Turkey - State-owned enterprise sector review (Vol. 2 of 2) : Annexes

Report No. 10014.TU Turkey State-Owned Enterprise Sector Review (In Two Volumes) Volume II: Annexes March 3, 1993 Country Operations Division Country Department I Europe and Central Asia Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distr,bution and may be used by recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.Report No. 7281 -MAI  TURCU CURREn Y TurkisALEirS Currency Unit Turkish Lira (TL) USS1.00 = TL2609 (1900 Average) ABBREVIATION LIST ASOK Agir Sanayi ve Otamotiv Kurumu Csteeo, machinery, vehicles) BCRIC British Columbia Resource In.'estment Corporation BEP Basic Earning Power BoO Board of Directors BOTAS Boru Hatlari ile Petrol Tasima A.S. (oil pipeline) CAYKUR Cay Isletmeleri Genel MOdOrlOgO (tea processing) CEO Coffpany Executive Officer CIF Cost, insurance freight CITOSAN TOrkiye Cimento ve Topral Sanayi T.A.S. (cement) CPI Consumer Price Index DHMI Devlet Hlava Meydanlari Isletmelesi Genel MOdOrLOgO (airport administration) DITAS Deniz Isletmeri ve Tankercilik A.S. (maritime tanker transport) DL Decree-Law DMB Deposit Money Banks DMO Devlet Malzeme Ofisi (printing and stationary) DSF Development and Support Fund EBF Extra-Budgetary Fund EBIT Earnings before interest and taxes EBK Et ve Balik Kurumu (meat and fish processing) EDC Earnings decline cover EM.SAM. Emekli Sandigi Genel MOd(rLOgO (Civil Servants Rctirement Furd) GEMSAN Turkiye Gemi Sanayi A.S. (shipbuilding) HAB High Audit Board HDF Housing Development Fund HDPPA Housing Development and Public Participation Administration HPC High Planning Council IGSAS Istanbul Gubre Sanayi A.S. (fertilizer) IIBK Is ve IsCi Buimu Kurumu (Turkish Esmployment Organization) ILO International Labor Organization ISE Istanbul Stock Exchange ISO Istanbul Chamber of Industry JSC Joint-Stock Coapany MKEK Makina ve Kimya EndOstrisi Kurumu (weapons, chemicals) MOU Memorandumi of Understanding MRR Maximun Rate of Return ORPL Output related profits levy ORUS Orman Urunleri Sanayi Kurumu (forestry and wood products) PEI Public Economic Institution PETKIN Petrokimya Anonim Sirketi (petrochemicals) POAS Petrol Ofisi A.S. (oil products, retail) PPA Public Partnership Administration PTT TOrkiye Curmuriyet Posta Telegraf ve Telefon isl. Genel MOdOrLOgO RPI Rate of price inflation SAS Scandinavian Airline System SCF Societe de Ciment FranCais SEE State Economic Enterprise SEKA TUrkiye Seltloz ve Kagit Febrikatari (paper) SEKER TOrkiye Seker Fabrikalari A.S. (sugar) SGA Single Government Agency SOE State Owned Enterprise SPO State Planning Organization SPSF Support and Price Stabilization Fund TARIM Tarim Isletmeleri Genel MOdurlOgO (agro products) TCDD Turkiye Cuihuriyet Devlet Demiryollari (railways) TDCI TOrkiye Demir ve Celik IsletmeLeri (iron & steet) TDI TOrkiye Denizcilik Isletmeleri (port administration and shipping) TEK TUrkiye Elektrik Kurumw (electricity) TEKEL Tutun, Tutun Mamulleri, Tuz ve Atkol Isletmesi GeneL MOdOrLOgO (alcohol & tobacco) THY TOrk Hava Yollari A.O. (airlines) TKI TOrkiye Kom.r IsLetmeleri Kurumu (hard coal mines) TMO Toprak Mahsulleri Ofisi (soil products) TPAO TOrkiye Petrotleri A.O. (refineries) TSEK TOrkiye Sut Endustrisi Kurumw (dairy) TTK TOrkiye Taskom.rO Kurumu (Lignite mining) TOGSAS TGrkiye Gubre Sanayi A.S. (fertilizer) TUPRAS TOrkiye Petrol Refinerilari A.S. (refineries) TZDK TGrkiye Zirai Donatim Kurumu (distribution of agro acts) USAS Ucak Servisi A.S. (airport catering) YEMSAN Yem Sanayi T.A.S. (animal feed)  FOR OFFICIAL USE ONLY TURKY STATE-eBrJED ENTERPRISE SECTOR REVIEW ANNEX I Overview of the Sector 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.  STATE-OWNED ENTERPRSEB SECTOR REVIEW Overview of the sector Table of Contents Paae No., A. criaiin, Size, and IMgortance. ............. * ..................... 1 Definition of the Sector .1 Historical Background and Current Composition. .......... 2 Economic Importance. .....4 B. Recent Reforms ... .... . 5 Pricing Policies .... 11 Market Regulation .... . .. ........ 12 Institutional Framework .....12 Personnel ....... 13 Privatization .... . .. . ... ......... . .14 C. Financial Performance. ...... .15 Aggregate Sector Performance 5...... Profitability ... ..........15...... i Capital Structure. .. ................ .. 17 Financial Risk 8...... Cash Flow Analysis. .... 19 Specific Cases: ...... 20 Railways (TCDD)............................. . . . . . 21 Hard Coal Mine (TTX) ......22 The Soil Products Office (TMO)........ 23 Financial Viability of SOEs ..3 Methodology ...... .... ... . .... ..... 24 Best Case Scenario. .... .... .. ............ 24 A More Realistic Scenario....... 25 D. Economic Performance ...... . ................. 26 E. Concluding Bemarks. . . . ...... . .......... 31  Table of Contento Icontinued) Page No. List of Tableo Table A1.1 Sector Classification of SOEs ................ 3 Table A1.2 Value Added by Sector ..., 6 Table A1.3 Fixed Investment of SOEs by Sector ................ . 7 Table A1.4 Employment of SOEBs by Sector ....................... 8 Table A1.5 International Trade of SOEs ........................ 9 Table A1.6 External Debt and Domestic Liabilities of SOEs ..... 10 Table A1.7 Aggregate Profit and Loss Statement ................ 16 Table A1.8 Aggregate Condensed Balance Sheet of SOEs .......... 18 Table A1.9 Financial Risk Indicators of Aggregate SOE Sector.. 19 Table A1.10 Aggregate SOE Sector Cash Flow Analysis ............ 20 Table Al.l1 TCDD Financial Information ......................... 21 Table A1.12 TTK Financial Information .......................... 22 Table A1.13 TMO Financial Information ..... . 23 Table A1.14 Forecast of Financial Accounts: Best Case Scenario. 25 Table A1.15 Forecast of Financial Accounts: A Realistic Case ... 26 Table A1.16 Comparison of Selected SOE Prices with Border Prices .....................e............... 27 Table A1.17 Share of SOEs in Value Added, Employment and Fixed Assets in 500 Largest Industrial Firms .......... 28 Table A1.18 Incremental Capital Output Ratios (1985-1990) ...... 29 Table Al.19 Labor Productivity ........ . 30 Table A1.20 Total Factor Productivity for Selected SOEs (1985-1990) . ............................. . 31 List of Fiqures Figure A1.1 Capacity Utilization in Public and Private Industry ........................................ 28  STATE-OWNED ENTERPRISE SECTOR REVIEW OVRVIEW OF THE_SECTOR A. Oricin. size. and IMnoRqtance Definition of the Sector 1. For the purposes of this report, state-owned enterprises (SOEs) consist of SEEs, PEIs, their companies and affiliated partnerships as defined by Decree Law 233 of June 1984, with the following limitations and conventions: (a) The distinction between SEEs and PEIs made in Decree Law 233 is of little relevance for the analysis; thus, all enterprises are grouped under the term SOEs. (b) The analysis of the report is limited to nonfinancial SOEs and, therefore, excludes the banks (Ziraat, Emlak, Halk, ana Denizcilik) subject to Decree Law 233. (c) Enterprises owned or participated in by the Government outside the scope of Decree Law 233 are excluded from the analysis. These entities are not included in public accounts and their joint size compared with those subject to Decree Law 233 is relatively small. (d) Decree Law 233 makes a distinction between "enterprise " (28 units), "company" (62 units) and "affiliated partnership" (44 units). An "enterprise" is ful'-y owned by the Government and acts as a parent-holding of a group of "companies," which it fully owns, and "affiliated partnerships," in which it owns a majority share. The analysis in this report takes place mainly at the holding or enterprise level, with exceptions noted explicitly. (e) SOEs also have minority participations in about 100 joint-stock companies, often representing a controlling stake. The links between SOEs and minority participations are only relevant in as far as SOEs contribute to the equity and receive a share of their profits. (f) When SOEs are transferred to the PPA fcr privatization, they are subject no longer to Decree Law 233 but to Decree Law 3291, the law on privatization. These SOEs (e.g., PETXIM, SUim6ebank, and THY) are included in the analysis, to the extent possiDle. (g) When SOEs are privatized they are, of course, no longer included in the sector's accounts. Similarly, if SOEs are reclassified under a different law, such as Turizm Bankasi in 1987, they are also excluded.  -2- ANNEX 1 Historical Back2round and Current Composition 2. Strong sentiment against foreign business after the War of Independence (1919-23) left Turkey with only two possible agents of industrialization: the local entrepreneurs and the state. At the initial stages, the Government left industrial development to private forces and enacted two key laws: one provides incentives to private industry, and the other bars imports of goods already produced in Turkey. The GoverrMuent founded a large bank and a state industrial holding (later to become Stmerbank), which took over four existing state enterprises and entered into mixed ventures with private enterprise. 3. The disruption of agricultural export markets during the Great Depression and the ensuing foreign exchange shortage accelerated industrial import substitution and proved to be a decisive factor in the country's turn toward etatism. This move was reinforced by nationalism, distrust of private enterprise, and the interests of the bureaucracy. Influential leaders emphasized the predominant place of private enterprise and the need for statism to play a temporary role. Their initial motivation was to accelerate development by joining private capital or, if this was not possible, by selling shares owned by the state to private enterprise at an early opportunity and on easy terms. 4. On economic grounds the Government's intervention was motivated by two elements: the absence of domeetic capital and the lack of entrepreneurial and technical skills. Although the establishment of state enterprises is not the best way to resolve these deficiencies, Turkey was eager to show rapid results of industrialization. It also adopted a policy aimed at industrial independence, which at that time, was synonymous to the development of heavy industries. The need to unify the country politically added the dimension of regional economic development. 5. The first legislation on SOEs (Law 3460 of 1938) emphasized that the public companies should be run as private enterprises; they would withdraw from a given field of activity, by selling shares to the private sector, as soon as private enterprise could be expected to become viable. Despite these good intentions, none of the SOEs has been sold to the private sector, and only an insignificant amount of shares has been divested to the public. The emphasis on the use ot SOEs later rhifted. They went from being a main vehicle of industrialization to being an investor in large projects. They also targeted projects that private industry would not find attractive or that might create bottlenecks in the economy. This shift led, during the sixties, to heavy investments in intermediate and capital goods industries, sheltered by import protection. 