Turkey - Labor Intensive Industry Project

Document of -i v The World Bank FILE COPY FOR OFFICIAL USE ONLY Report No. 3189-TU TURKEY STAFF APPRAISAL REPORT LABOR INTENSIVE INDUSTRY PROJECT February 6, 1981 Regional Projects Department Europe, Middle East and North Africa Region 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.  CURRENCY EQUIVALENTS Turkish Liras (TL) per US$ 1959-70 - average 09.00 1970 - average 11.50 1971 - average 14.90 1972 - average 14.15 1973 - average 14.15 1974- - average 13.90 1975 - average 14.45 1976 - average 16.05 1977 - January - March 16.05 - March - September 17.50 - September - December 19.45 1978 - January - March 19.45 - March - December 25.25 1979 - January - April 25.25 - April - June 26.35 - June -December 47.10 1980 - January - April 70.00 - April - May 73.70 - June - July 78.00 - August - October 11 80.00 - October 12 - October 25 82.70 - October 25 - November 10 84.80 - November 11 to December 87.95 - December to date 89.25 ABBREVIATIONS AND ACRONYMS SYKB Sinai Yatirim ve Kredi Bankasi A.O. TSKB Turkiye Sinai Kalkinma Bankasi A.S. DESIYAB Devlet Sanayi ve Isci Yatirim Bankasi DYB Devlet Yatirim Bankasi EIB European Investment Bank Eximbank Export Import Bank (U.S.A.) COFACE Compagnie Francaise d'Assurance pour le Commerce Exterieur SEE State Economic Enterprises SIDO Small Industry Development Organization SMI Small-Medium Scale Industry SSI Small Scale Industry MSI Medium Scale Industry  FOR OFFICIAL USE ONLY TURKEY LABOR INTENSIVE INDUSTRY PROJECT STAFF APPRAISAL REPORT Table of Contents Chapters Page No. I. INTRODUCTION ..........................., 1 II. UNEMPLOYMENT AND PROSPECTS FOR JOB CREATION .... ......... 2 A. Trends in Labor Supply and Employment ..................... 2 B. Urbanization, Urban Poverty and Urban Unemployment ........ 3 C. Role of Industry in Job Creation - Past Performance ....... 4 D. Prospects for Employment Generation ....................... 6 E. The Bank's Involvement in Industrial Finance .... ......... 6 III. THE INDUSTRIAL SECTOR .............................., 7 A. The Economic and Policy Setting .......................... 7 B. Structural Features of Manufacturing Industry .... ........ 8 C. Problems Affecting SMI Development and Proposed Remedial Action .............. 10 D. A Strategy for Promoting Employment Generation in Industry ......................... 12 IV. THE FINANCIAL SECTOR .14 A. The Institutional Set-up .14 B. Interest Rates and Foreign Exchange Risk .15 C. Financial Assistance to Small-Medium Scale Enterprises ... 17 V. THE INTERMEDIARY - SYKB .18 A. Institutional Developments ............................... 18 B. Development Impact of SYKB's Operations ..... ............. 20 C. Financial Situation and Prospects ...... .................. 21 VI. PROJECT AND LOAN FEATURES ........ ........................ 26 A. The Project ............................................... 26 B. Loan Features .................... 30 VII. RECOMMENDATIONS .33 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.  Annexes Annex 1: Deficiencies and Technical Assistance Requirements of SMI in Turkey Annex 2: Interest Rates on Industrial Loans and Final Cost of Borrowing Annex 3: SYKB: Approvals, Commitments and Disbursements: 1976-June 1980 Annex 4: SYKB: Analysis of Approvals by Sector, Geographical Location, Size, Repayment Terms and Type of Projects: 1976-June 1980 Annex 5e SYKB: Summary Income Statements 1976-1979 Annex 6: SYKB: Summary Balance Sheets 1976-1979 Annex 7: SYKB: Summary of Arrears Annex 8: SYKB: Sectoral Distribution of Loans Outstanding Annex 9: SYKB: Projected Loan Approvals, Commitments and Disbursements Annex 10: SYKB: Summary of Projected Income Statements 1980-1984 Annex 11: SYKB: Projected Sources and Applications of Funds 1980-1984 Annex 12: SYKB: Projected Balance Sheets for the End of 1980-1984 This report is based on the findings of an appraisal mission which visited Turkey in June 1980 and was composed of Messrs. S. Banerji, Z.S. Khan and S. Malik. Mr. G.C. Maniatis headed the sector survey/project identification mission and contributed to the report. Mr. F. Batzella headed the preappraisal mission.  TURKEY LABOR INTENSIVE INDUSTRX PROJECT I. INTRODUCTION 1.01 The economic crisis in Turkey which began in mid-1977 still con- tinues and is reflected in poor growth rates, large balance of payments deficits, and high inflation and unemployment l/. Since 1978, the Govern- ment has implemented a number of stabilization measures, the most compre- hensive and far reaching of which is the January 1980 economic program 2/. However, given the accumulation of economic problems and Turkey's limited capability over the medium-term in increasing considerably the net inflow of capital, a return to stable growth will inevitably take time. Unemploy- ment, particularly in urban areas, which began to increase rapidly after 1973 when external migration slowed down and worsened further in recent years due to deteriorating economic conditions, has become an overwhelming social issue. 1.02 Employment growth in the services sector which absorbed the bulk of the labor force in the past two decades has slowed down considerably. Because of rapid mechanization and other deep-seated factors in agricul- ture, a net outflow of workers from the sector can be expected to con- tinue. The industrial sector, on the other hand, has generated far fewer jobs compared to its share of investment because of industrial policies which favored capital-intensive investments. Nevertheless, considerable potential for generating new productive and permanent employment opportuni- ties exists within the industrial sector, particularly through the develop- ment of relatively labor and skill intensive industrial enterprises. Recent policy initiatives of the Government indicate its awareness of and reliance on the industrial sector in generating more jobs. Small (SSI) and medium scale (MSI) labor and skill intensive industrial enterprises appear to have considerable growth potential in such sub-sectors as engineering, processed foods, etc. where Turkey has a comparative advantage and export prospects due to the large supply of skilled labor at comparatively low wages, domestic availability of appropriate raw materials and intermediate products, and proximity to markets in Europe and the Middle East. The development of this segment of industry not only offers good prospects for efficiently generating employment opportunities in urban areas, but also in promoting the structural transformation of the industrial sector in the direction of greater efficiency 3/. 1/ A detailed review of Turkey's economic situation and prospects appears in Turkey - Policies and Prospects for Growth, March 1980. 2/ This has been described and discussed in detail in the President's Report No. P-2727-TU dated February 29, 1980. 3/ For a more comprehensive and detailed analysis of employment issues and the industrial and financial sectors, see Report No. 2913-TU entitled "Prospects for Small-Medium Scale Industry Development and Employment Generation", September 1980.  - 2 - II. UNEMPLOYMENT AND PROSPECTS FOR JOB CREATION A. Trends in Labor Supply and Employment 2.01 Turkey's total population in 1978 was estimated at 43 million, having grown by an annual average rate of 2.5% since the mid-1950s. Although the total working age group has increased at roughly the same annual rate as total population, the growth in total labor force (estimated at 16.1 million in 1978) at 1.6% per annum has been much slower, reflecting a decline in the labor force participation rate. Despite the slower growth of the labor force compared to population, the Turkish economy has created far fewer jobs than required to absorb the growing labor force during the past fifteen years. Total employment grew from 12.6 million in 1962 to 14.7 million in 1977 or by only one percent per annum during each of the three plans covering the period 1962-1977. The difference between the growth of total employment and total labor force has been particularly large during the Second (1968-1972) and Third Plan (1973-1977) periods. This disparity in growth rates did not result in a rapid rise in unemploy- ment during the Second Plan period mainly because of the rising emigration of workers abroad. From a negligible amount in 1962, the number of workers employed abroad had grown to over 800,000 in 1975, or about 16% of total non-agricultural employment. However, since 1973 net migration abroad has declined sharply, and employment abroad as a percentage of total non- agricultural employment has fallen to below 13% in 1979. Although the relevant statistical series on employment are of limited coverage and reliability, the unemployment rate in Turkey appears to have increased sub- stantially in recent years as a result of reduced external migration, worsening economic conditions and sluggish growth of productive employment opportunities. Non-agricultural employment rose by only 134,000 in 1978, as compared with 196,000 in 1977. Total surplus labor including that in the agriculture sector is estimated to have exceeded 2.8 million or about 20% of the labor force in 1979. 2.02 The growth and sectoral distribution of employment is shown in the table below. SECTORAL DISTRIBUTION AND GROWTH OF EMPLOYMENT Percent Shares Growth Rates 1962 1967 1972 1977 1963-67 1968-72 1973-77 Agriculture 77.0 72.2 66.9 61.8 -0.4 -0.5 -0.4 Industry /a 7.9 9.2 10.7 12.6 4.2 4.1 4.5 Manufacturing (7.2) (8.2) (9.7) (11.0) 3.5 4.4 3.8 Services 15.1 18.6 22.4 25.6 5.2 4.8 4.2 Total Civilian Employment 100.0 100.0 100.0 100.0 0.9 1.0 1.2 /a Includes mining, manufacturing, electricity, gas and water.  - 3 - Between 1962-1977 employment in agriculture declined in absolute terms and its share in total employment decreased by about 15%. During the same period, the bulk of the increase in employment outside agriculture occurred in services, whose share in total employment increased by over 10%. Indus- trial employment increased at between 4 and 4.5 percent per year on average during the three Plans, but its share in total employment, at around 13% in 1977, is still quite small. B. Urbanization, Urban Poverty and Urban Unemployment 2.03 Turkey is rapidly evolving into an urban and industrial country. Urban population has been growing at about 5% per annum, or double the national average, with the urban share of the total population increasing from 18% in 1950 to 45% in 1978. The seven largest urban centers 1/ (over 250,000 population) increased their share in the national population from 35% to 41% between 1965-1975, particularly at the expense of the smaller urban centers in the 10,000-100,000 size category, suggesting that rural- urban migration has tended to bypass the smaller centers in favor of larger cities. These deep-seated urbanization trends can be expected to persist. Urban population growth is projected at 4.5% per annum for the next decade and it is anticipated that 75% of the population might be urban residents by 1995. 2.04 Available data suggest an increasing concentration of urban poor in the smaller centers--or that the incidence of urban poverty 2/ is inversely related with the size of the urban center. Thus, in centers of 100,000-500,000 in size, the incidence of poverty is twice that of the metropolitan centers, and in smaller centers even greater. The higher incidence of poverty in secondary urban centers basically reflects greater difficulty in securing employment due to the persistent (and widening) gap between available employment opportunities and growth of the local labor force. Both the urbanization trends and the spatial incidence of urban poverty strongly suggest the need for sustained effort to create new job opportunities in smaller urban centers. 2.05 The number of urban unemployed, i.e. excluding surplus labor in agriculture, exceeded 1.5 million in 1979 or about 10% of the total labor force. Registrations in employment exchanges indicate that non- agricultural unemployment in the 67 provinces of Turkey increased on an average by over 18% a year during 1970-1977. The increase was particularly sharp in the East and South-East regions, followed by the Mediterranean and Black Sea regions. The metropolitan cities of Ankara and Istanbul alone accounted for 22% of total urban unemployment and, along with Izmir and l/ Istanbul, Ankara, Izmir, Bursa, Eskisehir, Adana and Gaziantep. 2/ Defined as households with incomes less than one-third the national average or TL 31,000 in 1976 prices.  - 4 - other regional urban centers 1/, their combined share exceeded 75% of total urban unemployment in 1977. Regional urban centers show a higher growth rate of unemployment than the major cities which partly reflects a lower base but also the greater difficulty in securing employment. Unemployment (1976-1977 averages) for all Turkey appears particularly high among primary school graduates (54%), followed by middle level (26%) and barely literate (19%). This pattern suggests in part the importance of providing a minimum number of years of schooling and of upgrading technical skills to enhance the employment potential of the labor force. C. Role of Industry in Job Creation - Past Performance 2.06 Turkish planning focused primarily on rapid growth and moderniza- tion through industrial development, especially growth of manufacturing, since it was regarded as the basis for economic and social development. The generation of employment was supposed to follow naturally from rapid industrial growth and the concomitant high rates of investment. However, the Government's import substituting development strategy as well as the industrial and financial policies that were followed, channelled a large part of industrial investment to sub-sectors 2/ and projects with high incremental capital-labor ratios 3/, particularly in the public sector, so that industry's share of employment increased very slowly compared to the growth of industrial investment. Manufacturing industry received about 27% of total investment during 1968-1978, but its share of total employment only increased from 7.1% to 11% in the same time span. The implicit sub- sidy on imported capital equipment provided by overvalued exchange rates, together with custom duty deferrals or exemptions, and the policy of main- taining relatively low (even negative) interest rates undoubtedly encour- aged capital-intensive investment. Institutional factors i.e. labor legis- lation and increased unionization as well as a high degree of industrial strife also influenced investment decisions and technology choices in the same direction. 2.07 Although capital intensity in the private sector has been increas- ing relatively faster than in the public sector for the past several years, on average it is still only two-thirds of that in public sector enterprises in spite of the high level of overstaffing prevalent in public enter- prises. The lower capital intensity of the private sector is in part 1/ Adana, Afyon, Antalya, Aydin, Balikesir, Bursa, Elazig, Eskisehir, Gaziantep, Hatay, Kayseri, Kocaeli, Konya, Kutahya, Malatya, Sakarya, Samsun, Sivas, Trabzon and Zonguldak. 