Turkey - Fourth TEK Transmission Project

Document of The World Bank FOR OMCIAL USE ONLY ~2 AL- S-gj5K -7V Rqlrt No. P-4031--iu REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK OF RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO USt142.0 MIlLION TO THE TURKISH ELECTRICITY AUTHORITY WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR A FOURTH TEK TRANSMISSION PROJECT May 28, 1985 This documet hm a resftitd distibuton .d may be used by redplents only ih the perfornmace of ther official dut.lbs couteub my not othewise be diselo_ed witout World Bank authorluton.  CURRENCY EQUIVALENTS Currency Unit Jan. 1980 /1 Jan. 1981 Jan. 1982 Jan. 1983 Jan. 1984 Mar. 1985 US Dollar - TL 70.00 TL 91.00 TL 139.60 TL 191.15 TL 309.20 TL 490.40 TL 1 - US$ 0.014 US$ 0.011 US$ 0.007 US$ 0.005 US$ 0.003 US$ 0.002 {l Since January 1981, the rate is being adjusted for the differential inflation between Turkey and its major trading partners. Fiscal Year January 1 to December 31 WEIGHTS AND MEASURES kVA = kilovolt ampere kW = kilowatt kWh = kilowatt hour GWh (Gigawatt Lour) = 1,000,000 kWh HV = High Voltage kV (kilovolt) = 1,000 volts MW (Megawatt) = 1,000 kW MVA (Megavolt-ampere) = 1,000 kVA MVAR (Megavolt-ampere reactive) 1,000 kVAR One meter (m) = 3.28 feet One kilometer (km) = 0.624 miles One kilogram (kg) (1,000 grams) = 2.2 pounds One ton (metric ton) (1,000 kg) = 2,205 pounds One kilocalorie (kcal) (1,000 calories) = 3.968 BTU toe = tons of oil equivalent GLOSSARY AND ABBREVIATIONS CEAS - Cukurova Elektrik A.S. (Cukurova Power Company) DSI - Devlet Su Isleri (State Hydraulic Authority) EdF - Electricite de France EIB - European Investment Bank KEPEZ A-S. - Kepez Electric Company KfW - Kreditanstalt fur Wiederaufbau LRMC - Long-Run Marginal Cost MENR - Ministry of Energy and Natural Resources MTA - Mineral Research Institute PEE - Public Economic Establishment PPAR - Project Performance Audit Report EPF - Public Participation Fund SAL - Structural Adjustment Loan SEE - State Economic Enterprise SPO - State Planning Organization TEK - Turkiye Electrik Kurumu (Turkish Electricity Authority) TKI - Turkiye Komur Isletmeleri Kurumu (Turkish Coal Enterprise) TPAO - Turkiye Petrolleri Anonim Ortakligi (Turkish Petroleum Corporation)  FOR OMCIAL USE ONLY TURKEY FOURTH TEX TRANSHISSION PROJECT Loan and Project Summary Borrower: Turkish Electricity Authority (TEK) Guarantor: RepubLic of Turkey Amount: US$142 million equivalent Terms: Seventeen years including four years of grace, with interest at the standard variable rate. Project The project would support the further expansion of Turkey's Description: transmission grid to acconmodate increased load and generation capacity. It would support the construction of about 800 km of 380-kV transmission lines an,d transformer substations at the 380-kV and 154-kV voltage levels with a total installed capacity of about 5400 MVA. The project would also include a tower testing facility, line stringing equipment, consulting services and training. Proiect Benefits The project would be an important component of TEK's system and Risks: development program for electricity supply. Construction of transmission lines and transformer substations under the project would allow full utilization of several large generation plants now under construction. Technical assistance would be focussed on improving TEK's capabilities in network engineering and the design of transmission lines and substations. A physical project risk would be the possibility that adverse climate and terrain conditions would delay construction during the winter. Adequate construction technology is available and would be used. The engagement of consultants to assist TEK in project implementation would be a condition of loan effectiveness. Tho document hua nstioad disbutim and maybe usedby reipintsonly in theperformnace |ofthiofficial *duties.Itscontents maynot othwwiebedisclosed wkout WorldBank authodzwon |  Estimated Proiect Costs: US$ Million Equivalent Local Foreisn Total 380 kV Transmission Lines Karakaya-Osnaniye 7.6 21.1 28.7 Altinkaya-Carsamba 1.7 4.2 5.9 Hamitabat-Alibeyhoy 3.1 8.8 11.9 Karakaya-Diyarbakir 1.5 6.0 7.5 Other Connections for 380-kV Substations 0.7 2.0 2.7 Tower Testing Station 2.0 2.5 4.5 Line Stringing Equipment - 4.5 4.5 Total 16.6 49.1 65.7 Substations 380/154-kV Substations 4.0 20.5 24.5 154/30-kV Substations 10.7 26.7 37.4 Total 14.7 47.2 61.9 Computer Hardware/Software .1 2.2 2.3 Engineering/Training 2.2 1.0 3.2 Total 2.3 3.2 5.5 Total Base Cost 33.6 99.5 133.1 Physical Contingencies 3.4 9.9 13.3 Price Contingencies 12.0 36.6 48.6 Total Project Cost 49.0 146.0 195.0 Interest During Construction - 13.0 13.0 Total Financing Required 49.0 159.0 208.0 Financing Plan IBRD - 142.0 142.0 TEK/Government 49.0 17.0 66.0 Total 49.0 159.0 208.0 Estimated Bank Disbursements USS Million Equivalent - IBRD FY 1986 1987 19E. 1989 1990 1991 Annual 4.4 21.1 34.1 32.7 24.1 25.6 Cumulative 4.4 25.5 59.6 92.3 116.4 142.0 Economic Rate of Return: 11.2 percent Appraisal Report: No. 5571-TU, dated May 20, 1985 Map: No. 18845  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TURKISH ELECTRICITY AUTHORITY FOR A FOURTH TEK TRANSMISSION PROJECT 1. I submit the following report and recommendation on a proposed loan to the Turkish Electricity Authority (TEK) with the guarantee of the Republic of Turkey for the equivalent of US$142.00 million to help finance the foreign exchange cost of a Fourth TEK Transmission Project. The loan would have a term of seventeen years including four years of grace, with interest at the standard variable rate. PART I - THE ECONOMY 1/ 2. An economic mission visited Turkey in June 1982, and its report entitled "Turkey: Country Economic Memorandum, Recent Economic Developments and Medium-Term Prospects" (No. 4287-TU) was distributed to the Executive Directors in June 1983. The report of a mission to review the financial sector, entitled: "Turkey: Special Economic Report - Policies for the Financial Sector" (No. 4459-TU). was distributed in September 1983. A Bank mission reviewed the Government's Fifth Five-Year Plan (1985-89) in August/September 1984 and its findings are reflected in this section. 3. Turkey is about as large as France and Germany combined, with a population of around 48 million and an estimated GNP per capita of $1230 in 1983. The density of population is low (78 per square kilometer of agricultural land), and about 47 percent live in urban centers. Population growth (2.2 percent per annum) is below the median for middle-income countries. Despite rapid economic growth in the mid-1970s as well as substantial emigration of workers (to Western Europe and more recently, to the Middle East), the employment situation has deteriorated steadily with an unemployment rate currently estimated at about 19 percent. There is, however, little or no absolute poverty, although income distribution ir skewed. There are considerable regional differences in income and large rural-urban disparities. Recent data indicate a probable worsening in income distribution, especially of wage and salary earners, and a sharp real decline in average earnings. Educational enrollments have expanded greatly, but the level of adult literacy remains relatively low. Background 4. During the 1970s Turkey did not make the necessary adjustments to the shocks caused by the steep rise in oil prices, stagflation in the OECD economies, and the consequent deterioration of its terms of external trade. 1/ Parts I and II are substantially the same as Parts I and II of the President's Report on the Industrial Schools Project (P-3956-TU), dated April 18, 1985.  Until 1977 Turkey maintained high rates of economic growth by raising the share of public investment in GDP. This was financed initially by workers' remittances and, following the quadrupling of oil prices, increasingly by short-term borrowings. The rapid GNP growth came to an abrupt halt in 1977 as the massive external debt burden led to a sharp deterioration in creditworthiness, severe shortages of imports, and disruptions in industrial production with a rise in unemployment. By the end of 1979, domestic inflation had also become an issue of critical importance. 5. The Turkish authorities' response to the crisis of the late 1970s was a major shift in development strategy in 1980, moving towards outward orientation and giving an increased role to market forces. Policies were adopted to expand exports and increase workers' remittances whiclh, together with liberalization of imports, encouragement of foreign investment and prudent external debt management, were aimed at alleviating the balance of payments constraint and import shortages. On the domestic front, the objectives were a reduction in the inflation rate, reform of the State Economic Enterprises (SEEs), a more efficient financial sector, improved resource mobilization and better selection of investments, especially in the public sector. 6. The adjustment program, which has been supported by the Bank through five structural adjustment loans, involves far-reaching changes in attitudes, institutions, and the legal and policy framework, all of which require time to put in place. Major structural changes have been made in the exchange rate system, the export and import regimes, the tax system, interest rate and selective credit policies and the public investment program. Implementation of the adjustment program was carried out under a military regime during September 1980 - November 1983 and since then by an elected government. The Structural Adjustment Program - 1980-84 7. The Turkish economy has shown an impressive response to the structural adjustment program and actual performance met or exceeded the Government's own targets through 1982. By contrast, results in 1983 and 1984 proved to be mixed, due in part to adverse economic developments on the external front, slippages in the monetary program, a persistent shortfall in Government revenues and the renewal of inflationary pressures. 