6. As Table A1.1 shows, SOEs today are still active in almost all sectors of the Turkish economy, and not only in such areas of services as electricity, railways, and telecommunications, as they are in most other OECD countries. The main activity of the SOE determines the sectoral classification in Table A1.1, although most SOEs are large conglomerates with diversified activities. A typical example is Etibank; primarily a mining  -3- TabtL Al : Sector Clasification of SOEs SOE Act i ty AGRICULTUMR 1 Tarim Isletmeleri Gnel ludurlugu tTARIN)l/ Agriculture 2 Orman Urunleri Sanayfi Kurutm (ORUS) Forest Products MINING I Etibank Aluminum & Zinc, Mining Electronic mchinery, Chemicals 2 Turkiyo Taskorumu Kurumu (TTK) Comt mining 3 Turkiye Komur Islotmeleri Kurmu CTKI) Lignite Mining MANUFACTURING FOOD, BEVERAGES, TOBACCO 1 Turkiye Seker Fabrikalari A.S. (SEKER) Sugar Processing 2 Et ve Balik Kurunu CEBK) Meat, Fish Processing 3 Turkiye Sut Endustrisi Kurumu CTSEK) Dairy 4 Cay Isletmesi Genel Mudurlugu (CAYKUR)1/ Tea Processing 5 Tekel Isletmesi Genel Mudurlugu (TEKEL)1/ Tobacco and Alcoholic Beverages TEXTILES 1 SiUerbank 2/ Textfles PAPER, PRINTING, PUBLISHING 1 Turkiye Seluloz ve Kagit Fabrikalari Isletaesi tSFKA) Pulp and Paper 2 Devlet Makzeme Ofis (DMO) Stationary and Printing CHEMICALS, CHEMICAL PRODUCTS 1 Turkiye Petrollerf A.D. (TPAO)3/ Crude Oil Refineries 2 Petkim Petrokimya A.S. (PETKIM)2/ Petrochemicals 3 Turkiye GObre Sanayi A.S. (TUOSAS) Fortilizer 4 Istanbul GUbre Sanayl A.S. CIGSAS) Fertilizer NON-METALLIC MINERAL PRODUCTS 1 Turkiye Cimento Sanayf T.A.S. (CITOSAN) Cement BASIC METAL 1 Turkiye Demir ve CaLik Isletmeleri (TOCI) Iron and Steel MACHINERY AND EQUIPMENT I Makina ve Kimys Endustrisi Kurtu (MIEK) Machinery and Chemicals 2 Agir Sanayl ve Otomotiv Kurumu CASOK) Industrial machinery and Automobiles, Steel 3 Turkiye Gemi Sanayi A.S. COGENSA) Shipbuilding OTHER MANUFACTURING 1 Yem Sanayii T.A.S. CYEMSAN) Anim-aL Feed ENERGY 1 Turkiye Elektrik Kurutu (TEK)I/ Power, Electrical Equipment SERVICES TRANSPORTATION 1 Turkiye Ciumihuriyet Devlet Demiryollar1 Isletmesi CTCDD)1I Railway Services, Transportation Equipment 2 Devlet Hava Heydanlari Islets.esi GenL Hudurlugu CDHMI)1/ Airports Administration 3 Turkiye Have Yollari A.D. (THY)l/ 2/ Airline 4 Turkiye Denizcilik Isletmeleri (TOI) Seaports Administration 5 Boru Hatlari fLe Petrol Tasim. A.S. (BOTASA4/ Oil Pipeline 6 Deniz Isletmeri ve Tankercilik A.S. (DITASA4/ Maritime Tanker Transport COMMUNICATION 1 Turkiye CLunuriyet Posta Telegraf ve Telefon (PTT)1/ Post, telegraph, teLephone TRADE 1 Toprak Mahsulleri ofisi (TMO) Soil Products 2 Turkiye Zirai Donatim Kurumu tTZDK) Fertilizer Distribution, Tractors, Agricultural Equipment 3 Poas Petrol Ofisi A.S. (POAS)4/ Distribution of Petroleun Products Source: Treasury. Uotes 1 The enterprise is classified as a Pli3fc Economic Institute uider Turkish Law All others regutated by Decree Law 233 are State Economic Enterprises (SEEs). 2 Currently under PPA for Privatization. 3 Excluding BOTAS, DITAS, and POAS. 4 Affiliated cowanies of TPAO.  - 4- MNNIX company, it also produces basic metal. (aluminum, ferrochrome) elect >nic machinery, chemicals; it even owns a sizeable bank. Lack of disaggrtgated data prevented a more detailed classification. 7. The results of Turkey's policy choices for industrial development aro clearly reflected in the sectoral composition of the SOEs. Coal, basic metals, chemicale, paper products, and heavy machinery are mostly produced in the public sector. Strategic considerations of self-sufficiency and an income support policy geared at he agricultural sector and urban poor also lead to SOE involvement in agricultural products, especially trade and food proceesing. Until recently, the processing and trade of tea, tobacco, sugar and alcohol were all state monopolies. Economic lortance 8. Tables Al.2 - Al.6 on value added, fixed investment, employment, international trade, and debt indicate the importance of the SOE sector for the Turkish economy. (a) Aggregate value added (see Table A1.2) has been around 10 percent of GDP at factor cost for the last fivo years.-V The SOEs' share in value added is disproportionately large in mining, energy, and transportation, and communication. It has been declining in manufacturing as a result of the Government's policy not to expand activity in this sector during the last five years. In contrast, public value added rose significantly in transportation and communication. (b) Gross fixed investment by SOEs (see Table Al.3) has declined from 30 percent of total investment of the economy in 1985 to 15 percent in 1991. This decrease reflects not only the Government's deliberate policy to move out of sectors competing directly with the private sector but also the increasingly difficult budgetary situation. Nevertheless, the share in investment is high compared with that of value added, which indicates the relatively capital intensive nature of the SOEs. The bulk of public investment by SOEs takes place in the energy and transportation and communication sectors both in absolute and relative terms. (c) Employment (excluding Petkim and SUmerbank) (see Table Al.4) declined from its peak in 1988-89 by about 4,000 people to a total of almost 596,000. This represents a declining share in total employment, from 3.8 percent to 3.5 percent, and in non agricultural employment from 7.8 percent to 6.7 percent. In line with value added, SOEs employ more people in mining and energy. 1 Value added was estimated as the sum of all factor payments. It is biased downward because of the practice of some SOEs to include a fraction of interest payments and personnel expenditure in investment and cost of goods and services sold.  Although most SOEs gradually lowered einployment, in some sectors (electricity, airlines, and te:aeconmunication) there was a noticeable expansion. (d) The trade balance (see Table A1.5) of the sector as a whole is negative (US$lbillion), even after excluding imports of crude oil for the public refineries. The use of SOEs in import substitution activities is an important explanatory factor for thin observation. In 1989, SOEs imported 33 percent of total imports of goods and nonfactor services (including oil) and 24 percent of investment goods. Exports are concentrated in a few sectors (mining, chemicals, and transportation services), and they declined from 13.6 percent of total in 1985 to about 10.3 percent in 1989. (e) Compared with the private sector, SOEs obtain a disproportionally laLge amount of foreign and domestic credits (see Table A1.6). On the external side, explicit Treasury guarantees allowed them to borrow almost three times as much medium and long-term credits as their private sector counterparts. Domestically they claim about 20 percent of total credits from the banking system. Credits from other sources, mainly other public entities also provide an important amount of financing (about half of domestic sources). Low equity, declining operating surpluses, and large investment programs maintain SOEs' debt at this relatively high level. B. Recent Reforms 9. In 1980, the Government issued the following guidelines for the reform of the SOE sector: the Government would (a) abstain from expanding the public sect(r; (b) reduce monopoly powers earlier granted to SOEs, such as the power to increase competition and enhance productivity and creativity; (c) reduce (and eventually eliminate) the SOEs reliance on the Government's budget for both operating subsidies and debt financing; (d) revitalize and reorganize the SOEs' management and make them competitive and profit and cost conscious; and (e) privatize SOEs that no longer have a specific national mission. The change was prompted by increased pressure on the Government's budget constraint, since the borrowing requirement of the SOEs had risen to three quarters of the total public sector borrowing requirement by 1979. New legislation was passed to implement these changes: Decree Law 233 on State Economic Enterprises and Public Economic Establishments (June 1984), Law 3291 on Privatization (May 1986), Decree Law 399 on the Personnel Regime of SOEs (January 1990), and further amendments as part of other legislations. Dissatisfied with the results of these modifications, Treasury prepared a new draft law in 1990 that was never passed. The general guidelines for reform translated into changes in pricing policy, market regulation, the institutional environment, and the personnel regime, at different episodes during the decade. In 1984, the Government formally set up the institution to deal with the privatization aspects of its reform ntrategy. Actual divestiture only started toward the end of the 1980s.  -6- mN.EX I IAW_"1..g: Value Added by Sector A. Current prices TL bilLion 1985 1986 1987 1919 AGRICULtURE 30 51 90 119 179 348 TARIM 16 20 44 58 79 215 ORUS 14 30 45 61 100 133 NININO 403 536 777 1169 2278 2734 Etibank 160 192 306 652 1053 847 TTK 99 72 110 90 307 585 TKI 143 272 361 427 918 1301 PAWUFACTURING 1182 1593 2374 2736 4560 8461 SEKER 80 72 84 167 321 713 EBK 17 23 9 8 86 164 TSEK 5 6 10 16 33 65 Caykur 54 44 68 100 175 231 TEKEL 253 281 279 328 623 1766 Saimerbank 90 151 244 SEKA 44 66 124 246 444 464 D:O 8 . 10 15 34 51 73 TPAO 298 388 542 687 1031 2267 Petkim 47 110 298 TUGSAS 28 42 77 84 179 309 IGSAS 83 42 67 Citosan 48 96 150 183 310 603 TDCI 105 171 263 516 636 921 HKEK 71 91 139 175 430 697 AS301 15 19 36 66 113 0 GEM!'AN 15 17 25 31 72 93 YEMSAN 3 6 9 13 12 28 ENERGY 418 589 780 1743 2378 3942 TEK 418 589 780 1743 2378 3942 TRANS. & COM0M. 737 910 1636 3018 5919 9631 TCDD 167 157 254 237 751 1801 DHMI 23 37 67 170 236 414 THY 65 59 125 278 522 688 USAS 9 12 38 TDt 112 144 209 340 479 691 BOTAS 79 115 192 311 819 767 DITAS 2 5 7 18 11 26 PTT 279 382 744 1664 3102 5243 TRADE 171 164 72 387 695 1477 TMO 81 70 -27 158 192 750 TZDK 43 46 41 103 130 180 POAS 47 48 58 126 373 546 AGGREGATE TOTAL 2940 3843 5728 9173 16008 26591 GDP AT FACTOR COST 25526 35628 52929 91741 151906 251732 B. Percentage of total - current prices 1985 1986 1987 1988 1989 1990 AGRICULTURE 0.6% 0.8K 0.9K 0.7K 0.7K 0.8% MINING 61.9K 70.9% 73.3% 63.7K 73.6% 60.1% MANUFACTURING 18.4K 17.7K 17.5X 11.5X 11.9K 14.3% ENERGY 44.7K 36.8K 35.6% 43.5K 38.0K 39.4K TRANS. & COHM. 27.2Z 24.9X 30.7K 32.4X 36.5K 37.6% TRADE 4.1K 2.7K 0.8% 2.4K 2.6K 3.3K AGGREGATE TOTAL 11.5X 10.8X 10.8K 10.0% 10.5K 10.6% Source: Treasury.  7 {L 10.Lm_?