available suppliers' credits) and the foreign exchange costs of technical assistance, estimated at US$3.0 million (para. 4.05). The cost estimates of plant and machinery are based on quotations received by the SEEs and have been updated in 1980. However, as bids are yet to be invited on a firm basis, the foreign currency requirements could vary from the estimate. If the technical assistance component is not fully utilized, the surplus may be utilized by the SEEs for import of plant and equipment as needed. Otherwise the surplus amount would be cancelled. - 40 - Onlending Rates and Foreign Exchange Risk 5.03 At present DYB's lending rate for both foreign and local currency loans is 21.5% p.a. This rate is fixed by the Government and bears no relationship to the cost of resources, prevailing interest rates for com- parable borrowed funds elsewhere in the country or to the long-term infla- tion rate. In respect of foreign currency loans where the risk is borne by the sub-borrower, the rate of 21.5% is too high in comparison with rates prevailing in international capital markets for similar loans as well as compared to the onlending rate prevailing in the private sector. For local currency funds this rate is substantially negative and prevents DYB from mobilizing resources from the domestic market. The inflation rate was 50% in 1978, 65% in 1979 and 105% in 1980. Because of the uncertainties asso- ciated with changes in economic structure expected in response to Govern- ment policy initiatives, it is difficult to forecast the rate of infla- tion. It is, however, tentatively projected to decline to 60% in 1981, 40% in 1982 and 30% in 1983, if Government policies are effectively imple- mented. In order to rectify the situation, and in keeping with Govern- ment's announced policy to expose SEEs increasingly to market forces, agreement was reached during negotiations that the interest rate regime prevailing in the private sector will apply to subloans made under the pro- posed loan. Consequently, DYB's interest rate on foreign currency subloans will equal the cost of Bank funds plus a spread of 3.5% and applicable taxes and is estimated at about 18.5% exclusive of interest rebates. This is acceptable in comparison with rates prevailing in international capital markets for similar loans. The interest rate on local currency subloans will be aligned with lending rates prevailing in the market for comparable loans, currently about 50% p.a. before interest subsidies but including taxes, which is acceptable. The exchange risk relating to the foreign currency subloans will be borne by the beneficiary SEEs, as in the case of the earlier two loans made through DYB. Procurement and Disbursement 5.04 International competitive bidding will be required for bid pack- ages exceeding US$l million. It is expected that six contracts totalling $24 million will be placed under ICB. Local manufacturers of equipment would be allowed a preferential margin of 15% of the c.i.f. costs of com- peting imports or the existing rate of customs duty, whichever is the lower. Compatibility with existing equipment and spare parts may dictate that certain items be purchased on a proprietary basis. However, the Bank will review all cases of proprietary procurement. 5.05 For bid packages below $1 million, procurement procedures followed by the SEEs under existing regulations will apply. These regulations require international competitive bidding for all purchases exceeding TL 10.0 million ($111,000 equivalent). At least five bids are ranked and reviewed compulsorily by a "bid evaluation commission" composed of representatives of the Technical, Projects, Purchase and Finance Depart- ments of the SEE concerned. The bid evaluation report is submitted to a - 41 - selection committee consisting of the Heads of the above four departments and the recommendation of the committee is finally reviewed and approved by the Board of the bEE. The above procedure ensures an adequate degree of international competition and is acceptable for procurement of bid packages below $1 million. 