2/ Iron and steel, chemicals, pulp and paper, petroleum, and non-metallic minerals. 3/ For example, the average cost per job created in the manufacturing sector increased from $16,700 in 1976 prices during the First Plan period to $35,750 in 1976 prices in the Third Plan period.  -5- due to its greater involvement in light and non-process industries-- fabricated metal products, electrical and mechanical machinery, building materials, wood and furniture, leather and food industries--which have on average lower capital intensity than basic and intermediate goods indus- tries, as well as because it is predominantly populated by small and medium scale industrial enterprises which have a relatively lower capital inten- sity compared to large scale enterprises. Detailed and comparable sta- tistics on the distribution of capital intensity by size of establishment within individual industrial sub-sectors are lacking. Nevertheless, a comparison of the investment cost per job for 542 projects granted Certifi- cates of Encouragement between January 1979 and June 1980, roughly two-thirds of which were new projects, shows that the average investment cost per job for projects below TL 40 million ($570,000)(SSI) is roughly one-half that of projects between TL 80 million ($1.14 million) and TL 160 million ($2.28 million) (MSI). Furthermore, the average investment cost per job for the small and medium scale (SMI) group, i.e. below TL 160 mil- lion investment, is TL 1.06 million ($15,100) which is less than one-third the average investment cost per job (TL 3.28 million or $46,800) of the larger projects. This attests to the significantly lower capital intensity of the SMI group. It is noteworthy that during 1970-1977, the share of SMI in total manufacturing employment increased from 31% to 35% and including the unorganized sector, their share currently stands at about 55%. TURKEY INVESTMENT COST PER JOB BY PROJECT SIZE IN MANUFACTURING /1 Total Investment Average Investment Number of in Mach. & Equip. Employment Cost Per Job Size Projects ('000 TL) Generation ('000 TL) US$ /2 Investment in Mach. & Equip. Below TL4O million 129 3,523,465 4,896 720 10,290 TL40-TL80 million 146 8,435,001 8,979 939 13,400 TL80-TL160 million 108 12,267,042 8,868 1,383 19,760 TLl60-TL320 million 69 15,940,000 8,466 1,883 26,900 TL320-TL640 million 44 19,540,407 9,947 1,964 28,050 TL640-TLI,000 million 18 14,451,318 4,779 3,024 43,200 Over TL1,000 million 28 103,793,432 23,677 4,384 62,630 Total 542 177,950,665 69,612 2,556 36,500 /1 Based on projects which received Certificates of Encouragement during 1979-June 1980. /2 Based on an average exchange rate of TL 70 = $1. Source. State Planning Organization, 1980.  -6- D. Prospects for Employment Generation 2.08 The future level of unemployment depends on the growth rates of labor supply and employment opportunities. Labor supply is projected to increase by 330,000 per year over the next five years. It is, however, considered most unlikely that employment growth in the medium term will keep pace with the growth of the labor supply. In agriculture, since past trends in mechanization and other deep-seated factors are likely to persist, there may even be a decline in aggregate sectoral employment in absolute terms. The employment growth rate in the services sector has also been declining in recent years (para. 2.02). This sector is expected to create some 175,000 new jobs annually over the next five years. However, employment in the services sector includes informal urban sector employ- ment, much of it of a marginal nature which is socially and politically undesirable. With the industrial sector projected to absorb some 85,000 workers per year, it is evident that the number of job seekers is likely to increase by about 70,000 annually over and above the existing stock of unemployed. 2.09 In view of the above, it is apparent that the industrial sector will have to assume greater responsibility for creating productive employ- ment than hitherto considered necessary. Given the steadily increasing capital intensity of industrial investments and the limited availability of investment funds, the only sensible means of accomplishing this objective would be a concerted effort to foster development of relatively more labor- intensive but efficient industries. Small and medium scale labor and skill intensive enterprises have considerable growth potential in a wide range of activities (para. 3.13) and the expansion of this segment of industry offers the greatest potential of creating productive and permanent jobs in urban areas at a relatively low investment outlay--which provides the rationale for the proposed project. E. The Bank's Involvement in Industrial Finance 2.10 The Government has increasingly become concerned with the rising unemployment. The macroeconomic policy changes introduced as a part of the Government's structural adjustment program articulated in January 1980, can be expected to have a favorable impact on employment, since export-oriented sectors stressed by that program have relatively low capital-labor ratios. The recent liberalization of the interest rate regime and the adoption of a flexible exchange rate policy, should also help remove the bias towards capital intensity in agriculture and in industry. Furthermore, in the con- text of the identification and preparation of the proposed project, the Bank prepared a sub-sector report entitled "Turkey - Prospects for Small- Medium Scale Industry Development and Employment Generation" (Report No. 2913-TU) which has been published with the Government's concurrence. The report makes a number of specific recommendations aimed at fostering the efficient development of labor intensive SMI (e.g. a program to strengthen the Halk Bank's organization and procedures). The Government has already implemented a key recommendation to provide eligible SMI with the same  - 7 - incentives as is available to large firms under the Certificate of Encour- agement 1/ and has also agreed to assume the foreign exchange risk for SSI borrowers under the proposed project (para 6.13). During negotiations, the Government's attention was drawn to the recommendations made in the SMI Report (cf), particularly the need for developing an overall development strategy and policy for the SMI sector. It is intended to continue this dialogue in future projects of this nature. 2.11 The Government's new economic policies favor an enlarged role for the private sector in developing manufacturing industry with new public investments mainly directed towards developing infrastructural facilities. The private sector is expected to take the lead in creating jobs and increasing exports. The Bank fully endorses these initiatives, and is assisting Turkey in fostering the process of structural change in the industrial sector through increased support for private investments. In recent years the Bank through its operations has induced TSKB to increase its lending to projects located in less developed regions, to labor inten- sive enterprises and to export oriented projects. It has also made a loan to TSKB and SYKB to provide financial and technical assistance to private sector export oriented textile projects. The Bank now plans to further emphasize this orientation towards exports and employment in support of Government policies. The prospective lending program includes additional loans through intermediaries to further strengthen the export capability of private enterprises. The proposed project, primarily aimed at fostering employment generation through the development of labor intensive manufac- turing industry, is expected to be followed in the future by additional projects with the same objectives, possibly including other intermediaries. III. THE INDUSTRIAL SECTOR A. The Economic and Policy Setting Role of Manufacturing Industries in the Economy 3.01 Rapid growth coupled with the pursuit of an import substitution strategy has led to a substantial structural change in the manufacturing sector. The share of intermediate and investment goods in manufacturing value added increased steadily from nearly one half in the early 1960s to about two-thirds in the mid-1970s. Value added in manufacturing grew at an annual average rate of about 10% and its share in GDP at factor cost 1/ Under the Certificate of Encouragement, projects located in less developed regions, or in specified priority sectors or with an export undertaking are entitled to various incentives (depending on the nature of the project) which include interest rebates, exemption from the transaction tax on interest and exemption or deferral of customs duties. See Annex 2 for details as well as para. 8.02 of Report No. 2913-TU.  - 8 - increased from 13% to 20% between 1962 and 1977. However, it increased by only 3.1% in 1978 and declined by 5.9% in 1979. Similarly, fixed invest- ment in the manufacturing sector, which absorbed some 30% of total fixed investment up to 1975, has registered a 25% decline in the last two years and its share in total fixed investment has fallen to 25%. An important reason for this steep decline is the extremely low level of capacity utilization (45% in 1979) mostly due to the acute shortage of foreign exchange, power, fuel oil and other domestic inputs. However, smaller firms achieved a higher capacity utilization (70% in 1979) partly because of lesser dependence on imported raw materials and spares. The share of manufactures in Turkey's total merchandise exports increased from 17% in the late 1960s to about 35% between 1970 and 1979. But manufactured exports still constitute a very small proportion (around 7%) of manufactur- ing production. The dominant export commodity is textiles and clothing (50% of the total), followed by food products (15%) and leather products (7%). The private sector has historically invested mainly in profitable consumer goods production. Its share in total manufacturing investment has declined from almost 80% at the start of the First Plan to just over 50% at the end of the Third Plan. It currently accounts for 45% of total manu- facturing investment, 69% of value added, 83% of employment in manufactur- ing and 86% of manufacturing exports. During 1965-1975, value added in the organized 1/ private sector increased at a respectable annual average rate of 17% compared to about 9% in the public sector, in spite of the increas- ing share of the public sector in manufacturing investment. B. Structural Features of Manufacturing Industry Size Distribution 3.02 Small (establishments with less than 50 workers) and medium scale enterprises (establishments employing 50-200 workers) are predominant in Turkish manufacturing 2/. In 1970, there were about 175,000 establishments in the private sector 3/, of which 487 (or 0.3% of total) employed 200 or more workers, 941 (or 1.2%) between 50 and 199, 3,391 (or 1.9%) between 10 and 50 workers, and the balance of some 170,000 establishments (or 97.2%) less than 10 workers. In the last category, the so-called unorganized sector, over 162,000 (or 93%) establishments employed 4 or less workers. There is no recent statistical information available on the unorganized 1/ Comprising establishments employing 10 or more workers. 2/ Because of the unavailability of industrial sector data disaggregated by asset size of enterprises, SSI and MSI are defined here in terms of number of workers employed rather than by asset size. However, both definitions are comparable based on the capital intensity of SMI projects granted Certificates of Encouragement (para. 2.07). 3/ They probably number around 180,000 currently.  - 9 - sector, but the situation probably has not changed perceptibly in this sec- tor during the 1970's. In the organized sector, between 1970 and 1977 the total number of establishments increased from 4,819 to 8,537, or by an impressive 77%. The increase has been more dramatic in the medium (50-200) and small scale industry (10-49) sectors, where the number of establish- ments rose by 88% and 82%, respectively. The number of large scale estab- lishments also increased, but by a modest 23%. The observed growth is mostly the net result of new entry and upward inter-class shifts all the way up from the unorganized sector. Sectoral Distribution 3.03 Analysis of the sectoral distribution of the growth in the number of manufacturing establishments in the organized sector during 1970-1977 indicate that the most dramatic increases, both in absolute numbers and percentage-wise, have been in basic metals, including foundries, and metal products, followed by leather products, plastics, and chemicals, reflecting the potential in these industries and the quick response of new entrepre- neurs, as evidenced by the high incidence of new entry in the face of rising demand for consumer and intermediate goods (backward linkages). It is also notable that in the more traditional industries such as food, beverages and textiles (excluding clothing), the growth in the number of establishments was very low. This reflects the already higher level of development of these industries (large original base) and, possibly, growth in the size of establishments. Distribution of Employment 3.04 The distribution of employment by size of establishment in the organized manufacturing sector is shown below. DISTRIBUTION OF EMPLOYMENT IN THE ORGANIZED MANUFACTURING SECTOR Size of Establishment Year Growth Rate, 1970-77 (No. of Persons Employed) 1970 % 1977 % % Annual Average 10-49 71,681 14 123,411 16 72 8.1 50-99 41,971 8 74,318 9 77 8.5 100-199 47,156 9 80,836 10 71 8.0 200+ 349,648 69 511,328 65 46 5.6 Total 510,456 100 789,893 100 55 6.5 Source; Table 8, Report No. 2913-TU. Employment in manufacturing increased by 55% during 1970-1977, growing at an annual average rate of 6.5%. The growth rate has been much higher (8.0-8.5%) in the medium and small compared to the large scale enterprises  - 10 - (5.6%) 1/. Enterprises in the 10-200 workers range created 118,000 new jobs between 1970 and 1977, or 17,000 a year, which is quite remarkable when compared to 161,000 jobs, or 23,000 annually, created by the 200+ firms during the same period. The increase in employment has been the result of the growth in the number of establishments, primarily at the lower end of the spectrum, as well as of the growth in the size of firms, measured by the number of persons employed, particularly at the upper medium and large scale industries. In the SMI segment of industry, employ- ment growth has been particularly high in basic metals, metal products and leather goods, raising substantially their respective shares in total employment in this segment. Metal products, textiles and clothing, food and beverages, chemicals and basic metals accounted for 88% of total employment in the small-medium size group. This same group also accounts for 94% of total employment in large scale industry. Regional Distribution 3.05 In spite of the Government's efforts to foster regional dispersal of industry through investment incentives, manufacturing industries show a high regional concentration in the four major urban areas which account for about 75% of the total number of manufacturing establishments. Istanbul accounts for 42%, followed by Marmara (14%), Izmir (10%) and Ankara (8%). Though the bulk of the unorganized small firms are also located in the major urban areas, small firms in the same industries are often con- centrated in certain urban centers e.g. metal products in Gaziantep, Bursa and Konya; leather products in Istanbul. The above points to the need for continued efforts at regional dispersal of industries, particularly aimed at employment creation in the secondary urban centers. C. Problems Affecting SMI Development and Proposed Remedial Action Internal Constraints 3.06 SMI generally face internal and external constraints which create conditions inimical to efficient operation. Major internal problems adversely affecting productivity, quality of output or service and, by extension, constraining the growth of SMI and particularly of SSI, include; (a) out-of-date machinery; (b) deficient technical and management methods (product design and production procedures, engineering, production planning and work methods, materials selection and procurement, quality control, preventive maintenance, etc.); (c) poor working conditions and housekeeping, in part due to shortage of suitable factory premises and infrastructure; and (d) marketing problems. Annex 1 provides in a tabular 1/ To the extent that underreporting by smaller establishments for a variety of reasons (e.g. evasion of social security and tax payments) takes place, the actual level of employment is underestimated. So are levels of production and value added.  - 11 - form an assessment of the deficiencies in five important industries-- engineering, wood-working and furniture, leather processing and footwear, chemical, plastic and rubber products, and garments/made-up goods. Not all of these problems necessarily apply to every enterprise. Their relative importance varies with the particular industrial activity, size of establishment, and the surrounding circumstances of each enterprise 1/. Nor do they imply that the small enterprise is inherently inefficient. Their existence rather attests to a built-in weakness, namely the lack of specialized managerial, technical and marketing expertise within a small organization. External problems tend to compound the internal ones. Limited access to institutional finance and technical assistance make it difficult for smaller firms to improve their operations. These deficien- cies are institutional in origin, reflecting past ambivalence regarding the development potential of the sector and inadequate allocation of credit and technical assistance by intermediaries supposedly responsible for assisting SMI. 3.07 At this juncture, the "technological gap" and the attendant need for "vertical" as opposed to "horizontal" growth of production units pose a more intractable problem. For SMI using traditional skills to produce basic consumer goods such as furniture, garments, footwear, simple building hardware and household utensils for a relatively undemanding market, this is not a serious problem. Productivity and quality in these subsectors can usually be upgraded without too much difficulty by introducing and financ- ing better tools and simple machines (hand operated or powered) and demonstrating their advantages on-the-spot or in formal shop practice courses. For modern SMI, on the other hand, considerations involving product design and quality, operating efficiency and the importance of meeting promised delivery schedules, market expansion nationally and inter- nationally, dictate size of factory and management sophistication above the micro-range. Adequate production facilities, specialized staff and manage- ment skill (financial, technical and commercial) are critical to the suc- cess of the enterprise, whether producing finished products or components for larger factories. It is therefore necessary to complement any program of financial assistance with appropriate technical assistance in order to bring about the desired modernization and improvements in operating efficiency. 1/ Medium scale establishments usually have less need for general institutional technical assistance. Areas requiring outside assistance refer primarily to marketing, financial planning, management functions, and to technical problems which are specific to the industry and require specialized know-how (e.g. metallographic analysis in foundries, quality and process control in chemicals). Such types of technical assistance are usually available from suppliers of machinery, engineering consulting firms and universities (e.g. Middle-Eastern Technical University). Financial intermediaries could help diagnose problems, extend assistance, or refer firms to appropriate delivery agencies.  - 12 - 3.08 The relatively advanced stage of industrial development in Turkey dictates fundamental differences in the formulation of technical assistance programs compared with other developing countries. Thus, it is important to appreciate that there is no dearth of small entrepreneurs; the need is rather to redirect an increasing share of industrial growth into modern more efficient small-medium size enterprises. Institutional assistance in identifying, evaluating, financing and implementing suitable projects should, therefore, be strongly oriented to promoting partnership, corporate or cooperative ownership. Similarly, improvements in project design, plant layout and equipment selection, factory operations, necessitate a more sophisticated level of technical assistance. The extension services of the Small Industry Development Organization (SIDO) 1/, currently being reorganized and strengthened should be able to assist in the solution of the more routine problems, but specialized consultants are required to assist in the solution of more complex technical and management problems faced by medium scale and small scale enterprises in the upper end of the size range. It is, therefore, proposed through the project to complement the extension services to be made available under the SIDO program in the near future by providing specialized consulting services to enterprises receiving financial assistance (para. 6.06). D. A Strategy for Promoting Employment Generation in Industry 3.09 In devising a strategy and the requisite policy framework to promote industrial employment creation in urban areas, the role of SMI looms large. Indeed, creation of employment opportunities and growth of SMI are closely linked. Industrial development in Turkey has progressed to the point where future growth of SMI depends on increasing adoption of modern efficient production processes, specialization in production, improved product designs and higher product quality, modern management methods, and developing closer linkages with larger manufacturing firms either as sub-contractors or ancillaries for the provision of parts, components and sub-assemblies or with large scale trading establishments serving either the national or export markets. Tnese needs can be achieved primarily through well-conceived and properly tailored financial and 1/ The Small Industry Development Organization (SIDO), has been evolving since 1968 with UNDP/UNIDO finance and technical assistance with the objective of providing non-financial assistance to small scale enter- prises. During the first phase (1968-78) a regional pilot program was implemented at Gaziantep which included a model industrial estate, a common workshop and laboratory facilities and a technical extension service. The Ministry of Industry now plans to replicate the program with suitable modifications reflecting the Gaziantep experience, to cover four to six additional regional urban centers. The extension service of the SIDO program which is still in an embryonic stage aims to provide assistance in resolving technical, management and marketing problems of SSI. For additional details, see paras. 7.09-7.13 of the Turkey SMI Report (cf).  - 13 - technical assistance programs, including skill upgrading and accelerated training; promotion of cooperation between small and large enterprises (e.g. through sub-contracting or marketing arrangements, etc.); and by inducing structural changes (e.g. cooperative arrangements and consolida- tion of smaller enterprises), export orientation, and adaptation to new circumstances, rather than protecting inefficient and out-of-date methods of production from the competition of more modern methods. Also the effort to develop SMI should have an export-orientation. The presumption seems to be that exporting firms should be large, entrenched entities. However, in the light of Turkey's own experience in garments and leather, this is not a condition sine qua non. 3.10 Emphasis on relatively less capital-intensive and more on skill- intensive technologies, which are to a considerable extent suitable for SMI, should greatly facilitate job creation. This does not mean to imply, however, that the introduction of more sophisticated and specialized equip- ment at this stage of Turkey's development should be discouraged. What it does suggest is that an indiscriminate choice of highly capital-intensive techniques and equipment should be avoided. Given the scarcity of capital and foreign exchange and the comparatively lower wages in Turkey by US or European standards, a conscious effort should be made to adopt, to the extent possible, appropriate technologies suitable to the local circum- stances. Appropriate technology in this context should be viewed rather as a complement to, and not a substitute for, modern technology. Financial intermediaries such as SYKB could play a useful role in guiding prospective borrowers in the choice of appropriate technology. 3.11 The objective should be to achieve an appropriate balance between larger and smaller (but efficient) establishments, utilizing more or less capital-intensive techniques, in accordance with the country's factor endowment--a symbiotic relationship in which the activities of small and large firms conform to their respective comparative advantages l/. In essence then the strategy should be to direct private investment and to extend support primarily to SMIs with relatively high probability of survival and success and conducive to promoting the gradual integration of the SMIs with the rest of the industrial sector. Viability and self- sustained growth of SMI are most likely to be attained, it would seem, by focusing on industrial activities with promising growth potential and characterized by rather low economies of scale, catering to specialized or low-priced market niches, or displaying complementarity with activities undertaken by larger firms in the form of ancillary or sub-contracting arrangements, or provision of services. At the enterprise level, the establishment with a realizable potential for growth, and consequently for continuing viability, is likely to be the one in which there is some degree of specialization of management functions. 1/ The issue is not promotion of small versus large establishments, or indiscriminate support of SMI for the exclusive purpose of alleviating unemployment at any cost.  - 14 - 3.12 Subsectors which appear most promising in terms of potential growth of SMI comprise the foundry, engineering (fabricated metal products, electrical and non-electrical machinery, transport equipment, and profes- sional and scientific equipment), food processing, ready-made garments, footwear and leather products, wood-based and furniture, plastics, and con- struction materials. Aside from growing domestic demand and export poten- tial, factors reinforcing the potential growth and viability of the SMI in these industries include: relatively low scale economies in a wide range of activities in each industry; locational factors, such as local process- ing of bulky raw materials (saw mills) or local production of bulky prod- ucts (construction materials); complementarity with larger industry, involving manufacturing operations in which the processes are readily separable (e.g. producing specialized machine products, components and tools), craft or precision handwork, simple operations of assembly, mixing or finishing, provision of services and repairs to other industries; pro- duction of differentiated products for specialized markets, or low-priced mass consumption goods. Engineering is perhaps the most inviting of all subsectors, and its development should therefore command higher priority, as it combines virtually all the above mentioned features. In general, all industries mentioned above belong to the so-called "modern" SMI sector but, for a wide range of products, they require small-medium scale of plant and low capital intensity 1/. Their expansion should inter alia enlarge employment in the urban areas in an economically efficient manner. IV. THE FINANCIAL SECTOR A. The Institutional Set-up 4.01 Turkey has a well-developed banking system. At the end of 1977 there were 40 banks, state or privately owned, excluding the four invest- ment banks DYB, TSKB, SYKB, and DESIYAB; of these, 28 are privately-owned with 5 foreign-controlled. The remaining 12 are banks established and controlled by the state under special laws and serve as instruments to implement the Government's economic development objectives. Although the state-owned institutions provide regular banking services, such as holding deposits or making loans, each bank serves a specific industry or target group, e.g. agriculture (Ziraat Bankasi), small industry (Halk Bank), etc. The private commercial banking sector is characterized by a high degree of concentration, with three banks (Is, Yapi-Kredi, and Akbank) accounting for 70% of the assets and credits in this segment of the sector. Commercial banks have an extensive network of branches throughout the country and even small urban centers are served by several banks, implying a high level of competition for deposits, the bulk of which is onlent to the more developed regions. 1/ The kind of activities suggested here are known to be dominated by SMI and expressly exclude the traditionally large scale, capital-intensive "process industries" (steel, aluminum, pulp, fertilizer, etc.).  - 15 - 4.02 Roughly half of total private fixed investment in the organized sector of industry is financed by intermediaries, including commercial banks. Another 40% of private industrial investment is financed out of internally generated funds; about 8% from bond issues, and the remaining 2% through direct foreign financing. TSKB provided about 6.5% of the total fixed investment requirements of organized sector private manufacturers during 1977-1978 followed by SYKB with 1.5%, the latter mostly for domestic currency investments. The other sources of long-term industrial finance are the new and rapidly-growing State Industry and Labor Investment Bank (DESIYAB), designed to mobilize inter alia the savings of migrant workers for investment in widely-owned companies mainly in the less developed regions (potentially complementing TSKB's regional development efforts), the Halk Bank, a Government owned commercial bank, which provides a modest amount of term finance for investment in fixed assets by small scale indus- try and artisans and the Investment Finance Corporation, established in 1976, which participates in the equity of large industrial firms located in the less developed regions. Commercial banks provide an estimated 30%-35% of total fixed investment requirements, mostly through short term loans which are periodically rolled over. 4.03 Commercial banks focus heavily on short term lending and mainly cater to the needs of larger companies in which they have equity holdings. Private commercial banks control a large share of the equity of major com- panies (portfolio of shares and securities was TL 11.5 billion in 1977), reflecting the promotion of such undertakings by controlling interests. In turn, the principal industrial concerns in Turkey are major shareholders of private banks, which attests to the close linkages between the financial and manufacturing sectors. In the secondary urban centers where competi- tion for business is keener, smaller enterprises have access to commercial banks for working capital finance, assuming the client satisfies the stringent security requirements. However, since 1972, commercial banks have increased medium-term lending to the private sector, in response to regulations whereby they were required to earmark 10% (and, since 1976, 20%) of their portfolio for loans of 2-5 year maturities. The private commercial banks have sustained virtually no losses from credit operations and operate on high profit margins. The return on equity increased from 23% in 1972 to 63% in 1977 primarily through decreased capital ratios while maintaining profit margins on total assets. B. Interest Rates and Foreign Exchange Risk 4.04 Until July 1, 1980 Government regulated interest rates both for deposits and lending, differentiating by activity and maturity. Nonethe- less, interest rates on deposits increasingly provided negative real returns to savers due to the accelerating inflation. This has led to disintermediation and diversion of investments to real estate and other non-financial assets. Lending rates were differentiated by activity to encourage investment in priority activities and regions, a policy which has met with some success. This was accomplished through interest rebates both to the borrower and the lender with commercial banks being especially encouraged to lend on a medium term basis through access to the Central Bank's rediscounting faciLity. The interest rate on industrial loans was  16 - 27.5% (including a 5.5% transaction tax) before any interest rebates which ranged up to 9% depending on the nature of the project. However, no dis- tinction was made between interest rates on foreign and local currency loans, though borrowers of foreign currency assumed the full exchange risk. While the interest rates on TL loans were negative in real terms, the effective cost of foreign currency loans was high compared to rates prevailing in the international capital markets. As a result, the demand for such funds was sharply curtailed. The paucity of long term savings, combined with negative real interest rates on TL loans, created an excess demand for TL credit, and resulted in a severe shortage of local currency credit. 4.05 The interest rate regime was reformed on July 1, 1980 in line with the Government's new macro-economic policies, particularly those aiming at restraining domestic inflation, maintaining a competitive foreign exchange rate and fostering mobilization of savings. The Government officially deregulated interest rates, allowing the banks to fix freely interest rates on private sector TL deposits and loans. The banks now collectively deter- mine base interest rates before commission, taxes and subsidies for TL loans for industrial borrowers based on activity and maturity (Annex 2). These base lending rates are revised every six months by the banks taking into account expectations of inflation and market conditions. In addition to the base rate, borrowers are charged a 2% commission for collateral held, and a transaction tax plus an interest equalization fee totalling 40% of the base interest rate. Qualifying borrowers, however, are eligible for interest rate rebates from the Government on priority investment projects issued Certificates of Encouragement varying from 25% to 60% of the base rate, depending on the nature and location of the investment (para. 3.02). As rebates on all loans are often paid with considerable delay, the incentive effect is somewhat diluted. The current effective interest rate on TL loans for the first half of 1981, after taking into account various taxes and charges but excluding rebates, varies from 30% to 48% on medium term TL loans and on long-term loans it is about 52% 1/ (Annex 2). The adoption of the present system of market-determined interest rates for TL deposits and loans represents a significant step towards insuring that interest rates closely reflect domestic inflationary expectations and market conditions. In fact, deregulation has led the banks to increase interest rates substantially on term deposits over the past six months (from 15% to 33% for deposits of between six months and one year maturity) and has contributed to improved resource mobilization. It can thus be reasonably concluded that the variable interest rate policy adopted by the banking system should ensure interest rates that reflect the true cost of capital during the life of the project, and hence unlikely to result in a subsidy to the borrower. 4.06 On foreign currency loans, the base interest rate is set by the intermediary's cost (or the weighted average cost) of foreign currency 1/ Domestic inflation levels are projected at 85% in 1981, 60% in 1982, 40% in 1983 and 20% thereafter. Based on these assumptions, the nominal interest rate would have to be 37.5% for a TL sub-loan of seven years maturity to yield a zero real interest rate.  - 17 - borrowings plus a spread of 3.5%. Borrowers also pay a transaction tax and interest equalization fee of 40% on the base interest rate and are eligible for interest rebates depending on the nature and location of the invest- ments as in the case of TL loans. Thus, the effective interest rate on foreign cuirency loans, after taking into account all taxes and charges but excluding rebates, varies between 16.6% and 19.8% with the borrower assuming the full foreign exchange risk (Annex 2). This is satisfactory, considering the prevailing interest rates in the international capital markets for similar loans. However, as outlined in para. 5.22, the long range effect on the spread on SYKB's financial structure and resource mobilization requires a detailed analysis and review which SYKB has agreed to undertake in the coming months. C. Financial Assistance to Small-Medium Scale Enterprises 4.07 While well established larger enterprises have access to invest- ment finance from institutional sources, recourse to non-institutional sources of funds (self-financing, curb market, sale or mortgage of personal property, solicitation from family members) is an important feature of the SMI segment of industry. Lack of access to institutional sources for financing fixed assets is particularly noticeable in SSIs occupying the middle of the size range and in MSI. However, the true dimensions of its extent and severity are hard to ascertain, in view of the reluctance of many SSIs to seek financial assistance from banking institutions. Lack of collateral, unwillingness to disclose the true financial position of the enterprise, fear of possible interference of the bank with operations, short-sightedness and complacency seem to be some of the reasons. Both SYKB and TSKB have been providing some term resources to the MSI segment, but so far this has been far from adequate. The proposed project will partially fill this financing gap by inducing SYKB to increase its lending to the MSI and SSI segments of industry. 4.08 Small enterprises occupying the lower end of the SSI size range and artisans are conveniently, though not adequately, served by the Halk Bank through the intermediation of some 650 guarantee cooperatives with a membership totalling 415,000. The Halk Bank is the major supplier of short and medium term funds to SSIs but so far it has had a limited impact. Because of shortage of funds, limits on loan size and orientation toward cooperative financing, its lending to manufacturing enterprises for working capital has been limited to about 12% of its portfolio and for machinery and equipment to only 8% (in 1977). Also, the Halk Bank has kept the credit granting authority of the branch manager to a minimum (TL 150,000 or US$6,000 equivalent in 1978) and has emphasized fully collateralized (or guaranteed) loans with immediate legal action (within 3 months) if repay- ment problems develop. These two characteristics reflect the conservatism of the Halk Bank and put the development orientation of the institution in question. Furthermore, the Halk Bank needs to strengthen its organization, systems and procedures in order to improve its overall capability and efficiency. 1/ In view of the above, the Bank has selected SYKB which is 1/ The Bank has assisted the Halk Bank in drafting terms of reference for a study to strengthen its organization, systems and procedures. The Bank is pursuing the initiation of the study in its dialogues with the Government.  - 18 - interested in increasing its lending to SMI as the intermediary for the proposed project. V. THE INTERMEDIARY - SYKB 1/ A. Institutional Developments Establishment and Ownership 5.01 SYKB was established in 1963 by five major commercial banks in Turkey; namely Is Bank, Akbank, Guaranti Bankasi, Osmanli Bankasi and Vakiflar Bankasi, to meet the investment financing needs of the private industrial sector. The paid-in capital of SYKB is TL 400 million of which 60% is owned by Is Bank--the largest bank in Turkey--and the remainder is equally divided among four other founding banks. Board 5.02 SYKB's Board consists of six members including the Chairman. Mr. Cahit Kocaomer, General Manager of Is Bank, has been the Chairman since February 1976. The other five members are representatives of the four shareholder banks and, Mr. Orhan Altan, SYKB's General Manager. Organization 5.03 Project identification, appraisal and supervision are undertaken by the Financial Analysis, Technical, and Economic Study and Research Departments, each headed by a manager. Resource mobilization and loan administration including legal, insurance and accounting matters are handled by the Loans Department. SYKB plans to change its present organizational structure to make it more responsive to its fast expanding operations. In order to reach SMI sub-borrowers in the smaller urban centers under the proposed loan, SYKB proposes to utilize the branch network of certain commercial banks (para. 6.05). Management and Staff 5.04 The General Manager, Mr. Altan, appointed on January 1, 1979, appears competent and imaginative and is gradually transforming SYKB into a more dynamic and development oriented financial institution. The total professional staff of SYKB was 44 on June 30, 1980, of which 22 are classi- fied as engineers, economists or financial analysts. The staff is gen- erally experienced and turnover has been very low. SYKB has developed a phased program to increase its professional staff by 24 over the 1981-1984 1/ Appraised in July 1979 in connection with a Textile Project (Report No. 2525b-TU).  - 19 - period, of which 18 will be employed in direct project-related activities. These additions should meet projected operational requirements. During negotiations, an assurance has been obtained from SYKB that it will review annually its staffing needs with the Bank in the light of prevailing operating conditions and promptly thereafter recruit additional staff as needed. The progress of recruitment of additional staff will be periodic- ally reviewed by the Bank during supervision of SYKB. Policies 5.05 SYKB has adopted a policy statement in January 1979 which ensures sound lending operations. The statement provides, inter alia, for conduct- ing sectoral and sub-sectoral studies to identify priority development areas and viable projects with high economic priority. It further stipu- lates that SYKB will finance projects whose majority control is vested with the private sector and provide up to 60% of the fixed investment cost of the project; its total exposure in an enterprise will not normally exceed 20% of its own equity; equity investments will not exceed 25% of the enter- prise's capital and 10% of its own equity, while total equity investments will not exceed its own equity; and it will not carry foreign exchange risk. SYKB follows conservative though reasonable collateral policies. Procedures 5.06 Appraisal: SYKB's appraisal procedures are satisfactory. Appraisal includes assessment of the management capability and credit- worthiness of the applicant and economic, technical, marketing and financial viability of the proposed project. 5.07 Supervision: SYKB supervises its projects through regular visits but does not prepare standard supervision reports although special problems are recorded. Also, borrowers are not required to submit periodic opera- tional reports to SYKB. SYKB could strengthen its supervision procedures by developing a more formal systematic program of project supervision. The Bank has made specific suggestions to SYKB in this regard and SYKB has agreed to take these into account in developing a formal supervision program. This program will also include a comprehensive evaluation of the operations of each enterprise receiving a technical assistance grant (para. 6.06). During negotiations SYKB agreed to submit details of such a super- vision program for Bank approval by July 1, 1981 and implement the same within three months thereafter. 5.08 Procurement and Disbursement: SYKB's procurement procedures are designed to ensure economy and efficiency. Normally at least three bids from suppliers in different countries are required for purchase of imported goods. For local procurement, adequate domestic shopping is required. These procurement procedures are consistent with those adopted by other Bank assisted DFCs and are considered satisfactory. Disbursement proce- dures are satisfactory.  - 20 - Operations 5.09 Approvals, commitments and disbursements of loans and equity investments for 1976-June 1980 are given in Annex 3. Total loan com- mitments of SYKB have increased from TL 502.9 million in 1976 to TL 1,233.8 million in 1979; they reached TL 1,608.1 million in January-June 1980. However, the increase in real terms was marginal, given the high level of inflation during this period 1/. The annual fluctuations in working capital loans and local and foreign currency investments mainly reflect the resource availability of SYKB. During the 1976-1978 period, local currency loan approvals comprised 92% of total loan approvals but decreased to 45% of total loan approvals during the January 1979-June 1980 period, as a result of the availability of new foreign currency resources. Equity investments have been very small ranging from TL 4.8 million to TL 29.5 million during the 1976-June 1980 period mainly due to the thin capital market in Turkey. 5.10 Analysis of SYKB's loan approvals during the 1976-June 1980 period by sector, geographical location, size, repayment terms and type of projects is given in Annex 4. During this period, the main beneficiaries of SYKB's loans have been textiles (21.2%), metal products (16%), iron, steel and other products (10.8%), electrical machinery and appliances (10.3%), machinery and equipment (8.5%) and food products (7.8%). About 54% of approvals were for loans between TL 10-75 million in size; 12% being below and 34% above the range. About 80% of total loan approvals were for fixed investment, of which about one-half were for new projects. B. Development Impact of SYKB's Operations 5.11 Although SYKB has only recently initiated promotional activities, it has completed studies on the export of textile goods and the development prospects of the forest products processing industry. During the last three years, SYKB has generally financed priority projects which had obtained Certificates of Encouragement. SYKB's loan approvals for projects located in the semi-developed and less developed regions of Turkey have increased from 27% of total approvals in 1976 to 40% in 1979 and 81% in January-June 1980, which shows SYKB's increasing contribution to the regionally balanced industrial growth of the country. It is estimated that about 15,000 direct jobs would be created by projects which received loans for fixed capital investment during the 1977-1979 period, with an estimated average cost per job of $40,630 equivalent in 1978 and $20,900 in 1979. The higher average cost in 1978 resulted from financing a few large capital-intensive projects. SYKB's own contribution to the total fixed investment in these projects was 7.2% in 1978 and 20.2% in 1979. 1/ Inflation rates were 35% in 1977, 50% in 1978 and 65% in 1979 and the average for 1976-1979 was 46% per year.  - 21 - C. Financial Situation and Prospects Profitability 5.12 SYKB's income statements for 1976-1979 are given in Annex 5. Net income showed a sharp increase in 1977 due to a change in the treatment of interest on loans from shareholding banks l/. Until 1976, these loans carried an interest rate of 11% per annum but, in 1977, the shareholding banks made them interest free and elected to take the return in the form of higher dividends. In 1977 SYKB's Articles of Association were amended to allow the entire net income after appropriation for certain reserves and bonus to management and staff (about 15% in aggregate) to be paid to share- holding banks as dividend. As a result, since 1977, SYKB's pay-out ratio has been high (about 85:15) although the actual returns to shareholders on their share capital and loans to SYKB have been low (about 10%), compared to interest rates on term deposits or other financial instruments. The relatively low profitability is primarily due to the narrow spread on local currency loans which has been the main activity of SYKB. However, SYKB's profits have shown a reasonable growth in the past, and are projected to increase in the future (para. 5.21), in line with the increase in its foreign currency loans. Financial Position 5.13 SYKB's comparative Balance Sheets for the years ending December 31, 1976-1979 are given in Annex 6. Although total assets almost doubled in current prices from TL 1,397.5 million at the end of 1976 to TL 2,737.0 million at the end of 1979, in real terms they declined by 41%. The paid-in capital has increased from TL 40 million to TL 400 million during the same period, the biggest increase of TL 300 million occurring in 1979 due to the conversion of a part of the loan from shareholding banks into equity. As a result, the long term debt/equity ratio decreased from 21.9:1 at the end of 1976 to 4.5:1 at the end of 1979 which was within the maximum limit of 7:1 agreed with the Bank under the Textile Project. The current ratio was 1.1:1 at the end of 1979 and is satisfactory. Quality of Portfolio 5.14 SYKB's arrears situation is reflected in Annex 7. Arrears and loans affected by arrears of more than three months were 0.8% and 3.6% respectively of the total loan portfolio on June 30, 1980. The loan port- folio is widely spread among different industrial sub-sectors (Annex 8) and 1/ The Articles of Association establishing SYKB provide that the founding banks were to lend 1% of their deposits in December 1962 to SYKB for a period of 20 years and to allocate additional amounts out of the annual increase in their deposits in future years. Shareholder banks may require payment of these funds prior to their maturity in the event of a decrease in their deposits.  - 22 - a large portion is secured by bank guarantees. The quality of the loan portfolio is, therefore, sound. SYKB has agreed under the Textile Project to retain at least 5% of its net annual income as a provision for bad and doubtful loans and investments up to a maximum of 2% of its loan and equity portfolio. This limit is considered acceptable considering the good quality of SYKB's portfolio. However, in view of its increasing involve- ment in the SSI sector, SYKB has agreed to periodically review this policy in the light of its relative exposure in the SSI sector and the quality of its portfolio. Audit 5.15 SYKB's audit has been performed up to 1979 by Touche Ross, Ltd., an international audit firm, and it has given an unqualified audit report. Operational and Financial Projections 5.16 Operational Forecast: SYKB's operational projections for the 1980-1984 period are given in Annex 9. These projections are based on the general industrial investment outlook in the private sector during the next three to five years (para. 5.18) and the project pipeline as of June 1, 1980, which includes pending loan applications for $33.07 million equiv- alent in foreign currency and TL 1.11 billion in local currency. Foreign currency loan approvals are projected at $18.5 million in 1980 and would be significantly higher than in previous years mainly due to the increased availability of such funds. These approvals are projected to increase at an annual average rate of about 24% in current dollar prices during the 1980-1984 period, which is considered reasonable due to the increasing cost of machinery and equipment and growing requirements of funds by the private industrial sector. The projected foreign currency loan approvals also include subprojects in the labor intensive SMI sector to be financed during 1981-1983 under the proposed Bank loan of $40 million. 5.17 The demand for invesment loans from SMI enterprises is expected to be stimulated by the major policy changes recently introduced by the Government which allow eligible SMI the same incentives as is provided to larger projects which receive the Certificate of Encouragement (para. 2.10). In addition, the higher capacity utilization of the SSI segment of industry in 1979 (about 70% on average) indicates that SSI has been affected significantly less by the economic downturn than larger firms (para. 3.01). Moreover, the Government has agreed to assume the foreign exchange risk for SSI subprojects proposed to be financed by SYKB out of the Bank loan. And the recent substantial reduction in foreign exchange interest rates (para. 4.06) should provide a further stimulus to investment for both medium and large scale projects. Finally, the fact that SYKB is in a position to finance both the investment and working capital needs in  - 23 - local currency of enterprises (currently a major problem for prospective investors) should further enhance lending for SMI 1/. 5.18 For 1981-1983, private manufacturing investment is projected to average around $1.4 billion per year, of which about 2% is expected to be financed by SYKB. A good indication of potential investment demand are the Certificates of Encouragement issued by the Government. SYKB has short- listed some 85 projects out of a much larger number which received Certif- icates between July 1979 and May 1980 (10 months) which satisfy its finan- cial requirements. Out of this short-list, the estimated foreign exchange requirements of projects satisfying the investment cost per job criterion of the proposed project amount to about $20 million. In addition, SYKB initiated a promotional effort in November 1980 to solicit loan applica- tions from prospective borrowers. By mid-January 1981, SYKB had received preliminary loan applications from eligible borrowers for 175 projects with total foreign exchange requirements of about $70 million. Sub-sectors from which significant loan applications have been received include engineering ($21 million), textiles and clothing ($20 million), basic steel products ($5.5 million), food products ($3.5 million), wood products ($2.5 million) and ceramic products ($2.3 million). Of these, SSI account for some 149 applications with a foreign exchange requirement of $35 million (50%). SYKB tentatively estimates that about 50% of the preliminary applications would meet its appraisal standards. It intends to continue this promo- tional effort in future which will undoubtedly result in more applica- tions. Based on the above considerations, it is reasonably expected that SYKB will be able to commit at least $10 million for SSI and $20 million for mostly MSI in foreign exchange for direct machinery imports over 1981-1983. Considering that, on the average the share of direct imports in machinery investment is about one-third for SSI and about two-thirds for most MSI, the implicit total investment (machinery only) for all sub- projects would be almost $60 million. If the Bank finances 40% of the cost of domestically produced machinery ($30 million) representing the imputed foreign exchange content 2/, an additional amount of about $12 million equivalent in TL could be utilized by SYKB. Thus a $40 million loan could be utilized by SYKB to finance both direct and indirect imports of machinery. 5.19 SYKB's local currency loan approvals are expected to increase from TL 891.5 million ($27.1 million equivalent) in 1979 to TL 1200 million ($15.1 million equivalent) in 1980 due to a few large loans. The approvals are expected to decrease to TL 990 million ($12.4 million equivalent) in 1/ TSKB's poor performance in the past in achieving its lending targets to labor intensive projects stem from (a) lack of local currency resources to meet both the investment and working capital needs of the projects and (b) the high interest rates on foreign currency loans which cur- tailed demand (para. 4.05). Also since these are mostly large new projects, sponsors faced difficulty in providing adequate equity from own resources. 2/ This percentage has been determined on the basis of a review of a representative sample of domestically manufactured machinery, typically financed by SYKB.  - 24 - 1981 but would increase thereafter at the rate of about 10% per annum in 1982 and 15% in 1983 and 1984. The equity investments of SYKB are esti- mated to remain low, increasing by TL 21.9 million in 1980 to TL 45.0 million in 1984. The projections indicate a decline in real terms of local currency operations mainly due to TL resource constraints arising from expected constraints in the use of the Central Bank's discount facility. 5.20 Resource Mobilization: The long-term resource position of SYKB at the end of 1979 was as follows: LONG-TERM RESOURCE POSITION AS OF DECEMBER 31, 1979 Local Currency Foreign Currency (TL in '000) ($ in '000) Sources Equity 465,949 Loans from: Shareholding banks 412,057 Central Bank 687,367 AID 103,564 6,758 EIB - 20,379 Eximbank 2,000 IBRD (Textiles) - 15,000 Total sources 1,668,937 44,137 Applications (Disbursements) 1,566,181 20,074 Surplus/ (deficit) on disbursement basis 102,756 24,063 Amount committed but not yet disbursed 156,730 1,876 Surplus/ (deficit) on commitment basis (53,974) 22,187 Amount approved but not yet committed 187,100 4,870 Surplus/ (deficit) on approval basis (241,074) 17,317 As can be seen from the above table, SYKB's major sources of local currency funds are loans and equity investments by share-holding banks, followed by loans from the Central Bank under its discount facility 1/. Although SYKB's local currency loan approvals and commitments exceeded its resources as of December 31, 1979, the shortfall could be covered through the fuller utilization of the discounting facility of the Central Bank and loan recoveries. The major unutilized foreign currency resources are the Bank loan ($15 million) and the second EIB loan ($7.5 million) made available in 1979. The foreign currency resource position of SYKB was comfortable as of December 31, 1979 although the existing Bank loan is earmarked exclusively for financing textile sector projects. Total foreign currency loan com- mitments during the 1980-1984 period are estimated at $124 million, or an 1/ This facility allows SYKB to refinance 60-80% of medium term loans granted for projects which are export oriented or have received a Certificate of Encouragement.  - 25 - average of-$24.8 million per annum. SYKB's uncommitted foreign currency resources as of December 31, 1979 were $22.2 million. This implies that additional funds of $101.8 million are required to meet the projected commitments. SYKB has already received a commitment of $14.5 million equivalent from EIB. Taking into account these funds and the proposed Bank loan of $40 million, the foreign currency resource gap decreases to $47.3 million which relates largely to 1983 and 1984. SYKB does not yet have firm plans to fill this gap but expects that existing and new sources will provide additional funds. SYKB plans to meet its local currency require- ments largely through the rediscount facility of the Central Bank and internal generation of funds. 