8. Real GNP expanded by 4.1 percent in 1981 and 4.6 percent in 1982. In 1983, GNP growth slowed down to 3.2 percent, due in large part to the effects of a bad harvest and a decline in the contribution of the foreign balance. The growth rate rebounded in 1984 to an estimated 5.7 percent, supported by favorable performance in the productive sectors with agricultural value added growing at 3.6 percent and industrial value added at 9.6 percent. Capacity utilization rates in private industry in 1984 are estimated to bave risen by about 5 percent to an average rate of 72 percent. On the expenditure side, the average annual real rate of growth of public fixed investment has been contained to 3.1 percent over the 1980-84 period while the growth rate of private investment has improved systematically from -17.3 percent in 1980 to 4.8 percent in 1983 and an estimated 5.4 percent in 1984. Private consumption, which had actually fallen by 5 percent in 1980, grew at 4.9 percent in 1983 and an estimated 5.0 percent in 1984. On the other hand, helped by strict budgetary discipline, the rate of growth of public consumption declined from 8.4 percent in 1980 to 1.8 percent in 1983. Estimates for 1984 suggest a modest growth of 2.4 percent.  9. Through 1982, the Government met with considerable success in reducing the rate of inflation through a combination of fiscal, monetary and incomes policies. After peaking at 107 percent in 1980, the anrual average rate of increase in the wholesale price index declined to 37 percent in 1981 and 27 percent in 1982. In 1983 the downward trend was reversed and the inflation rate rose to 30 percent. This rise was fueled by an expansion of Central Bank credits to firms and commercial banks in difficulty during the second half of 1983 as well as an unexpected increase in the budget deficit. The resulting liquidity expansion, in conjunction with a lowering of nominal deposit interest rates, encouraged consumption at the expense of savings. 10. Inflation accelerated further in the first half of 1984, although it moderated in the second half. The average inflation for 1984 is estimated at a little over 50 percent. The major factors that contributed to the worsening of the inflationary situation were the lagged impact of the expansionary monetary policy pursued during the second half of 1983, and a significant increase in agriculture product prices, especially of fresh fruits and vegetables, as a consequence of export liberalization and higher export market prices. Other important inflationary factors included substantial "catch up" increases of SEE prices and higher import prices resulting from the nominal depreciation of the Turkish lira. In addition, inflationary pressures stemmed from a larger than anticipated budget deficit in 1984 as a result of a slowdown in the growth of revenues. 11. Commercial bank interest rates, which were deregulated in July 1980, have increased substantially and are now positive in real terms. As a result, total bank deposits increased by 72 percent in 1980 over 1979, and in 1981 this trend accelerated, with total deposits growing by 103 percent and time deposits by 274 percent. Growth in total deposits slowed after 1982, and in 1983 and 1984 they grew at 53 percent and 42 percent respectively. The bankruptcy in late June 1982 of a major non-bank financial institution shook depositor confidence and was followed by a shift of funds into the larger banks. The Government averted ar. immediate crisis in the banking sector and undertook actions to reform and strengthen the financial sector as a whole. A new banking law was enacted in June 1983 which covered many of the recoumendations made in the Bank's report on the Financial Sector (No. 4459-TU). These included measures to reduce the undercapitalization of banks, place limits on the real assets and investments of banks, link the establishment of branches to the level of a bank's equity, reduce the interlocking between banks and corporations, introduce a deposit insurance scheme, and increase the role of the Central Bank in the supervision of the banking sector. A new law is currently before Parliament which will further the banking reform process by introducing standardized accounting for banks and improved procedures for handling non-performing loans. The Government also took a major step towards reducing the cost of intermediation by reducing the financial transactions tax from 15 percent to 3 percent. Separately, the Government has reduced the level of withholding tax applicable to interest payments on deposits and bonds from 20 percent to 10 percent. Other important developments in the financial sector include measures undertaken to revitalize the capital markets, for which IFC has provided technical assistance, and the sale of revenue-sharing certificates linked to the income from selected public facilities (e.g. the Bosphorus bridge).  12. The Government is committed to maintaining an interest rate structure for deposits which is positive in real terms. Time deposits have been yielding more or less positive real returns since end-1983, with interest rates ranging from 45 to 53 percent depending upon the term of the deposit. While positive real interest rates have provided an incentive to save, they have also meant high borrowing costs. Nominal interest rates range from 60 to 80 percent on non-preferential credits, in part because of the high intermediation costs of the commercial banks and their widely prevalent practice of requiring compensating balances. The interest rate differentials between preferential and non-preferential credits and among preferential credits are large and need to be reduced. The Government has reaffirmed its determination to achieve positive real rates on all lending by a combination of bringing down inflation and phasing out interest rate subsidies on preferential credits. In January 1985, it eliminated preferential interest rates on short-term export credits. High market interest rates, together with the limited availability of credit, have led to considerable liquidity problems for the private business sector, particularly for businesses supplying the domestic market. Measures are also needed to lower the operating costs of banks, which are well above prevailing levels in comparable countries. 13. In the fiscal area, progress was evident from 1980 to 1982 but there have been slippages in 1983 and 1984. The budget deficit to GNP ratio was reduced from 5.3 percent in 1980 to 2.1 percent in 1982, and the Public Sector Borrowing Requirement (PSBR) dropped sharply from 12.6 percent of GNP to 6.9 percent over the same period. However, the revenue to GNP ratio has been declining over the past three years. From a high of 20.3 percent in 1981, it has fallen sharply to an estimated 15.6 percent in 1984. Largely because of this significant shortfall in revenues, overall fiscal performance has worsened since 1983 even though government expenditures have been considerably curtailed (from 24.2 percent of GNP in 1980 to an estimated 20.8 percent in 1984) and budgetary transfers to SEEs as a percentage of GNP have fallen steadily (from 4.8 percent in 1980 to an estimated 1.6 percent in 1984). The budget deficit is estimated at 5.2 percent of GNP in 1984 and the PSBR at 8.8 percent. The downward trend in the Government revenue to GNP ratio highlights the urgency of mobilizing additional public resources. As a step in this direction, the Government introduced a Value Added Tax (VAT) in January 1985. 14. Improvements in the balance of payments were systematic through 1982 with the current account deficit decreasing from $3.3 billion (5.7 percent of GNP) in 1980 to $1.2 billion (2.2 percent of GNP) in 1982. However, in 1983 the current account deficit widened to about $2.1 billion (4.2 percent of GNP) as merchandise exports and workers' remittances fell short of targets. Exports rebounded strongly in 1984, growing by 25 percent in dollar terms to $7.1 billion. Remittances, too, registered a higher than expected increase, reaching $1.9 billion (up by 24 percent). Concurrently, there was a continued large inflow of deposits through the Dresdner scheme ($550 million in 1984). Under this scheme the Dresdner Bank collects deposits from Turkish workers in Germany and automatically places these funds at the disposition of the Central Bank of Turkey, which guarantees the deposits and pays an interest rate commensurate with the Euro-market rate. However, these increases were offset by a sharp rise in merchandise imports to $10.8 billion (up by 16 percent in dollar terms). As a result, the current account deficit in 1984 was considerably higher than projected, reaching $2.1 billion (4.3 percent of GNP), or about the same level as in 1983.  