Turkey - Industrial Schools Project

Document of The World Bank FOR OMCIAL USE ONLY ,(/ 3 3t- _7W Report No. P-3956-TU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQTJVALENT TO US$ 57.7 MILLION TO THE REPUBLIC OF TURKEY FOR AN INDUSTRIAL SCHOOLS PROJECT April 18, 1985 This documet has a resricted distibution and -y be used by recipients only in the perfornce of their officil duies. Its centents may nd therwse be disclosed withot World Bank autoriatiom.  TURKEY CURRENCY EQUIVALENTS Currency Unit Jan. 1980 1/ Jan. 1981 Jan. 1982 Jan. 1983 Jan. 1984 Mar. 1985 US Dollar - TIL 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 1/ Since January 1980, the rate is being adjusted for the differential inflation between Turkey and its major trading partners. TL 420/$l (the exchange rate at the time of appraisal) was used for Parts III and IV of chis report. FISCAL YEAR Republic of Turkey January 1 to December 31 LIST OF ABBREVIATIONS DTVE Directorate of Technical and Vocational Education MOE Ministry of Education (Milli Egitim Genclik ve Spor Bakanligi) MIT Ministry of Industry and Trade SAL Structural Adjustment Loan SEE State Economic Enterprise  FOR OFFICIAL USE ONLY TURKEY INDUSTRIAL SCHOOLS PROJECT Loan and Project Summary Borrower: Republic of Turkey Amount: US$57.7 million Terms: Seventeen years, including four years of grace, at the standard variable interest rate. Project The proposed project supports the Government's efforts to Description: improve industrial productivity and increase the supply and quality of skilled manpower. The project would provide equipment and refurbishment for 39 secondary-level industrial schools. It would also include technical assistance for curriculum and program development, overseas fellowship training and special studies. Benefits and The project would help meet the demand for skilled workers Risks: and junior technicians by producing some 2,500 additional graduates annually from 1991. It would increase access to training for low income-level groups in outlying provinces and is expected to result in an increase in the enrollment of women in the industrial schools system. It would also strengthen the management and planning capacity of the Ministry of Education and would help develop curricula and new industrial training programs in the industrial schools. There are no significant risks attached to the project. I 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.  $ Million Estimated Project Costs: Local Foreign Total Industrial School Facilities 6.36 38.91 45.27 Curriculum and Program Development 0.25 2.64 2.89 Textbook Translation & Production 2.11 1.13 3.24 Special Studies 0.04 0.20 0.24 Incremental Recurrent Costs 2.00 - 2.00 Total Base Cost 10.76 42.88 53.64 Physical Contingencies 1.07 4.29 5.36 Price Contingencies 3.17 10.53 13.70 Total Project Cost 15.00 57.70 72.70 $ Million Financing Plan: Local Foreign Total Bank - 57.70 57.70 Government 15.00 - 15.00 Total 15.00 57.70 72.70 Estimated Disbursements: * Million IBRD Fiscal Year 1986 1987 1988 1989 1990 1991 1992 1993 Annual 2.5 1.5 4.2 7.0 11.0 14.0 12.5 5.0 Cumulative 2.5 4.0 8.2 15.2 26.2 40.2 52.7 57.7 Staff Appraisal Report: No. 5482-TU, dated April 15, 1985. Map; No. 18811.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE "'ECTORS ON A PROPOSED LOAN TO THE t PUBLIC OF TURKEY FOR AN INDUSTRIAL SCHIOOLS PROJECT 1. I submit the following report and recommendation on a proposed loan to the Kepublic of Tttrkey for the equivalent of US$57.7 million to help finance the foreign exchange cost of an Industrial Schools Project. The loan would have a term of 17 years, including 4 years of grace, with interest at the standard variable rate. PART I - THE ECONOMY 2. An economic mission visited Turkey in June 1982, and its report entitled "Tv .rey: Country Economic Memorandum, Recent Economic Developments and MediumrTerm 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 Gczernment's Fifth Five-Year Plan (1985-89) in August/September 1984 and its findings are reflected in this section. 3. lurkey is about as large as France and Germany coubined, 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-1.970s 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 is skewed. There are considerable regional differences in income and large rural-urban * disparities. Recent data indicate a probable worsening ini 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 conse4uert de'erioration of its terns of external trade.  - 2 - 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 which, 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 n:obilization and better selection of investments, especially in the pubiic sector. 6. The adjustment program, wihich has been supported by the Bank through five structural adjustment loans, involves far-reaching changes in attitudes, institutiors, 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, tl;e export and import regimes, the tax system, interest rate and selective credit policies and the public investment program. Implementation of Ut.e 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 Goverunment's ownI targets through 1982. By contrast, results in 1983 and 1984 proved to be mixed, due in part to adverse economic development; 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 witlh agricultural value added growing at 3.6 percent and industrial value added at 9.b percent. Capacity utiLiz-tion rates in private industry in 1984 are estimated to have risen by about 5 percent to an average rate of 72 percent. On the expenditure side, the average annual real rate of growtlh 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 othier 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 annual 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. Given the tight monetary and fiscal programs likely to be agreed upon with the IMF as part of a new standby agreemenc (para. 25), the expectations are that inflation will decline this year. 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 an 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 recommendations 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 Governiment 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).  - 4 - 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 depo'it. 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 rarket. 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 perforiance 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). l'ie 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. 11L_ 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 gl.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 millioia in 1984). Under this scheme the Dresdner Bank collects deposits from Turkish workers in Gernany and automatLcally 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 $1U.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 il 1983.  15. On balance, merchandise export performance has been impressive over the 1980-84 period, growing at an average annual rate of about 26 percent in dollar terms. This growth has been led by the manufacturing sector and has involved a rise in the share of exports to the Middle Eastern countries. Industrial exports, comprised primarily of processed foods and textiles, have risen from 36 percent of total exports in 1980 to 72 percent in 1984. These results were achieved 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 contributing 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 ir.vestments 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 growtn 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 investmaent and b.8 percent in public investment; and (v) a declining external debt service ratio, from 2t 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 and the immediate prospects for the economy. The Bank's projections indicate the need for a continuation of the stabilization program well into 1987, implying a lower growth 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 1982 1984 A 1985 1989 eal Groeuth Reite teal Growth Rite Unit. ctual ftt. Projected 1982 193 198E 1955-89 12) U1) i?r /b 1983 1t b 114b6 12112 127U0 15899 5.U 3.7 5.7 5.b Agrtculture 2o58 2132 1202 :4111 b.4 -0.1 1.e 3.0 Industry 1099 3391 3588 4732 5.U 7.b Y.b 7.0 Service. 0.2JI 3929 b179 2771 9.1 4.0 1.3 5.7 Con-msption 958 212Cm 10539 22Y9OU 3.9 4.1 .8El 5.1 FPiad nvoateont 2111 2220 240U 3I 3.5 J.U I.A 7.5 tLperte ot *Lud. durrent S n