& : Fixed Investment of SOEs by Scctor A. Current prices - TL billion 'i9r'--1986 198_ 1988 19899 AGRICULTURE 3 5 6 20 27 15 MINING 243 257 175 302 206 350 MANUFACTURING 358 563 526 580 798 1409 ENERGY 459 684 1171 2166 3763 4267 TRANSPORT. & COMNICATIONS 530 884 1368 1866 1908 3378 TRADE 11 13 70 196 227 366 AGGREGATE TOTAL 1604 2406 3316 5130 6929 9786 FIXED INVESTMENT TOTAL PUBLIC 3236 5233 7924 11494 17351 27826 TOTAL ECONOMY 5270 8791 14587 24182 38304 60928 B. 1988 prices - TL billion AGRICULTURE 12 12 10 20 17 6 MINING 969 680 293 302 129 150 MANUFACTURING 1423 1491 883 580 498 602 ENERGY 1827 1811 1964 2166 2348 1824 TRANSPORT. & COMMUNICATIONS 2111 2342 2294 1866 1191 1444 TRADE 43 35 117 196 142 157 AGGREGATE TOTAL 6386 6370 5562 5130 4324 4183 FIXED INVESTMENT TOTAL PUBLIC 12881 13855 13292 11494 10786 11705 TOTAL ECONOMY 20976 23278 24468 24182 23992 26045 C. Percentage of total public 1988 prices AGRICULTURE 1.6K 1.4% 1.0K 1.9K 1.5K 0.7X MINING 71.5X 69.2X 53.4X 59.2X 37.8X 36.2% MANUFACTURING 74.7X 97.5X 96.9X 85.7% 101.5X 98.4X ENERGY 60.5X 52.5 62.4X 70.3X 73.1% 7228K TRANSPORT. & COMMUNICATIONS 59.8% 58.2X 51.6X 54.8X 36.5% 36.2% AGGREGATE TOTAL 49.6X 46.0X 41.8% 44.6X 40.1% 35.7% D. Percentage of total economy - 1988 prices AGRICULTURE 0.8X 0.8X 0.6% 1.1X 1.0K 0.4X MINING 65.9X 61.5K 41.0X 43.8% 24.6X 26.1X MANUFACTURING 30.8X 32.3X 22.8X 15.9% 14.9% 14.4X ENERGY 59.6X 50.8% 60.4X 66.5X 68.2X -6.2K TRANSPORT. & COMMUNICATIONS 42.2X 43.3X 39.0K 39.1K 25.2X 23.1K AGGREGATE TOTAL 30.4X 27.4K 22.ZK 21.2% 18.0K 16.1% Source: Treasury.  Taj_LeAIj.: Emptoyment of SOES by Sector 1985 1986 1987 1988 1989 1990 AgricuLture 17,356 16,400 15,203 15,962 15,604 14,115 Percent of totat 0.21 0.,0 0.18 0.19 0.19 0.17 Mining 96,490 98,637 99,706 99,411 97,737 96,221 Percent of total 47.77 45.67 45.53 46.45 47.22 54.67 Manufacturin6 Food, Beverages, Tobacco 116,290 114,941 108,213 107,713 107,832 103,482 Textiles 1/ . 42,359 40,236 39,151 0 0 0 Paper, Printing, Pubtlishing 14,268 13,786 13,427 13,384 13,632 13,235 Chemicals, Chemical Products 2/ 23,591 24,509 24,019 15,919 16,346 16,899 :onHetallic MineraL Products 12,136 11,886 10,072 10,102 9,658 9,708 Basic Metal 28,776 28,629 28,247 27,476 28,624 27,817 Machinery and Equipment 25,732 25,853 25,615 24,837 22,24 22,081 Other 1,414 1,571 1,565 1,646 1,728 1,676 Total 264,566 261,411 250,309 201,077 200,064 194,870 Percent of total 13.47 12.66 11.56 9.19 8.99 8.08 Energy Electricity 62,690 67,175 66,308 68,789 70,906 73,423 Services Transportation 90,814 92,544 89,837 89,641 89,635 89,490 Coffmunication 79,855 89,394 100,540 104,667 106,212 108,258 Trade 21,870 22,520 21,739 22,996 22,194 22,820 TotaL 192,539 204,458 212,116 217,304 218,041 217,55 Percent of total 3.85 3.90 3.86 3.83 3.75 3.59 Total 633,641 648,081 643,642 602,543 602,352 596,180 Memo: Total excl SCmerbenk/Petkim 583,729 600,116 597,042 602,543 602,352 596,180 Percent of civilian employment 3.80 3.79 3.66 3.64 3.59 3.48 Percent of non-cgric. erployment 7.80 7.64 7.28 7.17 7.01 6.69 Source: SPO. Notes: 1 SUkerbank excluded from 1988 onwards. 2 Petkfm excluded from 1988 onwards.  ANNE- Table AI.5: International Trade of soes 18 1986 1987 1988 1989 IMPORTS A. USS million Total 5,164 4,179. 5,495 5,801 5,146 Investment Goods 967 1,232, 1,505 1,492 941 TUPRAS 1/ 2,788 1,613 2,562 2,590 2,046 B. Share of imports of overall economy TotaL 45.52% 37.27% 38.81% 40.46% 32.58% Investment Goods 37.17% 35.47% 39.43% 37.41% 24.46% EXPORTS A. USS million Agriculture 0 0 90 28 6 Mining 196 179 226 338 330 Manufacturing 693 436 652 623 474 Food,Beverages, Tobacco 185 42 145 81 10R Textiles 2/ 24 43 0 0 0 Paper, Printing, Publishing 24 28 34 12 1 Chemicals, Chemical Products 3/ 388 227 351 391 257 NonMetaltic Mineral Products 8 8 12 10 18 Basic Metal 57 79 &8 111 45 MachInery and Equipment 6 9 22 17 44 Other 0 0 0 0 0 Services 702 710 932 1,283 1,172 Transportation 570 612 781 936 977 Communication 49 97 99 91 85 Trade 84 2 52 255 110 TOTAL 1,591 1,324 1,900 2,272 1,982 B. Share of total exports 4/ Agricutture 0.00% 0.00% 0.01% 0.00% 0.00% Mining 80.24% 72.33% 83.90X 94.56% 80.41% Manufacturing 11.57% 8.18% 7.21X 6.21% 4.61% Services 19.65% 21.79% 23.07% 18.18% 16.47% TOTAL 5/ 13.57% 12.35% 12.56% 11.48% 10.33% EXPORTS-IMPORTS (EXCLUDING OIL) USS Million (784) (1,203) (1,032) (939) (1,118) Source: Treasury. Notes: ITUPRAS imports mainly crude oil for its refIneries. 2 S(merbank is excluded after 1987, exports in 1987 were zero. 3 Petkim is excluded after 1987. 4 Series before and after 1986 are not comparable. After 1986 ISIC classification Is used for total exports, consistent with the SOE classification. The main difference concerns processed agricultural products that are no longer part of agrScultural exports in the ISIC classification. 5 Tctal exports a exports of goods and nonfactor services.  10- ~ANNEX 1 Teble A1.6: External Debt and Domestic Liabilities of SOEs 1985 1986 1987 1988 1989 1990 1/ Interest-bearing Liabitities (TL billion) 4169 7072 7391 17356 24102 35764 Foreign Debt (Sm) 2/ 2343 3551 4217 4260 4551 6045 MLT 2113 2938 3700 3988 4392 4785 ST 230 613 517 272 159 1260 Domestic Debt (TI billion) 2817 4381 3086 9625 13572 18052 Financial system 868 2046 3596 5373 6383 9858 Central Bank 3/ 122 213 763 1082 1321 1321 Bankirg system 746 1832 2833 4291 5062 8537 Other 4/ 1949 2335 -511 4252 7189 8194 Non-Interest bearing liabilities 5/ 993 1483 3329 4642 5362 7605 TotaL Liabilities 5162 8555 10720 21998 29464 43369 Ratilos: MLT External debt/Private 2.20 2.71 2.80 2.62 2.73 2.65 External debt/Total 9.20X 11.06X 10.48X 10.46X 10.90X 12.33X Credits/DMB total credits 15.59X 20.35X 22.43U 23.60X 17.23X 19.18% Domestic Debt/M2 32.99M 35.69X 17.43X 35.39X 29.90X 26.2iX Interest-bearing Liabilities/GNi 15.00X 17.96X 12.62X 17.26X 14.14X 12.45X Total Liabilfties/GNP 18.57X 21.73K 18.303 21.87X 17.29X 15.10X MEMO: Cash and Deposits 595 1036 741 1872 3217 2852 Source: Central Bank, Treasury. Wotes: I Estimate 2 Excludes onlerding in foreign exchange by the Treasury. 3 Including rediscounts. 4 Mainly to public entities (Tax Administration, Treasury and EBFs). Discrepancies between soe balance shoAet data and other data sources also enter this item. 5 aifnly accounts payable-accounts receivable.  -13.- ANNEX 1 Pricing Policies 10. In 1980, arguing for an opening of the economy and an increase in its competitiveness, the Government raised prices of all SOE products and liberalized price controls on some of their products. Some prices had been frozen since 1973, and the operational accounts of the SOEs had been steadily deteriorating as a result of major cost increases. No other measures we.e taken before the military took over the Government in the fall of 1980. The military continued to regulate SOE prices but allowed them to move, on the average, in line with price developments in the private sector. 11. The next democratically elected Government issued the Decree Law 233 in June 1984. It stated that prices of goods and services produced by plants of ventures, companies, and affiliated partnerships of State Economic Enterprises are free. However, for SEEs, the Council of Ministers may impose price restrictions whenever necessary. The loss, as well as the forgone profits, are compensated in a way that guarantees a 10 percent profit margin. The amount of the loss is calculated by the concerned ministry in cooperation with the Treasury. The Council of Miniaters may also impose other duties on the SoEs, for which they will bt compensated in a similar manner. For PEIs, the High Planning Council may intervene and modify the prices and rate schedules. The implementation of this regulation effectively reduced the amount of budgetary transfers resulting from duty losses imposed by the Government. At present, prices of only six products and services continue to be formally regulated: coal used for heating in Ankara and Eskesehir; electricity for the production of ferrochrome and aluminum; the distribution of fertilizer; grains; cargo transportation by rail, sea, and air; and sugar, depending on the market conditions. 12. In practice, however, price changes are still subject to miristerial review. Evidence of these implicit price regulations can be found by smparing the evolution of public and private prices before and immediately aft_r the elections in 1987. The average wholesale price index of public production in agriculture and industry was lagging its private counterpart by almost 20 percent over the first 11 months of 1987. After the November elections, prices jumped by 21 percent but could not recover the lost ground; the private sector responded with a 7.2 percent increase in the same month. In 1988 subsidies were also received by the iron and steel company (TDCI), the petroleum company (TPAO), and the tea company. This fact presents further evidence of Government interference in price decisions. Some managers admitted that they have to seek permission from the concerned minister to increase prices of their products. 13. The present pricing policy leads to a complex system of cross- subsidization in the public sector. Subsidies received by the coal company (TTK) benefit the electricity company, which, in turn, receives compensation for low rates it charges to the producer of ferrochrome and aluminum (Etibank). For further details on subsidization and pricing, see Annexes 2 and 5.  - 12 - ANNEX 1 Market Reg=lation 14. In 1984, state monopolies in sugar, tea, tobacco, alcoholic beverages, and fertilizer distribution were abolished. The only remaining legal monopolies in the manufacturing sector are for the production of lethal weaponry (MKEK) and newsprint and cigarette paper (SEKA). There are, however, sectors in which SOEs still have de facto monopolies. Etibank is the sole producer of copper and aluminum, while Petkim and TTX are sole producers of basic petrochemicals and hard coal, respectively. TEKEL still holds a monopoly for the production of distilled spirits, as well as for its imports, although the Government planned to eliminate the monopoly by the end of 1990. Sugar prod 'tion and imports are heavily regulated, making the sector unattractivA for private participation. Taxi meters and urea production are also exclusively in the hands of the public sector. Finally, there is little or no direct competition in the utility sector. Telecommunications, railway transportation, electricity distribution, airport and port authorities, and broadcasting are in the public domain. THY is the only airline allowed to have scheduled domestic flights. Institutional Framework 15. The main objective of Decree Law 233 is to raise efficiency of the SOEs by granting them larger autonomy and by attempting to reduce political interference. The law covers all nonfinancial enterprises in which the Government has a majority participation. It also contains a few minor regulations for enterprises with participations from the Government between 15 but not more than 50 percent of equity. All operations of the SOEs that are not explicitly regulated by this law became subject to Turkish commercial code. The Decree Law still regulates in detail many aspects of the operations of SOEs. For a complete analysis, see Annex 4. 16. Decrce Law 233 determined a new structure for the management and board of the SOEs, but by leaving management with a majority on the board, it created a conflict of interest between owner and manager. Investment and financing programs continue to be prepared as part of the national investment and budget plan; as such they must be ratified by the Council of Ministers. The concerned ministry appraises the projects and sends them to the State Planning Organization and the Undersecretariate of the Treasury for inclusion in the annual investment and financing program. The program's financing role is set by the Treasury and the SPO. The acquisition and sale of a company, affiliated partnership or joint venture must be approved explicitly by the High Planning Council. The Public Participation Administration will undertake the procedures relative to liquidation and sale, ae well as to the transfer of the operating rights. Assets of SOEs are considered state property and all transactions, rights, and claims are governed by the laws on state property. 