Turkey - Agricultural Reform Implementation Project

Document of The World Bank ReportNo: 21177-TU PROJECT APPRAISAL DOCUMENT ONA PROPOSED LOAN IN THE AMOUNT OF US$600 MILLION TO THE REPUBLIC OF TURKEY FOR AN AGRICULTURAL REFORM IMPLEMENTATION PROJECT/LOAN June 6, 2001 Environmentally and Socially Sustainable Development Turkey Country Unit Europe and Central Asia Region  CURRENCY EQUIVALENTS (Exchange Rate Effective June I, 2001) Currency Unit = Turkish Lira TL I = US$.0000088 US$I = TL 1,144,768 FISCAL YEAR January I to December 31 ABBREVIATIONS AND ACRONYMS ARIP - Agricultural Reform Implementation Project ASC - Agricultural Sales Cooperative ASCU - Agricultural Sales Cooperative Union CAS - Country Assistance Strategy CBT - Central Bank of Turkey CDSC - Cooperative Development Sub-Component (of the ASCU Restructuring Component) CSU - Cooperative Service Unit CIU - Component Implementation Unit DIS - Direct Income Support DFIF - Price Stabilization and Support Fund DSI - Devlet Su Isleri (Water Resources Agency in the Ministry of Energy) ERL - Economic Reform Loan EU - European Union EX - Executive Unit (ASCU CIU) FAO - Food and Agriculture Organization of the United Nations Fl - Financial Intermediary FISKOBIRLIK Hazelnut ASCU FrP - Farmer Transition Program GDOF - General Directorate of Forestry (of the Ministry of Forestry) GDRS - General Directorate of Rural Services IMF - Intemational Monetary Fund IRR - Intemal Rate of Return LDP - Letter of Development Policy LSS - Letter of Sectoral Strategy MARA - Ministry of Agriculture and Rural Affairs MIT - Ministry of Industry and Trade MOE - Ministry of Environment NGO - Non-Govemmental Organization NPV - Net Present Value PCU - Project Coordination Unit at Treasury PDA - Provincial Directorate of Agriculture RB - ASCU Restructuring Board SEE - State Economic Enterprise SL - Specific Investment Loan SIS - State Institute of Statistics SOE - Statement of Expenditures SPO - State Planning Organization TA - Technical Assistance TARP - Turkey Agricultural Research Project TARIS - Cotton, Figs, Raisins and Olives ASCU TCP - Technical Cooperation Project/FAO Tekel - State Monopoly for Tobacco, Alcohol, and Salt TMO - Turkish Grain Board TSFAS - Turkish Sugar Company TZDK - Turkish Agricultural Inputs Company TZOB - Union of Agricultural Chambers of Turkey UT - Undersecretariat of Treasury WUO - Water User Organization Vice President: Johannes Linn Country Director: Ajay Chhibber Sector Manager: Joseph R. Goldberg Task Team Leader: John Nash  CONTENTS A. Development Objective ..........................................................3 1. Project development objective .........................................................3 2. Summary project description ..........................................................4 3. Key performance indicators ..........................................................4 B. Strategic Context ..........................................................5 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project .............................5 2. Main sector issues and Government strategy ..........................................................6 3. Sector issues to be addressed by the project and strategic choices ................................................... 10 C. Project Description Summary ......................................................... 13 1. Project components ......................................................... 13 2. Key policy and institutional reforms supported by the project ......................................................... 17 3. Benefits and target population ......................................................... 17 4. Institutional and implementation arrangements ................... ...................................... 19 D. Project Rationale ......................................................... 20 1. Project alternatives considered and reasons for rejection ......................................................... 20 2. Major related projects financed by the Bank and other development agencies ............... ................. 21 3. Lessons learned and reflected in proposed project design ......................................................... 21 4. Indications of borrower commitment and ownership ......................................................... 24 5. Value added of Bank support in this project ......................................................... 24 E. Summary Project Analysis ......................................................... 24 1. Economic ......................................................... 24 2. Financial ......................................................... 27 3. Technical ......................................................... 28 4. Institutional ......................................................... 28 5. Environmental ......................................................... 30 6. Social ......................................................... 32 7. Safeguard Policies ......................................................... 36 F. Sustainability and Risks ......................................................... 36 1. Sustainability ......................................................... 36 2. Critical risks ......................................................... 37 3. Possible controversial aspects ......................................................... 38 G. Main Conditions ......................................................... 40 1. Effectiveness Condition ......................................................... 40 2. Other ......................................................... 40 H. Readiness for Implementation ......................................................... 41  I. Compliance with Bank Policies .......................................... 41 Annexes Annex 1: Project Design Summary .42 Annex 2: Detailed Project Description .46 Annex 3: Estimated Project Costs .63 Annex 4: Cost Benefit/Cost-Effectiveness Analysis Summary .64 Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary .74 Annex 6: Procurement and Disbursement Arrangements .75 Annex 7: Project Processing Schedule .87 Annex 8: Documents in the Project File .88 Annex 9: Statement of Loans and Credits .89 Annex 10: Country at a Glance .90 Annex 11: Letter of Sectoral Strategy .93 Annex 12: Social Assessment Report .100 Annex 13: DIS Pilot Report .104 Annex 14: Environmental Data Sheet .108 MAP: IBRD No. 24110  REPUBLIC OF TURKEY Agricultural Reform Implementation Project (ARIP) Project Appraisal Document Europe and Central Asia Region ECSSD Date: June 6,2001 Team Leader: John D. Nash Country Director: Ajay Chhibber Sector Manager/Director: Joseph R. Goldberg Project ID: P070286 Sector: AG - Agency Reforn Lending Instrument: Investment/Adjustment Theme(s): Rural Development Poverty Targeted Intervention: N Lending Instrument: Hybrid Investment/Adjustment Theme(s): Rural Development Loan Poverty Targeted Intervention: N Program Financing Data Estimated Type Indicative Financing Plan Implementation Borrower ._______ Period Bank FY) IBRD Others Total Commitment Closing US$ m % US$ m USS m Date Date Investm. 400.00 61.96 461.96 07/01/200 12/31/2005 Loan 1 Adjustm. 200.00 200.00 07/01/200 12/31/2005 Loan I__________ ______ Total 600.00 61.96 661.96 Project Financing Data Loan For Loans/CreditslOthers: Amount (US$m): $600.00 Proposed Terms: Grace period (years): 5 Years to maturity: 17 Commitment fee: 3/4 of 1 %  Financing Plan: Source Local Foreign Total GOVERNMENT 61.95 0.01 61.96 IBRD - Investment Loan 363.52 36.48 400.00 IBRD - Adjustment Loan 200.00 0.00 200.00 Total: 625.47 36.49 661.96 Borrower: REPUBLIC OF TURKEY Responsible agency: TREASURY DEPARTMENT Estimated disbursements Bank FY/US$M): FY 2002 2003 2004 2005 Annual 314.14 200.86 70.43 14.57 Cumulative 314.14 515.00 585.43 600.00 Project implementation period: FYOI-05 Expected effectiveness date: 07/01/2001 Expected closing date: 12/31/2005 Notes: 1. The front-end fee (FEF at 1% of the loan) has been included in the loan amount. 2. The loan is programmed for four years and closely overlaps four Bank Fiscal Years. 2  A. Development Objective 1. Project development objective: (see Annex 1) Background. The Government of Turkey has embarked on a structural adjustment and stabilization program of historic dimensions. The conceptual foundations of this were laid by the policy dialogue with the Bank over the last several years, which has included extensive analysis of the current system of agricultural supports, and recommendations on how to reform it. These recommendations have been adopted almost en toto in the Government's Letter of Development Policy (LDP) and agricultural strategy document, which together form the basis for the agricultural component of the Economic Reform Loan approved by the Bank's Board and made effective in May 2000. Once completed, these reforms will make Turkey a model for other countries' agricultural support policies. Development Obiective. The primary development objective of the Agricultural Reform Implementation Project (ARIP) is to help implement the Government's agricultural reform program, which is aimed at dramatically reducing artificial incentives and government subsidies, and substituting a support system that will give agricultural producers and agro-industry incentives to increase productivity in response to real comparative advantage. At the same time, the project is designed to mitigate potential short-term adverse impacts of subsidy removal, and facilitate the transition to efficient production patterns. Aside from promoting allocative efficiency, the reforms to be implemented are necessary for fiscal stabilization. The Government's agriculture policy reform program is described in the March 2000 "Strategyfor Reform of Agricultural Support Policies." The agricultural policy reforms are supported in part financially by the Bank under the Economic Reform Loan (ERL). The Government's strategic objectives to be supported by this project can be summarized in several elements. First, the Government intends to phase out the unsustainable and distortionary system of subsidies for fertilizer, credit and price supports--which disproportionately benefit large farmers, regressively tax consumers, and together cost over US$6billion a year--and to link prices to world market prices. The ARIP will assist the Govemment to introduce a unified national program of direct income support (DIS) for all farmers which will be simple, transparent, and will not distort the incentive structure as does the current system. The intention is not to fully compensate every farmer for income lost by removal of the old subsidy system, but rather to cushion the short-term losses and continue to provide adequate support to the agricultural sector, but in an incentive-neutral way. Within the existing legal framework, the DIS payments should be useable as collateral, thereby giving farmers enhanced access to credit. Payments under the DIS system will be recurrent, but these will eventually become more explicitly targeted (and harmonized with the EU system under the Common Agricultural Policy as it exists at the time of accession), or merged with the general social safety net system. The second initiative under the program will encourage farmers to quit producing crops which are currently heavily over- produced by offering one-time payments to cover their cost of switching to alternative activities. The third element of the program focuses on turning the quasi-govemmental sales cooperative unions previously used to administer support prices into organizations dedicated to serving their farmer members through a process of restructuring and privatization. This will reduce government involvement in the marketing and processing of agricultural products. Finally, the project will help the govemment maintain support for the program by clearly explaining it to the public. A key objective of the adjustment portion of the loan is to enable the Govemment to make up some of the anticipated shortfall in funds needed for the critical first round of DIS payments, expected in late 2001 and early 2002. The triggers for the quick-disbursing budgetary support element of ARIP would be the satisfactory introduction of the first DIS payments to the farmers, and satisfactory performance in the macroeconomic and sectoral reform programs, the latter as described in the Letter of Sectoral Strategy. Disbursements under the first and second adjustment tranches also depend on the adoption of a revised 2001 budget that does not introduce new or increase existing direct or indirect agricultural subsidies and 3  submission to Parliament of a 2002 budget that does not include credit or fertilizer subsidies and does not increase existing direct or indirect agricultural subsidies, respectively. Completing the agriculture reform program is a medium-term objective. The reforms will assist the Government in its aspirations for accession to the EU by increasing the efficiency of the sector and the economy at large, thereby helping it meet one of the most basic pre-conditions set down by the EU: that the applicant states have economies that are efficient enough to be competitive in the unified market. The challenges in carrying out these changes will be huge, and the Government has asked for the Bank's continued technical assistance in program design and implementation, as well as financial support for certain elements of the program. The financial support is crucial, given the tight budget constraints imposed by the macroeconomic stabilization package agreed with the IMF. 2. Summary Project Description (see Annex 2 for detailed Project Description). For the investment portion of the loan: Component A ($47.80 million): Design and Implementation of the Direct Income Support System (DIS) Component B ($180.58 million): Farmer Transition Program. Component C ($152.68 million): Agriculture Sales Cooperatives, and Cooperative Unions (ASCs/ASCUs) Restructuring. Component D ($12.95 Million): Project Support Services. For the adjustment portion of the loan: ($200 million) budgetary support 3. Key performance indicators: (see Annex 1) Key indicators include reduction of costs and lessening of the distortionary impact of agricultural subsidies; and delivery of financial and technical assistance to farmers, agricultural cooperatives and enterprises affected by the policy reforms. Quantifiable key output/impact performance indicators are described in more detail in Annex 1, but can be summarized as follows: Component A: Direct Income Support (DIS) - functioning DIS system covering 25% of eligible farmers is in place by the end of the first project year; 75% of farmers registered and receiving payments by 2002 and 95% of farmers registered and receiving payments by the end of the project; farmers exercise choice regarding crop selection and input use in response to market conditions. Component B: Farmer Transition - grants paid to about 25% of eligible farmers for conversion to alternative agricultural production in the 12 months following project effectiveness, and to the remaining 75% in the second project year; development of agricultural producers' organizations. Component C: Agriculture Sales Cooperatives and Cooperative Unions (ASCs/ASCUs) Restructurin - by 2004, all sustainable ASCUs are restructured to function as effective cooperatives owned by and operating for ASCs, and the ASCs are fully owned by and operating for farmer members; by 2005, poorly performing ASCUs have ceased operations. Component D: Project Support Services - effective and timely public information program in place during the first year of the project to explain reforms and ways to access assistance programs; training 4  for MARA extension staff in public relations completed during the first year of the project; timely and well targeted advisory services provided; effective social and financial monitoring and evaluation established; PCU and CIlUs established and functional. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Click here to get to the CAS Document Document number: R2000-218[IFC/R2000-221] Date of latest CAS discussion: 12/21/00 The ARIP is included in the CAS discussed in December 2000 and in the CAS update of June 2001. ARIP's role in the CAS The CAS presented to the Board in December 2000 was designed to help Turkey to lay the basis for sustained long-term growth and reducing economic vulnerability. This remains the core objective of the Bank Group strategy. Poverty and economic vulnerability, and widening disparities, have been worsened in Turkey by erratic growth and inflation: periods of rising inflation and slowing growth have especially hurt those at the lower end of the income distribution. Restoring stable and higher growth, creating employment, reducing inflation, and improving the management of the financial and public sectors, have again been shown to be the goals upon which Turkey must focus. In light of the economic crisis that began in February 2001, reaching the objective of sustained growth and reduced economic vulnerability requires Turkey to undertake accelerated structural reform, while working quickly to recover from the crisis and mitigate its worst effects. Thus, the Bank Group's strategy now is to focus on helping Turkey recover from the crisis while dealing with the deeper causes of the crisis - especially its large and inefficient public sector and fragile banking system - and address increasing social hardships. The Turkish Government requests intensive financial and technical help from the Bank Group and an acceleration of IBRD's assistance focussed on the structural and social issues.. Most relevant for the ARIP, accelerating the structural reform program to achieve growth is more urgent than before. Finishing the half completed agricultural reform is vital not only to attain promised productivity improvements but also to aid farmers who may be negatively affected in the short run by the reforms: the old distortions and subsidies have been tackled and are being phased out, but the direct income supports, help for farmers to change to more profitable crops, and assistance for transforming the cooperatives into viable and effective units have barely begun. Failure to make rapid progress on this front will greatly increase the pressure to re-introduce the old-style subsidies and interventions. ARIP also plays an important role in the Bank's support for stronger social policies through financing for severance payments for eligible redundant employees of ASCUs and ASCs, through funding for establishment of the national DIS system, and through budget support which the government may use to finance part of the initial DIS payments. This latter support is an important element in cushioning potential adverse impacts of the reform in that provides support to farmers who will no longer receive price supports and other distortionary subsidies. The DIS is designed to give proportionately more cash to farmers with smaller land holdings, thus improving the targeting of assistance in the sector. The ARIP would also help with the cost to farmers of shifting from uneconomic to more competitive crops in the newly market- oriented environment. ARIP also provides a key element for monitoring the social impact of the crisis and the overall reform program, through the agricultural household survey planned as part of the social monitoring and evaluation. This survey, which includes selected qualitative follow-up, will follow a panel of 5,000 rural and 500 urban households for a four-year period starting in the summer of 2001. It will be used to provide ongoing monitoring and evaluation of the impact of the crisis and the government's response in the agricultural sector. 5  Given the positive features of Turkey's new strategy and economic framework, but mindful of the risks it entails, IBRD has reformulated its planned support to Turkey. The financing plan required for the Government's new economic program entails an incremental US$2 billion of disbursements from IBRD over the original CAS disbursement profile for calendar year 2001. One element of this new strategy would be to increase the proposed size of the Agricultural Reform Implementation Loan (ARIP) from US$400 million to US$600 million by adding to it an adjustment component of US$200 million, disbursement of which would be based on progress in introducing the direct income support (DIS) payment system. with appropriate triggers to ensure that the reform program is on track. The estimated cumulative disbursements from the ARIP would be $126.32 million through CY 2001, $496.15 million through CY 2002, $574.23 million through CY 2003, $592.69 million through CY 2004, with full disbursement in CY 2005. 2. Main sector issues and Government strategy: Background. Most observers agree that Turkey has tremendous potential for rural growth, but this has gone largely unrealized. In the most recent 20-year period, while overall GNP was growing at around 5 percent per year, agriculture grew at a rate of about a third that figure. As a result, the sector shrank as a share of the whole economy from 36 percent to 15 percent over this period. Agriculture's share of exports has fallen from around 60 percent to about 10 percent. The growth rate has been trending downward for at least the last decade (see Figure 1). The sector still accounts for a very large share of employment, though this also has fallen considerably, from around 65 percent to about 45 percent. Unlike in many other countries, the proportion of the rural population that is properly classified as poor is about the same as this proportion in urban areas. Nonetheless, the fact that so much of the total population is agricultural means that quite a large fraction (about 42 percent) of the poor population in Turkey is employed in agriculture, with 11 percent of agricultural workers classified as poor, a higher percentage than any other employment category, except construction. The importance of rural development is amplified by the fact that rural areas show lower levels of human development as measured by an index of education, literacy, and income.' Development of rural areas and agriculture in particular has been impeded by heavy government intervention in the sector. While not all Fi 1: AiriciiltnraI Growth and govemment initiatives have been counterproductive, many have. Trade controls, 1 0 = 186 govemment procurement, heavy government 6 \ _ involvement in marketing, input subsidies Z 2 _ 1 (especially credit and fertilizer), and heavy -2 - investment in irrigation infrastructure on a -4 I 6 fully subsidized basis have created a net inflow -e 4 1 . -10 ~~~~~~~~2 of resources from the government to ie 1988 1992 1994 1898 1998 agriculture, but have had many negative effects z=3 A Suppon --- Gmowth ate - Tend (Goewth) on the sector and the economy at large. They Source: SIS. ITT and WR have discouraged production of products in which Turkey has a comparative advantage, squeezed out private sector marketers, and subsidized inefficient production technologies. The benefits of the subsidies have gone mainly to larger, wealthier farmers. In addition, some of the subsidies have been so large as to have serious macroeconomic effects. These policies also create barriers to Turkey's closer integration with the EU. While previous governments and the Bank have long recognized some of the problems created by these policies, reform has proven difficult in the face of political opposition. ' See "Turkey: Economic Reforms, Living Standards, and Social Welfare Study", grey cover report of World Bank, January 2000. 6  There is some evidence that the falling agricultural growth is due to stagnant or even declining technical efficiency in Turkish agriculture as measured by total factor productivity from 1990 to 1996. This is a startling conclusion, considering the enormous advances in agricultural technical efficiency in the world at large 2 The single most critical issue in the agricultural sector, as identified in previous Bank sector work, is the inefficient and costly system of agricultural support policies. These have not only manifestly failed to enhance productivity growth, but have been a heavy burden on consumers and taxpayers and a source of Turkey's macroeconomic problems. For this reason, reforming this system is a primary goal of both the ERL and the IMF's program. Through a dialogue initiated with Bank policy notes, the Government has developed a strategy to phase out the current mechanisms of support, and put in their place "decoupled" direct income payments, which would not be contingent on input use or output production decisions of the farmer. Thus, farmers would not suffer a precipitous reduction in income, but would be free to make efficient production decisions based on true economic values of inputs and outputs. The payments would be only moderately targeted at first. But over time, these payments will be more targeted toward the poor and integrated into the overall social safety net. The strategy, as elaborated in the government's Letter of Sectoral Strategy, is summarized below. The government is beginning the support policy rationalization with agricultural inputs and credit. The fertilizer subsidy has been held constant in nominal terms since 1997, resulting in a reduction of the unit subsidy from approximately 45 percent of the total price at the end of 1997 to approximately 31 percent by August 1999. The fertilizer subsidy will remain constant in nominal terms in 2000-01 to further lower the unit subsidy. As of early 2001, the subsidy is 17% of the unit price. The subsidy will be abolished in 2002. With regard to credit subsidies channeled through Ziraat Bank, in December 1999, the Government introduced a program for phasing out agriculture credit subsidies over the course of 2000. The program involved: (i) holding the nominal interest rate on agricultural credits constant until it is equal to 5 percent above the 3 month rolling average of the 12 month T-bill rate and thereafter allowing Ziraat Bank to freely adjust its rates as long as they are no lower than the reference rate; (ii) introducing a variable rate loan option for farmers; and (iii) providing cash compensation from the budget to Ziraat bank for any subsidy accrued in 2000. As T-bill rates fell dramatically in early 2000, the subsidy element was by March 2000 virtually eliminated. As interest rates have risen to extraordinarily high levels in the aftermath of the recent economic crisis, the government finds it necessary to re-introduce a subsidy element in Ziraat Bank lending rates on a temporary basis. The plan is to hold lending rates at 55 percent and make a budgetary allocation to Ziraat Bank to compensate for the difference between 55 percent and its opportunity cost of funds. This will be explicitly included in the amended 2001 budget at a level of 0.2 percent of GDP. The subsidy will be eliminated in 2002. These commitments are contained in the new Letter of Intent under the IMF program. With regard to agriculture support prices, the Government has begun a set of policy changes which introduce a link between support prices and relevant world market prices and initiate a phase-out of government subsidies via support prices by 2002. The support price for wheat in 2000 was linked to an appropriate world reference and set at a level which reduced the premium over the world price to approximately 35 percent. Import tariffs on grains were also reduced. The government also has now made a further reduction in the premium over world wheat prices to 20 percent and in the tariff on grain imports to 45% . In 2002, the support price mechanism based on interventions by the the state grain purchasing company (TMO) will be eliminated as the direct income support system is implemented in the entire country. Tariffs on grain imports will be reviewed each year and further reduced as necessary 2 See H.Akder, H. Kasnakoglu and E. Cakmak Turkey: Sources of Growth in Turkish Agriculture", April 2000. 7  to a level consistent with an overall low and uniform protection rate. The sales price for grain of TMO will be no less than the lower of: (a) the purchase price of TMO plus storage costs incurred up to the date of sale including imputed interest charges on stocks, or (b) the tariff-inclusive import parity price for grain of equivalent quality. This sales pricing policy is intended to reverse the past incentives of traders and millers to refrain from buying grain during the harvest season and storing it, leaving all storage costs to be absorbed by TMO. Starting in the 2002/2003 crop year, the government will no longer make support purchases of tobacco. Instead, all tobacco will be traded through contractual production or an auction. The premium on oilseeds and cotton has been reduced by one quarter in the 2001 budget and will be considered to be eliminated in 2002 as the direct income support system becomes operational nationwide. Payments under the tea pruning program are being reduced each year, (since they are linked by a formula to tea prices, which are being reduced in real terms) and will end after 2003. In the sugar market, the Government's program calls for reforms to reduce fiscal costs and make sugar beet prices more market determined. During a transition period while the mills are being privatized, TSFAS will allow each mill to negotiate price and quantity with the growers, without interference after the 2002/2003 crop year. The agriculture reform program encompasses commercialization and privatization of state assets in the sector with the medium-term objective of withdrawing the state from a direct role in agricultural and agroindustrial production. In the first phase in 2000, the Government has imposed a hard budget constraint on agricultural state economic enterprises (SEEs), including specific enterprise-by-enterprise limits on Treasury loan guarantees, equity injections and budgetary transfers. In parallel, privatization proceedings will be initiated for agricultural SEEs. In 2000, Privatization High Council decided that the sugar company (TSFAS) is under the scope of privatization. The sugar mills are expected to be privatized after a preparation period of 6 months. Some factories of the tea company (Caykur) are expected to be transferred to the Privatization Agency (PA) portfolio in 2001. The sale of Tekel's assets will also start in 2001. The agricultural input supply state economic enterprise (TZDAS), has been transferred to the PA, and its staff reduced from 3,300 to 1,144. The privatization of its remaining assets (primarily a tractor factory) will be finished in 2001, with all of its assets sold or liquidated, and all employees terminated or re-assigned. The law regarding the demonopolisation of the production of alcoholic spirits (one of Tekel's monopoly divisions), thereby allowing private entry into the industry, was enacted in January 2001. The new legislation which will be enacted by end-June 2001 will introduce auctions to replace the current system of support prices which Tekel must purchase tobacco. It will also enable the privatization of Tekel's production facilities for spirits and tobacco products. All of Tekel's assets have been transferred to the Privatization Agency with the target of completing asset privatization in 2002.Significant reforms are also being made in the sugar sub-sector, though some aspects will remain under the government's regulatory control for the next several years. The Sugar Law that was passed by Parliament in April 2001 is an improvement over the current regime, in that it will enable the privatization of the assets of TSFAS, eliminate the support pricing system, allow direct negotiation of prices between factories and growers, and thereby reduce the fiscal costs of the system. (The aspects of the Law dealing with support pricing will be applicable starting in the 2002-2003 crop year.) However, as it was the outcome of a political battle in Parliament, it is far from perfect. It retains a strong role for the state by setting up a the licensing and factory-by-factory quota system very similar to the EU's, though it does not make provision for export subsidies, as does the EU's regime. In the view of Bank staff, such a system is inappropriate for Turkey at this time. The Law does, however, allow for a reconsideration of the system in 2004, and Government has already indicated that it intends to carry out a more fundamental reform at that time by eliminating the Sugar Board and licensing system. While this will require a longer period for reform of the sugar sub-sector than for other sub-sectors, and means more uncertainty, Bank staff will stay engaged in the discussion of the long-term strategy. 