15. On balance, merchandise export performance has been impressive over the 1980-84 period, growing at an average anni''l rate of about 26 percent in dollar terms. This growth has been led by t'he manufacturing sector and has involved a rise in the share of exports to the Middle Eastern countries. Industrial exports, comprised primarily of p.rocessed foods and textiles, have risen from 36 percent of total exports in 19&' t3 72 percent in 1984. These results were acuieved by a combination of indirect (flexible exchange rate policy and import liberalization) and direct (tax rebates, preferential credits) measures to enhance the relative profitability of exports and offset the traditional bias towards producing for the domestic market. The flexible exchange rate policy was one of the most important factors cortributing to the growth of exports, together with the penetration of Turkish products in Middle East markets. 16. On the import side, the 1982-83 period was marked by a relative stability in the growth of merchandise imports, mostly due to exogenous factors. Imports fell by 1.0 percent in dollar terms in 1982 and rose by only 4.4 percent in 1983. This reflected price decreases in both oil and non-oil imports. Merchandise imports, however, increased substantially in value in. 1984. The increase has been most significant in some of the groups (e.g. raw materials and consumer goods) that have been subjected to major liberalization in terms of both a lowering of tariff rates and a significant removal of quantitative restrictions. Medium-Term Prospects 17. The Government's Fifth Five Year Plan (1985-89) was approved by the Grand National Assembly in July 1984. The Plan reaffirms the Government's determination to pursue an outward-oriented development strategy and to liberalize the economy by relying increasingly on market forces for allocation decisions. The public sector is targeted to play a supportive role by concentrating its investments in infrastructure rather than manufacturing, while the private sector is to be encouraged to play a leading role in the growth of manufacturing and exports. Some of the key targets are: (i) an average annual GNP growth rate of 6.3 percent; (ii) an average annual real rate of growth of merchandise exports of 10.6 percent; (iii) an average annual real rate of growth of merchandise imports of 8.2 percent; (iv) an average annual real rate of growth of 10.9 percent in private investment and 6.8 percent in public investment; and (v) a declining external debt service ratio, from 26 percent in 1984 to around 18 percent in 1989.  - 6 - 18. While the overall thrust of the Plan is in accord with the goals of the structural adjustment program, certain targets seem optimistic in view of both past performance end the immediate prospects for the economy. The Bank's projections indicate the need for a continuation of the stabilisation program well into 1987, implying a lower grovth rate in GDP for the early years of the Plan and a return to a higher growth path only in 1988. Key economic variables in the Bank's latest projections for the period 1985-89 are presented in Table 1: Table 1: TURKEY - SELECTED ECONOMIC INDICATORS, 1983-89 Av1srge Annual 1033 1934 1935 1939 Dal roeth note Real Growth Ioat Unit. Aitl gt. Projeted li1 (S) (S) COP /a TL Do at 1933 Pricee 11463 12122 12700 199 3.7 5.7 5.6 AriLcultu 2058 2132 2202 2411 -0.3 3.6 3.0 Industry 3096 3393 358 4732 7.3 9.3 7.0 Services 5631 5929 6179 7771 3.0 5.3 5.7 canemnptiea 9533 10034 10539 290 4.5 . 5 1 Fixed incLvta et 211 2220 2400 3180 3.0 1.3 7.5 Ezport. of goods Curr_t u 5728 7100 8541 L7574 13.9 23.1 9.4 Laporte of goods 9235 10756 11500 21307 12.0 15.3 7.2 Tred. balanes -3507 -3656 -2959 -3733 Curtnt account balanc Currant S * -2122 -2135 -1750 -2003 Ratios Insta It/GDP Z 19.0 18.3 13.9 20.0 Saviangsal S 16.5 17.1 17.4 19.5 Reports of goodmIGUP S 11.3 14.6 13.9 15.9 Currant account deficit/ S 4.Z '4.3 -2.8 -1.8 Debt service ratio / S 2S.0 25.0 23.7 19.8 PublLc fi"d ivetaat/ S 60.3 58.9 57.6 52.6 total fi sd irae_t No ite_: Cross capital required /d trreat S u 3687 4290 334 5905 /a At market prices; components are expressed at factor cost and will not add up due to exclusion of indirect taxes and subsidies. /b Based on constant TL. /c Total Debt Service (excluding short-term) /Exports of Goods and NFS plus Workers' Remittances. /d Includes net IMF. Source: State Planning Organization for actuals and IBRD projections.  - 7 - 19. Bank projections indicate a GDP growth of 5.6 percent per annum on average for the Plan period, with a low of 4.9 percent in the initial year of the Plan (stabilization period) and a high of 6.3 percent for the final year (growth period). Achievement of these growth rates will depend on the performance of the productive sectors, namely agriculture and manufacturing. This in turn will depend to a large extent on the Government's determination to constrain the growth of the public sector in line with public resources and to create a more favorable investment climate for the private sector. This translates itself into a projected real growth per annum in public fixed investment of about 5.0 percent on average for the Plan period, starting with a modest increase in the early years. The comparable figure for private fixed investment is 10.6 percent or a little more than twice the growth rate for public fixed investment. These figures are consistent with the need to meet the infrastructure requirements of the economy through the public investment program, while providing for the capacity expansion of the private sector necessary to meet the export and growth targets. 20. Merchandise exports are projected to grow at an average 9.4 percent per annum in real terms. Merchandise imports, on the other hand, are projected to grow more slowly in real terms through 1986 and then pick up to an average 7.5 percent per annum in the terminal years of the Plan. On these assumptions, the current account deficit is projected to decrease through 1986 as stabilization policies act to contain import growth while encouraging exports. As higher growth rates set in during the middle of the Plan period, the trend would reverse and the current account deficit would rise moderately through the end of the Plan. The terminal year 1989 would show a deficit of approximately $2.0 billion as compared to a 1985 figure of $1.7 billion. The projected capital account is seen to remain manageable throughout the period even in the face of some sharp increases in the amortization payments in t985-87 arising from the debts rescheduled during the 1978-80 period and an imposed constraint on foreign exchange reserves equivalent to at least two months' imports. Consistent with the above is an average debt service ratio for medium and long-term credits for the Plan period of 21.7 percent. Including short-term debt the average debt service ratio for the Plan period is 23.7 percent. Gross capital inflows required in 1989, on these assumptions, would be about $5.9 billion, or about 38 percent higher than the amount in 1984. Such an inflow is consistent with a decreasing debt service ratio from 1986 onwards. 21. The medium-term scenario presented above is, of course, only one of many possibilities and is used specifically to illustrate Turkey's potential in the light of the Government's own development strategy. Given Turkey's progress in the structural adjustment program, the favorable response which this has evoked from the international financial community and the present view of future resources and export market possibilities, the Government's somewhat more ambitious Plan targets would be feasible provided they are supported by slightly higher export growth rates and greater success in the mobilization of public resources. This may be more difficult to achieve in the early (stabilization) phase of the Plan. 22. In view of the sensitivity of the projections to the assumptions of export and import growth rates, a downside risk case has also been developed. With Turkey's export performance heavily dependent on exogenous factors such  as the world economic outlook and movements in international prices, a slower growth of merchandise exports (an average of 6.9 percent over the Plan period) would lead to a more difficult but still manageable balance of payments situation, more external borrowing, a lower GDP growth (averaging about 4.8 percent per annum) and a higher debt service ratio (22-24 percent per annum). In such a situation the Government would have little chance of absorbing the unemployed and improving tangibly the average standard of living. However, given the Government's emphasis on export promotion and the determined efforts to counter the bias towards producing for the domestic market, there is good reason to support the perspective set out in the medium-term scenario presented in paragraphs 18 to 21. External Debt and Creditworthiness 23. At the end of 1978, Turkey had $7.2 billion in short-term debt and $7.0 billion in medium and long-term debt. Between 1978 and 1980, Turkey rescheduled some $9.2 billion of outstanding obligations through a series of rescheduling arrangements concluded with official and commercial creditors. Approximately $6.0 billion of short-term debt, including $2.6 billion in convertible Turkish lira deposits and bankers' credits and $1.2 billion of non-guaranteed suppliers' credits, were consolidated into medium-term loans or partially converted into Turkish lira obligations. Following the resolution of the debt crisis, inflows were mostly from official sou.rces - major creditors being the OECD countries, the World Bank and Lhe IMF. Of the estimated total debt outstanding of $22.7 billion at end-1984, 81 percent constituted medium and long-term debt (including IMF). Short-term debt as a percentage of total debt outstanding fell from 51 percent in 1978 to about 11 percent in 1982, then increased to 14 percent in 1983 and to an estimated 18 percent in 1984. Much of this growth in the stock of short-term debt is due to the inflows associated with the Dresdner Bank scheme (para. 14). At end-1984 the outstanding liabilities associated with the Dresdner scheme are estimated to amount to $1.8 billion, which would represent about 45 percent of Turkey's short-term external obligations and 8 percent of its total outstanding debt. Based on the growth scenArio outlined earlier, debt outstanding and disbursed as a percentage of GDP is projected to fall from an estimated 41 percent in 1984 to 32 percent in 1989. This translates into a total debt outstanding forecast for 1989 of $30.6 billion, with short-term debt constituting about 23 percent of that total. Dresdner scheme inflows are projected to be around $600 million per annum throughout this period and to account for a large part of the rise in the ratio of short-term debt to total debt outstanding. 