Turkey - Sir Hydropower Project

Document of The World Bank FOR OFFICIAL USE ONLY Re port No. P-4259-TU REPORT AND RECOMMENDATION OF THE PRESTIDENT OF THE INTERNATIONAI BANK FOR RECONSTRUlCTION ANI) DEVELOPMENT TO THE EXECUTIVE DTRErTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO I1S$132 MTL.LI1ON 'ro rTHE REPlRBl, IC OF TURKEY FOR THE STR HYDROPOWER PROJECT Aiigus,t I, 1,9R This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit Jan. 1981 I/ Jan. 1983 Jan. 1984 Jan 1985 .Jan. 198b March 1986 US Dollar - TL 91.00 TL 191.15 TL 309.20 TL 451.00 TL 587.00 TL b68.00 TL 1 - US$ 0.011 US$ 0.005 US$ 0.003 US$ 0.002 us$ 0.002 US$ 0.002 /i Since January 1981, the rate is being adjusted for the differential inflation between Turkey and its mdjor trading partners. Fiscal Year January I to December 31 WEIGHTS AND MEASURES kVA = kilovolt ampere kW - kilowatt kWh = kilowatt hour GWh (Gigawatt hour) = 1,000,000 kWh HV = High Voltage kV (kilovolt) = 1,000 volts MUV Index = Unit value index of manufacttured exports in US$ MW (Megawatt) = 1,000 kW MVA (Megavolt-ampere) t 1,000 kVA MVAR (Megavolt-ampere reactive) = 1,000 kVAR One meter (m) = 3.28 feet One kilometer (km) = 0.624 mile 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 Electric Company) DSI - DevIeL Su Isleri (State Hydraulic Works) EdF - Electricite de France EIE - Electric Power Resources Survey Administration KEPEZ A.S. -- Kepez Electric Companv KfW - Kreditanstalt tur Wiederaufb;au LRMC - Long-Run Marginal Cost MENR - Ministry of Energy and Natural Resources MTA - MineraL Research Institute PEE - Public Economic Establishment PPF - Public Participation Fund SAL - Structural Adjustment Loan SEE - State Economic Enterprise SPK - Capital Markets Board SPO - State Planning Organization FEK - Turkiye Elektrik Kurumu (Turkish Electricity Authority) TKI - Turkive Komur Isletmeleri Kurumu (Turkish Lignite Enterprise) TPAO - Turkiye PeLrolleri Anoiiim Ortakligi (Turkish Petroleun (orporationl)  FOR OMCIAL USE ONLY TURKEY SIR HYDROPOWER PROJECT Loan and Project Summary Borrower: Republic of Turkey Beneficiary: Cukurova Electric Company (CEAS) Amount: US$132 million equivalent Terms: Seventeen years including four years of grace, with interest at the standard variable rate. Onlending Terms: The loan would be onlent to CEAS on at least the same terms as the Bank's with CEAS assuming the foreign exchange risk. Project The proposed project would support the Government's Description: strategy of developing Turkey's indigenous energy resources and of bringing about greater involvement of the private sector in energy development. Financing would be provided for the 283.5 MW Sir Hydropower Station on the Ceyhan river; the project would also include transmission lines to connect the power station to the national grid, technical assistance and training. Project Benefits The project would help in developing economically and and Risks: at least cost Turkey's indigenous energy resources. Although geological investigations for the Sir dam were comprehensive, there is still some risk that geological problems might appear during construction. The risk is considered manageable. Appropriate expert geological supervision would be provided. In addition, it is likely that CEAS will be restructured during project implementation. Proposals for restructuring would be discussed with the Bank. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Estimated Project Cost: US$ Million Equivalent Local Foreign Total Hydropower Project Land Acquisition & Settlement 20.0 - 20.0 Preliminary Works 14.8 - 14.8 Civil Works 36.5 22.7 59.2 Hydraulic Equipment 0.6 4.1 4.7 Electro Mech. Equipment 9.1 21.3 30.4 Switchyard Equipment 0.8 7.1 7.9 Engineering & Administration 8.2 5.5 13.7 Transmission Lines & Substations 7.3 21.6 28.9 Technical Assistance 0.1 1.5 1.6 Total Base Cost 97.4 83.8 181.2 Physical Contingencies 12.3 9.5 21.8 Price Contigencies 17.4 20.6 38.0 Total Project Cost 127.1 113.9 241.0 Interest During Construction IBRD Loan - 18.1 18.1 Total Financing Required 127.1 132.0 259.1 Financing Plan IBRD - 132.0 132.0 CEAS Internal Cash Generation 98.3 - 98.3 CEAS Share Capital 28.8 - 28.8 Total 127.1 132.0 259.1 Estimated Bank Disbursements ------ US$ Million Equivalent ------ IBRD FY 1987 1988 1989 1990 1991 1992 1993 Annual 14.9 20.5 28.0 32.7 23.2 L0.3 2.4 Cumulative 14.9 35.4 63.4 96.1 119.3 129.6 132.0 Economic Rate of Return: 11.5 percent Appraisal Report: No. 5919-TU dated August 1, 1986 Maps: IBRD 19443 and 19444  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 REPUBLIC OF TURKEY FOR THE SIR HYDROPOWER PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Turkey for the equivalent of US$132 million to help finance the foreign exchange cost of the Sir Hydropower Project. The loan would have a term of 17 years including 4 years of grace, with interest at the standard variable rate. The loan would be onlent to the Cukurova Elektrik S.A. Company (CEAS) on at least the same terms as the Bank loan, with CEAS bearing the foreign exchange risk. 