8  During this transition period, the government has indicated its commitment to run the system in such a way as to minimize fiscal costs and move forward with privatization. In November 2000, the support price for the growing season 2000 was increased in nominal terms by 25 percent, in line with the target inflation rate. In 2001, for the transition season of 2001/2002, a price adjustment of no more than the target inflation rate will again be made. From 2002 TSFAS will operate on a commercial basis and negotiate prices with beet farmers consistent with elimination of its losses. An inventory and evaluation of the sugar plants of TSFAS was begun in 2000, with the objective of preparing their privatization. The privatization process is expected to start in 2001 and be completed by 2002. The goal is to privatize all viable factories. The non-viable factories will be liquidated following successful implementation of the direct income support system or the establishment of appropriate social safety net provisions. The current sugar tariff of 139,5% is being reduced by 1.5 percentage points per year through 2004 in accordance with Turkey's WTO commitments. At the end of that period, the Government will carry out an analysis of the impact of this policy on consumers and producers, with the objective of considering further tariff reductions. Caykur has announced its new policy of buying only high-quality tea, and only tea from pruned areas. Caykur's purchases were limited to 600,000 tons in 2000 in line with the Government's fiscal program, and Caykur increased nominal prices about 25 percent (a reduction in real terms) to encourage growers to sell to the private sector factories. As these linkages are developed, Caykur plans to further decrease its purchases in 2001, while the production of altemative crops such as kiwi increases. Profitable factories of Caykur will be privatized and non-viable factories will be liquidated by the end of 2002. In the grain market, the state economic enterprise TMO will be restructured and down-sized in 2001 to preserve only its assets needed to carry out its minimal level of purchases and storage. In 2002, a significant part of its assets will be sold, as TMO will be intervening in markets only to purchase an appropriate quantity for strategic reserves and to regulate the market during a transitional period while commodity markets mature. It will make purchases from the commodity exchange and trade markets, except in areas where such markets are not operating, at prices prevailing in the market, with the intention of further reductions in TMO purchases each year. For the agricultural sales cooperative sector, the main issue is the role of government in cooperative management and development, especially its involvement in the financing and in the business operations of the cooperatives. Until the enactment of the new Agricultural Sales Cooperative and Agricultural Sales Cooperative Union (ASC/ASCU) Law in June 2000, cooperatives were mainly channels for implementation of government programs rather than member-owned cooperatives. Funded by government, the cooperatives were put under the supervision and direct control of the Ministry of Industry and Trade (MIT). This control was exercised by MIT at the ASCU level through appointment of management staff and through operational directives issued by the Ministry to the unions. The ASCUs controlled the primary societies (ASCs) which operated as de facto branches of the union rather than independent cooperatives responsible for their own finances, management and operations. The dominant role played by government proved to be detrimental to the development of the cooperatives and their capability to provide efficient services to their members. Being controlled from the top and being financed by funds flowing from the government, the cooperatives had no incentive to develop their operations, nor were they given the opportunity to do so. Having to work as agencies for price subsidies to farmers, the cooperatives could not become profitable. Their losses were aggravated by the fact that they were compelled to employ staff in excess of their requirements, at wages far above comparable private sector levels. Another critical consequence of the intervention by government in the operations of the cooperatives was that members developed no real feeling of ownership of their cooperatives. This is illustrated by a very low rate of participation in general assembly meetings in practically all societies. There is a widespread 9  perception among cooperative members that they are owners of their societies in name only and that, in reality, the cooperatives are government entities. This has important implications on member participation, member share capital contributions and member loyalty. Furthermore, with access to government funds and being managed through directives from above, the cooperatives at the grassroots level did not develop sufficient financial and business management skills. Therefore, they are now ill- equipped to assume responsibility for their own operations which they will have to carry out in competition with other private agro-business enterprises. Through the reform program for ASCUs, combined with the ASC capacity-building under the project, the government intends to change the current top-down orientation of the sector into the bottom-up structure that it must have to effectively support farmers. This overall program of agricultural policy reforms will assist the Government in its aspirations for accession to the EU by increasing the efficiency of the sector and the economy at large, thereby helping it meet one of the most basic pre-conditions set down by the EU: that the applicant states have economies that are efficient enough to be competitive in the unified market. The process of forward planning for EU accession within the context of agricultural policy reform is only just beginning in Turkey. In this context, the current reforms do not aim to harmonize policy with the Common Agricultural Policy as it exists now, since this is a moving target which may differ considerably from its current form by the time Turkey finishes its accession process. But the reforms and this project would help Turkey meet the more fundamental criterion of competitiveness in the unified market, and would set the stage for eventual harmonization. Other implications of this project for the Government's accession strategy include the necessity of linking the eventual phase-out of the DIS payments to EU accession timing. 3. Sector issues to be addressed by the project and strategic choices: In discussions of the ERL, the Government indicated that it would be able to move ahead with the agreed ambitious policy agenda only if the Bank supported the implementation of the program with the kind of investments and TA envisioned in the ARIP. The ARIP takes as given the broad strategic framework outlined above, and will address a number of choices that will need to be made in the course of implementing this strategy. An important strategic choice affecting the overall project design was to make the project a hybrid. The Government expressed great concern that the amount that can be allocated to the DIS payments in the 2001 and 2002 budgets is insufficient compensation to farmers for subsidies that have already been removed or will be removed in 2001. If it is perceived that farmers are bearing more than their share of economic hardship because the DIS program is underfunded, there would be a serious danger of a backlash that could endanger the reforms. To address this concern, the Bank and Government have made the strategic choice to design ARIP as a hybrid investment/adjustment operation, to provide financing for a $200 million quick-disbursing component against the Bank's standard negative list and a $400 million investment component. Conditions for release of the first tranche Of $100 million would be i) satisfactory performance in the macroeconomic program; ii) satisfactory performance in implementing the general sectoral reform program (as described in the Letter of Sectoral Policy); iii) adoption of a 2001 revised budget that: (a) does not provide for any new direct or indirect agricultural subsidies; and (b) does not increase existing direct or indirect agricultural subsidies, in real terms, as compared to subsidies in effect on January 1, 2001; and iv) initiation of DIS payments, defined as "25% of farmers registered and of these, 50% paid". These conditions could be met and first tranche released as early as late 2001. Conditions for release of the second tranche would be i) satisfactory performance in the macroeconomic program; ii) submission to Parliament of a draft 2002 budget which : (a) does not provide for credit or fertilizer subsidies; and (b) does not increase other existing direct or indirect agricultural subsidies, in real terms, as compared to subsidies in effect on January 1, 2001; iii) satisfactory performance in implementing the general sectoral reform program (as described in the Letter 10  of Sectoral Policy); iv) further progress in the initiation of DIS payments, defined as "50% of farmers registered and of these, 50% paid"; and (v) by November 1, 2002, or when the other conditions are met, whichever comes first, reduction in TMO wheat purchases to a level satisfactory to the Bank.. Thus, the government would have available an extra $200 million to supplement the DIS budget. It is anticipated that the conditions for for the second tranche in mid to late 2002. Components A (DIS) and B (Farmer Transition). Several choices have been made, including whether to make the payments to the user (farmer) or landowner. This choice was finalized on the basis of the experience of the pilot program, in which both were tested, and it was demonstrated that either option generally seems feasible, though paying owners would be faster and simpler. Economically it makes no difference who is the immediate recipient, since in the end, the payment will be captured by the owner of the inelastic factor of production-land-in the form of higher rent, just as are the current subsidies. However, in the Government's view, it would be politically unsustainable to make payments to landowners. We have therefore agreed to design the system to pay users, rather than owners of land, though the area eligible for payments will be based on the agricultural land area shown in cadastral records. The system design takes into account the lessons from other such DIS systems. One such lesson is that land registration records provide the most objective criterion on which to base payments, so these will be used, except in the regions where these records do not exist (about 17 percent of the total land area). Another set of critical choices concems the amount of payment per hectare, and whether it should be the same for each farmer. The decision on the average amount (approximately $100 equivalent per ha.) involved a trade-off between fiscal affordability and political acceptability; even this figure represents an eventual annual expenditure of US$1.9 billion per year. The decision to initiate DIS with a uniform national rate was based on the need to abstract the government from detailed questions of local land use, and attendant political claims and pressures. Although the Government preferred to roll out DIS payments nationwide in 2001, it was recognized that the registration process would take more than a year, and would likely only begin in earnest in mid-2001. It was therefore decided to develop the registry over two years. The criteria for selecting the areas for initial registration and DIS payments in 2001 will be objective (e.g., areas worst affected by natural disasters affecting agriculture or by the reduction of support) and will be more fully described in a government regulation to be published prior to consideration of the ARIP by the Bank's Board. The issue of targeting was also considered. One strategic choice made in the design of the DIS program was to give a minimum payment for farmers cultivating land below a minimum threshhold. This allows small subsistence farmers-- who benefit little if at all from the current subsidies, since they neither rely on purchased inputs nor have a saleable surplus-to receive some benefits from the DIS. Another decision was to cap the program at 20 ha, thus limiting payments to the top end of the land distribution. Thus, the payments will be moderately targeted. In principle, the payments could be more sharply targeted to the poor either 1) by means testing; 2) by differentiation of payment amount by some criteria associated with poverty; or 3) by putting lower ceilings on the area eligible for payments, or paying according to a sliding scale. The problem with all of these is that they would greatly increase the complexity of the system. In addition, a reform program that removed existing subsidies-which primarily benefit the better-off farmers-without giving them at least moderate compensation would be politically untenable. In the end, the government and project team judged that it would be best to install a simple, transparent mechanism to begin with. The information base from the project monitoring would then provide a solid empirical base on which to build a more targeted system in the future. A critical choice for the Bank in the farmer transition component was how to administer the assistance to farmers who wish to switch from the highly subsidized crops to an alternative activity. Several possible options were considered: a credit line, cash grants in an amount based on average expenses, vouchers redeemable for goods and services they will require in order to switch, reimbursement for actual expenses, or direct provision by the project of the goods and services. Any of these options would serve 11  the productive purpose of helping farmers start new activities when removal of the subsidies causes their current crops to become economically unviable for marginal farmers. Under any of the options, farmers would need to put up some of their own resources. The credit line option was rejected because it would have required a relatively lengthy and complex preparation process and then an additional level of monitoring during implementation. The importance of simplicity in preparation was amplified by the fact that this project was-based on the government's request for urgency- prepared on a very accelerated schedule. (The elapsed time from the initial Project Concept Review meeting until the beginning of appraisal was a period of about 4 1/2 months.) After considerable discussion, cash grants were chosen, so as to provide maximum freedom to farmers to implement replanting according to the ecology of their land and their own skills and capabilities. This mechanism - as opposed to reimbursing farmers for actual expenses or provision of inputs - makes farmers pay market prices for inputs and so discourages environmentally unfriendly overuse. The project team also explored the possibility of allowing alternative non-agricultural activities to be eligible for financing under the farmer transition component., Although this would add another layer of complexity-particularly in the monitoring-- to an already-complex project, it would have the benefit of increasing farmers' options and improving resource mobility. However, it would be difficult to incorporate this in the project design for two reasons in addition to the extra complexity. First, the government for political reasons does not wish to be perceived as discouraging agricultural production, and fears that a grant program that would give farmers grants to cease producing their current crops and invest in other activities would cause land to be left idle. Second, such an outcome would also be inconsistent with the requirement in the Bank's Articles of Association that Bank loans be for productive purposes, since the land in this case would become unproductive. In order to achieve at least some of the benefits in terms of expanded options for farmers while recognizing the constraints on both the government's side and the Bank's, the grant mechanism has been designed to give farmers some flexibility while preventing the land from being idled. Farmers could, if they wished, uproot their own hazelnut trees, collect the portion of the grant for this purpose, and then sell their land and use the grant proceeds to start an alternative activity. By virtue of the fact that the buyer has paid for the land, it is clear that the land will continue to be used for a productive purpose. A clause in the grant agreement a farmer would have to sign in order to collect the grant would specify that neither he nor a buyer of the land would plant hazelnuts. However, there would be no economic incentive to do so in any case since hazelnuts would no longer be purchased at an artificially high price, which was what provided the incentive to plant the crop on this unsuitable land in the first place. Of course, sale of the land would be only one of the farmer's options; the other, which we would expect to be much more commonly exercised, would be to plant an alternative crop and collect the subsequent portions of the transition grant. Component C: Agriculture Sales Cooperatives and Cooperative Unions (ASCs/ASCUs) Restructuring. While project support for labor retrenchment in all of the ASCs/ASCUs can be justified on the basis of improved sector efficiency, project support for technical assistance or investments must be more selective. Project support should be envisaged only for those ASCUs which have a significant potential for becoming viable and sustainable. This decision will be taken on the basis of comprehensive financial, economic and institutional reviews of each ASCU, and assistance provided to those that demonstrate the ability and willingness to take decisions necessary for sustainability. Another set of critical choices are related to the kind and number of services to be provided in the future by the selected ASCUs to their member cooperatives and individual farmers. The first basic rule for this decision will be that ASCs/ASCUs should purchase (and process) only those agricultural products which in turn can be sold (i.e. for which there is a market) at a reasonable margin. By applying this rule, ASCUs should reduce the purchase of those crops for which there is only a very narrow market (e.g. apricots). Another basic criterion to be used in making choices that will redefine the core services of ASCUs will be the interest of the member owners. During the time ASCUs were dominated by the State these regional unions added functions to their farmer mandates which are mainly (if not exclusively) in the interest of government or the management but certainly not in the interest of the farmer owners. 12  Another critical choice in project preparation was to include a capacity-building component for the ASCs. The large majority of the ASCs are today entirely dependent on the ASC'Us to which they are affiliated, and many will find it difficult to make the transition from a position of total dependency to the status of more autonomous units with a capacity to run their own affairs. If not supported through capacity-building measures, many, if not most, of the ASCs may exit from the scene or their transition will take place only gradually over a period of years, during which time they would not be able to provide effective services to their members. Although the market for agricultural produce and farm inputs is fairly well developed, a possible failure of the ASCs may expose farmers to unfair trading practices by private traders. Therefore, it is important that efficient ASCs add to the competition and increase the farmer's choice between vanrous buyers and suppliers. C. Project Description Summary 1. Project components: (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown) Comp A: Direct Income Support (DIS) 74.30 16.08 47.80 11.95 Comp B: FarmerTransition 185.89 40.24 180.58 45.14 Comp C: Agricultural Sales 177.60 38.44 152.68 38.17 Cooperative Unions (ASCU) Restructuring Comp D: Project Support Services 18.18 3.94 12.95 3.24 Adiustment Loan 200.00 200.00 Front End Fee (FEF) 6.00 1.29 6.00 1.50 Total 661.96 100.00 600.00 100.00 Notes: I. The reported FEF pertains to both the investment and adjustment loans combined. 