24. The debt service ratio for medium and long-term credits (in relation to exports of goods and non-factor services and workers' remittances) increased from about 14.6 percent in 1981 to a peak of 28 percent in 1983 as a result of a large repayment of previously rescheduled debt under the earlier OECD agreements. Debt service obligations are likely to be high over the coming years and would average about $3.8 billion per year in 1985-89. However, the debt service ratio is seen to decrease from an estimated 25 percent in 1984 to 19.8 percent in 1989. The debt burden should remain manageable provided current policies are successfully implemented, the export drive is sustained, and Turkey continues to receive further support from international commercial and official sources. There have been encouraging  - 9 - signs of Turkey's ability to enter the market for commercial borrowings. From December 1983 to November 1984, Turkey had secured a little over $500 million from commercial credits, constituting about 23 percent of the total external credits received during this period. The Central Bank of Turkey recently completed the syndication of a $500 million multi-component medium-term (seven years) facility involving a large number of U.S., European, Japanese and Middle Eastern commercial banks as lead managers. 25. Turkey's economic program has been supported by the IMF through a series of standby arrangements. A three-year standby arrangement in an amount equivalent to SDR 1250 million was approved by the IMF's Board and became effective an June 18, 1980. The Government purchased the full amount authorized under the arrangement. The Government also purchased three-quarters of a SDR 225 million one-year standby arrangement which was approved by the IMF in April 1984 and replaced an earlier one-year arrangement terminated at the request of the Government. PART II - BANK GROUP OPERATIONS IN TURKEY 26. Through March 31, 1985 the Bank and IDA have lent $5383.5 million 1/ to Turkey, through 81 projects. Agriculture accounts for 19 percent of funds lent, industry and DFCs for 24 percent, power for 13 percent, structural adjustment and program loans for 32 percent, and urban development, transportation, education, tourism and technical assistance for the remaining 12 percent. Disbursements for all sectors combined (excluding structural adjustment loans) average 49 percent of appraisal estimates, as compared to 51 percent for Tunisia and 48 percent for Morocco. As of March 31, 1985, IFC commitments to Turkey totalled about $239 million, of which about $64 million were still held by IFC. Annex II provides a summary statement of Bank loans, IDA credits and IFC investments as of March 31, 1985. 27. Bank lending is aimed at supporting Turkey's medium-term objectives of restructuring the Turkish economy by placing more reliance on market forces and adopting a more outward-oriented strategy. The main vehicle for the Bank's operational discussions with the Government has been the structtural adjustment lending (SAL) program. SAL V, which was approved in June 1984, completed the series of five loans which the Bank had indicated would be the maximum to a country. Significant progress has been achieved in the :ast five years, but the task of restructuring is by no means over. The !t: phase will involve the broadening and deepening of the adjustment process a- the sectoral level. Recent economic developments have underlined the need for a continuation of the stabilization program without giving up the goals of 1/ Net of cancellations.  - 10 - sectoral adjustment. Hence the emphasis of Bank lending in the post-SAL period would be on striking an appropriate balance between sectoral adjustment lending designed to be quick disbursing and supportive of policy reforms in the major sectors, and carefully formulated project lending focussing on high priority projects principally in the agriculture, energy and transport sectors. 28. Efforts have already been initiated to develop a series of sectoral adjustment loans for the major sectors over the next few years, starting with agriculture. The loans for the agriculture sector would help to support a medium-term action program aimed at increasing the growth of primary production and exports, rationalizing public investment and strengthening sectoral institutions. Sectoral adjustment lending would also support measures to address the structural problems of the financial sector and enhance the utilization of industrial capacity in the public and private sectors, keeping in view the scope for the "privatization" of publicly-held assets in the manufacturing subsectors. Other sectors where sectoral adjustment loans could be developed include energy and transport. 29. Project lending, which will continue to make up the majority of the lending operations, will be designed to support and strengthen the adjustment process. A portion of project lending would be earmarked for the construction or rehabilitation of key projects in the energy sector. Other projects would be guided by the maior policy objectives of the Government, which include generation of foreign exchange (including improving productivity in export industries and providing essential infrastructure for exports), improvement of institutional efficiency, non-inflationary output growth and amelioration of the social costs of adjustment (including provision of social infrastructure and employment generation, with some emphasis on the least developed provinces in Eastern Turkey). 30. The close macroeconomic and sector dialogue established with the Government in recent years is expected to be pursued. The economic and sector work currently being undertaken includes a review of the five-year development plan and studies of housing finance, telecommunications and electronics. Topics to be covered in the future include a review of the puDlic investment program, a study focussing on the impact of structural adjustment, a review of transport investments and studies of engineering and agro-industries. 31. This would be the sixth loan to Turkey presented to the Executive Directors this fiscal year. Other projects being processed include the Kayraktepe and Sir Hydropower Projects. 32. Turkey's debt burden is projected to remain manageable throughout 1985-89 (paras. 23 and 24). The Bank Group's share of Turkey's total external debt was 12.4 percent in 1983, is estimated at 13 percent in 1984, and is expected to grow to about 17 percent by 1989. Official debt outstanding is projected to increase from $11.4 billion in 1984 to $14.4 billion in 1989 and private medium and long-term debt outstanding is projected to increase from $5.7 billion in 1984 to $8.8 billion in 1989. The Bank group's share of total debt service payments is projected to increase from about 12 percent in 1983 tu an estimated 13 percent in 1984, and to about 17 percent in 1989.  j w -11- 33. IFC has invested in synthetic yarns, textiles, pulp and paper, glass, aluminum, cement, iron and steel products, heavy diesel engines, motor bicycle engines, piston rings, food processing and tourism. It has also invested in the Industrial Development Bank of Turkey (TSKB) and provided guarantees for overseas contracting firms. In addition, IFC is currently providing technical assistance to the Government with respect to the development of the capital market and a regulatory framework for leasing. PART III - THE ENERGY SECTOR AND THE POWER SUBSECTOR Energy Resources 34. Turkey has substantial untapped lignite and hydropower resources, as well as more limited, but still important, oil, gas and coal resources and geothermal potential. Hydropower with potential economic viability is estimated at about 29,500 MW under average hydrological conditions and corresponds to an annual production of about 100,000 GWh. Only 15 percent has been developed so far, but this is projected to rise to about 30 percent by 1990. Proven recoverable reserves of oil are about 16 million tons; however, potential reserves that may become economically recoverable, using enhanced oil recovery techniques currently being tested, could be as high as 30 million tons. Oil production has been declining over the last decade, as few discoveries have been made in recent years; in 1983 production was about 17 million tons, equivalent to 45 percent of total consumption. Proven recoverable gas reserves are about 400 billion standard cubic feet. Domestic gas will, however, be supplemented, beginning in 1987, by large scale imports of natural gas from the U.S.S.R. 35. Total known