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 Development Plan (1985-89) in September 1984 and its report: "Turkey: The Vth Five-Year Plan in the Context of Structural Adjustment" (No. 5418-TU) was distributed in July 1985. 3. Turkey's area is about 780,000 square kilometers (i.e. about equal to the area of France and West Germany combined) with a populaticniL uf around 50 million and GNP per capita of $1200 in 1984. The density of popuilation 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 emigration of workers (to Western Europe and to the Middle East), there is still substantial unemploymenc which, including disguised unemployment in agriculture, is estimated at about 19 percent of the civilian labor force. 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 increase in income inequality since the 1970s, especially a relative deterioration of the position of wage and salary earners and an improvement in the position of the trading and commercial classes, and, more generally, of capital-owners. Educational enrollment has expanded greatly, but the level of adult literacy remains relatively low compared to the European average for middle income countries. 1/ Parts I and II are substantially the same as Parts I and II of the President's Report on the Second Railway Project (P-4223-TU) dated Jui.._ 11, 1986.  -2- 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. Until 1977 Turkey maintained high rates of economic growth by increasing public investment. The foreign exchange requirements were financed initially by workers' remittances and then increasingly by borrowing, a large part of it short-term. The rapid GNP growth came to an abrupt halt in 1977 as the massive external debt burden led to a sbarp deterioration in creditworthiness, severe shortages of imports, disruptions in industrial production and a rise in unemployment. By the end of 1979, domestic inflation had also become an issue of critical importance. 5. In response to the crisis of the late 1970s, the Turkish authorities made a major shift in development strategy in 1980, moving towards outward orientation and giving an increased role to market forces. To alleviate the balance of payments constraint and import shortages, policies were adopted to expand exports, increase workers' remittances, liberalize imports, encourage foreign investment and improve external debt management. 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, an Agricultural Sector Adjustment Loan, and a Financial Sector Adjustment Loan involves far-reaching changes in attitudes, institutions, and the legal and policy framework, all of which require time to be 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 started in January 1980, continued under a military regime during the period September 1980 - November 1983, and has since been carried out by an elected government. The Structural Adjustment Program, 1980-85 7. The Turkish economy has shown an impressive response to the structural ad,ustment program and the outcome met or exceeded the Government's own targets through 1982. The overall performance deteriorated in 1983 due to a combination of factors (slowdown of export growth, slippages in the monetary program, shortfall in Government revenues), but improved again, except in the area of inflation and the budget deficit, in 1984. The improvement was maintained in 1985, this time including a slowdown in inflation and a reduction in the budget deficit. 