2. The percentage columns exclude the adjustment loan of USS 200M. 3. 3. The figures in this table include contingencies. Summary by Component Component A: Design and implementation of the Direct Income Support system (DIS). Since the DIS will allow the government to disengage from its current support mechanisms in a politically acceptable and humane way, this component is at the heart of the whole program. The objective of this component is to set up a mechanism for identifying farmers who are eligible for payments under the DIS, and a mechanism for delivering those payments. The effectiveness of the program will be tracked through the ARIP social and financial monitoring and evaluation systems. This component will finance technical assistance, training, software and equipment to set up a farmer registry and to complete computerization of existing land registry records. rhe budgetary support component would be used by the Government to partially finance the first DIS payments. 13  Component B: Farmer Transition will help farmers make the transition to alternative activities as the govemmental supports are reduced. The current inconsistent and arbitrary pattern of state purchases commissioned to ASCUs or SEEs send very confusing messages to farmers and agricultural processors when they are deciding what to produce and how to produce it. It is leading them to overproduce crops which they can produce only at high cost relative to world markets, and underproduce crops which they can produce more efficiently. The objective of this component is not to compensate farmers for income lost through removal of input subsidies and price supports (the function of the DIS payments is to provide some compensation for this) but rather to cover the one-time cost of converting from previously highly supported crops. Currently the most serious problems are with hazelnut and tobacco. As a result of high support prices, there has been a large expansion of cropping area in these crops, with significant amounts of surplus production and stock accumulation. It is expected that under the reform program, the artificially high prices of these products will decline significantly-more so than the incomes of growers of other crops -- and many of these farmers in areas which have good alternatives will want to stop producing them. This component will provide grants to certain hazelnut and tobacco farmers to cover the average cost of buying inputs for alternatives, and preparing and tending fields in the transition period; and to hazelnut farmers to cover the uprooting costs. It would also include a small sub-component to support strengthening or establishment of farmers' associations which would help in the transition. Component C: Agriculture Sales Cooperatives and Cooperative Unions (ASCs/ASCUs) Restructuring. The Government's Agricultural Sector Reform Program includes the structural reform of the agricultural sales cooperatives. As a result of earlier State intervention in the cooperative sector, the State now plays a dominant role in the sector and its intervention has proven to be unproductive and fiscally unsustainable. This intervention has left the ASCs and their unions alienated from their members, saddled with excessive wage costs, heavily indebted and without proper arrangements for corporate governance. Under the new law on Agricultural Sales Cooperatives and their Unions, adopted in June 2000, the ASCUs will no longer receive annual allocations of funds from the budget. Instead, they will be required to become, once again, independent, financially autonomous and self-managed organizations dedicated to serving their farmer members by selling and processing crops on their behalf. However, as a transitional measure, an amount of TL 250 trillion has been made available from the budget as a credit to the ASCUs to enable them to procure the 2000/2001 crop. In order to obtain this credit, the ASCUs were required to submit detailed business plans including their plans for cost cutting through labor retrenchment. The repayments of these credits will flow to a revolving fund which can be used by the ASCUs in future years or until the time that they are sufficiently self-financing and sufficiently creditworthy to obtain working capital loans from commercial banks. As shown in the Table below, the agricultural cooperative sector includes 16 ASCUs, 330 ASCs and around 750 thousand farmer members. The ASCUs and ASCs had around 16,500 employees at the end of July, 2000. The larger ASCUs, particularly the three which procure cotton, have large industrial facilities for secondary processing of the crop. Under the project, the role of the ASCUs will be dramatically reduced and they will be transformed into sales agencies for marketing the produce of their member ASCs and providers of business services to the ASCs. Many of the ASCUs and ASCs have already begun to retrench workers in order to eliminate excess labor and achieve wage parity with their private sector competitors. As shown in the table below, 12,155 workers are subject to retrenchment. Following retrenchment, any replacement workers will be hired at wages equal to those paid by the private sector. The new law on ASCUs provides that the government's budget should cover the cost of severance payments to all retrenched workers. As the amount of crop procured by the ASCUs is currently constrained by lack of working capital the savings resulting from the retrenchment program will initially be used to strengthen the working capital position of the ASCUs. Once this has been accomplished, future savings can be used for refurbishment investments or be distributed among the ASCUs' farmer-cooperators. 14  Some ASCUs will require further restructuring in addition to labor retrenchment if they are to become sustainable. Since most of the ASCUs lack the institutional capacity to restructure themselves and survive in their new business environment, the ASCU law provides for the creation of a Restructuring Board which will provide various types of assistance to the ASCUs and their member ASCs, on a voluntary basis. This component would provide TA for establishing the Restructuring Board, as well as TA to the ASCs/ASCUs to assist them in designing and implementing: (i) restructuring measures; and (ii) business development and capacity building programs. As mentioned above, the ASCU law also requires that the budget pay for the cost of severance payments associated with labor retrenchment. This component of the ARIP project will provide the government with the resources necessary to implement the provision. To aid in the effort of all cooperative units which decide to restructure and attempt to become commercially viable, this component would finance severance payments to the affected workers. The Cooperative Development Sub-Component (CDSC) of the ASCUs Restructuring Component will contribute to the transformation of the ASCs into genuine cooperative organizations which are: i) member-controlled and operate in accordance with needs and priorities identified by their members; ii) efficiently managed and able to provide effective services to their members; and iii) competitive and self- reliant and thereby able to operate in competition with other private sector enterprises without having to depend on government subsidies and supervision. Achievement of this objective will enable farmers to take ownership of their cooperatives and get access to efficient services which improve farm productivity and income. 15  Profile of the Agricultural Cooperative Sector Name of ASCU Location Crop Name Tons of Crop Nunmber of Number of Nunber of Number of Primnry Proceaing Facilities Secondary Processing Facilities Procured In Employees ASC's ASC memnbers Employees to 1999/2000 be Retrenched I TARIS-Cotton Izrnir Cotton 247,828 3,634 44 62,452 2.653 27 Ginning facilities Conon Seed Oil, Margarine, Soap, Detergents, Spining Mill, Fabric-s 2 TARIS-Fig Dry Figs 11,358 1.104 15 7,792 700 1 Fig Sizing and Calibration Fig Processing, Cologne 3 TARIS-Raisin Raisin 57,997 769 14 26,293 880 None Raisin Processing, Vinegar and Boiled Grape Juice 4 TARIS-Olive Oil Olive Oil 7,780 889 33 27,732 426 28 Olive Oil Extraction Units Olivc Oil Processing, Table Olivc packing 5 CUKOBIRLIK Adana Cotton 139,046 3,546 40 63,003 3,546 7 Ginning facilities Cotton Seed Oil. Spinnig Mill, Fabrics, Dying and Clothing _____ ____ ____ _____ ___ ____ ____ Soyabean 24,724 6 ANTBIRLIK Antalya Cotton-Citrus 51,959 1,035 6 29,064 779 4 Ginning facilities Cotton Seed Oil, Spinnig Mill and Soap, Citrus Packing 7 FISKOBIRLIK Giresun Hazelnut 142.384 2,416 49 238,733 2,347 17 Crtshing facilities Hazelnut Processing 8 TRAKYABIRLIK Edirne Sun Flower 356,102 1,656 48 107,705 482 None Trakya Seed Oil and Karacabey Seed Oil 9 KARADENIZBIRLIK Samaun Sun Flower 54,628 449 21 69,200 76 None Merzifon Seed Oil and Dogan Erdil Seed Oil 10 GUJNEYDOGUltIRLIK Gaziantep Pistachio 1,062 190 14 17.502 150 None Pistachios and Red Pepper Packing Red pepper 976 Red Lentils 5,722 11 MARMARABIRLIK Bursa Olive Oil 42,208 562 8 48,025 13 None Table Olive Tz TASKOBIRLIK Nevebir Dried Grape 8,783 71 9 4,310 59 None Vinegar, Wine and Grape Juice 13 KAYISIBIRLIK Malatya Apricot 1,550 62 6 8,178 21 None None 14 KOZABIRLIK Bursa Silk Cocoon 132 35 5 10,489 6 None Silk Cocoon 1 TIFTIVKBIRLIK Ankara Mohair 139 22 12 18,449 7 None None 16 GULBIRLIK Isparta Roses 2,234 19 6 7,392 10 None Rose Flower Seed Oil, Parftune _TOTAL 1,156,612 16,459 330 746,319 12,t155 16  Component D: Project Support Services. This component will provide for a) Public Information Campaign to provide accurate and timely information about the reforms and describe the support mechanisms available under the project to farming communities through television, radio and newspaper announcements. This subcomponent would also provide training for MARA extension services staff to enable them to answer farmer questions about the program and present accurate information about the reforms and assistance programs to their clients, the farmers, and a mechanism to collect feedback from the public; b) advisory services connected with project management, agricultural statistics, laboratory and food testing, crop insurance and other topics relevant for reform program implementation that are not addressed in the other components; c) monitoring and evaluation to gauge the social and financial impact of the agricultural reform program and supporting ARIP components; and d) a Project Coordination Unit (PCU) for project coordination, procurement and financial management support to the implementing agencies, and Component Implementation Units to assist the implementing agencies. Adjustment Component. This component provides financing for a $200 million quick-disbursing component (in 2 equal tranches) against the Bank's standard negative list. Conditions for release of the first quick-disbursing tranche would be i) satisfactory performance in the macroeconomic program; ii) satisfactory performance in implementing the general sectoral reform program (as described in the Letter of Sectoral Policy); iii) adoption of a 2001 revised budget that : (a) does not provide for any new direct or indirect agricultural subsidies; and (b) does not increase existing direct or indirect agricultural subsidies, in real terms, as compared to subsidies in effect on January 1, 2001; and iv) initiation of DIS payments, defined as "25% of farmers registered and of these, 50% paid". Conditions for release of the second quick-disbursing tranche would be i) satisfactory performance in the macroeconomic program; ii) submission to Parliament of a draft 2002 budget that : (a) does not provide for credit or fertilizer subsidies; and (b) does not increase other existing direct or indirect agricultural subsidies, in real terms, as compared to subsidies in effect on January 1, 2001; iii) satisfactory performance in implementing the general sectoral reform program (as described in the Letter of Sectoral Policy); iv) further progress in the initiation of DIS payments, defined as "50% of farmers registered and of these, 50% paid"; and (v) by November 1, 2002, or when the other conditions are met, whichever comes first, reduction in TMO wheat purchases to a level satisfactory to the Bank. 2. Key policy and institutional reforms supported by the project: The project will support implementation of the reform program already broadly agreed under the ERL and announced by the Government in the LDP for that loan and more fully in the "Strategy for Reform of Agricultural Support Policies" adopted by the Interministerial Committee on Agricultural Support Restructuring in February 2000. During ARIP preparation, more specific targets have been identified for 1) further price and tariff reductions for grains in 2001 and beyond, and phaseout of the support price for grains and tobacco; 2) the pricing mechanisms for TSFAS, Tekel, and Caykur while they are in the process of privatization; 3) targets for privatization of agricultural SEEs; 4) reduction of the premium payments on oilseeds and cotton; and (5) an eventual exit strategy for the revolving fund for ASCUs and for DIS payments (linked to EU accession). These are summarized in the description of Government strategy in Section B-2 above. 3. Benefits and target population: The Govemment's reform program has great long-term benefits, but will impose some losses on certain groups in the short run. This project will help implement the reform program in the most efficient way, while providing a safety net for potential short-term losers. The safety-net is targeted to four groups: redundant employees of the ASCUs who receive severance payments financed by the project; cooperatives who benefit from capacity building (and their member farmers); farmers who receive assistance in making a transition to alternative crops when support prices for their traditional crops are 17  eliminated; and farmers who receive DIS payments (virtually all farmers). Less directly, benefits will go to taxpayers (in the form of lower public spending and inflation) and to consumers (in the form of lower prices for agricultural goods). An estimate of the fiscal cost of the policies that are being reformed is around $ 6 billion in 1999. The reform program reduced this cost to about $3.5 billion in 2000, and will continue the reduction to about $2.1 billion in 2001, $0.2 billion in 2002, and nil in 2003. Not all of this will be net fiscal savings, however, since some will be used for the direct income payments. These payments will not fully compensate all losses; in 2001 farmers will receive around US$ 100 per hectare under the DIS, but this could possibly be raised in the following years as the support price mechanisms are phased out. The effects will be monitored so the amount could be adjusted appropriately over time. The likely costs of the DIS payments will be about $ 500 million in 2001, one installment to farmers, and $ 1.9 billion in 2002 with two installments. This amount will thereafter remain constant (in US$) unless the amount paid per hectare is adjusted. The DIS should become more explicitly targeted (and harmonized with the EU system under the Common Agricultural Policy as it exists at the time of accession), or merged with the general social safety net system. In any case, since farmers will be producing marketable crops more efficiently and will benefit more per dollar of government budget from direct cash payments than subsidies in kind (much of such subsidy actually has gone to workers in ASCU and SEE enterprises), it should be possible to realize important short-term fiscal savings from the reforms, even including the direct income support payments. Within the population of approximately four million Turkish farm families , quantitative estimates of how much different groups gain or lose from the whole reform package (based on farm budgets) are quite uncertain. It is clear that some farmers will lose a lot, some will lose a little, and some -- those that grow crops that were not heavily supported and did not use much credit or fertilizer -- will gain. Livestock producers who purchase fodder will unambiguously gain from cheaper feed grain prices. Small-scale producers who grow mainly for self-consumption will not be affected by the phaseout of current subsidies and support prices, but will benefit from DIS payments, so they will clearly be net gainers from the program. Farmers growing highly supported crops and using a lot of credit and fertilizer will lose from the reduction in subsidies and support prices. But quantitative estimates of these losses are inherently too high, since they assume that farmers will keep growing the same crops when their relative prices fall, whereas in reality, many will change to more profitable crops or other activities, thereby minimizing the drop in income. Indeed, accelerating this process is the main objective of the Farmer Transition component. It is clear, for example, that tobacco farmers who grow unsaleable tobacco will either upgrade their production so it can be sold at the auction or switch to another activity. There will be strong incentives from the overall program for farmers to switch to crops that do not now have high support prices, such as cotton, sunflower, horticultural crops, and forage, and to livestock. Support to develop farmers' association will help farmers by providing effective training, by facilitating input supply and insurance coverage, by strengthening the negotiating power on all markets and by formulating demand for agricultural research and extension to shape the technology generation and transfer process. The ultimate beneficiaries of the CDSC sub-component will be farmer members of the ASCs. The capacity-building support under CDSC will provide the members with the tools necessary to exercise their ownership rights, and to shape the activities of the ASCs from the point of view of farmer needs. As the primary societies become more efficient in their business operations, farmers will benefit through improved services, higher prices for agricultural produce delivered to the cooperatives, and competitive prices of farm inputs. Restructuring of the ASCUs, reduction of staff, and introduction of an optimal division of work between the unions and the cooperatives will contribute to lower costs in the whole ASC system and, thereby, to improved returns to farmer members. 