17. Given these features, Decree Law 233 did not achieve its objectives, and improvements in efficiency of the companies did not occur. A new SOE law waa drafted with the objective of enhancing the autonomy of commercially oriented SOEs by amending Decree Law 233 in those areas where it did not allow SOEs to operate on the same basis as their private sector  -13- ANNEX counterparts. The main provisions of the draft law, reflecting the thinking of key government officials, were as follows: (a) Con-ersion to joint-stock companies: Subject to the results of "financial, administrative and technical evaluations," SEEs and PEIs will be converted by December 31, 1991, to joint-stock companies subject to the commercial code. SEEs and PEIs deemed not suitable by the High Planning Council for conversion to joint- stock companies will remain under Decree Law 233, though they could be converted at a later date if their situation permits. (b) Board of irectores: The board of directors of converted SEEa/PEIs would be composed of sevan members, including: the director general, two assistant directors general, and four other members appointed by the shareholders. Affiliated partnerships will have a five-member board: the director general (appointed by the SEE/PEI board), two assistant directors general, and two others. Converted SEEs/PEIs will also have a three-member Supervisory Board appointed by the shareholde_s. (C) Investments and oDerating budoet: Converted SEE/PEIs and affiliated partnerships continue to be included in the Government's annual investment and financing program until the Government's shareholding falls below 50 percent. Converted SEE/PEIs that pay dividends and do not require financial support from the Government will have full autonomy in investment, real estate, vehicle leasing/purchasing, and staffing. The Treasury maintains the right to abolish this freedom, however, if it judges that the SEE/PEI is engaging in activities that delay debt payments to the Treasury or damage their financial equilibrium. SEE/PEIS cannot be assigned duties for fulfilling investments or operating enterprises for which budgetary allocations have not been made in the fiscal year. (d) Sales of Shares: Converted SEE/PEIs and affiliated partnerships will be permitted to sell shares as follows: 5 percent to employees, 10 percent to residents of the province where the SEE/PEI is located, and, subsequently, additional shares to the public via the Stock Exchange. 18. The new legislation was never implemented, in part due to technical reasons (expiration of the authorization law) and in part due to lack of political support. Efforts continue, however, to prepare another draft law with a broader coverage. Personnel 19. Appointments at the management level have been subject to specific conditions. Before Decree Law 233, experience in the public sector was a prerequisite to be eligible for appointment as director general or assistant director general. Decree Law 233 modified this requirement to a minimum of  -14 - ANNEX 1 four years of pablic sector experience out of a total experience of at least 10 years. An amendment in June 1989 modified the requirement to a minimum experience of eight years in the public sector or 15 years in the private sector, or a combination of the two in which two years of private sector count as one year of the public sector. Since January 1990, there are no longer requirements of this type. In any case, the concerned minister could always waive the requirements. 20. The e mloyment regime differs for three dategories of employees of the SOEs (see Annex 6 for details). Workers fall under the general Labor Law (1475), which applies equally to public and private enterprises. The legal situation for salaried and contractual employees is more restrictive because part of the permanent employees are civil servants and their status is regulated by Law 657 on civil servants. Decree Law 233 provided for the possibility to hire employees on the basis of annual one-year contracts, but as a result of a court challenge of this practice, the Supreme Court ruled that this provision violated Article 128 of the Constitution. Law 399 (January 1990) corrected this situation by adding civil servant positions and by stipulating that employees can only be laid off for disciplinary reasons not for economic reasons. 21. There is little flexibility for SOEs with respect to the determination of salary levels and nayments of nerformance-based bonuses. For civil servants, the salary scale is determined by the High Planning Council. Until recently, there were differences in salary structures among SOEs, but a standardized structure with 10 categories was introduced for all SOEs. Law 399 permits the payment of annual bonuses, but they are based on a rigid point scale applicable to all SOEs and independent of the profits of the SOE. The maximum allowed bonus is 8 percent of the annual salary. In the past, the total salary bill paid to contract employees could not exceed 10 percent of the total wage bill of permanent employees. Since 1988, however, only the salary scale is still determined by the High Planning Council. Privatization 22. Privatization was made an integral part or the Government's SOE sector strategy by including in Decree Law 233 a clause that permits the Council of Ministers to decide on the privatization of SOEs without parliamentary approval. Privatization of subsidiaries, majority-owned companies, operations, and units can be decided by the Housing Development and Public Participation Fund? with approval from the High Planning Council. Minority shares can be transferred and sold by the Public Participation Fund without further approval. Although the objective of making the economy more responsive to market forces was the most widely argued one, secondary objectives have been admitted publicly. They include the development of domestic capital markets by stimulating broad shareholdership, the reduction 9 In early 1990, the Housing Development and Public Participation Fund was separated into two independent entities, the Housing Development Fund (HDF) and the Public Partnership Administration (PPA).  - 15 - ANNEX 1 of the budgetary burden, and the generation of revenue for the Treasury. As in many other countries, the budget constraint seems to be an important consideration, and the recently observed increase in the list of companies to be privatized coincides with rising public sector deficits. (See Annex 3 for details). C. Financial Performance AareQ~ate Sector Performance 23. The SOE sector has experienced a sharp decline in overall financial performance since 1985. There are several structural weaknesses underlying the deterioration, including large operating deficits due to increasing wage and interest expenses, high debt stocks to foreign and domestic commercial banks due to negative cash flows, and unprofitable capital investmentn.y All data presented in this section exclude the Soil Products Office (TMO) to avoid too strong a distortion cf the data, since TMO is mainly used to implement the government's income support policies. Profitability 24. Table A1.7 shows the aggregate profit and loss statement for the sector. The operating surplus has been declining rapidly since 1985 due to increasing wage expense and interest payments caused by growing debt stocks. Wage expense has risen over 200 percent, while interest expense has grown over 100 percent in real terms since 1985. This increase in expense has culminated in an operating deficit of almost TL2 trillion in 1990 and a projected 1991 deficit of TL6 trillion. The operating result, which contributed 3.6 percent to GDP in 1985, is expected to reduce GDP by 1.4 percent in 1991. 25. The largest contributors to the overall 1990 SOE deficit include TDCI (TLI trillion), TCDD (TL821 billion), TTK (TL752 billion), and TEK (TL639 billion). Combined losses for all firms in the sector totaled almost TL5 trillion, while profitable firms earned a combined TL3 trillion. The most A Accounting practices are not uniformly followed by all SOEs. Some include part of interest payments, depreciation, and wage expenses in cost of goods sold. Nonoperating revenues and expenses include both operating and nonoperating income and expenses. Duty losses reported as income are actually accrued duty losses (i.e., duty losses earned but not paid). SOEs have a one- time opportunity to convert debt owed to the Government to equity and, hence, debt related indicators show a peculiar behavior over time. Turkey's accounting standards are not adequately adapted to the high-inflationary environment. Fixed assets and depreciation are revalued based on a Government-imposed inflator, but the income statements are not adjusted. In a high-inflationary environment, input costs are understated relative to the sales they generate due to production lags, and revaluing input costs to their actual value would substantially reduce reported operating surpluses. Inventories are valued at average historical cost of the previous three months.  -16 -NNIX profitable SOEo in 1990 include TPAO (TLl.l trillion), PTT (TL641 billion), and TEKEL (TL592 billion). These three firms earned 78 percent of the total profits of the sector in 1990. 26. A firm's ability to generate an operating surplus from its earnings and capital determines its profitabilLty. The ratio chosen to reflect the SOE's profitability in a high-inflationary environment is the return on capital employed ratio (ROCE). This benchmark is defined as earnings before interest and taxes (EBIT) / (equity + lnterest-bearing debt). The ROCE measures how efficiently (i.e., profitably) the firm is using its Table A1.7: Aggregate Profit and Loss Statement-" (TL biLLion) 1985 1986 1987 1988 1989 1990 1991"' 1985-1990 REVENUE TOTAL CURRENT REVENUE 9910 12892 17993 28143 48916 79693 132693 SALES AND OTHER REVENUE 9555 12644 17847 27949 48559 79416 131621 DUTY LOSSES 355 248 119 157 332 255 1042 SUBSIDIES 0 0 27 37 25 22 30 EXPENSES TOTAL EXPENSES 8393 11264 15603 25451 44607 76787 132079 COST OF GOODS SOLO 6517 7603 10874 15617 29178 48890 85468 DEPRECIATION CURRENT YEAR 374 777 1282 2311 3950 5724 7371 PROVISIONS 33 42 85 137 230 630 485 OTHER EXPENSES 1469 2842 3362 7386 11249 21543 38755 OF WHICH WAGES 966 1273 2016 2907 7370 14498 29394 EARNINGS BEF. INT. & TAXES 1517 1628 2390 2692 4309 2906 614 INTEREST 267 509 1091 1561 2052 3638 5437 EARNINGS BEFORE TAXES 1250 1119 1299 1131 2257 -732 -4823 TAXES 251 515 665 709 864 1095 1321 OPERATING SURPLUS/LOSS 999 604 634 422 1393 -1827 -6144 DIVIDENDS 0 0 0 70 140 362 520 RETAINED EARNINGS 999 604 634 352 1253 2189 -6664 Return on Capital Erployed 17.18% 14.25% 12.74% 10.64% 16.30X 6.79% 5.28% 11.98% Return on Capital Employed-Private M&E NA 22.90% 21.50% 21.30% 14.80% NA NA 20.13% Operating Surplus as % of GDP 3.59% 1.53% 1.08% 0.42% 0.82% -0.64% -1.40% MEMORANDUM ITEM: GNP 27797 39370 58565 100582 170412 287254 439637 Source: Treasury and IBRD estimates. Notes: Excluding T#O. Program.  - 17- ANNEX 1 capital base (equity and debt) to generate an operating surplus. It also reflects the firm's financing rate breakeven point. If a firm's weighted average cost of capital is above the ROCE, it is not profitably using its capital, becauce the cost of financing is greater than the return the firm earns on its capital investment. Subsequently, any additional, similar investments will continue to decrease the firm's operating surplus. 27. Whereas the ROCE of both public and selected private manufacturing and energy companies (these subsectors make up the majority of the SOE sector) fell since 1985, the average ROCE for the entire period is 12 percent for SOEs versus 20.1 percent for the private sector.i/ This 8.5 percent spread is significant because it represents the difference between overall sector profitability and deficit. Moreover the ratio has been declining steadily since 1985; it is now at 6.8 percent significantly below the weighted cost of capital (13 percent) for firms listed on the ISE. SOEs are not earning sufficient profits on their capital investments to cover their financing expense, while the private sector can generate a surplus from its invested capital. gaoital Structure 28. The consolidated balance sheet for the sector is presented in Table A1.8. Total borrowing increased 13.6 percent in real terms between 1985 and 1990. This increase contrasts with a 14 percent real decline in fixed assets during the same period, implying that SOEs are using outside borrowing to finance normal operational needs rather than to fuel profitable sector growth. TMO's stocks have risen significantly in recent years, raising the share of inventories in total assete from 15 percent in 1985 to 19.2 percent in 1990. This stock-building activity is exclusively related to policy- induced agricultural support purchases. Excluding TMO, inventories have remained roughly constant as a share of assets over the period 1985-90. 29. Capital structure is important because the securities mix that a firm uses to finance its assets helps determine its overall financial health. The indicator chosen to reflect the sector's current capital structure is the financial leverage ratio. This gauge is defined as (equity + total liabilities) / equity. The financial leverage ratio measures how much of a firm's capital is debt relative to owner's equity. A ratio close to 1.0 implies that the firlm is primarily using equity to finance its working capital and capital investment needs. The benefits of using leverage are its flexibility in managing a firm's cash (i.e., cash is not dedicated to financing one or more projects) and its ability to allow firms with insufficient liquid assets to finance potentially profitable capital investmente. However, when real interest rates are high, too much leverage causes exorbitant interest expense and usually precludes the firm from making a profitable return on capital investments. A The decline of the ROCE in private sector in 1989 is due to the sharp recession in industry in the first half of the year.  - 18 - ANNEX1 30. As Table A1.8 indicates, the financial leverage ratio for the SOE sector has averaged 2.37 from 1985 to 1990. The private manufacturing and energy subsectors (both capital-intensive industrial subsectors) averaged 1.32. The difference is to some extent due to the dominant weight of a few large SOEs, such as TEK (electricity) and TDCI in the average, but for most other SOEs the financial leverage is also higher than in the private sector. In a behavioral sense, the difference can be explained by the fact that private companies facing high real interest rates prefer to use equity as the main source of financing to reduce interest expenditure. SOEs do not have that choice because equity contributions are determin:ed through the central government's budgetary process, largely independent of the cost of financing. Table A1.8: Aggregate Condensed Balance Sheet of SOEs1' (TL billion) 1985 1986 1987 1988 1989 1990 1985-1990 ASSETS: TOTAL CURRENT ASSETS 5144 6424 6541 14143 21492 28036 OF WHICH INVENTORY 1848 2116 2952 4868 7919 12523 FIXED ASSETS 6826 9599 16313 24105 37582 54063 OTHER LONG TERM ASSETS 990 1642 1908 2051 3209 3363 TOTAL ASSETS 12960 17655 24762 40299 62283 85462 LIABILITIES: TOTAL BORROWING 7213 10510 11781 26123 35204 50371 NON-INTEREST LIABILITIES 3272 3989 5274 10096 13797 22514 OF WHICH ACCOUNTS PAYABLE 2928 3539 3588 6463 8039 15914 SHORT TERM BORROWING 1185 2255 1308 4857 6650 7017 LONG TERM BORROWING 2756 4266 5199 11170 14757 20840 TOTAL EQUITY 5747 7155 12981 14176 27079 35091 TOTAL LIABILITIES & EQUITY 12960 17665 24762 40299 62283 85462 Financial leverage ratio 2.26 2.47 1.91 2.84 2.30 2.44 2.37 Fin. leverage - Private M&E NA 1.40 1.33 1.31 1.22 NA 1.32 Source: Treasury and IBRD estimates. Note: 1 ExcLuding TMO. Financial Risk 31. Financial risk, or solvency, is related to a firm's capital structure and is defined as the risk to the owners from the use of debt obligations. Too much debt, relative to the firm's earnings, causes operating deficits because of larger interest expenses. If the debt load becomes unmanageable and the firm's liabilities are greater than their assets, the firm becomes insolvent.  - 19 - dN 32. A measure of the firm's ability to generate an adequate operating surplus to repay the interest and fixed charges on its debt is the "times interest earned" ratio (TIE). It is defined as (BBIT + depreciation) / interest. The TIE ratio can also be used to determine to what point earnings can decline before the firm is no longer able to meet its interest obligations. This indicator is called earnings decline coverage (EDC) and can be calculated as (1 - (1 / TIE)) x 100 percent. The earnings decline coverage indicator is an important measure of solvency. A firm with a low EDC is a high financial risk because its operating surplus is barely sufficient to repay its current debt obligations. An unexpected decline in operating surplus could cause the firm to default on its debt since it will have insufficient funds to pay its interest expenses. Table A1.9: Financial Risk Indicators of Aggregate SOE Sectorl' 1985 1986 1987 1988 1989 1990 1991" 1985-1990 AGGREGATE TOTAL: Times interest earned 6.87 4.72 3.34 3.21 2.57 2.02 1.47 3.24 Earnings decline coverage 85.44% 78.81% 70.06% 68.82% 61.07% 50.44% 31.9% 69.11% PRIVATE MANUFACTURING/ENERGY: Times interest earned NA 2.36 3.11 2.94 3.85 NA NA 3.07 Earnings decline coverage NA 57.60% 67.89% 66.04% 74.02% NA NA 66.39% Source: IBRD estimates and Istanbul Chamber of Industry. Note: ' Excluding TMO. Program. 33. The sector's earnings decline coverage has gradually decreased from 85 percent in 1985 to 32 percent projected in 1991. This indicates that the sector is becoming increasingly risky (see Table Al.9). Wage increases granted in 1991 (141 percent nominal), which are not yet reflected in the figures of Table A1.9, are more than sufficient to make the earnings decline coverage negative. This trend implies that the sector would no longer be able to cover interest payments, and, therefore, would be technically bankrupt. Cash Flow hnalysis 34. Cash flow measures the firm's ability to generate sufficient internal funds (through operating surplus and depreciation) to finance operational (working capital) and capital investment nee4p. A firm with a negative cash flow can be investing heavily in new capital equipment to earn future profits or it can be consistently generating insufficient internal cash to finance operational and investment needs. A negative cash flow suggests that the firm requires outside financing (usually from commercial or foreign banks) to meet these needs.  -20 - ANNEX 1 35. Table A1.10 examines the cash flow and borrowing requirements of the sector. Free cash flow is calculated as gross cash flow -(working capital + capital investment) + (nonoperating income - nonoperating expenditure). Gross cash flow is defined as operating surplus - taxes + depreciation. Free cash flow, therefore, is the firm's total after-tax cash that is available to all providers of the firm's capital. Table A1.1O: Aggregate SOB Sector Cash Flow Analysis (TL billion) 1986 1987 1988 1989 1990 NET OPERATING MARGIN 1590 2139 2696 2368 3419 DEPRECIATION 777 1282 2311 3950 5724 TAXES -515 -665 -709 -864 -1096 GROSS CASH FLOW 1852 2756 4298 5454 8048 WORKING CAPITAL 563 -795 2486 3742 -2344 CAPITAL INVESTMENT 4202 11545 10247 18585 22360 TOTAL INVESTMENT 4765 10750 12733 22327 20016 FREE OPERATING CASH FLOW -2913 -7994 -8435 -16873 -11967 NON OPERATING INCOME 21 676 -73 1942 381 FREE CASH FLOW -2892 -7318 -8508 -14930 -11587 Borrowing Requirement -988 -2036 -2436 -2285 -1314 Percent of GNP 2.5% 3.5% 2.4% 1.3% 4.6% Source: Treasury, IBRD estimates. 36. The sector's free cash flow shortage has been very high in recent years (7 to 9 percent of GNP), but it improved somewhat in 1990. However, capital investment declined 45.2 percent, and working capital needs have fallen 5 percent in real terms since 1986. Specific Cases: TCDD. TTK. THO 37. Several SOEs are in extremely poor financial condition, including TCDD, TTK, TMO, Caykur, TZDK, and EBK. TMO, Caykur, and TZDK are in agriculture-related industries and are, therefore, subject to government- imposed price restrictions and subsidies. EBK is'a small company with a minimal impact on the sector. Hence, this analysis is limited to TCDD and TTK  - 21 - ANEX I to determine the depth of their financial problems and their overall effect on the economy. Railwasys TCDDI 38. Table A1.11 summarizes the key financial information for TCDD. TCDD has embarked on a capital investment program that has increased debt stocks, causing interest expense to rise and operating surplus to decline continuously. Wage expense has also risen 204.4 percent in real terms since 1985. Together, wages and interest expenses have strongly contributed to an operating deficit of TL821 billion in 1990 and a projected 1991 operating deficit of TLl.9 trillion (0.5 percent of GNP). Table A1.11: TCDD FinanciaL Information 5TL billion) 1985 1986 1987 1988 1989 1990 1991" OPERATING SURPLUS/LOSS 5 -41 -21 -83 -152 -821 -1919 Return capital employed 2.46X -1.88% 1.08% -0.39% 0.04% -8.75% .15.17X Financial Leverage ratio 1.50 1.63 1.51 1.85 1.70 1.96 2.00 Times interest earned 6.67 0.81 1.78 1.09 0.88 0.88 -0.46 Earnings decline cover. 85.00% -23.08% 43.86% 6.36% -13.87% -13.38% NA FREE CASH FLOW -115 -54 -907 -1380 -2176 -991 Free Cash Flow as % GDP -0.29% -0.09% -0.90% -0.81% -0.76% -0.23% TCDD borrowing requirement -26 15 -31 3 -137 -302 -1009 Borrowing Req. as X GDP -0.09% 0.04% -0.05% 0.00% -0.08X -0.11% -0.23% MEMORANDUM ITEM: GNP 27797 39370 58565 100582 170412 287254 439637 Source: Treasury and IBRD estimates. Note: t Program. 39. The increase in capital ;nvestment and subsequent large operating deficits caused by the increese in wage and interest expensees have also contributed to a growing negative cash flow. This decline culminated in a negative free cash flow of TL2.2 trillion in 1990 (almost one percent of GNP). Subsequently, TCDD has been forced to further increase its debt stocks to finance normal business operations. 