8. After expanding by 4.1 percent in 1981 and 4.6 percent in 1982, real GNP growth slowed down to 3.2 percent in 1983, due to the effects of a bad harvest, stagnant exports and lower workers' remittances. The growth rate rebounded in 1984 to 5.9 percent, mostly on account of favorable performance in agriculture (3.7 percent growth) and industry (9.3 percent growth). Merchandise exports also expanded strongly, by more than 25 percent in dollar terms. In 1985, according to the latest estimates, the economy grew by about 5.1 percent, as against the program target of 5.5 percent. The slowdown in  growth was most significant in agriculture (2.8 percent growth) and manufacturing (5.5 percent), due respectively to less favorable climatic conditions and slackening domestic demand. On the expenditure side, the average annual real rate of growth of public fixed investment over the period 1980-84 was 3.8 percent. Provisional estimates for 1985 indicate that public fixed investment totalled TL 3,181 billion, implying a much higher real growth (17.1 percent) over 1984 than programmed (5.8 percent). The growth of investment was c9ncentrated in infrastructure--energy, transportation and telecommunicatk6&i The growth rate of private investment has fluctuated more severely, falling by 17 percent in 1980, recovering slowly, and then rising by 7.3 percent in 1984 and by 7.0 percent in 1985. 2rivate consumption, after declining by 5 percent in real terms in 1980, grew by 5 percent in 1983 and 1984 before slowing down to an estimated 3.7 percent in 1985. Strict budgetary discipline contributed to a steady decline in the real rate of growth of public consumption from 8.4 percent in 1980 to 1.7 percent in 1983; however, it increased to 3.2 percent in 1984 and an estimated 3.3 percent in 1985. 9. During 1981-82, 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 average annual rate of increase in the wholesale price index (WPI) decelerated 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. Inflation accelerated further in 1984, and reached 50 percent, due to the lagged impact of the expansionary monetary policy pursued during the second half of 1983, and a significant increase in agricultural product prices, especially of fresh fruits and vegetables, as a consequence of export liberalization and higher export market prices. Other contributory factors included substantial "catch up" increases of SEE prices - since January 1984 most SEEs have effectively been allowed to set their prices freely - 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. 10. In 1985 inflation declined considerably -- the average annual rate of increase in the WPI fell to 43.2 percent, after reaching a very high level in the first quarter of 1985 (about 60 percent as of March 1985). By December 1985, the month-over-month change in the WPI (i.e. December 1985 over December 1984) had correspondingly declined to 38.3 percent and by May 1986 it had dipped even further, dropping to about 28 percent for the first time in two and half years. Factors causing the high inflation rate in the first quarter of 1985 were the introduction of a value added tax (VAT) in January 1985 and continued substantial increases in the prices of several key intermediate goods and inputs. Thereafter, several factors combined to lower inflationary pressures: (i) monetary growth slowed, particularly in the fourth quarter, with M2 growth declining from an annual rate of 64 percent as of September 1985 to 53 percent at year-end; (ii) by April 1985 most of the catch-up increases in the prices of SEE products appeared to have been completed and the rate of price adjustment abated considerably; (iii) the significant slide of the dollar, which started after March 1985, resulted in a  - 4 - slowing down of the nominal depreciation of the Turkish lira against the dollar and therefore in smaller increases in prices of imported products than were witnessed in 1983-84; (iv) the persistence of high real interest rates (which increased as inflation declined) helped to channel liquidity towards savings rather than consumption and thus lowered aggregate demand; and (v) lower exports of certain agricultural products (cereals and pulses) meant that the domestic market was well supplied, thus easing inflationary pressures on food prices. The steady deceleration in the inflation rate, which has now continued for over 12 months, reinforces the expectation that the Government's target rate of 25 percent for 1986 could be achieved, particularly considering the large decline in world oil prices since January 1986, the continued weakening of the dollar relative to other international currencies, and the Government's maintenance of a tight monetary and fiscal program. 