5.21 Projected Profitability and Financial Position: SYKB's projected income statements, cash flow statements and balance sheets for the 1980-1984 period are given in Annexes 10-12. Net income is projected to increase from TL 105 million in 1979 to TL 178 million in 1982 and to TL 274 million in 1984 despite the increase in corporate income tax from about 28% to 53% in 1980. Return on equity 1/ should improve from 47% in 1979 to 71% in 1982 and further thereafter. The return to shareholders on their total investment will be 10.8% in 1980 and will increase to 18.3% in 1982. The liquidity position will also be satisfactory as indicated by current ratios of 1.1:1-1.3:1 and debt-service coverage of 1.1-1.3 times during the projected period. Debt-Equity Limit 5.22 Under the first Bank Loan (1754-TU), SYKB was authorized a debt/ equity limit of 7:1 and, as a condition of the loan, it increased the paid-in capital to TL 400 million. Subsequently, with Bank approval, SYKB converted TL 187 million of shareholding banks' loans into quasi-equity to meet the additional needs arising from the devaluations of the TL in 1979-80. The projections, however, indicate that SYKB's debt/equity ratio will reach 7:1 by end-1981 and increase further in subsequent years. SYKB has requested the Bank to relax the debt-equity limit. SYKB's request can be supported on the grounds of SYKB's efficient management as tested directly since the first Bank loan has been appraised, prudent financial policies and practices, and sound portfolio. It is also recognized that SYKB would find it extremely difficult to convince its shareholders to provide additional equity over the next 2-3 years because of very low returns on their existing investment and their cost of funds is around 40% at present. It is therefore proposed that SYKB's debt-equity limit be increased to 9:1. However, as the issue of debt-equity limit is linked to the returns to shareholders on the one hand and the resource mobilization efforts of SYKB on the other, it was agreed during loan negotiations that SYKB would make an in-depth study of this subject. The study would analyze all relevant factors including the cost of mobilizing resources in Turkey 1/ This does not include the interest free loans from shareholders and is related to net income before tax.  - 26 - by various means (e.g. loans, bonds, debentures, and equity), the adequacy of spread allowed by the Government in the light of the high prevailing inflation rate and the impact of these factors on SYKB's present and potential profitability and financial position. It would come up with recommendations which should ensure an adequate return to shareholders, as well as a reasonable financial structure. The findings of the study would be discussed with the Government and the Bank and further action would be taken in the light thereof to implement the recommendations of the study. The terms of reference of the study will be discussed with a Bank mission which will visit Turkey in March 1981 and the study is expected to be finalized by June 1981. VI. PROJECT AND LOAN FEATURES A. The Project Project Objectives and Strategy 6.01 In the light of Turkey's rapidly growing urban unemployment and limited prospects for job creation (para. 2.08), generation of productive and permanent employment opportunities in urban areas has become an over- whelming social issue. The proposed project aims primarily at creating jobs in urban areas through the support of labor and skill intensive manu- facturing enterprises, mostly small and medium scale, which offer the greatest job potential at a reasonably low investment cost per job. 1/ SYKB, which will implement the project, will make special efforts to promote and assist projects in the twenty-three urban centers, which account for over 75% of total urban unemployment (para. 2.05), in order to make a tangible impact on the urban centers more affected by unemployment. At the same time, the growth of this segment of industry will contribute to the efficient and balanced development of the industrial sector. Project Scope and Description 6.02 The project has two components: (a) financial assistance, and (b) technical assistance. These are described below. 1/ In this connection, the issues raised in the OED report ("Sector Opera- tions Review: The Industries and DFCs Program in Turkey, No. 3077 dated July 18, 1980)" concerning the low contribution of the industrial sector towards employment and exports have been addressed. The pro- posed project specifically addresses the employment issue. Further- more, many labor intensive sub-projects are likely to be in sub-sectors with export potential where Turkey has a comparative advantage because of relatively low wage costs. Thus the project inter alia addresses the export issue in the OED report.  - 27 - Financial Assistance 6.03 The proceeds of the Bank loan will be onlent by SYKB to eligible enterprises to finance subprojects involving acquisition of fixed assets and associated permanent working capital in foreign exchange, as required. In order to maximize the employment impact of the project, it is proposed to limit the maximum investment cost (excluding land and building) per job created for subprojects financed under the loan at US$15,000 1/. This is based on a review of the capital intensity of investment projects which have received Certificates of Encouragement from the Government (para. 2.07) and projects financed by TSKB, SYKB and the Halk Bank. It is esti- mated that the average investment cost per job for the aggregate of sub- projects financed will be about $12,000. The proposed limit represents a significant reduction over the average cost per job prevailing in recent years in the Turkish manufacturing sector, currently estimated at US$50,000 in 1980 prices (para 2.06). It would be unrealistic to establish a much lower investment cost per job limit, as far too many viable projects would be disqualified and the employment impact of the project would greatly diminish. 6.04 At least one-third of the loan will be earmarked for SSI sub- borrowers. This will induce SYKB to lend to SSI, which are generally more labor intensive than large scale firms, and will complement TSKB's lending to much larger labor intensive enterprises; 2/ in addition, it will achieve a better regional distribution of prospective jobs among the secondary urban centers. Given the low stipulated investment cost per job limit, it is anticipated that the greater part of the balance of the loan will be committed to medium size enterprises i.e. firms with fixed assets not exceeding US$2.0 million. In order to eliminate the uncertainty arising from future devaluations and to encourage SSI to borrow from institutional sources of term finance, the Government has agreed to assume the foreign exchange risk on loans to SSI sub-borrowers. For the purposes of this project, SSI is defined as follows: for new subprojects, the fixed assets of the enterprise, excluding land and building, after project implementa- tion should not exceed US$350,000, whereas for expansion SSI subprojects, the fixed assets of the enterprise, excluding land and building, should not exceed US$500,000. 6.05 SYKB lacks a branch network of its own. This has not been an impediment in the past as large clients approach SYKB on their own. How- ever, to reach potential SMI clients, particularly the SSI, it has agreed to 1/ All dollar figures are in prices as of December 31, 1980. These limits would be adjusted in succeeding years for dollar inflation. 1/ Labor intensive projects financed by TSKB have a maximum investment size limit of about $3.0 million (with the maximum asset size of the enterprise after the project limited to $6.0 million) and a maximum investment cost per job limit of $22,500, all in mid-1980 prices.  - 28 - utilize the branches of its shareholding commercial banks to identify and promote eligible subprojects, particularly in smaller urban centers with high levels of unemployment. The commercial banks will be primarily acting as agents for SYKB and will identify, screen and channel potential borrowers to SYKB and also assist in loan administration. However, SYKB will appraise, approve and supervise all such subprojects. SYKB will pay a one-time fee of 1.5% of the sub-loan amount to the participating commercial banks for these services. The working arrangements with the participating commercial banks and the fee to be paid to them have been formalized in a draft protocol which was approved by the Bank during loan negotiations. Execution of the protocol, either with Is Bank, the largest shareholder, or with at least two other cooperating banks is a condition of loan effective- ness. Furthermore, SYKB has agreed to promote labor intensive subprojects in the priority urban centers by providing technical assistance for feasibility study preparation and market research as well as equity finance from its own resources to eligible subprojects which might not be otherwise implemented (para. 6.01). Technical Assistance for SMI 6.06 As mentioned earlier (para. 3.09) SIDO, currently being reorga- nized and strengthened, should be able to assist small and artisanal enter- prises resolve some of their more routine technical problems. But the solution of more complex technical and management problems often faced by medium and small scale enterprises in the upper end of the size range necessitates a more sophisticated level of technical assistance than can be provided through SIDO. Fortunately, there are a considerable number of individual consultants and consulting organizations, private and public, available in Turkey who can provide assistance in resolving complex tech- nical, management and marketing problems facing industrial firms. It is, therefore, proposed to utilize the services of these consultants to assist small and medium scale enterprises who are in need of specialized technical assistance on a cost sharing basis. The beneficiary enterprises will select the consultants. However, in order to assist enterprises in iden- tifying and recruiting the most suitable consultant, SYKB has agreed to prepare by June 30, 1981 a roster of qualified consultants, classified by field of specialization. The program will be administered by SYKB's Project Appraisal and Supervision Department. SYKB has agreed to assign initially at least one technical staff member to administer the program, particularly to oversee the contracting of consultants by enterprises and coordinate all extension activities. In order to monitor the effectiveness of the technical assistance program, SYKB has agreed to prepare a compre- hensive report evaluating the effect of the technical assistance on the operations of each beneficiary enterprise six months after the implementa- tion of such assistance. This report would be a part of the proposed supervision system to be introduced by SYKB (para 5.07). In addition, Bank supervision missions will periodically review the functioning of the tech- nical assistance program to assess whether the desired objectives are being achieved and suggest changes, if needed, to improve operations.  - 29 - 6.07 SYKB has agreed, furthermore, to establish a fund to finance technical assistance costs of its sub-borrowers in general, but particu- larly for the labor intensive small and medium scale firms to be financed under the project. The costs of technical assistance will be shared between the fund and the beneficiary enterprise normally on an 80:20 basis. Furthermore, the maximum amount of funds provided as a technical assistance grant should not normally exceed 2% of the sub-loan amount. A least two-thirds of the total amount in the fund would be reserved for financing the technical assistance costs of eligible sub-borrowers. SYKB has agreed to finance the fund through a charge on its interest spread and commissions available under the loan equal to one-half percent of the out- standing loan amount. It is estimated that the fund will accumulate at the rate of $200,000 per annum when the loan is fully disbursed. However, during the initial period (two to three years) of implementation of the project when no income will accrue to the fund, SYKB has agreed to make initial contributions to the fund on an interest free basis of $25,000 equivalent on July 1, 1981 and an equal amount on January 1, 1982 to set the scheme in operation. SYKB will recover the advance as income accrues to the fund. The fund will be used to finance the following specific activities: (i) providing consultants and other services to sub-borrowers to assist them solve technical, management and marketing problems relating to project preparation, implementation and operation; (ii) training of enterprise staff both at the enterprise and at outside facilities, e.g. the Marmara Research Center, in specific areas relating to the operation of the enterprise; (iii) training of SYKB's staff on subjects related to SYKB's objectives and operations; and (iv) hiring of consultants by SYKB for specific periods to undertake special studies relating to SYKB's objectives and operations. Project Evaluation 6.08 Since the project contains elements which are being tried out for the first time (the cooperative arrangement with the commercial banks and the technical assistance program), it would be desirable to thoroughly evaluate these elements in order to obtain insights for improving the design of future Bank projects in this area. Consequently, SYKB has agreed to carry out by June 30, 1983 a comprehensive study under terms of refer- ence satisfactory to the Bank, on the following aspects: (i) the function- ing of the cooperative arrangement with the commercial banks for promoting and financing SMI projects; (ii) the impact of the technical assistance program on the efficiency of beneficiary enterprises and the appropriate- ness of the overall design of this program; and (iii) any other aspect of the project requiring evaluation. Project Benefits and Risks 6.09 Project Benefits: The project would create about 5000 permanent and productive employment opportunities mostly in regional urban centers with high unemployment levels, at an average investment cost per job created (for the aggregate of sub-projects to be financed under the loan)  - 30 - of about $12,000 (based on a maximum limit of $15,000) which relates to an average of $50,000 for the manufacturing sector as a whole. Although the number of direct jobs generated is modest, the project will permit the Bank to strengthen and focus its dialogue with the Government to induce it to adopt an overall strategy and policy framework for fostering the develop- ment of labor intensive industry. The SMI sector report prepared in the context of project preparation provides the basis for this dialogue. The project is viewed as a first operation and is likely to be followed in the future by additional projects with the same objectives. As the project will be evaluated two years after loan effectiveness (para. 6.08), it will provide valuable insights for improving the design of future Bank projects with similar objectives in Turkey. About one-half of the machinery invest- ment under the project will be of domestic origin, which should stimulate the development of domestic capital goods industries and generate addi- tional employment in these industries. By fostering the growth of effi- cient SM! in subsectors where Turkey has a comparative advantage and con- siderabl- export potential, the project should assist in the longer term in the much needed restructuring of the industrial sector. The technical assistance component of the project would improve the productivity of the user firms and would stimulate the development of domestic industrial con- sulting firms which in the longer term should contribute to improving the efficiency of Turkish industry. 