5.06 Although DYB will be the disbursing agency, it would not be practical to assign to it full responsibility for ensuring compliance with Bank guidelines because of unfamiliarity with Bank's procurement pro- cedures. The Bank therefore should be involved in the review process. To keep the task manageable, it was agreed that the Bank would review on an ex-ante basis, the bidding documents, evaluation of bids, and the award of contract for all bid packages exceeding US$l million (estimated to number around six). The Bank loan will be disbursed against 100% of the foreign expenditure for imported equipment and spares and foreign consultants as well as 100% of the ex-factory costs of contracts won by local manufac- turers under ICB; and 75% of the total costs of any local consultants. Disbursements under the proposed loan will be made on the basis of standard documentation. Supervision of Subprojects 5.07 DYB will supervise the projects and will periodically report to the Bank regarding compliance of the conditions by the SEEs. Since some of the proposed projects are technically complex and DYB does not have in-house capability to adequately supervise the implementation of the proj- ects, a plan for supervision of the subprojects, specifying scope and extent of supervision and including arrangements for engaging consultants to assit DYB staff in supervision as necessary was prepared and agreed during negotiations. Under the plan, DYB staff would be required to visit each project on a quarterly basis and prepare comprehensive supervision reports highlighting problems likely to be encountered. Semi-annual reports would be translated into English and submitted to the Bank for review. In addition DYB would obtain quarterly progress reports from the SEEs during project implementation detailing physical progress of the proj- ects as well as a breakdown of cumulative expenditures on each project. During the operational phase, comprehensive progress reports would be obtained by DYB from the SEEs on an annual basis. VI. RECOMMENDATIONS 6.01 During negotiations, agreements were reached with the Government that: (i) In the event that funds generated internally by the three sEEs are insufficient to (a) complete the projects; or (b) meet cost esca- lations beyond the levels provided for; the Government (the Share- holder) will provide or cause to be provided, funds necessary to complete the projects, either as share capital or loans through - 42 - DYB and/or commercial banks within an overall debt/equity ratio of 60:40 for the SEEs and a debt service coverage ratio of 1.5 times (paras. 4.28, 4.48, 4.64). (ii) The Government will permit KDC and KBI to set their selling prices so as to cover full costs of production (based on standard costs) and to achieve an adequate return on investments (paras. 4.53, 4.69). (iii) The Government will review and revise the pricing policy for sugar and by-products so as to cover the full cost of production based on standard costs and provide an adequate return on investment (para 4.18). (iv) The sugar law would be reviewed and revised to enable TSF to earn a return on equity commensurate with levels prevailing in the market (between 30-40%) (para. 4.18). (v) The Government will develop indices for monitoring and evaluating the operating efficiency, financial performance and management efficiency of the three SEEs by September 30, 1982 for review with the Bank before implementing the system by January 1, 1983 (para. 4.06). (vi) The Government will carry out a study under terms of reference agreed during negotiations, to review DYB's future (para. 3.09). (vii) The Government will direct the Mining Investigation and Explora- tion Institute to develop and implement a 5-year program of copper deposit exploration in the vicinity of Murgul from 1982 (para. 4.73). (viii) The Government will provide, or cause to be provided, sufficient funds to DYB to enable DYB to extend local currency loans to the SEEs as envisaged in the financing plans for the six subprojects (para. 4.03). 6.02 The following agreements were reached with DYB: (i) DYB's interest rates for both foreign and local currency subloans will be in line with those applicable to private sector firms for similar loans and the foreign exchange risk will be borne by the SEEs (para. 5.03). (ii) DYB will ensure that the Bank's procurement guidelines will be followed by the SEEs for bid packages exceeding $1.0 million, and that internatonal shopping procedures will be applied for bid packages below $1.0 million (paras. 5.04, 5.05). (iii) DYB will supervise the projects with the help of consultants dur- ing implementation and throughout the life of the loan and ensure the SEEs' compliance with the provisions of the subloan agreements (para. 5.06). - 43 - (iv) DYB will obtain and submit progress reports on the projects quarterly during the implementation stage and at least yearly during operational stage (para. 5.06). (v) DYB will incorporate the conditions stated in para. 6.03 in sub- loan agreements for the six projects and submit the subloan agree- ments for review to the Bank (para. 5.01). 