18  Especially the small-scale farmers are expected to be the main beneficiaries of efficiently operating cooperatives. They lack the bargaining power which large-scale farmers have in the market for agricultural outputs as well as inputs. Often dependent on crop financing from traders, small-scale farmers have to commit their crop to these traders and, therefore, are not in a position to bargain for the highest possible price. As experience from many countries shows, cooperatives are an appropriate tool for farmers to improve their market position as well as to reduce costs of the support services which they need. 4. Institutional and implementation arrangements: Implementation of the investment part of this project will extend over four years. Treasury will serve as lead implementing agency, and will establish a Project Coordination Unit (PCU). Policy guidance and interagency coordination will be managed through a Steering Committee chaired by the Undersecretary of Treasury and consists of the Ministry of Agriculture and Rural Affairs (MARA), Ministry of Industry and Trade (MIT), the State Planning Organization (SPO), Ziraat Bank, the Ministry of Finance, the State Title and Cadastre Agency, the State Statistics Institute (SIS), and the Agricultural Chamber of Producers (TZOB). Most of the SC members also serve on the Agricultural Restructuring Board. The Treasury PCU will handle day-to-day coordination and implementation duties, including procurement, disbursement, financial management and project monitoring. MARA will establish Component Implementation Units to manage implementation of Components A (DIS) and B (Farmer Transition). For Component C (ASCs/ASCUs Restructuring), an Executive Unit reporting to the ASCs/ASCU Restructuring Board will be established and will function as the CRJ for that component. The adjustment portion of ARIP would be implemented in accordance with standard Bank procedures and practices for adjustment loans. The ARIP adjustment component will be implemented by the Central Bank of Turkey based on an Implementation Agreement between the Undersecretariat of Treasury and the CBT. Implementation arrangements will be fully consistent with Bank practice for adjustment loans. Upon notification to the Bank of the establishment and initial operation of the DIS system, the proceeds of the adjustment portion of the loan will be deposited by the Bank into the designated Deposit Account at the CBT at the request of the Borrower. In accordance with the Operational Directive on the Simplification of Disbursement Rules under Structural Adjustment and Sector Adjustment Loans (February 8, 1996), disbursements will not be linked to specific purchases. Therefore, there will be no procurement requirements for the adjustment portion of ARIP. Financial Management Arrangements For the investment portion of the project: All the accounting records would be maintained at the PCU. Ziraat Bank will be the main Bank handling the payments on behalf of the PCU (Treasury). Ziraat Bank, though no better than other state owned banks in terms of financial strength, has a wide network of branches in rural areas to make payments to the farmers. Based on the payment advises sent by the Ziraat Bank, the PCU will pass necessary entries in the Books of Accounts. The accounting system at PCU will be centralized and fully computerized. PIUs will not maintain any books of accounts. Employee-wise severance payment records will be maintained by each ASCU. MARA district offices will maintain the farmer registration records- which will be computerized during the course of project implementation. Details regarding the flow of transactions and various internal controls are included in Annex 6. 19  For the adjustment portion of the project: The adjustment portion of the loan would be released by the Central Bank to the Govemment as additional resources for the general budget for partially meeting the DIS expenditure of the government. The Government will submit to the Bank a monthly report on receipts and payments showing the transactions on the Deposit Account and from this account into other accounts of the Central Bank or Treasury (the related accounts), starting with the first receipt of Bank funds, and ending when Bank disbursements on the loan have ceased and when the balance on the Deposit Account has been reduced to zero. Treasury Controllers that are satisfactory to the Bank as independent auditors will carry out the audit of the Deposit Account and related accounts and records in accordance with appropriate auditing principles consistently applied. The audits will be conducted starting at the end of fiscal year 2001 of the Borrower on the basis of terms of reference agreed between the Bank and the Borrower. The audit reports will be submitted to the Bank no later than four months from the close of the fiscal year. In addition to the above, the Bank may request that its own staff carry out special reviews of the Deposit Account and related accounts and records. If the proceeds of this loan are used for ineligible/unintended purposes, the Bank will require the Borrower to either: (i) return that amount to the account for use for eligible purposes, or (ii) refund the amount directly to the Bank. The first tranche ($100 million) under the adjustment loan will be released when the policy-related conditions are met and at least 25% of the farmers are registered in an auditable database, the DIS payments made to these farmers are pre-audited by MARA inspectors, and consultants appointed to design, develop, and implement computerized DIS system have prepared acceptable functional specifications of the system. The second tranche ($100 millions) will be released when the policy - related conditions are met and at least 50% of the farmers are registered, DIS payments made to the farmers are audited by an independent auditor, and the computerized system is implemented and the database of the farmers is updated to include the farmers already registered and payments already made. D. Project Rationale 1. Project alternatives considered and reasons for rejection: Originally, the Bank discussed with the Government a multi-component single loan, which would have the components currently envisioned in the ARIP, plus several others as well. These other components included commodity market development, land management, agricultural services, and preparation for EU accession (harmonization of legislation and institutional improvements). However, it is clear that some of these tasks are more urgent than others to ensure the success of the reform program. Thus, the Government requested that we prepare a project to support these more urgent tasks on a priority basis, leaving some of the others for a later operation. The ARIP focuses only on the tasks that must be started in 2000-2001 to support the transition from a heavily govemment-influenced to a market-driven agricultural sector Another option considered for this project's design is an adjustment operation. Under this option, the Bank team would work with the Government during project preparation to design an implementation schedule for the reforms, with benchmarks that could be used as tranche release conditions. During supervision, the team would work with the Government to carry out this program. Necessary expenditures would be financed from the Govemment's general budget, which would be reimbursed by loan disbursements. The very real advantage of this option, as opposed to the investment project option, is that it might have permitted faster project preparation and disbursement of loan proceeds. The disadvantage of this option is the lack of a mechanism to monitor and evaluate the implementation of the reforms, and to design additional interventions if need be. 20  The Bank and the Government concluded that a hybrid adjustment/investment loan would be the most appropriate instrument, to allow for rapid implementation of the DIS system, farmer transition component, a pilot agricultural statistics component, and initial work on ASCU restructuring, to be complemented by lending in two tranches of $100 million each, to be released when the initial DIS system is in place and payments have been made and other specific indicators of progress in the macroeconomic and sectoral reform programs are met. This approach will keep the Bank involved in the reform process and follow up in a "hands on" manner, while the adjustment portion will help the Government to fund payments at a level sufficient to meaningfully cushion the adverse effects on farmers of withdrawal of other subsidies. Alternative institutional arrangements for implementation of the ASCU CDSC were considered during project appraisal. One alternative possibility would have been to attach the local implementation teams (the CSU field officers in the current project design) to the ASCUs, i.e., as cooperative development sections of the unions. This was rejected on the grounds that it would have given the unions the opportunity to unduly influence their affiliates in the sensitive process of restructuring which will involve difficult question of division of assets, functions and powers between the union and the societies. However, the local field officers of CSU will operate in close consultation and collaboration with the unions. 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned): Latest Supervision Sector Issue Project (PSR) Ratings (Bank-financeI projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) Sectoral economic policy reform Economic Reform Loan (ERL) Socio-economic policy reform Privatization Support Project (PSP) Institutional development Commodity Market S S Development Project (LIL) Natural resource management Eastern Anatolia Watershed S S Rehabilitation Project Other development agencies Economic policy IMF Stand-by Arrangement IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: The main lesson learned from past experience in Turkey is the gross inefficiency of the current mechanisms of support for agriculture. The alternative mechanism of direct income support has been tested and is now used in a number of countries, including the US for the most important field crops and Mexico (the Procampo program)3. 3 See "From prices to incomes: Agricultural subsidization without protection?" DecNote, Research Findings, No. 32, 1997, World Bank, Washington, D.C. 21  Component A (DIS): One of the key lessons of well functioning DIS programs is the importance of an adequate registry of farmers. The registry of farmers has to be accurate, reliable and transparent, so as to avoid manipulation and misuse for other purposes. As experience in Mexico's Procampo and other similar programs shows, the registry of farmers has to be assembled before the program enters into operation, so as to have the program run smoothly without practical complications and complaints. The registry also has to be simple, containing only a few variables needed to implement the program efficiently and in particular, facilitate payment. Another key element is the clear definition of the criteria on which the payment amount will be determined. Experience says that the simplest way is to pay according to the number of hectares owned or farmed by the beneficiary rather than in relation to agricultural production or cultivated area in certain crops. Intemational experience on developing a registry of farmers provides a basis for comparing the cost, speed and transparency of various methods. For instance, in Romania 4.5 million farmers were registered following local cadastre records. The process was completed in about 3 months nationwide. The cost of the registry per farmer was about two dollars, including taking the information from the cadastre books and processing. Another example was Procampo in Mexico where the registry of farmers was made initially on declaration by farmers of area planted in the last three years with verification by the Ministry of Agriculture (MOA). The registry took a longer time than in Romania because of the implications and problems with self declarations of farmers. At the beginning of the Procampo program, the criterion was to give the payment according the number of hectares cultivated with certain crops in the three years before the program started. Once the program was announced the farmers increased the cultivated area of the eligible commodities. Gradually the data base has been cleaned over the years, and disputes over the accuracy of farmers declaration of area planted are usually resolved by a bipartite committee composed of farmer representatives and local MOA officials. There are other examples in Latin America of registries of beneficiaries for social programs. Those registries have been more expensive (8-10 US dollars per family) than the registry of farmers because those registries have been based on censuses of poor areas and ask a great number of questions (over 65 questions) to establish poverty levels. Adequate measures have been taken to prevent these potential problems in the design of the DIS at national level. Component B (Farmer Transition): One major lesson leamed from the successful implementation of the Eastem Anatolia Watershed Rehabilitation Project (EAWRP), which is being implemented in 11 provinces of Turkey, is the importance of giving farmers a wide range of options, rather than pre- selecting an altemative crop for them. This project includes the participation of the villagers in rehabilitating micro-catchment (MC) areas. The interactive approach of the Project depends on the ability of the villagers first to identify problems for which the Project can supply a solution and then respond positively to the options. Communities choose from a "menu" of options, which comprise various treatments, some of which are conditional on, and must be adopted in, association with another. To encourage the adoption of the treatments which have only long-term benefit or short-term costs, the Project finances the initial investment and establishment phase of the supporting activities. Once the participatory plans are prepared for the MCs, members of the community also participate in project implementation, and contribute to the costs. In the Project, even though the MC villages are very poor, the villagers are willing to share the cost e.g., providing the cement for the water collecting ponds, providing transportation for the construction material, or providing labor. For the ARIP Project, it will be critical that farmers be given options, as in the EAWRP. Such a selection from the menu would encourage the adoption of and participation in both long-term and short-term measures. The long term benefits would be more sustainable cropping patterns , better price formation in the market, more stable income; the less immediate benefits would be explained and supported by a public awareness campaign. The more direct and short-term benefits to the farmers would be provision of funds needed for inputs such as seed, seedling, diesel, fertilizer, equipment services, chemical supply and demand driven extension service, and training as matching grants from the project. 