40. TCDD has significant potential to increase its performance by drastically reducing wage expense and working capital needs and selling its manufacturing company, which is draining operating and capital investment funds from the railway business. TCDD should also focus on areas where it has a comparative advantage (e.g., transportation of bulk goods), and with the exception of a few profitable lines leave other activities (e.g., parcel transportation and passengers) to trucks and buses.  - 22- ANNEX 1 Hard Coal k._e TTK) 41. As Table Al.12 indicates, TTK also has severe financial problems. Its operating deficit totaled TL752 billion in 1990, and it is projected to reach TL2 trillion in 1991 (0.5 percent of GDP). This deficit io caused by wage expenses that have increased 160.7 percent in real terms since 1985 and cost of goods sold, which are greater than incoming revenues. Table A1.12: TTK FinanciaL Information (TL billion) 1985 1986 1987 1988 1989 1990 1991'~ OPERATING SURPLUS/LOSS 7 *46 -77 -157 -350 -752 -1980 Return on capital emltoyed 12.77% -57.75% -37.06% -593.30% -94.23% NA NA Financial teverage ratio 2.01 2.77 1.61 13.55 1.48 NA NA Times interest earned 9.00 -6.80 -5.08 -14.29 -14.66 -24.41 -27.48 Earnings decline cover. 88.89% NA NA NA NA NA NA FREE CASH FLOW -18 -169 1 -646 104 -1324 Free Cash Flow as % GDP -0.05% -0.29% 0.00% -0.39% 0.04% -0.31% TTK borrowing requirement 20 -18 -35 -96 -220 -1039 -730 Borrowing Req. as % GDP 0.07% -0.05% -0.06% -0.10% -0.13% -0.36% -0.17% MEMORANDUM ITEM: GNP 27797 39370 58565 100582 170412 287254 439637 Source: Treasury and IBRD estimates. Note: Program. 42. TTK has inadequately replenished its fixed asset stock, which has contributed to higher cost of goods sold. Its fixed assets have been depreciated and not replaced because of its inability to self-finance capital investments. TTK is not overburdened with interest-bearing debt; it has financed its working capital needs through deferred payments (i.e., noninterest bearing liabilities). Using noninterest liabilities is an accepted working capital management technique, but the magnitude of the anount owed (TL1.4 trillion in 1990) combined with largs operating deficits implies that TTK will not he able to repay its creditors. 43. TTK'e current financial position does not give it an opportunity to reverse its current trend. It would have to reduce wage expense and receive a sufficiently large equity infusion tr overcome its current negative equity position and embark on a massive capital asset replacement program. This strategy would reduce cost of goods sold, but would dramatically increase interest expense because of the debt needed to finance this program. The overall effect of this course of action would bring TTK to the brink of insolvency.  - 23 - ANNEX 1 The Soil Products Office (TMO) 44. The Soil Products Office (TMO), excluded from the aggregate analysis, is the agency executing the Government's agricultural support and urban income support policies. As such, the company is entirely policy driven; hence a discussion of its financial performance yields little. Table A1.13 shows some summary indicators of performance. Although TMO has always had an operating loss, its borrowing needs have been modest until recently. In some years, the company has earned a reasonable return on capital. Yet, the volatility in the indicators and their recent deterioration show that the company is fulfilling a noncommercial role. When world prices for agricultural crops were high, TMO's performance was quite good (e.g., 1988), but recently the wedge between domestic purchase prices and international prices has become so large that TMO has been making significant losses. Excessive stockbuilding in 1990 pushed TMO's borrowing requirement to 1.9 percent of GNP. Financing of these stocks and their sale at a loss is expected to raise the operating loss to almost 0.5 percent of GNP in 1991. Before the higher than anticipated price increases took hold in the 1991 season, TMO's borrowing needs in 1991 were anticipated to be 1.1 percent of GNP. After the increases, the domestic price for wheat is about $US170 per ton, 60 to 70 percent above world market priced. Jeble A1.13: TH Financial Information 1985 1986 1987 1988 1989 1990 1991" Operating surpluses" -0.24% -0.22% -0.26% -0.05% -0.12% -0.05% -0.44% Borrowing reqcirement 0.35% 0.90X 0.81% 0.16% 0.59% 1.92% 1.1% Return on capitat employed 15.0% 3.75% -8.8X 48.1% 22.2% 0.8% -3.6% Financial leverage 4.4 8.9 25.5 23.6 24.6 4.1 1.5 Earnings decline cover 13.0% -181.0% n.a. 75.3% 19.55% -901.4% 195.2% Source: Treasury and IBRD calculation. Notec: D Program. Before duty loss compensation. Fi ancial Viblity of SOEs 45. To anticipate future financial trends in the sector, a forecasting and valuation model was used to predict the viability of the SOEs over the next five years to determine which SOEs should be privatized and which should be liquidatod.  -24 I NE Methodoloatv 46. Projected operating surplus, the need for interest-bearing debt financing, the projected free cash flow, the profitability of capital investments, financial indicators, and the projected value of the firm in 1996 were all used to claseify the enterprises as viable or nonviable. The value of each enterprise was calculated as the sum of the present value of projected free cash flows for 1991 through 1996, plus the terminal value in 1996, minus the value of projected liabilities in 1996. The terminal value was calculated based on a weiglhted average cost of capital of 13 percent, real revenue growth rate, and projected net operating income for 1996. This analysis assumes that the following SOEs will be retained in the public sector over the medium term: DlMI, PTT, TCDD, TDI, and TEK. In addition to these enterpriscs, Petkim, SUmerbank, THY, and TMO were also excluded from the analysis. 47. A firm with increasingly negative net income and negative free cash flow, a history of unprofitable capital investments, increasing debt burden, declining financial indicators, and a negative projected terminal value was determined to be a candidate for liquidation because it would have no value for private Bector purchase. Marginal firms and those SOEs that, through better expense management and financial restraint, seem to have the potential for improvement were considered privatization candidates. 48. There are two important caveats to the forecasting and valuation model. First, the analysis was done at the holding company level; hence, it cannot differentiate among companies within a holding because of a lack of disaggregated data. Second, the analysis takes the quality of the original data as given, even though some problems were discovered during the analysis.11 Best Case Scenario 49. The best case scenario assumes that the SOEs, through reforms or privatization, would be able to raise revenues by 20 percent. Additionally, the analysis assumes that the sector will decrease wage expenses by 30 percent and face a real interest rate of 7 percent on all outstanding interest-bearing debt. Table A1.14 reflects these results based on 1990 accounting data. 50. Even under these positive assumptions, seven SOEs would not become financially viable, leaving about 120,000 employees to be assimilated into the private sector. These liquidation candidates represent 13 percent of fixed assets and 21 percent of employment of the sample analyzed. The Government will have to assume TL5.3 trillion in outstanding debt, which will be partially offset by a cash gain of TL400 billion and the sale value of fixed assets (book value TL7 trillion). I The most severe one was that for many SOEs the flow of funds statements could not be reconciled with changes in the balance sheets.  -25 - ANNEX l Table_A_.14: Forecast of Financiat Accounts: Best Case Scenario INVIABLE SALE RETAIN TOTAL TL Trillion/Units NUMBER 7 18 5 30 REVENUE 6.6 36.9 14.8 58.3 FREE CASH FLOW -0.5 -1.2 -9.9 -11.6 CASH GAIN/LOSS 0.4 -0.4 -0.1 -0.2 DEBT 5.3 4.5 18.0 27.9 FIXED ASSETS 7.0 8.9 38.2 54.1 EMPLOYMENT 120242 201829 254270 576341 PERCENTAGE OF TOTAL NUMBER 23.3% 60.0% 16.7% 100.0% REVENUE 11.3% 63.3% 25.4% 100.0% FREE CASH FLOW 4.3% 10.4% 85.3% 100.0% CASH GAIN/LOSS -235.3% 248.8% 86.5% 100.0X DEBT 19.1% 16.3% 64.7% 100.0% FIXED ASSETS 12.9% 16.5% 70.6% 100.0% EMPLOYMENT 20.9% 35.0% 44.1% 100.0% ASSUMPTIONS: 20% INCREASE IN REVENUES DUE TO PRODUCTIVITY GAINS 30% DECREASE IN WAGE EXPENSE DUE TO PRIVATE SECTOR MGT. CONTROLS 7% REAL INTEREST RATE ON DEBT Source: IBRD estimates. A More Realistic Scenario 51. In order to test the sensitivity of this analysis' assumptions, a more realistic scenario was created. In this case, prices will have to fall by 20 percent (see also next section), but, because of existing unused capacity and the state of the current fixed asset stock, productivity and efficiency will increase 15 percentY. The net effect is a five percent decrease in revenues. However, wage expenses due to private sector management controls are again assumed to decrease by 30 percent. Real interest rates are fixed at seven percent. Table A1.15 shows these results based on 1990 accounting data. 52. In this case, 17 SOEs will not become financially viable, leaving almost 194,000 employees to be retrained or assimilated into the private sector. This number represents 56.7 percent of the firms, 33.6 percent of total sector employment, and 24 percent of fixed assets. The government will have to assume an additional TL7.4 trillion (26.5 percent) of outstanding sector debt. Also it will realize a cash loss of TLO.1 trillion due to A To the extent that it is linked to further reduction in trade protection, the 20 percent decrease in prices could also reduce imported input costs. However, imported inputs represent only 34 percent of the total cost of production of SOEs; so a proportional reduction in fixed and intermediate good prices still has a significant negative effect on the firm's profitability.  -26- ANNEX 1 liquidation, partly offset by the sale value of fixed assets (book value of TL12.7 trillion). !RTabLe1.15: Forecast of Financial Accounts: A Realistic Case INVIABLE SALE RETAIN TOTAL TL TriLtLion/Units NUMBER 17 8 5 30 REVENUE 15.5 28.1 14.8 58.3 FREE CASH FLOW -0.3 -1.4 -9.9 -11.6 CASH GAIN/LOSS -0.1 0.1 -0.1 -0.2 DEBT 7.4 2.5 18.0 27.9 FIXED ASSETS 12.7 3.1 38.2 54.1 EMPLOYMENT 193747 128324 254270 576341 PERCENTAGE OF TOTAL NUIJMBER 56.7% 26.7X 16.7X 100.0X REVENUE 26.5% 48.1% 25.4X 100.0X FREE CASH FLOW 2.6X 12.1X 85.4X 100.0X CASH GAIN/LOSS 77.6% -64.2X 86.5X 100.0X DEBT 26.5X 8.8X 64.7X 100.0X FIXED ASSETS 23.6X 5.8X 70.6X 100.0X EMPLOYMENT 33.6X 22.3X 44.1X 100.0X ASSUMPTIONS: 5K DECREASE IN REVENUES DUE TO DECREASE IN SUE PRICES TO MARKET PRICES 30K DECREASE IN WAGE EXPENSE DUE TO PRIVATE SECTOR MGT. CONTROLS 7K REAL INTEREST RATE ON DEBT Source: IBRD estimates. 