6.03 It was agreed during negotiations that the following conditions would be incorporated in DYB's subloan agreements with all the three bEEs to the effect that the SEEs would: (a) (i) Reduce, by December 31, 1982 and thereafter maintain their debt-equity ratios below 60:40, and current ratios above 1:1 at any time (paras. 4.19, 4.48, 4.64). (ii) Submit by September 30, 1981, for review by DYB, the staffing plan of the departments responsible for the construction and commis- sioning of the projects. The staffing of the departments should be adequate to handle the projected workload. The SEEs should also introduce appropriate control systems for both cost and time management of the projects (paras. 4.32, 4.50, 4.65). (iii) Prepare, by September 30, 1981, a detailed implementation plan for each of the sub-projects, for review by DYB. Thereafter, the SEEs should sumbit to DYB progress reports on a quarterly basis showing the status of construction of plant and equipment and financial expenditures incurred (paras. 4.32, 4.50, 4.67). (iv) Review, by september 30, 1981, their compensation policies for technical and management staff and suitably upgrade their salary and benefits structure in order to hire and retain qualified staff (paras. 4.16, 4.40, 4.68). (v) Develop, by Decermber 31, 1982, a plan for rationalization of their staff both at the factories and in the head offices. New hiring should be limited to highly qualified engineers, technologists and financial experts (paras. 4.16, 4.40, 4.59). (b) Engage engineering consultants as necessary to: (i) Supervise erection and commissioning of new equipment (para. 4.04). (ii) Supervise training of staff in use of new equipment (para. 4.04). (c) Engage consultants as necessary to: (i) Develop and introduce by December 31, 1982, a work incentive system in their plants (paras. 4.04, 4.16, 4.40, 4.68). - 44 - (ii) Develop and introduce by September 30, 1982, a system of cost accounting and budgetary control. This should include a system for setting targets for output, quality, raw material and auxiliary material usage and labor utilization for each plant (paras. 4.04, 4.24, 4.52, 4.68). (iii) Investigate, by September 30, 1982, current production control and preventive maintenance procedures and prepare an action program for necessary improvements (paras. 4.04, 4.23, 4.52, 4.68). (iv) Develop, by September 30, 1982 for review by DYB, a comprehensive program for training technical and managerial staff at all levels in the head office and plant (paras. 4.04, 4.16, 4.40, 4.52). (v) Review TSF's extension services to suggest improvements in agronomic practices of beet farmers (para. 4.13). (d) (i) Bear the local costs of engaging consultants as required for (b) and (c) above (para. 4.04). (ii) Submit reports prepared by the consultants for review by DYB and the Bank before implementation of findings (para. 4.04). 6.04 In addition, it was agreed that for each sub-project, the follow- ing two disbursement conditions will apply: (i) Submission by DYB of a final appraisal report for each sub- project, satisfactory to the Bank (para. 5.01). (ii) Submission of subloan agreements between DYB and the SSEs, satis- factory to the Bank (para. 5.01). 6.05 In view of the understandings and conditions listed above, the proposed project is suitable for a Bank loan of $70 million. - 45 - ANNEX 1 DEVLET YATIRIM BANKASI Approvals, Commitments and Disbursements of Term Loans 1/ (1977-1979) (TL Million) 1977 1978 1979 Approvals of New Projects No. of Projects 23 18 9 Loan Amounts Approved Local Currency Loans 22,775.1 19,492.3 3,008.8 Foreign Currency Loans 679.8 2,798.7 758.1 Total Amount Approved 23,454.9 22,291.0 3,766.9 Loan Commitments New Projects 4,101.3 1,130.1 372.7 On-going Projects .9,434.8 8,857.0 11,175.9 Total Commitments 13,536.1 9,987.1 11,548.6 Loan Disbursements Local Currency 10,397.8 7,533.5 11,863.1 Foreign Currency 2,537.8 1,008.9 1,868.7 Total Disbursements 12,935.6 13,731.8 1/ Excluding loans for working capital. - 46 - ANNEX 2 DEVLET YATIRIM BANKASI Income Statements (1978-1980) (TL Million) For Years Ending December 31 1978 1979 1980 INCOME Portfolio Income 7,747.9 9,950.9 11,685.9 Income on Investments 442.5 399.7 380.1 Income on Foreign Exchange Transactions 992.3 2,638.4 5,210.9 Other Income 0.6 5.5 0.3 Total Income 9,183.3 12,994.5 17,277.2 EXPENSES Interest Paid 6,592.3 7,327.4 9,483.4 Losses on Foreign Exchange Transactions 1,054.0 2,679.1 4,973.1 Other Charges