reserves of hard coal are estimated at about 1 billion tons, all located in the north of Turkey. Coal production has been declining as operations move to deeper, less accessible seams; in 1983 production was 3.5 million tons (2.2 million toe). Proven and probable lignite reserves are about 8 billion tons, but about half of this is of extremely low quality (950-1,000 kcal/kg). Lignite production in 1983 was about 20 million tons, equivalent to about 4.6 million tons of oil. There is potential for geothermal development, for both space heating and electricity generation, and a review of promising geothermal sites is under way. Energy Consumption and Supply 36. Total gross energy consumption was about 38 million toe in 1983, of which commercial energy consumption amounted to 30 million toe. Petroleum made up the most significant share of primary commercial energy (58 percent), with lignite (20 percent), hydropower (9 percent), coal (11 percent), asphaltite and imported electricity making up the balance. Overall, about 23 percent of final commercial energy consumption was in the form of electricity. Non-commercial energy production (primarily fuelwood, but also other biomass) was an important energy source, accounting for 37 percent of total domestic energy production. The most notable change in the pattern of energy consumption over the past two decades has been the decrease in the relative share of hard coal in the total. This was accompanied by a rapid growth in consumption of petroleum until the mid-1970s, peaking at over  - 12 - 50 percent in 19771/78; and a rapid rise in the share of lignite (primarily for thermal power production) and hydroelectric power consumption starting in the second half of the 1970s. During this period, hard coal consumption stayed relatively constant in absolute terms, while traditional biomass energy sources increased slightly in absolute terms but decreased steadily as a percentage of total energy consumed. 37. Trends observed in the growth and pattern of energy consumption during the latter part of the 1970s are expected to continue during the 1980s and 1990s. The most important factor in the growth of energy demand will be the growth rate of the economy as a whole and the growth of the relatively energy-intensive industrial sector. The demand for lignite is expected to grow rapidly, both for direct consumption by households and industry and, even more importantly, for the power sector. The growth in demand for petroleum will be moderate due to the much higher price of imported oil and petroleum products and its substitution by other energy sources. Organization of the Energy Sector 38. The energy sector :n Turkey is characterized by the dominance of Government owned enterprises and agencies. The Ministry of Energy and Natural Resources (MENR) is responsible for the development of energy resources in Turkey. The Turkish Hard Coal Enterprise (TTK). the Turkish Lignite Enterprise (TKI), the Turkish Petroleum Company (TPAO), and the Mineral Research Institute (MTA) have responsibility for the extraction of fossil .uels and radioactive minerals. Identification, design and construction of hydroelectric projects is entrusted to the State Hydraulics Authority (DSI). The Turkish Electricity Authority (TEK) is responsible for the generation, transmission and, since November 1982, the distribution of almost all the electricity sold in Turkey. TEK is also responsible for the implementation of the Government's program for rural electrification and the construction of all generating and transmission facilities, with the exception of hydroelectric plants for which DSI has responsibility. 39. Private sector participation in the supply of electricity was, until 1983, confined to two small private utilities (CEAS and KEPEZ) and industrial companies which generated power for their own use. However, recent changes _- Government energy policy now give greater encouragement to private sector participation in the development and production of energy (para. 41). The Government is actively seeking ways to encourage both local and foreign private sector participation in geothermal development, lignite mining, hydroelectric projects and the construction and operation of power plants fired by imported fuels. Energy Sector Policy 40. To meet its energy requirements, Turkey launched a massive program in the late 1970s to increase the domestic production of electricity and lignite. This program tended to stretch the implementation capabilities of the State energy agencies, and spread resources too thinly over too many projects, with resulting long delays in completion schedules. This has, in turn, resulted in an energy deficit which is likely to remain a feature of the Turkish economy at least through the 1980s. MENR and TEK are in the process  - 13 - of improving their energy planning capabilities; and MENR has produced Turkey's first energy policy paper. Furthermore, the recent Five Year Development Plan (1985-89) contains some broad objectives relevant to the energy sector including the following: - Priority is to be given to domestic sources of energy, especially hydra and lignite, provided that they are economically justified; - Imported energy including, but not limited to, oil will be considered; - Renewable and nonconventional resources such as geothermal, solar and biogas are to be supported; and - Private sector financing, both local and foreign, will be sought for participation in energy development. 41. Two features of Government policy appear to represent a departure from previous energy policy. The first is that Government policy is now quite clearly to encourage private sector participation in the energy sector. There are now no legal constraints to private sector electricity generation, and existing private utilities like KEPEZ and CEAS have plans to increase their capacities. In addition, the State Planning Organization (SPO) is currently undertaking, with assistance from consultants, preliminary studies to assess whether private finance could be sought for the construction and operation of thermal plants based upon imported fuels (coal, nuclear) and geothermal sources. The second shift in policy focus is increased concern that indigenous resources be developed only when economically justified. Improving efficiency in the lignite mining subsector at least to levels at which marginal production costs are competitive with imported coal, or conversely abandoning such mining ventures if such economies cannot realistically be met, will thus be a major energy policy concern for the Government. 42. A less explicit but no less important component of the Government's energy policy relates to the pricing of energy products. Regular increases in the prices of petroleum products to maintain prices at economic levels has been a feature of the Government's pricing policy for the past five years. Electricity tariffs have been increased sharply since early 1984. As of April 1, 1985 bulk power tariffs are roughly at the level of long run marginal cost. Prices of petroleum products are being maintained at international levels. Lignite prices, which had shown a threefold increase in real terms in the seven years preceding 1983, declined slightly in in real terms in 1984. 43. The Government is also in the process of developing a program for the conservation of energy by encouraging more efficient use in existing and new industrial enterprises. Energy efficiency programs and legislation have been evaluated by both the MENR and SPO, and legislation has been passed which allows for tax credits for various types of investments in energy efficiency improvements. The Bank included financing of energy audits in selected manufacturing facilities under Loan 1916-TU. These audits have been completed and are under review. TEK has engaged consultants to assist in the development of an energy conservation and load management program.  - 14 - Electricity Supply and Demand 44. The present installed power capacity in Turkey im about 7,600 MW of which 3,500 MW (50 percent) is thermal and the balance hydro. The share of hydroelectric power has increased over the past ten years from 33 percent in 1972 to about 50 per cent in 1984. On the thermal side, lignite has made an increasing contribution to the production of electricity. Total gross generation in 1984 was about 30,000 GWh. of which TEK accounted for almost 90 percent. Imported electricity from Bulgaria and the U.S.S.R. accounted for a further 2,500 GWh. Total availability was less than the potential effective demand. estimated at 35,000 GWh. There is considerable evidence that power shortages have caused cutbacks in production in industries such as cement, textiles and paper. In addition to the capacity constraint, the high level of total system losses (technical losses plus energy unaccounted for), estimated at about 20 percent, contributed to the supply shortages. 