22  Component C (ASCs/ASCUs Restructuring): The performance of rural cooperatives in most developing and transition countries is mixed at best. Usually, the main reason for this poor performance is excessive government involvement. Government often mandates cooperatives to carry out specific policies and programs (e.g. in Turkey, ASCs and ASCUs had to implement intervention purchases on behalf of government). In addition, through cooperative departments and sector ministries, governments heavily controlled cooperatives and intervenes in their operations, with the rationale that "ill-informed and illiterate cooperative members must be guided and protected from the harsh reality of the markets". As a result of mandated tasks and dominating management, government tums many cooperatives into state organizations similar to SEEs. Since the beginning of the nineties, more and more governments are undertaking efforts aiming at redefining their role in cooperative development in order to make it consistent with their role as a facilitator of private sector development. In addition, cooperatives seek support in their transition from government dependency to viable private sector enterprises. The design of the whole ASCU component, including the CDSC, is based on contemporary trends and experiences in the development of cooperatives and other farmer organizations. There is evidence from many countries in different regions of the world that cooperatives financed and controlled by government have degenerated into inefficient organizations, ultimately losing the support and participation of their members. Ownership, member participation and relevance of services in relation to members' needs are key concepts in the new cooperative development strategy which has emerged after failure of the government-controlled cooperative systems. Experience from cooperative reform projects in other countries--e.g. the Agricultural Development Project in Poland and the Intensive Cooperative Management Improvement Project in Kenya--illustrate the difficulties involved in moving from a system of government control and dependency to cooperative autonomy. Cooperatives find it difficult to graduate to autonomous, member-controlled enterprises able to compete effectively in an open market. In order to make the transition successful, cooperatives need a comprehensive range of support services over a comparatively long period of time. Such services need to be tailored to the needs of individual cooperatives through a participatory process, involving members in the identification, design and implementation of the support. This is why the CDSC assistance to ASCs is based on a rather elaborate process of member mobilization, business planning and plan implementation, and why CDSC includes a full package of support services ranging from member information and board member training to business management consultancy and management systems development. Adjustment portion of ARIP: In developing the ARIP, and the reform program which it supports, staff have drawn on the experience of past adjustment lending to Turkey in the 1 980s, as well as on the recent experience with adjustment lending across the Bank. The core lessons learned from this experience include: * Successful implementation of adjustment loans requires intensive dialogue with the Government and key local stakeholders. Critical aspects of the agriculture reform program have been the subject of intensive dialogue over several years, including national seminars in 1998 and 1999 in conjunction with preparation of the ERL; * Conditionality must be clear and straightforward with strong Government ownership. The ARIP design and component contents were discussed in detail with the Government on at least three occasions prior to appraisal, and the dialogue intensified during four weeks of continuous discussions through appraisal, and has continued in the period before and during negotiations.; 23  * Close cooperation with the IMF is essential. Cooperation with the IMF on Turkey is very close. The Bank participated in all key discussions on the Standby program. The Fund has a particular interest in agricultural policies because of their fiscal implications and the Fund program incorporates key agricultural policy reforms supported by the ARIP; * Adequate funding for the program is critical and has been promised for the economic program into 2003. 4. Indications of borrower commitment and ownership: The Government has already taken several politically difficult measures to reduce inefficient subsidies, and is strongly committed to many other actions which are tranche-release conditions under the ERL and IMF Standby Arrangement, as outlined in 2 above. It has included still other commitments in its LDP for the ERL and the accompanying Agricultural Strategy, as well as in the ARIP Letter of Sectoral Policy. Further indication of borrower commitment is found in the Government's request for access to retroactive financing under ARIP in the amount of US$35 million to finance severance payments to ASCU workers made redundant through the restructuring process. The Government has already started the process of withdrawing from its financial involvement in the ASCU/ASC system by declaring in the agricultural sales cooperative law that the ASCUs, after a short transition period, will have to finance their operations without government loans or grants. This law also provides the framework for transformation of the cooperatives into entities not subjected to intervention by the state. 5. Value added of Bank support in this project: The Bank's involvement will add value in two ways. First, in its comprehensive stabilization program the Government requested the Bank's support for agricultural reform based on mutual consensus. In response to this request, advice has been provided over the last two years in a series of Bank policy notes and policy workshops that have tried to build a consensus for the reforms. This has been absolutely indispensable in deciding to adopt the program of direct income support, and then in setting it up, since this is not a system with which the Government was previously familiar. It has also been critical in helping the Government think through the question of how best to sever its links with the ASC system. In the short and medium term, the Government will continue to need assistance in considering how to spend the approximately $397 million that was put into the DFIF fund in 2000 to be invested on ASC/ASCU operations and restructuring. Second, the Government needs the financial support the loan will provide. In the wake of the February 2001 financial crisis, the revised 2001 budget will of necessity be even tighter than the 2000 budget. It would not be able to support the measures necessary to implement the reforms. In particular, there is a real danger of an insufficient allocation for the first DIS payments, which could undermine the system's sustainability and credibility. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): Other (specify) NPV=US$ million; ERR = % (see Annex 4) As noted previously (Section B.2.), the ARIP is expected to have a positive impact on the currently inefficient and costly system of agricultural support policies. These have not only manifestly failed to enhance productivity growth, but have been so expensive to both consumers and taxpayers that they have been a source of Turkey's macroeconomic problems. For this reason, reforming this system is a primary 24  goal of both the ERL and the IMF's program. The Government's strategy, assisted by the ARIP, phases out the current mechanisms of support, and puts in their place "decoupled" direct income payments, which would not be contingent on input use or output production decisions of the farmer. Thus, farmers would not suffer a precipitous reduction in income, but would be free to make efficient production decisions based on true economic values of inputs and outputs. As the economic justification for the proposed policy change has been dealt with in the preparation of the ERL it will not be analyzed again in this section. However, an economic analysis is required for the investment project components - DIS, Farmer Transition and ASCUs/ASCs. DIS: A cost effectiveness analysis is undertaken to determine the 'best' mechanism for implementation of the DIS component of the project. Cost-effectiveness analysis examines which combination of the various investments delivers the component objectives at least cost. In this case - what is the least cost mechanism that can be developed to identify beneficiaries who are eligible for payment under the DIS, and deliver the payments. Several mechanisms were piloted in four provinces and seven counties (annex 4 provides details). The least cost mechanism, which was selected to develop the national registry of farmers, costs about 10 to 40 percent less than the possible alternatives. At a cost of US$14.5 per farmer, it is slightly higher than registries developed in other countries such as Costa Rica, Nicaragua and Colombia. The additional costs are the result of extending the registry system to the local level and the accelerated timetable for its completion. Farrner Transition: A cost-benefit analysis of this component yielded high returns. The (economic) internal rate of return for the component, based on the stated assumptions (Annex 4), is estimated to be 53%. For each of the crops to be replaced, the rate of return was estimated at 36% for hazelnuts and 337% for tobacco. The methodology used was biased towards lowering rates of return by using generous shadow prices for the crops to be uprooted, and by attributing the cost of Fiskobirlik restructuring to the hazelnut uprooting. The benefit per hectare from tobacco replacement are similar to that of hazelnut replacement but achieved at lower cost thus yielding much larger return to the initial payments. The discounted net benefits (net present value) of the component amounted to US$303 million. All the returns are relatively high and are amplified by the current economic losses made on the proposed areas to be uprooted. As an illustration - if nothing were grown on this land after uprooting the internal rate of return would still be about 25% for hazelnuts, 277% for tobacco, with an overall 42% return. Farmer Transition Sub-component NPV (US$) IRR Hazelnuts 140,726,018 35% Tobacco 106,680,101 337% Overall 303,226,728 53% Sensitivity analysis was applied using switching values (Annex 4). The results suggest that the NPVs are not particularly sensitive to changes in the price, yield and costs of production of hazelnuts, tobacco and their replacement crops. ACSUs/ASCs: Not only are the ASCUs/ASCs overstaffed but they also pay wages which are much higher than those paid by competing private traders/processors. Therefore, labor retrenchment would not only increase the efficiency of the various crop sub-sectors but would also increase the prospects for ASCU/ASC sustainability. The ASCUs and ASCs plan to retrench around 12,155 workers and then hire around 9000 replacement workers at market wage rates as shown in the table below. 25  The ASCU/ASC Retrenchment Program No. of Workers No. of on Payroll at No. of Workers Replacement No. of Workers on Year Ending Beginning of Retrenched Workers Hired Payroll at End of July 31 - Year During Year During year Year 2001 16,459 (8,586) 4,181 12,054 2002 12,054 (1,899) 3,469 13,624 2003 13,624 (1,234) 1,018 13,408 2004 13,408 (261) 175 13,322 2005 13,322 (175) 162 13,309 Total (12,155) 9,005 The costs and benefits associated with the retrenchment program are presented in the Table below. The financial rate of return is calculated to be 99.6 percent. Using an average severance payment of TL 9.5 trillion and an average annual wage saving of TL 7.8 trillion in each year of a ten year period for each worker retrenched and not replaced, both expressed in August 2000 TL, the economic rate of return for each worker retrenched and not replaced is 82 percent. Projected Financial Costs and Benefits of the ASCU/ASC Retrenchment Program (Constant August 2000 TL, billion) Projected Wages Projected Wages and Severance Payments without With Project Projected Net Project Benefit Year Ending Projected Severance July 31 - Wages Payments Total 2001 130,008 100,789 77,087 177,876 (47,868) 2002 130,008 69,087 15,680 84,767 45,241 2003 130,008 65,546 11,632 77,178 52,830 2004 130,008 64,843 2,460 67,303 62,705 2005 130,008 64,273 1,650 65,923 64,085 The core business of an ASCU is the sale of crops procured from its member ASCs. In most cases, a shortage of working capital prevents the ASCUs from fully exploiting their core businesses. The direct savings in wages and benefits associated with labor retrenchment would alleviate this working capital constraint and permit the ASCUs to procure and sell a greater quantity of the crops produced by their member farmers. Provided the incremental crop purchases can be sold at a profit the IRR's from outlays for severance payments would be even higher than those indicated above. 26  2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4) Project Costs and Financing Project Costs 1. Total Cost. The total cost of the project is estimated at US$ 661.96 million equivalent, including taxes, and physical and price contingencies, of which US$ 36.49 million equivalent in foreign currency and US$ 625.47 million equivalent in local currencies. A summary of project costs and project financing information can be found in the accompanying tables. 2. Base Cost. Base costs are estimated in March 2001 prices using the prevailing rates of exchange of approximately TL 1 million for US$ 1. The average physical contingency for all components is estimated 5 percent of base cost. Actual rates on physical contingency varied from 0 to 35 percent depending on the nature of project interventions and the degree of confidence in the base data. The project was fully costed out in US$. Price contingencies were applied to base costs over the project implementation period of four years (2001-2005). Inflation on foreign exchange costs was calculated by assuming 2.5%, 2.6%, 2.4% and 2.3% for 2001 through 2004 on the dollar, and one point higher for local inflation in dollar terms, i.e 3.5%, 3.6%, 3.4%, and 3.3% for 2001 through 2004. VAT at 18% is applicable on most purchases and is levied on the tax-free base. In Turkey VAT turns out to be equivalent to 14.53% of total cost, and this is what is shown in the COSTAB. On cars, taxes (VAT and other levies) amount to 45% of the total cost. On miscellaneous operations cost, an average tax of 10% was assumed. Project Financing Project financing will be provided out of two sources. The Bank will contribute US$ 600.00 million equivalent inclusive of the front-end fee assessed at 1%. This includes (a) an investment loan for US$ 400.00 M and (b) an adjustment loan for US$ 200.00 M. The Bank's contribution corresponds to 86% of the investment portion and 90% of the overall funding requirements for the hybrid investment/adjustment operation. The Government will contribute all applicable taxes on transactions and other non-tax items amounting to US$ 61.96 M. The government has requested retroactive financing from the project in the amount of US$ 35 M. While the amount of retroactive financing is within Bank guidelines for the size of the project, it is unusual that almost all of this will be used in one component, specifically to pay severance payments of retrenched workers of the ASCUs and ASCs. The reason for this is the extreme urgency of making these payments. The ASCUs were in 2000 in poor financial condition, and were faced with the prospect of being cut off from government funds with only a one-time infusion of funds from the DFIF. To improve their chances of survival, it was critical to get as much excess labor as possible off their books in 2000. Therefore, the Bank agreed that these expenditures would be eligible for retroactive financing. Fiscal Impact The ARIP will have a large positive net fiscal benefit by supporting implementation of the Government's agricultural policy reform program, which is a cornerstone of its disinflation strategy. The program is 27  targeted to save some US$5-6 billion annually in budget previously allocated to agricultural subsidies and price support, and a cumulative total of approximately US$14.5 billion over the 2000-04 period. At an anticipated full annual cost of US$1.9 billion in DIS payments, the net fiscal savings would be over US$3 billion per year. Fiscal Impact of the Reform Program, 2000-2003 Fiscal cost of selected agricultural support 1999 2000 2001 2002 2003 1. Credit subsidy 956 139 198 0 0 2. Fertilizer and inputs 290 194 147 0 0 3. Budgeted transfer to SEEs (duty loss and equity) 244 243 189 0 0 4. Deficit of SEEs TMO 1,374 306 172 0 0 Sugar 662 841 371 0 0 Tekel (tobacco, incl. support purchase) 922 909 797 75 0 Caykur (incl. tea pruning) 104 24 28 14 7 5. Cotton and oilseed premium 265 293 166 0 0 6. ASCU 582 602 0 0 0 7. Farmer transition 0 0 69 104 0 8. Direct income support payments 0 0 500 2,400 1,900 Total 5,399 3,551 2,637 2,593 1,907 Note: Includes programs that would be affected by the agreed reform program. Year 2002 DIS payments include approximately $500 million in "makeup" payments for 2001 plus $1,900 million in "normal" annual payments. Source: Treasury; Own calculations for SEEs 3. Technical: This project builds on recent sector work, experience gained from implementation of DIS program on a pilot scale, and detailed rapid analysis of the costs of restructuring the 16 ASCUs, which together permit a thorough analysis of the costs of the operation together. The structure of the DIS program benefits from the experience gained in similar operations in Romania and Mexico. Cost estimates for the three major components -- DIS program, farmer transition grants, and ASCUs restructuring, severance and labor redeployment -- have been carefully reviewed and agreed between the Government and the Bank. The project's technical design is well suited to Turkey's requirements for rapid investment to support implementation of the agricultural policy reform through establishment of the DIS program on a national scale, provision of grants to farmers seeking to transition to altemative crops, and support for restructuring ASCUs. Specific investment identification and cost estimates have been calculated on the basis of data compiled and analyzed by the preparation and appraisal missions, and reflect the priorities and costs identified by the Government, within an acceptable margin of error for costs. 