and Commissions 1.2 9.4 9.5 Administrative Expenses 5.9 9.8 16.8 Salaries and Wages 24.5 40.2 66.8 Depreciation 0.7 0.8 0.8 Provisions for Possible Losses 232.0 163.5 319.9 Extraordinary Losses 1/ - - Total Expenses 7,910.6 11,671.5 14,870.3 Profit before Tax 1.272.7 1.323.0 2.406.9 Taxes Paid 1,272.7 820.3 1,491.7 Profit after Tax 791.2 502.7 915.2 1/ Under the Ministry of Finance's orders dated January 10, 1980, interest on loans totalling TL 40.1 billion which was accrued but not paid by various SEEs during 1976-78 was written off under a general consolidation of SEE debts to other SEEs including DYB. DEVLET YATIRIM BANKASI Balance Sheets (1978-1980) (TL Million) (As of December 31) 1978 1979 1980 (As of December 31) 1978 1979 1980 ASSETS LIABILITIES C rrent Assets Current Liabilities CAsh and Deposits 646.5 118.1 161.3 Interest Payable 3,148.0 3,940.1 3,822.3 Bonds 974.1 958.7 1,101.5 Accounts Payable 734.5 372.9 377.0 Akcrued Interest 3,085.6 4,362.7 4,077.6 Current Maturities of Debt 2.058.7 2,788.1 2,984.2 Akcounts Receivable 826.3 425.6 948.3 Total Current Liabilities 5,941.2 7,101.1 7,183.5 C4rrent Maturities of Loans 12,543.2 12,673.3 12,434.6 Long Term Debt Other 3.0 6.0 0.5 DYB Bonds 43,346.5 49,718.6 54,953.0 _Ttal Current Assets 18,078.7 18,544.4 18,723.8 Treasury Loans 2,805,4 6,137.2 2,674.9 J loan Portfolio IFF Funds Taken Over 581.6 507.2 426.3 Working Capital Loans 447.0 367.6 314.0 Central Bank Loans 3,097.6 5,007.0 5,640.0 Investment Loans Foreign Currency Borrowing 5,053.2 7,851.6 13,813.8 Local Currency 45,948.7 54,104.6 65,082.8 Other Borrowings 2,212.4 891.2 1,891.7 Poreign Currency 5,133,1 8,180.9 14,146.9 Gross Long Term Debt 57,096.7 70,112.8 79,399.7 Total Investment Loans 51,081.8 62,285.5 79,229.7 Less: Current Maturities (2,058.7) (2,788.1) (2,984.2) loans from Managed Funds Net Long Term Debt 55,038.0 67,324.7 76,415.5 Working Capital Loans 5,575.9 9,286.1 2,760.9 Central Bank Deposits 1,289.9 1,289.9 1,289.9 Investment Loans 5,086.4 5,432.9 5,825.8 Equity Total 10,602.3 14,719.0 8,586.7 Paid-in Capital 2,000.0 3,083.1 3,499.9 Oross Portfolio 62,131.1 77,372.1 88,130.4 Reserves and Surplus 2,582.9 3,466.3 4,732.8 ,ess: Current Maturities (12,543.2) (12,673.3) (12,434.6) Total Equity 4,582.9 6,549.4 8,232.7 Tess: Provision for Possible Losses (832.0) (995.5) (1,315.4) TOTAL LIABILITIES AND EQUITY 66,852.0 82,265.1 93_121.6 bet Portfolio 48,755.9 63,703.3 74,380.4 Pixed Assets 17.4 17.4 17.4 TOTAL ALSSTS 66,852.0 82,265.1 93,121.6 __ _ST 6_25 - - 48 - ANNEX 4 DEVLET YATIRIM BANKASI Resources (1978-1980) (TL Million) As of December 31 1978 1979 1980 Own Funds Paid-in Capital 2,000.0 3,083.1 3,499.9 Reserves and Provisions 2,813.0 3,928.6 6,048.2 Total 4,813.0 7,011.7 9,548.1 Borrowed Funds Bonds Outstanding 43,346.5 49,718.6 56,467.0 Deposits 1,289.9 1,289.9 1,289.9 Treasury Loans 240.7 184.9 126.2 IFF Funds Taken Over 340.9 322.3 300.1 Foreign Currency Loans 5,053.2 7,851.6 13,813.8 Advances from Budget 5,963.0 5,921.8 7,531.7 Total 56,234.2 65,289.1 79,528.7 TOTAL RESOURCES 61,047.2 72,300.8 80,076.8 - 49 - Selected Documents and Data Available in the Project File A. Evaluation Reports 1. Turkiye Seker Fabrikalari A.S.: Ankara, Ilgin and Susurluk Sugar Factory Projects 2. Karabuk Demir Ve Celik Fabrikalari: Karabuk Steel Plant Blast Furnace Modernization Projects 3. Karadeniz Bakir Isletmeleri A.S.: Murgul Copper Concentrator Rehabilitation, Balancing and Modernization Projects B. Consultants' Reports 1. Report of Mr. P.B. James on Turkish Sugar Industry 2. Report of Mr. S. Izgiz on Karabuk Steel Plant Modernization Project 3. Report of Mr. A.H. Yazan on Karadeniz Copper Co. Murgul Copper Concentrator Modernization and Extension Project C. Draft Appraisal Reports (prepared by DYB) 1. Ankara Sugar Factory Project 2. Ilgin Sugar Factory Project 3. Susurluk Sugar Factory Project 4. Karabuk Steel Plant Blast Furnaces Raw Material Preparation Modernization Project 5. Karabuk Steel Plant Blast Furnaces Stoves Modernization Project 6. Black Sea Copper Corp. Murgul Copper Mining and Concentrator Modernization and Extension Project D. Annual Reports (In Turkish) 1. Turkiye Seker Fabrikalari A.S. 1977, 1978, 1979 2. Turkiye Demir Ve Celik Fabrikalari 1977, 1978, 1979 3. Karadeniz Bakir Isletmeleri A.S. 1977, 1978, 1979 B U L G A R I A S e a N 34- b/ack 5ea Edr e- ..it Ineopu Sio U. S. S. R. =~~~~E QF MA4R Ii R AIQ -^sS A/l
Группа Всемирного банка · Staff Appraisal Report
Turkey - State Industrial Enterprise Finance Project
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