45. Growth in demand for electricity averaged about 9 percent per annum over the period 1965-1983. Between 1970 and 1983, the percentage of population with public electricity supply rose from 51 percent to 78 percent. Per capita consumption of electricity is currently about 550 kWh. TEK's latest long-term generation plan (1987-2005) is based upon a projected overall growth in energy demand of about 11 percent per annum, with peak demand increasing at about 9 percent per annum. This represents a considerable sustained annual increase in demand, particularly as the base from which the demand is extrapolated (1987) appears to be high. 46. For more than two decades the Turkish power subsector has been confronted with major problems. Electricity supply has been insufficient to meet demand in every year since 1971, resulting in high costs to the economy as imports increased and supply interruptions continued. Many of the issues facing the subsector can be traced to institutional problems in the public sector agencies responsible for planning and implementing the subsector's investment program. This has resulted in project delays, consequent substantial cost escalations, power shortages, frequent and protracted plant breakdowns due to inadequate maintenance, and relatively high system losses, especially in the urban networks. The shortage of qualified staff in TEK resulted in resources, human and financial, spread too thinly over too many projects in the investment program. 47. The Government agrees that closing the supply gap will require a major coordinated effort by the major agencies in the subsector. It plans to emphasize increased supply in parallel with managing demand and improving efficiency of existing facilities. To illustrate the magnitude of the task, it should be noted that Turkey would have to bring ou stream three times more capacity in the 1980s than in the 1970s and that the momentum would have to be sustained throughout most of the 1990s. Also, scarce resources will be tied up in technologies new to the country, such as nuclear, and in projects of an unprecedented size. TEI and DSI will have to meet their respective production targets commensurate with TEK's plans. Even if a lower growth rate in electricity demand is assumed, and optimistic assumptions are made about the sector's implementation capacity, some power shortages are likely to continue throughout the 1980s.  _ 15 - Bank's Role in the Power Subsector and Experience with Past Lending 48. The proposed project would be the sixteenth Bank operation in the power subsector in Turkey. The Bank has made eleven loans and a technical assistance grant (total $639.7 million), and IDA has granted three credits (total $55.7 million) for four hydroelectric projects, two thermal power stations (oil- and lignite-fired), a lignite mine, and several transmission and distribution networks. The technical assistance grant helped reorganize Turkey's power subsector. The first five loans/credits were for projects in the CEAS coacession area. All these projects were completed successfully, although often with long delays. The Bank has made four previous loans to TEK, for the First, Second and Third Power Tr.nsmission Projects, and for the Elbistan Mine and Power Project. 49. A Project Performance Audit Report (PPAR) distributed to the Board in November 1981, 1/ on the Keban Transmission (Loan 568-TU) and the first TEK Power Transmission (Loan 763-TU) projects, found that these projects had met their physical objectives despite implementation delays and cost overruns. A Project Completion Report on the Istanbul Power Distribution Project (Loan 892-TU), distributed to the Board in December 1982, 2/ also reported physical completion of the project after considerable delay. Major constraints to timely project completion were identified as shortage of local counterpart finance and, in the case of Loan 892-TU, late preparation of bidding documents. A major conclusion of the TEK II (Loan 1194-TU) Project Completion Report was the need for improvement in the monitoring and coordination of the project. The report recommended the establishment of a single unit within TEK to be accountable for project implementation. Such units are now regularly used in Bank financed power projects in Turkey. Implementation of the Third TEK Transmission Project (Loan 2322-TU) is satisfactory. 50. The Bank has been able to assist the Government in the consolidation of the power sector and in the creation of TEK. The Bank has also supported efforts to bring about other institutional reforms. Considerable progress has been made in areas such as TEK's accounting system, system planning, and procurement procedures. The Bank has also assisted in attracting funds from other bilateral and international financing agencies (e.g. EIB, German Aid (KfW), US EXIMBANK). Planned Strategy for Assistance to the Subsector 51. Sector policy discussions, which recently have been held twice a year with the Government and energy sector agencies, have provided a useful forum to discuss the issues and constraints facing the subsector. The Bank is generally in agreement with the Government's strategy for the energy subsector. Detailed agency by agency action programs have been prepared and will be discussed with the Bank in 1985. Current and future Bank lending would be based on these action programs. For the electric power subsector, it 1/ No. 3695, dated November 23, 1981. 2I No. 4264, dated December 29, 1982.  - 16 - has been agreed that attention would be given to a selected number of high priority issues. The strategy includes focus on (a) investments which yield quick returns, such as completion of priority ongoing investments, upgrading of existing facilities, reduction in losses and improvements in maintenance procedures and efficiency; (b) programs to ensure a balanced electric power development program with respect to adequate investment in generation, transmission, distribution and general plant; (c) technical assistance to strengthen capabilities in planning, financial management and manpower development; (d) investment in new generation options such as those based upon imported coal and natural gas; and (e) an increase the role of the private sector in the production of electricity. 52. The Government and the Bank have jointly identified a series of investments which would address the above medium-term issues, in addition to the two proposed operations. The Bank agrees with the size and structure of Turkey's 1985 power sector investment program and with the investment strategy proposed for subsequent years. Detailed future investment programs will be reviewed with the Bank. PART IV - THE PROJECT Project History 53. The proposed project is part of a comprehensive transmission development program designed to meet TEK's needs up to the early 1990s. The project was identified in September, 1984 and appraised in February 1985. Loan negotiations were held in Washington from April 30 to May 2, 1985. The Turkish delegation was led by Mr. Tunc Bilget, Chief Financial and Economic Counselor in the Turkish Embassy in Washington and included representatives of the Ministry of Energy and Natural Resources, the Treasury and TEK. A report entitled "Staff Appraisal Report of a Fourth TEK Transmission Project", (No. 5571-TU) dated May 20, 1985 is being circulated separately to the Executive Directors. The main features of the loan and project are given in the Loan and Project Summary and in Annex III. Project Setting and Objectives 54. The proposed project conforms to the Government's strategy for increasing domestic production of energy economically and improving the balance between investments in generation and investments in transmission and distribution facilities. Since the main indigenous energy resources (hydro and lignite) are typically far removed from the main load centers, TEK has had to pay special attention to the construction of a least cost, long-term transmission grid at the 380-kV level. Implementation of this grid started in 1974 and the related long-term construction program is being updated regularly to take account of growth and changes in TEK's load and generation requirements. The latest update in January 1985 covers the requirements through the early 1990s.  - 17 - Project Description 55. The proposed project would be a continuation of the ongoing Third Transmission Project (Loan 2322-TU) and would constitute the fourtb phase of development of the 380-kV transmission network, covering 1986-1990. It would include the following components: (i) construction of about 800 km of 380-kV transmission lines to interconnect the Altinkaya and Hamitabat power stations to TEK's bulk supply system and provide two additional links for the Karakaya power station; (ii) construction and/or extension of 380/154-kV transformer substations with total installed capacity of about 2,100 MVA; (iii) supply, installation and commissioning of equipment for the construction and extension of 154-kV substations with about 3,300 MVA of new installed capacity; (iv) construction of a tower testing station for towers for transmission lines up to 380-kV, with possibility of extension to the 800-kV range; (v) supply of specialized line stringing equipment and vehicles to be used in the installation of transmission lines; (vi) training and supply of devices, such as computer ha-rdware/software to strengthen TEK's capabilities in network engineering, planning and in transmission lines and substation design; and (vii) consulting services to assist TEK in the implementation of the project. 