4. Institutional: The Treasury has been proposed, and agreed to serve as the coordinating implementing agency to oversee the project. Within Treasury, overall responsibility for ARIP implementation rests with the General Directorate for State Owned Enterprises, which has current and past experience providing leadership on this issue for the Government. Two key agencies would sign protocols (Implementing Agreements) with 28  Treasury and have day-to-day responsibility for managing their respective components: MARA for DIS and farmer transition, and the Restructuring Board for the ASCs/ASCUs component. All contracting for ARIP will be managed by the Treasury through the ARIP Project Coordination Unit. Social monitoring activities would be contracted directly by Treasury with an independent third party, with review and oversight by related Government agencies (SPO and SIS). Two small project implementation groups would be established at MARA: one for the DIS component, and one for farmer transition support. The Executive Unit of the ASCU Restructuring Board will support implementation of the ASC component. An interagency Steering Committee chaired by Treasury will provide policy level guidance and coordination among the implementing agencies. 4.1 Executing agencies: The primary executing agency for ARIP is Treasury, the General Directorate for State Owned Enterprises. In coordination with Treasury and support from the PCU, MARA will be responsible for the execution of the DIS and farmer transition components, while the ASC RB Executive Unit will carry out the ASC component. The relative roles, responsibilities and coordination modalities will be defined in the protocols (Implementing Agreements) to be signed between Treasury and MARA, and Treasury and the ASCU RB. 4.2 Project management: As noted above, the project will be coordinated by Treasury, which has experience with Bank-financed projects and plays the leading role within Government for economic policy reform. A Project Coordination Unit (PCU) will be established within Treasury to provide overall coordination of the ARIP and work closely with the other key agencies involved in delivery of project activities. The PCU will comprise a Financial and Procurement/Reporting Department with nine full-time staff to address management, financial, procurement, and reporting/communication functions. Two Deputy Directors will provide daily liaison with MARA and the ASC/ASCUs RB. The Director and Deputy Directors and two staff would be civil servants, and the other four staff would be long term local consultants financed by the ARIP. If the need arises, the number of PCU staff would be increased. In addition, the project will finance short-term international technical assistance and training to assist with organization and functioning of the PCU. The PCU will be responsible for facilitation of project implementation, in particular, operating a sound accounting, financial management and reporting system, producing the required financial statements and Project Management Reports (PMR), and meeting the pre- and post- audit requirements. In addition, as noted above, CIUs will be established in MARA and the ASC/ASCUs RB to support component implementation. The CIUs will each be staffed with local and international consultants financed under ARIP. 4.3 Procurement issues: None. 4.4 Financial management issues: The risks in this operation are considered moderate to high both from the financial control perspective and reputational risk perspective. A number of measures have been/are being agreed to minimize the risks. For example, in the area of severance payments an agreement has already been reached that all severance payments will be pre-audited by an independent firm. Similarly, for FT grants an agreement has been reached for the pre-audit of payments by MARA inspectors. For strengthening the operational 29  oversight an agreement has been reached to appoint an independent firm to conduct the operational audit. As regards, banking arrangements are concerned, which are considered weak, an agency agreement will be required between the treasury and the Ziraat Bank stipulating maintenance of separate accounts in respect of the project funds. The financial management assessment conducted by an accredited FMS in May 2001 revealed that the project authorities have put in place a computerized project financial accounting and reporting system, developed Financial Management and Operational Manuals, appointed Finance Manager and Accountant to handle the financial accounting and reporting, and are in the process of recruiting additional staff for the PCU. Agreements have been reached on various pre-audit and audit arrangements including the TORs. 5. Environmental: Environmental Category: B 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis. Major: None. Other: ARIP supports the implementation of agricultural policy reforms, financing fundamental changes in Turkish agriculture by introducing a program of direct income support, diminishing State control of agricultural commodity prices, and by drastically reducing price supports for of a number of crops that, till now, received considerable State support. The project will likely have social consequences; these are discussed in Section E.6. below. The minor environmental risks are related to the potential improper removal of hazelnut trees from areas not targeted for transition to other crops (e.g., hilly terrain along Black Sea coast that is well suited to hazelnut), and compliance with environmental regulations governing closure of agroindustrial enterprises. Erosion is an important problem along the Black Sea Coast. The effects of erosion are usually exacerbated by incorrect agricultural techniques and illegal forest clearing. Coupled with heavy rainfall, especially in the Eastern part of the region, soils containing nutrients are washed into the sea. Erosion is especially severe in the Trabzon and Samsun provinces where forests are cleared for corn production. Hazelnut plantations on areas which were gained through forest clearing also caused land slides and soil losses. The three most important rivers forming in the Turkish Black Sea region are Kizilirmak, Yesilirmak and Sakarya which originate from the central Anatolian plains. The watersheds of thee rivers are 78,000km2, 38,000 km2 and 58,000 km2, respectively. As elsewhere in Turkey, the use of pesticides and fertilizers is intense in these watersheds and large concentrations of nutrients flow into the rivers by way of soil erosion and groundwater to be discharged into the Black Sea. The applicability of OP 7.50, Projects in International Waterways, for ARIP was considered by the project team. Given that the project has been found to present only very minor environmental risks, that monitoring and mitigation measures for these are to be implemented under the project, and that the project is designed to have no negative impact on international waterways, it has been determined that OP 7.50 would not apply. The Government's ambitious agricultural policy reform program, supported by ARIP, should benefit the environment by gradually phasing out of fertilizer (and, potentially, pesticides) subsidies. The Farmer 30  Transition component of ARIP provides an opportunity for the introduction of environmentally friendly agricultural practices. Such practices would also have the effect of reducing nutrient flows into the groundwater and rivers, ultimately reaching the Black Sea, Agean and Mediterranean. A Global Environmental Facility project aimed at reducing agricultural non-point source pollution in the Black Sea region of Turkey is also being prepared, and would complement the Farmer Transition component of ARIP. Conversion from hazelnut and tobacco to other crops is not anticipated to have any significant negative environmental impact. Conversion from tobacco to other crops is considered environmentally neutral. The possible environmentally negative effects of conversion from hazelnut to other crops have been addressed by the careful targeting of areas of current hazelnut production that will be eligible for support under the Farmer Transition component of ARIP. The only potential problem is with hazelnut, and this has been anticipated in project designs. Based on the surplus production, it is calculated that 100,000 ha of hazelnut area needs to be uprooted. This will cover the three type of areas: i) counties where hazelnut planting has been extended without permission (58,868 ha), consisting mostly of flat land, ii) flat/low lands in both permitted and non-permitted areas where hazelnut is produced, and on slopes less than 6% (estimated as 28,588 ha), and iii) high elevations/forestry areas where most of the production is carried out on illegally cleared forest land, irrespective of the official permission categorization (estimated as 17,544 ha). Switching from hazelnut to other crops in flat lands and on slopes less than 6% does not present environmental risks. The illegally cleared forest land will be replanted with trees appropriate to the ecosystem, such as alder (Alnus sp.), chestnut and walnut. Hazelnut areas on hills and slopes, where the ecology generally does not allow economic production of other crops, will not be included in the Farmer Transition Program. The other environmental issue of moderate concern in the project is the closure of agroindustrial enterprises (e.g., cotton ginning plants, packing houses, warehouses, etc.) that may occur in connection with the restructuring of ASCUs. The number and type of facilities that could be closed cannot be known until the ASCUs begin to carry out their restructuring plans. While Turkish law does not specify environmental liability for facility closures, responsibility for sound environmental management and compliance with applicable regulations rests with the owner of the property, and transfers with the property to the new owner. In consideration of the limited capacity of regional Ministry of Environment (MOE) offices to monitor compliance by the previous or new owners of a facility, the PCU will retain a qualified environmental specialist as needed to assess the requirements and assist the MOE with compliance oversight. The potential impact of the reform program on forest communities and mitigating activities are discussed in the next section. 5.2 What are the main features of the EMP and are they adequate? A brief environmental management plan will be developed by the Borrower to address: (i) the potential minor environmental risks of project interventions, including the hazelnut-tree uprooting, and the environmental risks created by possible factory closings or changes in ownership. Mitigating actions will be listed for interventions where such risks are identified; (ii) the current legislation and procedures to monitor and mitigate the effects of possible outcomes such as uprooting and factory closings (iii) the local institutional set-up and capacity to monitor these interventions and their impact; 31  (iv) the methods, and agencies that will provide environmental oversight. 5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: N/A Given the fact that the project poses no major environmental risks, an EMP is considered sufficient instead of a full EA. The draft EMP (dated April 13, 2001) was reviewed prior to negotiations and found generally satisfactory. The final EMP satisfactory to the Bank will be adopted by the Govermnent not later than July 15, 2001. 5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted? Several environmental NGOs based in Ankara and the Black Sea region, where hazelnut growing is prevalent, are to be consulted by Government regarding the environmental issues associated with the project prior to negotiations. Inputs from the consultation will be taken into account by Government in preparation of the final EMP. 5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP? Treasury as lead agency for the project is responsible for monitoring and evaluating all aspects of the project. The Treasury PCU will coordinate oversight for environmental monitoring with MARA and Ministry of Forestry (should forest lands be at issue) regarding hazelnut uprooting, and with the ASCU Restructuring Board in connection with possible plant closures. Monitoring will be conducted according to the methods and schedule described in the EMP. As noted in the following section a background study is being carried out in order to identify 'hot spot' areas where the DIS might encourage deforestation and where the DIS registration process should be speeded up. If necessary a pilot project will be launched to address specific difficulties faced by farmers of forest lands. Also, data collected in social monitoring and evaluation exercise will be used by a research institute in MARA to track changes in cropping patterns and their impact in forest areas. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. The policy reforms are designed to have wide-ranging long term social benefits. These will accrue to Turlish society in the form of higher agricultural productivity, lower food expenditures, more efficient public expenditures, and a healthier economy. Net benefits will also accrue directly to certain groups of farmers. These include farmers that do not currently receive input subsidies and support prices for their crops and farmers that are net consumers of crops that receive price supports, such as livestock producers. The reforms mnight well have short and medium term negative effects, including higher social tension and increased poverty among some groups. The project is designed to mitigate potential short and medium term negative effects resulting from the policy reforms. The most vulnerable to the reforms are farmers 32  will be made redundant as a result of restructuring. Farmers will be provided with DIS and Farmer Transition assistance, and redundant ASCU employees will receive severance payments. Farmers growing crops that have the highest support prices (in relation to world prices) are expected to face the greatest difficulties. These include tobacco, sugar beet, hazelnut, and tea farmers. Farmers, as well as other stakeholders involved in the production of these crops, participated in a series of qualitative social assessments. The purpose of these assessments was to: (a) characterize production and marketing patterns, with an emphasis on identifying differences in these patterns between small (poor) and large (non-poor) farmers; (b) identify current land tenure and land ownership structures; (c) determine farmer perceptions and expectations of the proposed agricultural policy reforms; and (d) assess the potential impact of the proposed agricultural policy reforms on rural to urban migration. Detailed results of these assessments are summarized in Annex 12 and are available in background papers found in the project files. The social assessment revealed that certain groups of hazelnut and tobacco farmers are likely to face the greatest difficulty as a result of the policy changes. These are hazelnut farmers on steep mountain slopes in the North East and tobacco sharecroppers in the South East. As with all farmers, these groups will be eligible for DIS payments. However, since the short-term impact is expected to be more severe for them than for other groups, these farmers may also receive special payments in addition to the DIS. In the long term, the Farmer Transition Support component will indirectly soften the impact of policy reforms on these groups by reducing supply. Also, over time, careful social monitoring and evaluation will be used to improve the delivery of DIS payments to these vulnerable groups, as well as other vulnerable groups identified during monitoring and evaluation. The social assessments found that in some areas many farmers do not have proof of land ownership. A procedure for lowering the cost to the farmer of processing land titles is included in the loan conditions. In more complicated cases, the DIS component of the project will establish a mechanism whereby farmers or landowners without deeds can register for DIS through a process of confirmation with local MARA offices, TZOB, the village council and Muhtar. This registration process raises the possibility that there will be disputes over land boundaries. There are two legally binding land dispute resolution mechanisms in Turkey, (a) referee boards, and (b) expert committees. Referee boards are court approved semi-formal processes. Dispute holders enter into a contract with a mutually agreed person, committee, or NGO that will arbitrate a resolution for them. After the contract is notarized, the process is initiated. A judge from the local court evaluates both the contract and the referee board decision and elects to approve or reject it (usually it is approved). Expert Committees are organized when a dispute is taken directly to the court. In this case the court selects a committee of experts to make a decision. These experts are professionals registered with the court and randomly selected for each case. Dispute holders apparently prefer this method because it is more convenient and transparent. Project component D will facilitate the land dispute resolution process, since the public information campaign will provide information to farmers on their rights and the land dispute resolution mechanisms. MARA is also funding from its own budget informal dispute resolution mechanisms to facilitate the DIS registration process. A potential concern is the eligibility for DIS of households growing their crops on forest land. A social assessment of issues affecting forest communitie.X' and the magnitude of their economic activities on forest lands was recently completed for the Forest Sector Review. Recent field visits indicate that holdings are small and many farmers on