11. In the fiscal area, progress has been uneven. During 1980-82 the budget deficit declined from 5.3 to 2.1 percent of GNP, but increased to almost 5 percent of GNP in 1984, due mainly to a disappointing performance in raising tax revenues. In 1985, however, the budget deficit is estimated to have been TL 621 billion or 2.3 percent of GNP, a significant improvement over 1984. This is largely because the Government took several measures in 1985 to increase revenues, the most important of which was the introduction of VAT. In its first year, VAT collections amounted to about TL 1 trillion, significantly above the target. Other tax measures which were adopted included substantial increases in various fixed charges and duties and large increases in penalties for overdue tax payments. As a result of these measures, budget revenues rose from 15.4 percent of GNP in 1984 to 17 percent in 1985, reversing the downward trend in revenues over the previous three years. Government expenditures decreased from 20.3 percent of GNP in 1984 to an estimated 19.3 percent in 1985. 12. Progress has also been made in rationalizing interest rates and reforming the banking system. Since 1981, interest rates on time deposits at commercial banks have been positive in real terms. Time deposits have been yielding a positive real return since early 1984. Positive deposit interest rates have resulted in a steady growth in deposits, about 10 percent per annum in real terms in 1984 and 1985. Improvements in incentives for savings were accompanied by administrative reforms of the banking system, the enactment of a new banking law, and measures to revitalize the capital market. 13. While positive real interest rates have provided an incentive to save, they have also meant high borrowing costs. Effective nominal interest rates range from 60 to 80 percent on non-preferential credits, in part because of the impact of high liquidity and reserve requirements, the option which commercial banks have to invest in high-yielding government bonds, and high intermediation costs. The Government took a number of steps in 1985 to reduce the interest rate differentials between preferential and non-preferential credits: in particular, the preferential interest rate for export credits was discontinued in January 1985, while, during the year, interest rates for larger agricultural loans and for loans to SEEs were increased from 28 and 22 percent to 34 and 35 percent respectively. The narrowing of the gap between interest rates on preferential and non-preferential credits, together with the decrease effected in the amount of preferential credits, is expected to increase the general availability of credit and exert a downward pressure on non-preferential interest rates.  14. Improvements in the balance of payments were substantial between 1980 and 1982, with the current account deficit decreasing from $3.3 billion (5.7 percent of GNP) in 1980 to $1.2 billion (1.6 percent of GNP) in 1982. In 1983 the current account deficit increased to $1.8 billion, as merchandise exports stagnated and workers' remittances fell by one-third. These developments were reversed in 1984 as exports increased by over 25 percent in dollar terms to reach $7.4 billion. Remittances, too, registered a higher than expected increase, reaching $1.8 billion (up by 20 percent over 1983). Merchandise imports grew by more than 16 percent to reach $10.8 billion. As a result of these developments, both the trade and the current account deficits declined as compared to 1983. Latest estimates for 1985 indicate a further strong improvement of the balance of payments situation. Merchandise exports grew by 11.6 percent (in dollar terms) in 1985, while merchandise imports increased by 8 percent. Among the invisibles, tourism revenues and investment income from abroad increased significantly compared to 1984 and previous years. Workers' remittances, on the other hand, declined by 5 percent. The current account deficit in 1985 is now estimated at about $1.0 billion, or about 1.9 percent of GNP. 15. Merchandise export performan,:e has been impressive throughout the 1980-85 period, during which expcrts *egistered an average annual rate of increase of about 23 percent in doi'Lax 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, composed primarily of processed foods and textiles, have risen from 32 percent of total exports in 1980 to more than 72 percent in 1985. These results were achieved by a combination of indirect measures (flexible exchange rate policy, import liberalization) as well as direct measures (tax rebates, preferential credits) to enhance tne relative profitability of exports and offset the traditional bias towards production for the domestic market. Successful penetration of the Middle Eastern markets has brought their share in total Turkish exports from 17 percent in 1980 to around 40 percent in the 1983-85 period. 