6.10 Project Risks. The project, being the Bank's first operation in Turkey specifically aimed at urban employment creation through support to mainly labor intensive SMI, can draw on little direct historical lessons to guide its implementation. In the short term, economic problems besetting Turkey could affect the demand for investment finance from industry. SYKB does not have a branch network and has had little experience with lending to SSI, and hence will need to rely on the proposed arrangement with its shareholding commercial banks to identify potential SSI subprojects, particularly in the secondary urban centers. However, SYKB can be trusted, based on its past performance that it will meet the challenge. Further- more, the proposed arrangement for utilizing the services of consultants to provide technical assistance to SMI is also a novel feature, and its efficacy will have to be established in practice. All in all, SYKB a long established investment bank, is fully committed to achieving the objectives of the project and has agreed to take special initiatives in this con- nection. On balance, therefore, the risks are reasonable and acceptable. B. Loan Features 6.11 Lending Arrangements: At the request of the Government and SYKB, it is proposed that the loan be made to the Government which will relend it to SYKB under a subsidiary loan agreement on terms and conditions accept- able to the Bank. SYKB will repay the loan to the Government based on the aggregate composite amortization schedule of individual sub-loans. SYKB prefers this arrangement since the Government is assuming the foreign exchange risk on part of the loan and will need to provide additional local currency resources to supplement debt service payments as devaluations  - 31 - occur. The maturity of individual sub-loans which will be commensurate with the economic life of the equipment financed and the sub-borrower's debt-servicing capacity is expected to average around twelve years includ- ing two years grace. It is proposed that the Government repay the loan to the Bank on a fixed amortization schedule of three years grace and 15 years maturity which will be commensurate with the aggregate amortization schedule of individual sub-loans. The final date for subproject submission will be December 31, 1983 and the closing date June 30, 1986. 6.12 Loan Size and Use of the Loan Proceeds: A loan of $40 million is recommended to be used to finance the full cost of imported machinery and equipment and, when required and justified, associated permanent working capital in foreign exchange. In addition, Bank funds may be used to finance 40% of the cost of domestically produced machinery and equipment, net of taxes, reflecting the imputed import content of such locally manu- factured machinery and equipment (para. 5.18). 6.13 Lending Terms to Sub-borrowers: The current investment outlook in industry appears to be constrained by the uncertainty arising from the obligation of sub-borrowers, particularly SSI sub-borrowers, to bear the foreign exchange risk. SSI entrepreneurs are especially affected since they have great difficulty in hedging or planning against foreign exchange rate changes and in absorbing sudden losses. In order to encourage sub- borrowers of small scale labor-intensive projects to undertake investments, there is need to eliminate the uncertainty associated with future devalua- tions but at the same time such sub-borrowers should not be subsidized. The following agreements have been reached with SYKB'and the Government concerning interest rates and foreign exchange risk on sub-loans: (a) The Government will bear the foreign exchange risk for all SSI sub-loans and the sub-borrower will pay the prevailing free market Turkish Lira interest rate for similar types of loans as deter- mined from time to time (para. 4.05). On the portion of the loan utilized by sub-borrowers other than SSI for financing the imputed foreign exchange content of locally produced equipment, the sub-borrower would pay the prevailing free market Lira interest rate, while the Government would bear the foreign exchange risk (para. 4.05). It should be noted that, in the latter case, the sub-borrower would receive a TL loan for the purchase of locally produced machinery and, therefore, cannot be expected to assume a liability in foreign exchange. (b) For all other sub-loans utilized for direct imports, the sub- borrower will bear the full foreign exchange risk and the interest rate would be determined by the cost of Bank funds to the Govern- ment plus SYKB's spread and commission (para. 6.14). 6.14 Free Limit: The free limit for sub-loans will be $750,000 which is the same as that adopted under the Bank's textile project (Loan No. 1755-TU). It is estimated that about 80-100 SSI subprojects and 30-40  - 32 - other subprojects would be financed through tha loans. The first five sub-loans to SSI and the first five to other sub-borrowers, irrespective of loan amount, will be submitted to the Bank for approval. It is estimated that about 45% of the loan amount will be utilized for above free limit projects requiring the Bank's approval. For the purpose of monitoring sub- projects below the free limit, SYKB has agreed to translate ex-post and submit to the Bank the appraisal reports of a sample of 10% of SSI sub- projects and 25% of other subprojects below the free limit, selected by the Bank from the list of approvals submitted. SYKB will compute the economic rate of return (ERR) on all its projects with an investment in fixed assets exceeding US$750,000. 6.15 SYKB's Spread: SYKB will receive a gross spread of 5.5% (3.5% spread plus a 2% p.a. commission) on all sub-loans to be made under the project. However, the gross spread includes a half-percent annual payment to the technical assistance fund (para. 6.07) and a 1.5% one time fee to commercial banks for utilizing their branch network which would result in a net spread slightly below 5%. Though the normal spread allowed to inter- mediaries on foreign currency loans in Turkey is 3.5%, the slightly higher spread for this particular project, which has been agreed to by the Govern- ment, is considered reasonable and is justified on the following considera- tions: (i) about half of the loan will be onlent in Lira, where the real income from the spread will be eroded over the life of the sub-loans due to inflation, resulting in an average real margin on both foreign and local currency financing comparable to the spread being charged by TSKB; (ii) SYKB's lower debt-equity limit compared to TSKB's (10:1) implies that a larger average gross spread would have to be provided to it in order to ensure that equity investments in SYKB are equally attractive compared to TSKB given that both institutions have common shareholders; and (iii) SYKB will incur substantially higher administrative costs and possibly greater default risk in lending to SMI compared to large well established enter- prises. 1/ 1/ The experience of DFCs in financing SMI in the Philippines (The Philippines data are from "Transaction Costs of Credit to the Small Scale Sector in the Philippines" by K.A. Saito and D.P. Villanueva, Domestic Finance Studies, No. 53, IBRD, 1978), Columbia and India (Data from "Employment Creation and Small-Scale Enterprise Development", Table 3, World Bank Policy Paper, 1977) support this view. In each of these countries analysis of the portfolio of institutions primarily financing SMI as compared to those financing larger enterprises indi- cate that arrears over three months were over three times higher for the SMI financing institutions. In the case of DBP Philippines, data on default costs of lending to SMI and large enterprises indicate that default risk expenses for SMI are about double that of the large enter- prises. Data on administrative costs of lending to SMI by these insti- tutions indicate that these costs were on average two to three times that of lending to large enterprises.  - 33 - VII. RECOMMENDATIONS 7.01 During negotiations the following agreements and understandings were reached with SYKB and the Government: (a) Terms and conditions of the Bank loan to the Government (para. 6.11). (b) Terms and conditions of the subsidiary loan agreement between the Government and SYKB (para. 6.11). (c) Allocation of at least one-third of the loan for financing SSI and definition of SSI (para. 6.04), and provision for financing 40% of the net cost of domestically produced machinery (para. 6.12). (d) Conditions for sub-loans (terms, interest rates) (para. 6.13). (e) Government's agreement to assume the foreign exchange risk for all SSI sub-loans and for other TL sub-loans for financing imputed foreign exchange costs (para. 6.13). (f) Free limit for sub-loans and review by the Bank of a percentage of SSI and other sub-loans below the free limit. SYKB will compute the ERR for all sub-projects exceeding US$750,000 investment (para. 6.14). (g) SYKB will be permitted to charge a commission of 2% p.a. on all sub-loans over and above its normal spread of 3.5% (para. 6.15). (h) SYKB's debt-equity limit to be increased to 9:1 from the existing limit of 7:1 (para. 5.22). SYKB will prepare a study on the cost and earnings of its present and potential sources of funds with a view to ensure an adequate return to shareholders and a reasonable financial structure. (i) SYKB has agreed to establish a fund financed by a charge of 0.5% p.a. from its gross spread for financing technical assistance to SYKB's clients and other agreed purposes (para. 6.07). (j) SYKB has agreed to contribute initial amounts to the technical assistance fund on an interest free basis to be recovered from future income accruing to the fund (para. 6.07). (k) SYKB has agreed to prepare a roster of qualified consultants by June 30, 1981 classified by fields of specialization and periodic- ally update such a roster to assist clients identify and recruit suitable consultants. SYKB has agreed to initially assign at least one person to supervise all technical assistance activities (para. 6.06).  - 34 - (1) SYKB will introduce a more systematic program of project super- vision which will also provide for a comprehensive evaluation of enterprises receiving technical assistance grants six months after implementation of such assistance. SYKB has agreed to submit the details of the program for the Bank's approval by July 1, 1981 and implement the program within three months thereafter (para. 5.07). (m) SYKB will undertake a comprehensive evaluation of the implementa- tion of the project, under terms of reference approved by the Bank not later than June 30, 1983 which-would include an evaluation of the technical assistance program, the functioning of the coopera- tive arrangement with the commercial banks and any other matter relating to the project (para. 6.08). (n) SYKB will submit a signed protocol defining the arrangements between commercial banks and SYKB to permit it to utilize the commercial banks' branch network for project identification and other purposes (para. 6.05). (o) SYKB will make special efforts to promote and finance subprojects Tn the twenty-three priority urban centers utilizing its own resources as well as the branch network of cooperating commercial banks (para. 6.01). 7.02 In addition, the following conditions of effectiveness were agreed upon during negotiations: (a) Signature between the Government and SYKB of a Subsidiary Loan Agreement satisfactory to the Bank, defining SYKB's role and the principles and procedures reflected in the Loan Agreement (para. 6.11). (b) Execution of protocols (draft approved by the Bank) by commercial banks and SYKB, defining the arrangement under which SYKB will be permitted to utilize the branches of commercial banks for sub- project identification and other purposes. As a minimum require- ment, SYKB would execute a protocol with Is Bankasi, or with any two other commercial banks (para. 6.05).  - 35 - SELECTED DOCUMENTS AND DATA AVAILABLE IN THE PROJECT FILE Al Turkey: Prospects for Small-Medium Scale Industry Development and Employment Creation (in three volumes). Report No. 2913-TU, September 1980. B1 SYKB - Annual Reports, 1977, 1978 and 1979. B2 Halk Bank, Draft Project Identification Report, March 1979.  DEFICIENCIES AND TECHNICAL ASSISTANCE REQUIREMENTS OF SMI IN TURKEY Technical Aspect Non-Technical Aspect Unit Size Raw Financial in Work Machinery Product Production Quality Working Preventive Project Material Management Planning Workers Sector Methods Layout Design Planning Control conditions Maintenance Preparation Bookkeeping Procurement Marketing Functions and Contr. Up to 10 Engineering 3 1 2 1 3 3 3 1 3 3 3 1 1 10-99 including 3 3 3 3 3 3 3 3 1 3 3 3 3 100-199 Foundries 1 2 3 3 2 1 1 3 1 1 3 2 3 Up to 10 Woodworking I I 1 1 2 3 1 1 3 3 1 1 1 10-99 including 3 3 3 3 3 2 3 3 1 3 3 2 3 100-199 Furniture 2 2 2 3 3 1 2 3 1 1 3 3 3 Up to 10 Leather 3 1 3 1 3 3 1 1 3 3 3 1 1 10-99; Footwear 2 3 3 3 3 3 3 3 1 1 3 3 3 100-199 1 3 1 3 3 1 3 3 1 1 3 3 3 Up to 10 Chemicals 1 1 1 1 3 3 3 1 3 3 3 1 1 10-99 Plants and 3 3 3 3 2 1 2 3 1 3 3 3 3 100-199 Rubber Prod. 1 2 2 3 1 1 2 3 1 3 3 3 3 Up to 10 Clothing and 1 1 3 1 3 3 1 1 3 2 1 1 1 10-99 other made- 3 3 3 3 3 2 3 3 1 2 3 3 3 100-199 up goods 2 2 2 3 3 1 3 3 1 1 3 3 3 Legend: I Slight Requirement; 2 Moderate Requirement; 3 Great Requirement Work Methods: Correct use of machines, tools, etc.; tooling, Project Preparation:. Project evaluation and preparation of bankable loan sequence of operations. applications. Machinery Layout: Maximum use of space; arrangement of machines Bookkeeping: Keeping of simple accounts to show financial to reduce transfer time. position of the business. Product Design: Design of new products, modification of existing Raw Material Procurement: Material selection, source identification, purchasing, products to reduce cost or simplify production. importatPion procedures, inventory control. Production Planning: Maximum use of labor, machines and materials; work Marketing: Acquisition of market information, evaluation of market flow; machine loading; job simplification, setting data, methods of distribution, export procedures. Of standards. Management Functions: Specialization of functions, job specifications, Quality Control: Inspection/texting materials and products to evaluation of performance, labor laws, social security predetermined specifications. regulations. Working Conditions: Safety and health aspects of workplace. Financial Planning and Costing, pricing policy, budgeting, preparation of Preventive Systematic maintenance to avoid unscheduled Control: financial statements. Maintenance: stoppages.  - 37 - ANNEX 2 TURKEY Interest Rates on Industrial Loans and Final Cost of Borrowing Effective January 1, 1981 A. BASE INTEREST RATES I. Short-term loans (less than 2 years): General 31% Exports 22% II. Medium-term loans (2-5 years): Certificate of Encouragement 33% Exports 24% III. Long-term loans (over 5 years): 36% B. TAXES AND REBATES I. Taxes and Fees Transaction tax 25% of base rate Interest equalization fee 15% of base rate Commission 2% II. Interest Rate Subsidies Certificate of Encouragement 25% of base rate Export undertaking 40% of base rate Underdeveloped region 50% over base rebate rate C. FINAL COST OF BORROWING I. TL Loans Medium-term Loan with Certificate Less Long-term No Export Export Developed Loan with Undertaking Undertaking Region Certificate Base Rate (%) 33 24 33 36.0 Transaction tax @25% 8.25 - 8.25 9.0 Interest equalization fee @15% 4.95 3.6 4.95 5.4 Commission (%) 2.0 2.0 2.0 2.0 Effective Interest Rate (%) 48.20 29.60 48.20 52.4 Rebate (%) -8.25 -9.60 -12.38 -9.0 Final cost (% p.a.) 39.95 20.00 35.82 43.4 II. Foreign Exchange Loans Medium-term Loan with Certificate Less No Export Export Developed Undertaking Undertaking Region Base Rate (%) 9.25 9.25 9.25 SYKB spread (%) 3.50 3.50 3.50 Transaction tax @25% 3.19 - 3.19 Interest equalization fee @15% 1.91 1.91 1.91 Commission (%) 2.0 2.0 2.0 Effective interest rate (%) 19.85 16.66 19.85 Less rabates (%) -3.19 -5.10 -4.78 Final cost (% p.a.) 16.66 11.56 15.07  38 - SINAI YATIRIM VE KREDI BANKASI ANNEX 3 Approvals. Commitments and Disbursements: 1976 - June 1980 (TL 000') 1976 1977 1978 1979 _ .1980 No. Amount No. Amount No. Amount No. Amount No. Amount APPROVALS Loans:I/Working Capital Loans Local currency 26 53,550 24 65,350 34 273,600 18 438,100 2 76,500 Investment Loans Local currency 27 376,500 15 235,300 23 492,500 20 453,415 7 356,542 Foreign currency 11 72.840 5 50,978 - - 14 342,294 11 1,251,567 Sub-total 38 449,340 20 306,278 23 492,500 34 '795,709 18 1,608,109 Total Loans: 64 502,890 44 371,628 57 766,100 52 1,233,809 20 1,684,609 Equity Investments 3 7,921 5 14,750 2 4,834 5 29,500 1 5,000 COMMITMENTS Loans: Working Capital Loans Local currency 26 49,950 21 49,350 37 246,560 25 359,700 5 93,200 Investment Loans Local currency 34 334,500 16 213,840 32 457,000 18 269,166 6 66,137 Foreign currency 8 50.288 10 92,238 - - 3 107,576 3 99,275 Sub-total 42 384.788 26 306,078 32 457,000 21 376,742 9 165,412 Total Loans: 68 434.738 47 355.428 69 703,560 46 736,442 14 258,612 Equity Investments 3 7,921 5 14.750 2 4,834 5 29,500 - - DISBURSEMENTS Loans: Working Capital Loans Local currency 26 49,950 21 49,350 33 246,560 23 322,620 5 125,930 Investment Loans Local currency 33 269,038 18 288,662 29 381,200 19 231,416 12 102,387 Foreign currency 4 39,786 14 118,525 - - 1 8,945 5 234,499 Sub-total 37 308,a24 32 407,187 29 381,200 20 240,361 17 336,886 Total Loans: 63 358,774 53 456,537 62 627,76n 43 562,981 22 462,816 Equity Investments 3 5,648 7 8,461 5 6,230 4 19,667 3 7,900 Average Size of Loan Commitments Working Capital Loans 1,921 2,350 6,664 14,388 18,640 Investment Loans Local currency 9,838 13,365 14,281 14,954 11,023 Foreign currency 6,286 9,224 - 35,859 33,092 Average Size of Equity Investments 2,640 2,950 2,417 5,900 - Conversion Rate: US$1-TL 16.83 19.635 25.50 47.80 79.56 1/ Local and foreign currency loans to the same project are counted separately.  - 39- ANNEX 4 SINAI YATIRIII VE KREDI BANKASI Analysis of Approvals by Sector, Geographical Location, Size. Reapayment Terms and Type of Proiedge' 1976 - Ju,ne 1980 MT Millions) 1976 1977 1978 1979 Jan.-June TOTAL 1980 1976-June 1980 No. of Nio. of No. of No. of No. of No. of Loans Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Amount % A. By Sector Food products 2 55.0 7 43.5 1 27.0 5 58.9 1 175.2 16 359.6 7.8 Beverages - - 1 2.0 - - - - - - 1 2.0 - Textiles (Incl. spinning, 9 161.5 6 109.6 9 146.6 9 276.2 2 272.3 35 966.2 21.2 dyeing and finishing) Clothirng 3 8.0 1 2.0 1 15.0 1 8.8 - - 6 33.8 0'.7 Lumber & wood products - - - - - I 2.0 - - 1 2.0 - Wood-pulp & paper - - - - 1 8.0 - -- - I 8.0 0.2 Leather & leather products 1 3.0 1 5.0 1 4.0 1 12.0 - - 4 24.0 0.5 Rubber products & tires - - 1 50.0 1 3.0 1 45.0 - - 3 98.0 2.2 Chemicals 7 39.8 6 39.6 3 61.0 7 111.6 1 41.6 24 293.6 6.4 Plastic products - - 3 17.0 1 5.0 2 4.0 - - 6 26.0 0.6 Structural clay products 2 22.5 - -4 22.0 1 3.0 - - 7 37.5 0.8 Pottery, china & earthen- - - 2 19.3 1 25.0 3 99.4 1 69.6 7 213.3 4.7 ware Glass & glass products 2 3.5 1 1.5 - -2 61.5 - - 5 66.5 1.5 cement - - - -- - --- - - - Cement products 3 15.6 - - - -1 ,1 4 16.7 0.4 Metal smelting - - - - ---- -- - - Iron, steel & other prod. 2 25.0 2 32.0 4 95.0 5 140.2 1 198.9 14 491.1 10.8 Metal products 6 20.0 3 8.0 5 15.5 -6 245.1 6 441.6 26 730.2 16.0 Machinery & equipment 8 38.2 3 7.0 12 152.5 4 96.0 2 92.5 29 386.2 8.5 Electrical machinery. 11 66.7 4 27.4 9 101.5 2 38.7 3 235.7 29 470.0 10.3 appliances & supplies Agricultural machinery 1 2.5 - -2 55.0 - - -3 57.5 1.3 & implements Manufacture & repair 2 37.1 - -- --- - - 2 37.1 0.8 of vehicles Miscellaneous industries 5 14.5 3 7.7 2 30.0 2 31.4 2 156.1 14 239.7 5.3 TOTAL 64 502.9 44 371.6 57 766.1 52 l.1233.8 20 l.684.6 237 4,559.0 1o0-0. 8. Geographical Locatiou 1/ I. Eight most developed 45 364.5 31 250.4 39 454.1 34 736.6 7 316.1 156 2,121.7 46.5 regionLs II. Semi-developed regions 28 136.4 9 100.2 17 262.0 16 452.2 11 1,105.4 71 2,056.2 45.1 IIT. Least developed 1 2.0 4 21.0 1 50.0 2 45.0 2 263.1 10 381.1 8.4 regions 64 502.9 44 371.6 57 766.2 52 I1,33.8 20 1j.684.6 237 4590100.0 C. Size Up to 200,000 - -- - -- -- -- - - 200,001-500,000 2 0.8 - -- - -- -2 0.8 - 500,0Ol-1,000.000 6 6.0 3 2.4 2 2.0 - -- -11 10.4 0.2 1,000.001-3,000,000 20 43.1 17 34.9 11 29.0 5 11.0 I 1.0 54 119.0 2.6 3,000,001-5,000,000 9 38.4 8 35.0 15 71.5 6 26.9 1 4.3 39 176.1 3.9 5,000,001-1O,000,O00 9 70.2 7 54.1 9 79.0 6 56.1 1 6.1 32 265.5 5.8 10,000,00l-20.000,000 13 192.3 5 75.2 7 104.0 14 202.0 - - 39 573.5 12.6 20,000,001-30,000,000 4 112.1 1 30.0 7 177.0 7 175.0 1 22.5 20 516.6 11.3 30.000,001- 0,000,000 1 40.0 3 140.0 5 240.0 6 236.1 2 91.6 17 747.7 16.4 50,000,001-75,000,000 - - - - 1 63.6 3 126.5 6 400.0 10 590.1 13.0 Over 75.000.001 - -- -- -5 400.2 8 1,159.1 13 1,559.3 34.2 TOTAL R 502.9V *Z 71 37 76-6.1 5-2 1,-233.8 20 1,684.6 237 4,559.0 100.0 Average size of loans 7.9 - 8.4 - 13.4 23.7 84.2 19.2 D. Repayment Terms Less thanlIyear - - - -- - 1 3.9 2 5.4 3 9.3 0.2 1-5 years 30 69.5 36 251.3 57 766.1 42 962.4 7 487.5 172 2,536.8 55.6 6 -10 years 29 386.4 6 103.7 - - 5 145.7 3 183.9 43 819.7 18.0 Over 10 years 5 47.0 2 16.6 -7- - 4 121.8 8 1,007.8 19 1,193.2 26.2 TOTAL 64 502.9 44 371.6 57 766.1 52 1,233.8 20 1.684.6 237 4 559-0 100.0 E. Ty-pe - a . Fixed investment loans: New projects 23 227.9 8 146.8 11 251.0 14 384.3 8 966.3 64 .1,976.3 43.3 Expansion 15 221.4 12 159.4 12 241.5 20 411.4 10 641.8 69 1,675.5 36.7 38 449.3 -20 3-06.2 23 49-2.5 -34 79_5.7 1-8 1,0. 33 3,651.8 80.06 Working capital loans 26 53.6 24 65.4 34 273.6 18 438.1 2 76.5 104 907.2 20.0 TOTAL 64 502.9 44 371.6 57 766.1 52 1,233.8 20 1,684.6 237 4590100.0 1.1 According to classification followed by TSKB, i.e.: I. Eight most developed regions: ProvinLces of Istanbul, Sakarya, Kocaoli and Bursa (North West Anatolia), irmir (South West Anatolia) and Adans, Ankara, Icel (Central Anatolia). 11. Semi developed regions: Northweist and Southwest Anatolia, excluding provinces under 1. III. Least developed regions: Central Anatolia, excluding provinces under I and entire Eastern Aniatolia.  - 40 - ANNEX 5 SYTB Summary Income Statements 1976-1979 (Millions of TL) 1976 1977 1978 1979 ---- audited ------- Income Interest and fees on loans 169.9 187.8 252.7 388.0 Income from other investments 3.0 5.4 11.5 19.8 Other income 1.5 7.7 6.2 9.2 Total income 174.4 200.9 270.4 417.0 Expenses Interest and fees on borrowings 136.4 56.8 91.8 182.8 Personnel costs 13.3 18.4 33.1 43.4 Taxes and fees 2.3 2.7 ) 7 13.3 Other costs 3.1 2.9 ) 1.1 Provisions for bad and doubtful loans and equity investments - - - 31.8 Total expenses 155.1 80.8 129.6 272.4 Income before tax 19.3 120.1 140.8 144.6 Tax on income 5.7 32.7 37.8 39.4 Net Income 13.6 87.4 103.0 105.2 Appropriations Legal and other reserves 5.4 13.3 15.6 16.0 Dividends 8.2 74.1 87.4 89.2 Tax adjustments - - - Total 13.6 87.4 103.0 105.2 Ratios Total income as %age of average total assets 13.0 13.3 14.6 17.2 Administrative expense as %age of average total assets 1.2 1.4 1.8 1.8 Interest charges as %age of average medium and long term debt 10.9 4.2 5.8 7.6 Interest income as %age of average loan portfolio 13.6 13.5 14.8 16.0 Earnings before tax as %age of average net worth 33.6 162.5 1/ 118.6 47.0 Net income as Zage of average net worth 23.7 118.3 86.8 34.2 Dividend as Zage of net income 60.3 84.8 84.8 84.8 Dividends as %age of year-end share capital 20.5 134.7 2/ 87.4 22.3 1/ The substantial increase is due to no interest being charged on loans from shareholders. If a notional interest of 11% on average balance of these loans is charged the ratio would reduce to49.3Zin 1977, 52.62 in 1978 and 26.9 in 1979. 2/ If it is assumed that loans from shareholders carried an interest of 11% per annum, the net return on capital investment will be negative in 1977, 9.12 in 1978 and 11% in 1979.  -41 ANNEX 6 SYRB Summary Balance Sheets 1976-1979 (Millions in TL) Dec.31 Dec.31 Dec.31 Dec.31 1976 1977 1978 1979 - audited --- ASSETS Cash 19.9 19.0 11.8 39.3 Sundry receivables 47.2 59.4 83.4 161.4 67.1 .78.4 95.2 200.7 Loans and investments: Loans 1,294.4 1,489.7 1,924.3 2,458.3 Equity Investments 33.0 41.5 47.7 67.4 Government and other bonds 0.8 0.7 0.7 0.4 1.328.2 1,531.9 1,972.7 2.526.1 Less provision for losses - - - 31.8 Net total loans and investments 1,328.2 1.531.9 1,972.7 2,494.3 Fixed assets (net) 0.7 0.6 30.2 42.0 Deffered taxes 1.5 2.0 - - Total ASSETS 1.397.5 1,612.9 2.098.1 2,737.0 LIABILITIES AND EQUITY Taxes due 8.9 36.8 37.8 53.2 Other payables 11.3 20.8 31.7 47.9 Dividends 8.2 74.1 87.4 89.2 28.4 131.7 156.9 190.3 Medium and long term debt: Local currency Shareholder banks 810.0 712.1 712.1 412.1 Government subordinated loans 106.3 106.0 105.8 103.6 Central Bank 83.7 113.3 390.6 601.7 Foreign currency AID 201.1 215.7 225.5 323.0 EIB 104.7 241.5 355.6 627.6 Exim Bank - - - 8.9 1,305.8 1.388.6 1,789.6 2,076.9 Staff Retirement Fund 3.6 4.6 2.2 3.8 Shareholders' equity: Share capital 40.0 55.0 100.0 400.0 Logal reserve 8.0 21.4 33.8 50.0 Contingency reserve 4.7 4.7 15 6 16.0 Other reserves 7.0 6.9 1 6 Total equity 59.7 88.0 149.4 466.0 Total Liabilities and Equity 1,397.5 1.612.9 2,098.1 2,737.0 Long term debt/equity ratio 21.9 15.8 12.0 4.5 Current ratio 2.4 0.6 0.6 1.1  - 42 - SINAI YATIRIM YE KREDI BANKASI ANNEX 7 S-sMary of Arrears (TL Thousands) Dec. 31 Dec. 31 Dec. 31 Dec. 31 June 30 1976 1977 1978 1979 1980 Arrears Principal: Up to 3 months 625 433 5,272 - 5,200 More than 3 months 4,414- 28,280 17,558 9,237 12,081 Interest: Up to 3 months 323 - 4,095 691 - More than 3 months 1,363 8,605 3,682 2,150 11,821 Total: Up to 3 months 948 433 9,367 691 5,200 More than 3 months 5,777 36,885 21,240 11,387 23,902 Total Arrears: 6,725 37,318 30,607 12,078 29,102 Loans affected by arrears of more than 3 months 66,205 61,138 77,681 72,633 117,333 Total loan portfolio 1,294,398 1,489,743 1,924,286 2,458,293 3,223,968 Arrears of more than 3 months as % of portfolio - Principal 0.3 0.2 0.9 0.4 0.4 - Interest 0.1 0.1 0.2 0.1 0.4 - Toeal 0.4 0.3 1.1 0.5 0.8 Total arrears as % of portfolio - Principal 0.4 0.2 1.2 0.4 0.5 - Interest 0.1 0.1 0.4 0.1 0.4 - Total 0.5 0.3 1.6 0.5 0.9 Portfolio affected by arrears of more than 3 months as Z of total portfolio 5.1 4.1 4.0 3.0 3,6  SINAI YATIRIM VE KREDI BANKASI Sectoral Distribution of Loans outstanding (TL Millions) December 31. 1976 December 31, 1977 December 31, 1978 December 31, 1979 June 30, 1980 Sector Nutmber Amount 7% Number Amount % Number Amount % Number Amount % Number Amount Z Food Products 35 126.5 9.8 23 162.9 10.9 24 194.6 10.1 22 236.7 9.6 21 278.1 8.6 Beverages 4 4.7 0.4 4 2.4 0.2 2 0.4 - - - - - - - Textiles (Including spinning, dyeing and finishing) 64 340.8 26.3 50 327.0 21.9 49 375.9 19.5 47 533.3 21.7 43 495.6 15.4 Clothing 10 10.6 0.8 7 8.1 0.5 5 16.1 0.8 7 28.0 1.1 7 24.9 0.8 Lumber and Wood Products 8 10.0 0.8 3 1.1 0.1 - - - 1 1.8 0.1 1 1.6 0.1 Wood-Pulp 'and Paper 6 18.5 1.4 3 16.2 1.1 4 20.4 1.1 2 15.6 0.6 2 12.7 0.4 Leather and Leather Products 2 8.0 0.6 2 .7.0 0.5 1 3.3 0.2 3 13.9 0.6 3 11.8 0.4 Rubber Products and Tires 7 2.1 0.2 3 50.4 3.4 3 40.6 2.1 2 27.4 1.1 4 62.1 1.9 Chemicals 32 86.4 6.7 31 115.4 7.7 24 116.9 6.1 18 137.3 5.6 17 277.3 8.6 Plastic Products 12 11.1 0.8 11 17.5 1.2 7 19.6 1.0 7 17.4 0.7 7 14.4 0.4 Structural Clay Products 11 19.1 1.5 9 18.8 1.3 12 34.5 1.8 10 32.3 1.3 10 29.8 0.9 Pottery, China and Earthenware 4 33.5 2.6 6 49.3 3.3 7 87.8 4.6 7 132.7 5.4 8 321.3 10.0 &- Class and Glass Products 11 35.0 2.7 9 35.6 2.4 6 32.3 1.7 5 39.7 1.6 4 53.1 1.6 Cement 6 30.9 2.4 5 15.8 1.1 2 2.1 0.1 - - - - - - Cement Products 6 12.6 1.0 6 14.3 0.9 6 13.6 0.7 6 15.1 0.6 7 19.7 0.6 Metal Smelting 3 33.2 2.6 1 35.6 2.4 1 36.2 1.9 1 50.9 2.1 1 76.4 2.4 Iron, Steel and Other Products 27 103.1 8.0 22 100.9 6.8 14 156.3 8.1 14 179.2 7.3 13 199.6 6.2 Metal Products 21 54.9 4.2 18 73.8 4.9 19 95.1 5.0 21 217.6 8.9 21 335.3 10.4 Machinery and Equipment 50 129.9 10.0 43 136.7 9.2 40 214.5 11.2 37 225.4 9.2 39 324.0 10.0 Electrical Machinery, Appliances and Supplies 32 106.5 8.2 32 150.9 10.1 38 254.6 13.2 36 277.3 11.3 34 325.9 10.1 Agricultural Machinery and Implements 5 20.8 1.6 4 17.7 1.2 6 46.1 2.4 4 56.9 2.3 3 67.3 2.1 Manufacture and Repair of Vehicles 2 5.5 0.4 2 38.2 2.6 2 48.3 2.5 2 76.6 3.1 2 113.5 3.5 Miscellaneous Industries 28 90.7 7.0 25 94.1 6.3 24 114.0 5.9 19 142.2 5.8 17 179.7 5.6 TOTAL 386 1,294.4 100.0 319 1,489.7 100.0 296 1,924.2 100.0 271 2,458.3 100.0 264 3,224.0 100.0 >  ANNEX 9 -44- S Y K B PROJECTED LOAN APPROVALS COMMITMENTS AND DISBURSEMENTS 1980 1981 1982 1983 1984 A. Foreign Currency ($000) Approvals 18,541 23,777 30,034 38,801 44,301 Commitments 4,562 19,121 28,127 33,801 38,371 Disbursements 6,205 18,079 24,454 31,213 36,944 B. Local Currency (TL Million) Approvals 1,200 990 1,089 1,252 1,440 Commitments 577 964 965 1,102 1,267 Disbursements 674 959 939 1,061 1,218  -45- ANNEX 10 SYKB Summary of Projected Income Statements 1980-1984 (TL millions) 1980 1981 1982 1983 198L INCOME Income from TL loans