56. The project would also include a training component which aims at continuing the improvements under way in TEK's capabilities in network planning and in transmission lines and substation design. Training would be provided for about 90 specialized and experienced personnel in various departments. TEK has agreed to submit a detailed staff training prograo to the Bank not later than June 30, 1986 and to implement the agreed program in accordance with a schedule satisfactory to the Bank. (Loan Agreement, Section 3.03). The continuing problems of maintenance of the transmission grid would be addressed under the Power System Operations Assistance Project which is being processed in parallel with the proposed project. Project Implementation 57. TEK would be responsible for execution of the project. Preparation of tender documents for procurement of goods is under way and would be completed by March 30, 1986. Construction of the transmission lines and substations is scheduled to start in mid-1986 and to be completed by June 30, 1990. The engagement of project management consultants to assist TEK in the implementation of the Project under terms and conditions satisfactory to the Bank would be a condition of loan effectiveness (Loan Agreement, Section 7.01).  - 18 - 58. Acquisition of rights-of-way for the lines is under way, and the implementation schedule has been estimated on the basis of TEK's experience with the Third Transmission Project. Land acquisition for the new 380-kV and 154-kV substations has not started yet. Therefore, to avoid delays on account of land acquisition, an action plan has been agreed which provides for land acquisition by TEK to be completed by September 30, 1986. The plan also provides for acquiring land for at least 10 substations by March 31, 1986, and for 50 percent of the total sites by June 30, 1986 (Loan Agreement, Section 3.05). Environmental Impact 59. The project would not have major adverse effects on the environment. Aesthetic effects and, to a lesser extent, noise would be the principal adverse effects and both would be kept at acceptable levels. Project Cost and Financing 60. The total cost of the proposed project, including physical and price ccvntingencies but excluding the interest during construction, would be about $195 million, of which $146 million would be in foreign exchange. The project cost estimates are based on January 1985 prices derived from quotations received recently by the Borrower for equipment and material similar to those included in the project. Total physical contingencies have been kept at about 10 percent of base cost, taking into account the advanced state of the design for the lines and the repetitive and routine nature of the work for the substations. Price contingencies have been computed assuming an implementation period consistent with Bank experience and projected annual increases in domestic and international prices. 61. The proposed Bank loan of $142 million would finance 89 percent of the foreign cost including $13 million to finance interest during construction. TEK's current tight cash flow situation, caused inter alia by its heavy investment program would ,ustify finance of interest during construction. The remaining $66 million of the total cost would be covered by TEK's internal cash generation, materials from stock, and Government contributions. The balance of $17.0 million of foreign exchange costs to be borne by the Government and TEK would cover the cost of materials and equipment to be supplied by TEK from inventory and the indirect foreign exchange cost for installation and erection which would be undertaken by TEK or local contractors. 62. TEK is currently exempt from import taxes and customs duties for the projects under construction. Therefore, taxes and import duties are not included in the project cost. The Government has confirmed that this exemption would extend to the proposed project. Financial Position of TEK 63. TEK's financial position improved markedly over the last year. TEK had suffered a net operating loss in 1983, due to a combination of poor hydrological conditions, high costs and insufficient tariff increases. The situation improved sharply in 1984, due to a substantial upward adjustment in  - 19 - tariff levels and sharply improved hydrological conditions. In 1984 the combined investments of TEK and DSI amounted to TL522 billion ($1.5 billion equivalent). The principal sources of financing for the two entities combined were estimated as follows: internal cash generation (16 percent); Government equity (41 percent); foreign borrowing (42 percent); and local borrowing (1 percent). 64. The approved subsector investment program for 1985 is TL600 billion ($1.13 billion equivalent), including TL400 billion for TEK and TL200 billion for DSI. While this is below the investment level required for the sector, it is more in line with existing implementation and financing capacity. The Government proposes to finance the program as follows: Government equity (21 percent); foreign borrowing (41 percent); local borrowing (2 percent); and internal cash generation (36 percent) 1/. TEK would contribute at least 32 percent in 1985 and 35 percent thereafter of the cost of TEK's and DSI's electrical power investment program (Loan Agreement, Section 5.03). It has been agreed that TEK and DSI's draft annual investment programs and budgets for the next five years, and related financing planning, would be discussed by the Government with the Bank by October 31 of each year. (Guarantee Agreement, Section 3.01 and Loan Agreement, Section 3.04). 65. Bulk electricity tariffs increased by about 40 percent in real terms in 1984, which more than made up for real decreases in the previous two years. Following further real increases in bulk power tariffs in 1985, as of April 1, 1985 they were roughly equivalent to long run marginal cost. Retail tariffs have also been increased in parallel since 1983. TEK confirmed that increases in bulk power tariffs would continue to be passed through to the retail level and that tariffs would continue to be adjusted automatically for increases in TEK's fuel costs (Loan Agreement, Section 5.04). 66. Given TEK's new authority to collect sales revenues directly from retail customers instead of the municipalities, the deterioration in TEK's working capital situation through 1982 should normally have been reversed in 1983. However, because of the significant real decrease in tariffs in 1983, serious cash flow problems continued in 1983. TEK's accounts receivable at the end of 1983 were equivalent to 267 days of sales revenue. Deferring payments to its fuel suppliers in 1983, TEK used its available funds for capital expenditures, rather than operating expenses, in order to avoid delays in the implementation of its investment program. This, combined with past accumulated arrears, increased TEK's accounts payable to TL283 billion by the end of 1983, exceeding one year's gross operating revenues. To stop rising indebtedness among public enterprises, the Government in 1984 converted TL230 billion in TEK's net overdue accounts payable to eqtuity. The Government does not expect to repeat the role of a financial clearing house for debts between public enterprises. Since mid-1984, TEK has been paying its fuel 1/ This number understates TEK's actual cash contribution, as it does not include the net Value Added Tax (10 percent) and the radio and television tax (3.5 percent) which are collected by TEK and passed on to the Treasury.  - 20 - suppliers on schedule. The current ratio improved from a level of about 0.8 in 1983 to an estimated level of 1.2 in 1984. It has been agreed that in future TEK would maintain a current ratio of at least 1.0. (Loan Agreement, Section 5.02). It has also been agreed that TEK would implement a Financial Action Plan, covering a reduction of accounts receivables (excluding arrears from municipalities) to the equivalent of 90 days of sales by the end of 1988, improvement of foreign debt service management improvement of financial planning and engagement of consultants to assist with improvements in cost accounting (Loan Agreement, Schedule 5). Audits 67. TEK's financial statements are audited by the High Control Board in the Prime Ministry. TEK is required by law to submit its balance sheets and final accounts to the Prime Ministry for auditing no later than the third month following the year they pertain to. TEK is then required to submit its annual audited accounts to the Bank no later than five months after the close of the year. However, there are shortcomings in both the scope and the timing of the present audit reports. The auditors rarely comment on the reliability of the presentation of the accounts, or on significant events which occurred during the year. The audit reports concerning 1981 and 1982 were received more than a year after the close of the fiscal year. Similarly, the audit report for 1983 had not yet been received as of April 1985. Most likely it will not be possible to meet the five month target for submission of audit reports until the 1987 report. TEK's consultants are giving priority to helping TEK improve the timeliness and accuracy of the financial statements. Furthermore, an upgrading of TEK's computer center, presently being studied, should improve TEK's ability to prepare and correct the annual financial reports. It is expected that the quality and timely submission of audit reports will improve gradually. The 1985 and 1986 reports are expected within ten and eight months, respectively, after the end of the given fiscal year, and within five months for 1987 and afterwards. Procurement and Disbursements 68. The goods and services to be procured for the proposed project have been grouped into 10 contracts for the transmission lines and 11 contracts for the substations to ensure effective international competition. Proposed contract packages with IBRD financing for the transmission lines are: Foreign Cost and Proposed Bank Financing (In $ Million) (a) Steel Towers 3.0 (b) Conductors and Shieldwire 36.6 (c) Insulators 4.0 (d) Hardware 3.3 (e) Tower Erection 