53. Recently, the Government agreed to give a further average nominal wage increase of 140 percent to SOE workers. Depending on the inflation outcome for 1991, this jump could imply a real wage increase of 30 to 40 percent. Barring any layoffs, many more companies will join the group of insolvent companies over the next two years. As the ability to self-finance capital investment and operational needs decreases, interest-bearing debt stocks will increase. This effect will put an additional strain on the already over-burdened capital structure of the SOEs, resulting in larger interest payments and a deeper deficit-debt spiral. D. Economic Performance 54. A weak financial performance, as documented in the previous section, need not necessarily imply low efficiency or low factor productivity. Output and factor prices faced by SOEs may differ from market values ae the result of government interference. This argument hold. less for SOEs producing tradeables, because selling below market prices would lead to excess demand and rationing, which is not observed in Turkey. Interference in pricing decisions to achieve noncommercial objectives, if not adequately compensated by subsidies, directly distort. indicators of financial performance. While price manipulations cannot be discarded entirely as a cause of poor financial performance of SOEs in Turkey, Table A1.16 reduces the  -27 NNEX power of this argument. It indicates that domestic prices of many goods and services produced by SoEs are significantly above border prices. At least for this subset of comnmodities, increased foreign competition would require a drop in the output prices, since they average 44 percent above CIF prices.Y Table A1.16: Comparison of Selected SOE Prices with Border Prices (12/31/1990) ENTERPRISE PRODUCTS IMPORT PRICE SOE SALE PRICE X DIFFERENCE (CIF S) (S) SOE/CIF SEKA Newsprint (ton) 800.00 605.26 -24.34% Quality Paper (ton) 520.00 1,199.25 130.62% Kraft Paper (ton) 590.00 691.73 17.24% CITOSAN Cement (ton) 41.00 63.53 54.96% TDCI Cast Iron (Hungary) 264.00 338.35 28.16% Iron-Steel (Europe) 280.00 387.22 38.29% Iron-Steel (L. Am.) 265.00 360.90 36.19% TTK Hard Coal (ton) 49.62 67.89 36.81% TZDK DAP Fertilizer (ton) 180.00 281.80 56.56% TSP Fertilizer (ton) 140.00 187.58 33.98% Anmrniwn Sulfate 60.00 109.14 81.89% Urea (ton) 85.00 165.66 94.89% SEKER Sugar (ton) 365.00 507.52 39.05% EBK Meat (Kg) 3.13 3.10 -0.79% CAYKUR Tea (Kg) 2.56 4.79 86.99% Etibank Copper (Ton) 2,735.15 2,706.95 -1.03% Unweighted Average 44.34% Source: Treasury and IBRD. 55. Indirectly, price distortions also affect allocative efficiency because SOE managers are not facing market signals to guide their operational decisions. The relatively inefficient use of resources is borne out by a generally lower rate of capacitv utilization in the public manufacturing sector compared with the private sector (see Figure Al.1). Insufficient resource use was especially noticeable in 1990 because foreign competition increased due to the real exchange rate appreciation. 56. Comparing the share of SOEs in value added, labor, and capital with the private sector's 500 largest industrial firms shows that SOEs produce approximately 45 percent of value added, with 66 percent of the fixed assets and 55 percent of the total labor (see Table A1.17). uisless these industries 7 Even if increased foreign competition would lower the price of imported inputs proportionately, the net effect on financial performance of these SOEs would be negative, ceteris paribus.  - 28 - ANNEX-1 Figure A1.1 Capacity Utilization in Ptibtic and Private Industry 100 _ eo......... ....... ........;,, 70 <;>/.............. . .........s 40 , . . . . . . . t 2 a 4 1 2 3 4 t 2 3 1 e 88 19s 0 1 P- ubllo - Private are characterized by declining returns to scale, the fact that SOEs employ a relatively higher share of both production factors indicates that they use an inefficient factor combination. Such a practice leads to a 12roductivito that is overall lower than the private sector's. Given the fact that SOEs are typically larger in size than private companies, decreasing returns to scale could render this observation invalid. In that case it was the decision on the size of the establishment rather than on the factor mix that was the wrong one. .Table A1.17: Share of SOEs in Vatue Added, Employment e.nd Fixed assets In 500 Largest Industrfat Firml (percent) - ~~~~ w ~~~~~ 1986 1987 1988 1989 1990 Effptoyment 57.0 54.9 55.5 54.5 53.4 Fixed Assets Current Prices 69.0 68.7 69.8 68.9 65.9 1988 Prices 70.7 69.6 69.8 68.8 64.8 Value Added Current Prices 45.8 44.8 47.0 45.8 41.6 198B Prices 43.8 44.7 47.0 44.9 40.5 Source: ISO and 18RD calculatlons. S7. A crude indicator of the efficient use of capital is the incremental capital output ratio (ICOR), which under certain assumptions can be interpreted as the inverse of the marginal productivity of capital. Table  -29- ANNEX 1 A1.18 shows that, in the aggregate, the ICOR of 80Ss is more than double that of the rest of the economy over the last five years. Lower marginal efficiency of capital on SOEo is especially striking in manufacturing and energy, while in mining, transportation, communication, and agriculture, SOEs appear to do better than the private sector. The latter may be due to sector specific characteristics and developments over the sample period.9' In any case, if SOEs as a group had been as efficient as their private sector counterparts, real GDP could have been higher by 3 percent in 1990. This figure is a rough eatimate of the efficiency loss due to suboptimal investment decisions in recent years. Table A1,18: Incremental Capital Output Ratios (1985-90) SOEs Non-SOEs Total 9.25 4.56 AgricuLture 1.46 3.32 Mining 15.61 -19.55 Manufacturing 44.88 2.17 Energy 16.28 5.71 Transport & Comnunications 5.11 -67.2 Source: IDAR calculations. 58. Mainly as the result of the hiring freeze introduced by the Government in the second half of the 1980s, labor productivitv indicators show a modest upward trend (12.1 percent) in the period 1985-1989 (see Table Al.19). Change in labor productivity varies greatly among individual SOEs, ranging from -70.6 percent for TZDK (tractor production) to +62.8 percent for IGSAS (fertilizer production) over the sample period. Although the average increase in labor productivity is a positive development, the 12 percent increase becomes insignificant when compared with the 100 percent uniform real wage increase over the same period. Moreover, in many cases the level of productivity in the SOEs is below that of the private sector, as indicated in part B of Table A1.19. This trend especially applies to the sectors of textiles, paper and publishing, machinery and equipment, and electricity. In 8 Value added of the private sector has fallen in mining and transportation and communication over the sample period; in agriculture, the sample of SOEs includes only TARIM and ORUS, representing less than one percent of value added of that sector.  _ 30 ANNEX 1 the sectors of mining, chemicals, and wood and wood products SOEs outperform the private sector in terms of gross value added per wotker.V Tablet AI19: Labor Productivity 1986 1987 1988 1989 1985-1989 A. Change in Labor Productivity3 Agriculture 33.5 -2.0 -1.6 1.2 30.3 Mining 1.7 -2.9 -3.6 17.6 11.9 Manufacturing 10.3 19.2 -2.1 24.2 -2.5 ELectricity (TEK) 3.5 14.4 4.5 5.2 30.1 Transportation & Communication -1.6 9.5 10.1 5.4 25.0 Total 6.3 13.8 1.0 -8.2 12.1 Selected Companies TZDK -7.8 23.1 -13.8 -70.0 -70.6 GEMSAN -32.8 55.9 -3.8 -42.0 -41.6 DITAS -4.2 16.2 -8.0 -34.9 -33.4 TTK -6.4 -3.8 -5.4 -4.2 -18.4 Etibank 3.4 0.1 24.7 4.1 34.4 THY 3.8 27.5 6.7 1.7 43.7 TPAO n.a. 19.7 -0.4 23.3 46.9 IGSAS -10.7 71.6 -4.3 11.0 62.8 M:emo: Real Wage Increase 100X B. Gross Value Added Per Workerl' (SOEs/Private Sector) Mining 0.74 1.26 1.75 2.00 1.44 Manufacturing 0.91 0.71 0.80 0.87 0.82 Food, Beverage, Tobacco 1.27 0.87 0.60 0.66 0.85 Textiles, Weaving Apparel & Leather 0.75 0.59 0.68 0.60 0.66 Wood, Wood Products, Furniture 2.53 2.15 1.69 0.67 1.76 Paper, Paper Products, Publishing 0.51 0.80 0.78 0.92 0.75 Chemicals, Petroleun Products, Plastics 1.10 1.18 1.29 1.74 1.33 Non-Metallic Mineral Produtcts 1.14 0.89 0.74 0.83 0.90 Basic Metal Products 0.65 1.04 1.33 0.83 0.96 Machinery and Equipment 0.44 0.28 0.32 0.58 0.41 Electricity 0.13 0.20 0.29 0.33 0.24 Total 0.85 0.74 0.86 0.90 0.84 Source: Treasury and ISO. Notes: 1 Based on a sample of main products representing 76 percent of total value of production in 1988; volume indices weighted by 1988 share in value of production. 2 Based on top 500 industriaL firmc in Turkey. 2 The figures in part B of Table Al.19 are subject to the caveat that value added is expressed in current prices due to a lack of price deflator. that differentiate between public and private production. The sectors mentioned here as poor performers would require increases between 25 percent and 75 percent to catch up with value added per worker in the private sector. Differences in price only are unlikely to be responsible for gaps of this size.  -31- ANNEX 1 59. For a limited subsample of SOEs total factor productivity (TFP) growth was calculated for the period 1985-1990T (see Table A1.20). With the exception of THY (airlines) only those companies that reduce their net capital stock were able to raise TFP. These companies are on an unsustainable path that will turn the decline in capital into reductions in value added in the near future. TEK (electricity) and PTT (telecommunications), which are rapidly expanding both capital and labor, are posting a significant decline in TFP.II/ Table A1.20: Total Factor Productivity for Selected SOEs (1985-1990, percentage change) Value Labor Capital TFP Added TTK 1/ -2.24 0.61 7.48 -2.85 TKI 50.50 3.09 *46.34 64.91 TDCI 23.68 -4.06 -19.25 26.78 TEK 56.80 17.12 221.11 -86.02 TCDD 50.26 -8.67 142.67 -2.51 THY 53.79 19.47 84.50 7.82 PTT 173.09 35.57 305.63 -14.54 Source: Treasury and IBRO calculations. Note: 1/ TTK's personnel expenditure exceeds value added over the saaple period. Its weight is set at unity for TFP calculation. E. CQnCludina Remarks 60. SOEs in Turkey are still active in almost all sectors of the economy. Aside from the usual monopolies in the service sector, they dominate in basic metals and cnemicals as the result of the Government's import substitution policies before 1980. Had these companies been operating as efficiently as their private sector counterparts, much of Turkey's current macroeconomic problems (fiscal deficits and high inflation) could have been avoided. Their performance on all indicators is poor compared with the private sector's and, worse, their performance deteriorated so significantly in the last five years that it threatens macro stability. A similar problem was solved in the early 1980s by raising SOE prices and depressing real wages, but this solution is much less an available option today. Increasingly high inflation, trade liberalization, and increased competition from the private sector have eliminated this option for tradeable goods. Two other major lossmakers (electricity and railways) can only partially rely on price hikes: -Lo Companies with the largest stock of fixed assets in 1988 were selected. 1J1 Since capital stock data are based on real net investment, the following two elements might bias the TFP indicator downward: (a) underreporting of depreciation, and (b) gestation lags of investment.  -32 - ANNEX I electricity tariffs are relatively high already, and railways face stiff competition from road transportation. 61. The poor performance of SOEs can be summarized as follows: (a) The combined operating surplus (excluding TMO) declined from 3.6 percent of GDP in 1985 to a deficit of 0.6 percent in 1990 and a deficit of 5.2 percent in 1991. (b) After an initial increase to 5.2 percent of GNP in 1987, the borrowing requirement of the sector (excluding TMO) fell to 3.4 percent in 1989 due to a drastic decline in investment (48 percent over 1985-91); however, deteriorating operating performance and limits to the reduction of investment pushed the borrowing requirement of SOES to a peak of 7.4 percent in 1991. (c) Since 1987, it is no longer profitable to use the capital of the SOEs because the cost of financing is greater than the return on investment. (d) The sector is becoming an increasingly higher financing risk, and after the real wage increases of 1991, the sector is likely to be technically bankrupt because it will be unable to cover interest payments. (e) The sector's cash flow shortage (savings-investment on a cash basis) has reached a staggering TL11.6 trillion in 1990 (4 percent of GNP). (f) Under optimistic assumptions about future improvements in efficiency, a large part of the sector, representing 21 percent of total employment, will not become viable. (g) The marginal efficiency of capital in SOEs over the last five years has been only half the private sector's; had SOEs been as efficient as private sector firms, in recent years GNP could have been higher by 3 percent each year. (h) SOEs in manufacturing employ more labor and capital than comparable firms in the private sector per unit of value added produced. 62. At the individual level, the picture is, of course, more mixed. Particularly poor performers are the hard coal mine (TTK) and the railways (TCDD). But also the electricity company (TEK), the steel mill (TDCI), and a few smaller companies (EBK, CITOSAN, TZDK) are in dire shape. There are few good performers, although some have good potential to become competitive (THY, PETXIM, ORUS, PTT, TPAO). In a class by itself, THO's financing needs increased to P record 1.7 percent of GNP in 1990, falling to 0.8 percent in 1991.  - 33 _ 63. Although one can always point to immediate causes of the deterioration of SOB performance, the recent real exchange rate appreciation, lack of investment funds and working capital, and tripling of the wage bill are in fact caused by the same underlying problem: poor macroeconomic management and continuing political interference in SOE decision making. This fact has prevented the SOEB from adjusting to the trade liberalization. At the beginning of the 1980s the Government was well aware of the problems caused by the SOB sector, and it undertook some legal changes that would lower interference in SOE decisions and would prepare for the divestiture of a major part of the sector. Today it is clear that the process has failed and that the problem is rapidly growing worse control. 64. To break the vicious circle, the Government needs to deal with the SOB problem in a radical manner. A number of SOEs or parts thereof that are financially and economically inviable need to be liquidated. For many SOEs, there is no reason for the Government to continue operating the enterprises. The private sector in Turkey has proven to be the main engine of economic development over the last decade, and this role could be reinforced by transferring ownership of potentially viable SOEs into private hands. This strategy appears to be the only adequate solution to increase the efficiency of the sector and the economy and to prevent politicians from imposing unwarranted noncommercial objectives on SOs. A few of the largest SOEs are likely to remain in the Government hands. Among those, TEK and TCDD are problematic cases that need to be (further) restructured and partially divested.  - 34 - ANNX 2 TURKEY STATE-OWNED ENTERPRISE, SECTOR REVIEW ANNEX 2 Fiscal Performance, Budaetarv Impact, and Subsidization  -35- alilX a TURKEY ~TATE-OWNED ENTERPRISE SECTOR REVIEW FISCAL PEREORMANCE. BUDGETARY IMPACT. AND SUBSIDIZATION Table of Contents Paqe No. A. Introduction ...................o n- . .. . .. .............. 34 BO Fiscal Performae .................. . .. ........... ......... ... 34 Distribution of Deficit .. .. ........ 44 Four Typical Performances ................s...... . ....... 44 Financing of Deficits ... ..... ...... 47 C. Burden_of SOEs on the_Reet of th Public Secto r. 54 D. Subsidies: Who Benefits and Who Pays? . .................. 58 E. ncludino Remarkls ......... ...... .................. .. 60 List of Tables Table A2.1 Borrowing Requirements .............................. 38 Table A2.2 Concentration of Deficits, Investments, and Borrowing 45 Table A2.3 TER - Fiscal Information ........................... . 46 Table A2.4 Petkim, PTT - Fiscal Information . . .48 Table A2.5 TMO, TEXEL, SEKER - Fiscal Information.. 49 Table A2.6 TRK, TCDD, TDCI - Fiscal Information. 50 Table A2.7 Financing of the Deficf t . . 51 Table A2.8 Commercial Bank Credits and Foreign Debt. 52 Table A2.9 Financial Flows Between SOEs and the Rest of the Public Sector... .. ... .. .. 55 Table A2.10 Financial Burden on the Rest of the Public Sector 58 List of Figures Figure A2.1 Public Sector Borrowing Requiremet by SOE.......... 39 Figure A2.2 PSBR - Investment - Change in Sto ck. ... 40 Figure A2.3 Investments ..................................... . ... 41 Figure A2.4 Change in Stockst..... .. .... .. ......... 42  - 36- A X 2 TURKEY STATE-OWNED ENTERPRISE SECTOR REVIEW -FISCAL PERFORMANCE. BUDGETARY IMPACT, AND SUBSIDIZATION A. Introduction 1. Thio annex reviews the performance of SOEs from the fiscal perspective, using conventional fiscal indicators, such as borrowing requirement (PSBR), primary deficit, and operational deficit. The sources of the observed performance, as well as the main contributors to it, are also investigated. Reviewing the composition of deficit financing gives an idea of the contribution of SOEs to inflation (crowding out of the private sector from the domestic financial market) and to the international creditworthiness of the country. 2. There is a very complicated network of financial relations between SOEs and the rest of the public sector. These relations are further obscured by differences in accounting procedures among SOEs and by the elapse of time. An attempt is made to disentangle these complex relations in order to identify the actual financial impact of SOEs on the rest of the public sector, in particular, the central government budget and extra-budgetary funds (EBFs). Finally, the subsidies provided to (and/or through) SOEs and their ultimate beneficiaries are discussed. B. liscal Performance 3. The borrowing requirement (after transfers) of the LOB sector has varied between 3.0 and 5.5 percent of GNP in the 1985-90 period, accounting for 38 to 72 percent of the entire public sector deficit (see Table A2.1). Graphs A2.1 through A2.4 show main aggregates for the sector, as well as individual SOEs ae averages for the 1985-90 period, and for 19901'. The fiscal performance of SOEs and the sources of SOE deficits have shown the following three distinct patterns during 1985-90: (a) Large and rising deficite (1985-87k: SOE deficits rose from 3 percent of GNP in 1985 to 4.4 percent in 1987. This period is characterized by large investment e:Apenditureu, especially in energy, telecommunication, and petrochemicals. Although investments by manufacturing SOBs had started to decline, total investment of the sector stayed around 6 percent of GNP. Stock- building added another 2 percent of GNP to SOE financing needs. The SOEs could, however, generate internal funds of only about 3.4 1 PETKIM and Sumerbank are not included in annual data for 1988-90. IHowever, they are included in the averages for the period 1985-90.  -3?- ANEX 2 percent of GNP/. Despite the lack of internally generated funds, the implementation of large investment and stock programs (generally imposed by the Government, as in the case of TEK, PTT, Botas, TMO, and TEKEL), was the main cause behind the large borrowing requirements during this period. (b) Declininc deficits i1988-89): SOE deficits declined to 2.7 percent of GNP in 1988 and 2.6 percent in 1989. They accounted for 44 percent of the total public deficit in 1988 and 37 percent in 1989 (lowest in the 1985-90 period). As part of the temporary fiscal adjustment program of the government in 1988, SOE investments were cut and SOE price adjustments were kept in line with inflation (even ahead of inflation). In 1988, investment expenditures declined to 5 percent of GNP, while internally generated funds rose to 4 percent of GNP, leading to a decline in the deficit from 4.4 percent in 1987 to 2.7 percent. Despite a further cut in investments expenditures, equivalent to 1 percent of GNP, the deficit declined only marginally to 2.6 percent in 1989 due to an erosion in internally generated funds. (c) Drastic deterioration (1990): The SOE deficit exploded in 1990, reaching 5.5 percent of GNP and accounting for 52 percent of the total public sector deficit. The factors leading to this drastic deterioration were quite different. First, a generous agricultural support policy led to a record-high increase in stocks; equivalent of 4.6 percent of GNP. Second, internally generated funds dropped to 1.8 percent. This decline was due to a large, and abrupt, increase in real wages. There was also another cause for the decline: most SOEs were unable to adjust to higher real cost of labor and increased private and foreign competition following the trade-liberalization in 1989 and the continuing appreciation of the real exchange rate. I Internally generated fund - retained earnings + depreciation + provisions + proviaions for foreign exchange losses + unpaid dividends to shareholder othsr than Treasury, where retainedl earnings - prnfit/loss - duty looses (claimed) - corporate tax - dividenids (paid) to Treasury.  -38 -NEX Table A2.1: Borrowing Requirements tX of GNP) 1985 1986 1987 1988 1989 1990 A. Public Sector PSBR 4.6 4.7 7.8 6.2 7.1 11.2 Primary Deficit 1.1 -0.1 1.9 -0.7 1.0 6.0 Operational Deficit .. 4.1 5.6 3.7 4.3 7.1 S. SOEs PSBR (After Transfers) 3.0 3.4 4.4 2.7 2.6 5.5 Primary Deficit 2.0 2.1 2.5 1.1 1.4 5.2 Operational Deficit .. 3.2 3.8 2.2 2.2 5.8 C. Share of SOEs in total tX) PSBR 66.6 72.1 56.6 43.6 37.0 52.5 Operational deficit .. 76.6 67.4 59.3 51.5 81.1 Memo Items Investm6nts+Stock Bultd-up 8.1 7.6 8.0 7.2 6.3 7.9 Investments 6.2 6.1 5.7 5.1 4.1 3.4 Stock Build-up 1.9 1.5 2.3 2.1 2.2 4.6 Intere3t Payments 1.0 1.3 1.9 1.6 1.2 1.3 Internally Generated Funds 3.2 3.6 3.4 4.0 3.0 1.8 Source: Treasury.  _ ......................O- D>u - ot-u07e377< - -3zq-tD--o -4 0 - o C- ' _ .. , -.-----------.................... d o 0 a fotd o _ 0 D) 0 C} a> . .... ,, . .............................. o . .................................... GI < c} 1I -o (D . .............................. 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