16. On the import side, the 1982-83 period was marked by a relative stability in the growth of merchandise imports, as prices of both oil and non-oil imports declined, and the volume rate of growth remained moderate. In 1984, however, merchandise imports increased substantially. The increase was most pronounced in some of the groups (e.g. raw materials and consumer goods) that have been subjected to major liberalization through a lowering of tariff rates and a significant removal of quantitative restrictions. In 1985, as domestic demand eased, and the initial effects of pent-up demand for importables released by import liberalization weakened, the rate of import growth decreased to about one-half of the level recorded in 1984. Medium-Term Prospects 17. The Fifth Five-Year Development Plan (1985-89), which was approved by the Grand National Assembly in June 1984, reaffirms the Government's determination to pursue an outward-oriented development strategy and to liberalize the economy by relying increasingly on market forces. 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:  - 6 - (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 10.9 percent in private investment and 6.8 percent in public investment; (iv) a declining external debt service ratio, from 26 percent in 1984 to around 18 percent in 1989; and (v) a decreasing rate of inflation reaching 10 percent p.a. in 1989. 18. While the overall thrust of the Plan is in accord with the goals of the structural adjustment program, the Plan targets, if viewed collectively and in the light of the developments in 1984 and 1985, appear somewhat ambitious and likely to strain domestic resources (especially in the public sector) as well as have an adverse impact on the external balance. Accordingly, the Government is adjusting the annual programs to ensure that they remain compatible with the fight against inflation and with a growth strategy commensurate with the Government's ability to generate resources. 19. The recent decline in international oil prices is likely to have a favorable impact on Turkey's balance of payments. The Bank's projections presented below take into account the most recent decline in oil prices. The analysis shows that the savings from direct petroleum imports alone could be about $1.3 billion in 1986. The favorable direct impact would be offset to some extent by lower export growth to oil-exporting countries (which account presently for about 40 percent of Turkey's exports) as well as lower profit and workers' remittances from construction activities in these countries. However, a compensating increase in Turkish exports to, and workers' remittances from, OECD countries on account of a more favorable OECD growth outlook is likely in the medium term. Our estimate puts the net positive impact of the oil price decline on Turkey's balance of payments at about $400 million in 1986. There would be indirect benefits as well in the medium term, including a reduction in the cost of debt servicing as a consequence of a decline in inflation and interest rates in OECD countries. An improvement in the balance of payments would give the Government the option of repaying its external debt sooner, thus improving Turkey's debt service ratio in the coming years, or using the extra resources to support a faster growth strategy. Given the uncertainty associated with the oil price projections, we have been cautious in revising GDP growth targets significantly at this time, in order to emphasize inflation control and a greater build-up of foreign exchange reserves. 20. The Bank's projections indicate a GDP growth of 5.9 percent p.a. on average for the 1986-90 period. At the beginning, growth might be relatively slow (5.3 percent p.a.), gradually accelerating in the outer years to an average rate of 6.1 percent p.a. in 1987-90. The inflation targets in the Bank's projections are also more conservative compared to the Plan targets, implying a reduction from about 43 percent in 1985 to around 18 percent in 1990. Key economic variables in the Bank's projections for the period 1986-90 are presented in Table 1.  Table l: rIKuEY -Eu*CTIf CUutNUMIC IU=)lATUic..