2.2 (f) Tower Testing Station 3.7 (g) Line Stringing Equipment and Vehicles 6.5 (h) Computer Hardware/Software 3.2 Ci) Training 0.8 (j) Consulting Services 0.2 Total 63.5  - 21 - Proposed contract packages with IBRD financing for the substations would be: Foreign Cost and Proposed Bank FinancinR (In $ Million) (a) Power Transformers 34.3 (b) Circuit Breakers 380 kV and 154 kV 13.5 (c) Circuit Breakers 35 kV 1.2 (d) Disconnecting Switches and Earthing Blades 4.2 (e) Lightning Arresters 1.5 (f) Measurement Transformers 4.4 (g) Measuring, Protection and Auxiliary Equipment 4.2 (h) Bus Bars and Hardware 1.0 Ci) Insulators 0.7 (j) Training 0.3 (k) Consulting Services 0.2 Total 65.5 All items financed by the Bank would be procured in accordance with the Bank's procurement guidelines. Items (a) through (h) for the transmission lines and (a) through (i) for the substations would be procured through international competitive bidding (ICB). For procurement through ICB, local firms would be allowed a margin of preference equal to the existing rate of customs duties applicable to nonexempt importers or 15 percent of the c.i.f. price of such goods, whichever is lower. Sixty man-months of consulting services for both components would be procured in accordance with the provisions of the Bank's Guidelines for Use of Consultants. Training manuals and other miscellaneous training aids and computer software/hardware packages would be purchased through limited international shopping for items of less than $10,000 up to an aggregate limit of $300,000; for such contracts the Borrower would obtain written price quotations from at least three reputable suppliers. To complete the project, TEK would provide the following goods and services which would not he financed by the Bank: (i) towers (material and fabrication) for three lines: Karakaya-Osmaniye, Altinkaya-Carsamba and Hamitabat-Alibeykoy and all the remaining equipment for the substations (line traps, panels, steel structures, etc.); and (ii) line stringing, and civil works and installation and erection of the substations which would be carried out by TEK's force account or local contractors. All the contracts for works, and equipment and materials to be financed by the Bank and costing over $250,000 each would be subject to prior Bank review. Other Bank-financed contracts would be subject to post-award review. The proposed procurement plans are susmmarized in the table below:  - 22 - Summary of Procurement Arranxements for the Project (US$ Million) Procurement Method Proiect Element ICB LCB Other Total Cost Transmission Lines - 8 Contract Packages 74.3 74.3 (62.5) (62.5) - Towers 16.6 /a 16.6 - Line Stringing 4.4 4.5 lb 8.9 Substations - 9 Contract Packages 65.0 65.0 (65.0) (65.0) - Other Equipment 2.6 /a 2.6 - Civil Works 11.2 /b 11.2 - Installation & Erection 11.7 /b 11.7 Others - Training 1.6 1.6 (1.1) (1.1) - Consulting Services 0.6 0.6 (0.4) (0.4) - TEK Project Engineering Administration 2.5 /b 2.5 TOTAL PROJECT COST 139.3 4.4 51.3 195.0 (127.5) (1.5) (129.0) Note: Figures in parentheses are the amounts to be financed by the Bank. The total does not include interest during construction. /a Equipment and material provided by TEK from its stock. /b Force account. 69. Disbursements from the proceeds of the proposed Bank loan would be made for: (i) 100 percent of the foreign expenditures of directly imported equipment and materials or 100 percent of local ex-factory prices of equipment and materials manufactured in Turkey; (ii) 20 percent of total expenditures for erection of steel towers; (iii) 100 percent of foreign expenditures for overseas training and training experts engaged under the project; and (iv) 100 percent of the foreign expenditures of foreign consultants and 85 percent of total expenditures for local consulting services.  - 23 - 70. It has been agreed that a special account would be established for the project to finance expenditures with a minimum of administrative delay. The initial deposit would be $8 million (Loan Agreement, Schedule 6). Proiect Justification 71. The proposed project is the least-cost means of interconnecting new generation plants and is part of TEK's long-term transmission expansion plan. The evaluation of transmission expansion alternatives is updated regularly to reflect experience with the initial network of lines, as well as changes in the development of TEK's interconnected system. The latest technical and economic evaluation in January 1985, which was discussed with the Bank, confirmed that the lines included in the project would be the least-cost means of extending the 380-kV network to interconnect new plants coming on line. 72. Since the project would form an integral part of TEK/DSI's 1985-1990 expansion program, the economic rate of return was calculated for TEK's investment program for 1985-90, the construction period of the proposed project. Measurable benefits were limited to the incremental revenue attributable to the program, computed on the basis of: (a) TEK's projected sales to industrial customers supplied directly at the high-voltage level and to low-voltage consumers supplied through TEK's distribution enterprises; (b) projected tariffs at the high- and low-voltage levels; and any net fuel savings resulting from investment in improved efficiency in the thermal plants. Tariff adjustments were projected in line with the financial projections. On this basis the return on the program is estimated at 11.2 percent. Project Risks 73. Most of the 380 kV lines are in mountainous areas difficult to reach. However, adequate construction technology is available to cope with the expected terrain and climatic conditions. 74. An action plan for the acquisition of land for the new 380 kV and 154 kV substations has been agreed (para.58). The proposed use of consultants to assist TEK in project implementation would provide improve coordination with construction of lines, substations and power plants affecting the project and would assist TEK in preventing delays in project implementation. 75. There is some possibility of a shortfall in available funds to meet overall investment requirements for the medium-term. However, even at the suggested lowest range of investment, the components which would be served by the proposed project represent a set of core high priority investments which are expected to remain unaffected.  - 24 - PART V - LEGAL INSTRUMIENTS AND AUTHORITY 76. The draft Loan Agreement between the Bank and the Turkish Electricity Authority, the draft Guarantee Agreement between the Republic of Turkey and the Bank and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement are being distributed to the Executive Directors separately. Features of special interest are listed in Annex III of this report. Engagement of consultants to assist TEK with project implementation would be a special condition of effectiveness (Loan Agreement, Section 7.01). 77. r am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 78. I recommend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments May 28, 1985 Washington D.C.  - 25 - ANEX I Page 1 of 5 T A L 3 X Tmmc - SOCIAL INDICATORS DATA UIQ mmcl rUamin CROON (NEIUIU AVERNm) is. NOMT (HAlT EC? ERTNATE) lb 13001k l,ia& ~RECENT~ HIDURitINCUW HAM? accAm 1,.6A 197aL riSITiWii CUOP HAMT A Tm (IunsaNi sq. R) TOTAL 710.6 750.0 780.6 ACRICULTURAL 3. 7 311 380.9 Cw P CAPITA (3}6) 240.0 440.0 1370.0 2143.3 11071.0 13mcxcvwmurrinu PFR CAPITA (KILOCRANS OF OIL EQUIVALEUT) 170.0 362.0 506.0 1I22.5 4996.9 POIUYATI A1W VITAL SAUEnC POPULATION.HID-YTAR (THOUSANS) 27509.0 35321.0 46459.0 URBAN FOPULATION (Z OF TOTAL) 29.7 32.9 43.9 40.0 70.3 POPULATION PROJECTHOIS POrULATION 1N YEAR 2000 (HILL) 65.4 STATIONARY POPULATION (KILL) 110.6 POPULATION HONZTUE 1. POPULATION eNSflT PER SQ. 11. 35.2 45.2 53.2 82.9 13.3 PER SQ. M. ACRI. LAZD 70.6 92.5 119.3 153.9 519.2 POPULATION AGE STRUCTURE (I) 0-14 TiS 41.2 41.0 36.2 31.6 22.1 15-64 YRS 55.2 54.3 57.3 61.1 66.1 65 AND ABE 3.5 4.7 4.4 7.1 11.7 N POPULATION CROWTH RATE (%) TOrAL 2.0 2.3 Z.3 1.6 0.6 URBAN 6.1 3.6 4.0 3.7 1.3 CRUDM BIRTH RATE (FI TOUS) 43.1 37.9 30.9 23.4 13.6 CRUDE DEATH RATE (PER THCuS) 15.5 12.2 0.8 8.8 9.2 GROSS RePRODUCTION RATE 2.9 2.6 2.2 1.6 0.9 FAMILY PLANNING ACCEPTORS. ANNUAL (THOUS) 65.6 USERS (Z OF MARRUED INEI) 5.3 /c 32.0 /d.- 30.0 / ... FOOD SA MTRITIOR INDEX OF FOOD PRDD. PER CAPITA (1969-71-100) 96.0 100.0 115.0 114.5 114.1 PER CAPITA SUPPLY OF CALORIES CZ OF REQUIREPMNTS) 115.0 111.0 122.0 1206. 132.3 PROTEINS (CROAS PER DAT) 85.0 80.0 86.0 89.7 98.5 OF WHICH ANIMAL AND PULCS 25.0 23.0 25.0 ! 34.5 61.3 CILD (ACES 1-4) IEATH RATE 47.0 23.0 9.0 5.2 0.4 LIFE EXPECr. AT BIRTH (TCAR5 50.5 55.9 62.7 07.4 74.9 INFANT IDRT. RATE (PER TRO0S) IB4.0 127.0 83.0 54.2 10.3 ACCESS TO SAE MATER (IPOP) TOTAL 52.0 75.0 lh URBAN ,, 51.0 70.0 7 RURAL 53.0 o. 0 W ACCESS TO EERErA DISPOSAL (Z OF POPULATION) TOTAL .. .. -URBAN 20.0 /h RURAL POPULATION PER PHTSCUAN 2600.0 2230.0 1630.0 1065.8 553.7 POP. PER IURSING PERSON 16300.0 /S 1880.0 1130.0 764.4 164.9 POP. PER HOSPITAL RED TOTAL 600.0 490.0 490.0 /f 326.3 120.6 URBN 340.0 A1 270.0 /k 270.0 7W 201.5 143.1 RUIAL 5100o0 71 50oo0 7W 5650.0 A ADHISSIONS PER HOSPITAL BED 20.2 2z.3 L 20.0 17.6 tSllC AVERSJE SIZE OF HOUSEHOLD TOTAL 5.7 11 5.9 URBAN .. .. RURAL AVER1 E NO. OF PERSONS/ROW TOTAL 2.4 /1 2.2 URBAN 2.0 7f 1.9 RURAL 2. 7 7ir ACCESS TO ELECT. (Z OF NILLNGCS) TUOAL 29.0 41.1 57.0 In URBA . 76.2 RURAL 2.0 18.0  - 26 - ANNEX I TAIL!LI 3A, Page 2 of 5 TU? - SOIAL IND IcAOE DATA SHUT TUU3?Y hu1 uh 0am03 (WIONCD