forestlands are engaged in animal husbandry or subsistence 33  farming. Therefore they are not expected to face particular difficulties as a result of the policy changes. Nonetheless, because land ownership is sometimes contested in forest lands, the public information campaign will encourage farmers in these areas to register for DIS using the same confirmation process used in other areas. A background study is being carried out in order to identify 'hot spot' areas where the DIS might encourage deforestation and where the DIS registration process should be speeded up. If necessary a pilot project will be launched to address specific difficulties faced by farmers of forest lands. The government would then be able to assist forestland households and other stakeholders to establish new participatory systems for sustainable, multi-use management of forest resources. Farmer perceptions and expectations of the reform program vary widely. Large farmers are typically much more familiar with the reform program than small farmers. Small farmers are fearful about potential changes in production and marketing and their ability to receive Government support. The Public Information Campaign will address this issue directly by providing information about DIS and farmer transition in a manner accessible to small farmers and appropriately adapted to different target audiences. This includes radio and television announcements, posters in mosques and coffee shops, and access to appropriately trained local extension agents. Many farmers indicated that one or more members of their household would be tempted to migrate in search of better income earning opportunities if price supports are removed. The social and economic impacts of migration induced by the policy reforms can not be predicted, but they most likely include changes in intra-household resource and labor allocation and costs in terms of the burden of finding new employment. The project will help to prevent migration that could be expected to occur in areas where there are numerous sharecroppers growing crops with high support prices. As noted earlier, special care is being taken to design a system that provides suitable and appropriately targeted payments to these farmers through a system complementary to the DIS. This system is likely to target sharecropper DIS payments per household rather than per hectare in order to avoid the burden of demonstrating land use in politically sensitive areas. In addition the social monitoring and evaluation system is designed to track the effects of the reformns on rural to urban migration. Approximately 12,000 ASCU employees will be made redundant as a result of the restructuring exercise. Detailed procedures have been defined and agreed with the Government to ensure eligible workers receive severance payments consistent with Turkish labor law. Redundant workers will also be eligible for local Labor Redeployment Services through the proposed Privatization Support Project. These include employment services, retraining services and small business assistance. The social monitoring and evaluation system will used to identify and make recommendations for adjustments to help individual workers and families that are experiencing problems re-entering the workforce as a result of ASCU restructuring. Monitoring and evaluation of the project is critical to successfully achieve the social development objectives. Project Component D provides for a Social Monitoring and Evaluation System that will be closely integrated with the financial management system. This system will allow tracking of DIS and farmer transition payments to the household and enable rapid and systematic evaluation of the policy reform and project interventions on rural households. It will ensure that problems with project components such as the DIS, Farmer Transition, Public Information Campaign, and severance payments can identified and that support can be redirected mid-stream as reeded. Two social monitoring systems will be financed by the project. The first will monitor the economic and social status of farmers throughout the country. The second will monitor the coping strategies of ASCU employees that are made redundant as a result of restructuring. Both systems will provide for analysis by 34  various socio-demographic features (e.g. age, sex, education, household size and region). A detailed description of the social monitoring and evaluation system is included in Component D. 6.2 Participatory Approach: How are key stakeholders participating in the project? Key stakeholders in the government include Treasury, MARA, and MIT. Outside the government they include farmers from different regions, farmer associations, private businessmen, ASCU and ASCs management and employees. Key stakeholders have and will continue to be directly involved in project design and implementation through ongoing dialogue with the project team. During project preparation and appraisal detailed discussions were held with all of the stakeholders. Treasury supports the project because it will lead to large short term fiscal savings and long term fiscal sustainability in the agricultural sector. MARA has traditionally administered the system of support prices and input subsidies. Therefore they have been unenthusiastic about the reform program. However, enthusiasm has increased as their understanding of the role they play in the DIS and the Farmer Transition components increased. TZOB's position is unclear. However, since its members are mostly the large, wealthy farmers that have profited the most from the system of support prices and subsidies, they will probably lean against the reform program. Farmers that are members of cooperatives (ASCs) affiliated with ASCUs will gain greater control of the cooperative, and are expected to favor the reforms. A more detailed, country-wide analysis of the political economy of the overall reform program is currently ongoing and provides a more comprehensive stakeholder analysis. During project implementation the Public Information Campaign will provide stakeholders with up-to- date information on project activities and services and how to access them. The campaign will be adapted to different stakeholders and include a mechanism for them to get clear answers to their questions from local extension agents and possibly hotlines or advisory services. Formal social monitoring and evaluation will be ongoing throughout the project to determine if effected households and groups are receiving the intended support. Once identified, qualitative interviews and focus groups will be held with those not receiving the intended support to determine how the project components can be redirected. The monitoring activities will also collect informnation on knowledge, attitudes, and perceptions of the reform program. This information will then be used to improve the effectiveness of the Public Information Campaign and build-up commitment and ownership. 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? Two workshops, attended by the press, representatives from civil society, and NGOs, were held to describe the Agricultural Reform Program and solicit feedback. In addition to consultation with stakeholders, informnal meetings were held with a number of NGOs. These included the Union of Chambers of Agriculture of Turkey (TZOB), Chamber of Engineers of Agriculture, Sustainable Agriculture Association, Agricultural Development Training and Social Solidarity Foundation, Development Foundation of Turkey, Aegean Farmer's Association and Union of Tekirdag Onder Farmers. ASCU/ASC capacity building will rely on NGOs and local institutions for the suggestions on the design and possibly implementation of training and business support activities. 6.4 What institutional arrangements have been provided to ensure the project achieves its s.'cial development outcomes? 35  In addition to project components designed to specifically mitigate potentially adverse policy impacts, a Public Information Campaign and a Monitoring and Evaluation System will be used to support project implementation. The Public Infornation Campaign ensures that farmers and ASCU/SEE employees are fully aware of the services available to them through the project and builds ownership and commitment. The Monitoring and Evaluation System ensures that project components can be adjusted mid-stream if they are not achieving their intended social objectives. 6.5 How will the project monitor performance in terms of social development outcomes? Inplementing the monitoring activities will be the responsibility of a third party contracted by the PCU. The project evaluation will be prepared on an annual basis by Senior Project Social Advisor and the evaluation and reconmmendation will be presented simultaneously to the PCU, Supervising World Bank Staff, Treasury, MARA, and MIT. 7. Safeguard Policies: 7.1 Do any of the following safeguard policies apply to the project? Policy Applicability Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) Yes Natural habitats (OP 4.04, BP 4.04, GP 4.04) No Forestry (OP 4.36, GP 4.36) No I Pest Management (OP 4.09) No Cultural Property (OPN 11.03) No Indigenous Peoples (OD 4.20) No Involuntary Resettlement (OD 4.30) No Safety of Dams (OP 4.37, BP 4.37) No Projects in International Waters (OP 7.50, BP 7.50, GP No 7.50) t Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60) No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. F. Sustainability and Risks 1. Sustainability: Any transition period is risky, but once the new DIS system is established, it should be more fiscally sustainable than the current system. It should also be politically sustainable, since DIS should be popular with farmers. Nonetheless, there will be substantial pressure for backsliding (see below). 36  2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1): Risk Risk Rating Risk Mitigation Measure From Outputs to Objective Political backlash could cause policy S The best counter-measures are: ensuring that reversals. The reforms will in the short stakeholders are adequately consulted; run reduce incomes of many farmers, carrying out a good public information and will cause some lay-offs from SEEs campaign; putting in place as quickly as and ASCUs. The new system possible the DIS system (especially in areas undermines the power base of two strong most affected by removal of support price ministries. This will create pressure for system); paying severance payments to laid- reversal or non-implementation of off workers; and building ownership of measures, or starting new subsidy ASCs/ASCUs by the members. schemes. DIS system could be under- or over- M We will carry out a continuous dialogue with funded. There will be pressure from both the Government and the RMF on this, farmers to make these payments high with the objective of ensuring that the funding enough to fully compensate for loss of is sufficient to adequately cushion the fall in subsidies and others concerned with incomes in a transition period, but still realize fiscal cost to make them very low. significant savings. Some funding for 2001 has already been placed in the budget, and the quick-disbursing component of ARIP would allow the government to more fully fund the program. From Components to Outputs The biggest risk for the ASC/ASCUs H Starting in 2001, most of the ASCUs will component is the possibility that begin repaying Price Stabilization and Support Government is not really serious about Fund (DFEF) credits but payments will not be withdrawing from these organizations returned to the budget but to a revolving fund and giving them independence and managed by the restructuring board. If the autonomy. board is independent, this means that the Government will no longer have the power to The additional risk is that the member allocate credits among the ASCUs. owners of the ASCs/ASCUs (i.e. Nonetheless, the Government may try to exert farmers) are not interested in taking fully influence. control of the ASC system because the system is too much discredited or does Elections will be held to elect ASC and ASCU not offer adequate potential for the boards of directors. If properly conducted, future. they will be the start of rebuilding farmer member support of their cooperatives. Even if these two risks can be successfully minimized, there will remain the unavoidable risk that many Only the ASCs/ASCUs which are successful in ASCs/ASCUs will ultimately prove to be transforming themselves into financially unsustainable, either because they fail to autonomous and viable businesses will survive. fully implement the necessary restructuring, or because, in the end, they 37  simply cannot compete with the private traders and regain the large share of the market already captured by these traders. For the farmer transition component, the M This risk is mitigated by the fact that these biggest risk from output to objective is crops will have large declines in their relative that few farmers will want to switch prices, so the incentives will be strong tc from the over-supplied crops, or will switch for farmers whose opportunity costs are decide to switch back. high (i.e., who have good altematives). Development of farmers' organizations to assist the farmers in growing alternative crops will also encourage the transition. Overall Risk Rating S l Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) 3. Possible Controversial Aspects: Social aspects Potentially controversial social aspects include the targeting of DIS payments, the size of DIS payments and Farmer Transition Support, and the eligibility of sharecroppers and farmers growing crops on forest land to receive DIS payments and Farmer Transition grants. Also, displacement of workers from ASCUs during restructuring is controversial, particularly with unions. Every effort has been made to design a simple, transparent system for delivering the DIS and Farmer Transition payments to farmers. This in fact was an important consideration in certain design features in the project, which were chosen over other options that would have had advantages, but would also have been more complicated and therefore less transparent. However, as with any government support program there is a risk that the system would become corrupted so that payments would be used to achieve political goals rather than long term economic efficiency. One of the major reasons for the Bank's continued involvement is to help the Government mitigate this risk. The removal of the price supports may result in a significant decrease in the welfare of poor sharecroppers in certain regions of the country. In order to avoid the social and economic problems associated with a large rural to urban migration in these regions, special care is being taken to design a system that provides suitable and appropriately targeted payments to these sharecroppers. While it can be expected that there will be some opposition to layoffs in the ASCUs and ASCs, the severance payments should be seen as a humane safety net to mitigate the adverse effects of a downsizing that was inevitable, given the unsustainability of the previous heavy subsidies and over-employment. The public information campaign will explain the program in this light. It is worth noting that many of the retrenchments have already occurred, and the only instances of serious protests were on those occasions when severance payments were deferred because Treasury did not have the funds to pay them immediately. Monitoring and managing these aspects of the project will be carried out in several ways, including: (a) regular qualitative and quantitative surveys of farm households, particularly in the areas where farmers are expected to face the greatest difficulties; (b) annual social impact evaluation to provide PCU, C1U and other key stakeholders with recommendations for mid-stream adjustments; (c) provision of severance payments to eligible displaced ASCU workers, and (d) regular updating of the types and availability of project support available to farmers through the public information campaign. 38  Perceptual and reputational risk issues Two aspects of the project could be controversial if they are misunderstood. One is the project's involvement with the tobacco subsector, which could be misunderstood as supporting tobacco production. In reality, the project does not support tobacco production in any way; to the contrary, one of its major objectives is to reduce production. It will do this in two ways: through the policy dialogue by supporting the elimination of the support price, which has artificially increased production; and through the farmer transition component, which will provide financial assistance to farmers to help them stop growing tobacco. A second facet of the project which might be controversial if it is misunderstood is the uprooting of hazelnut trees, which might be perceived to encourage erosion. In reality, the project design guards against this by excluding from eligibility hillside areas which would be subject to erosion. Uprooting will only be encouraged in flatland areas with good potential for other crops, which will be quickly re-planted. The reputational risk to the Bank from both of these potentially controversial aspects will be mitigated by the public information campaign, which will explain clearly the true nature of the project. Severance paynents The Operational Memorandum "Financing Severance Pay in Public Enterprise Reform Operations". dated March 5, 1996, requires that financing of severance payments under Bank projects must meet several criteria. First, the enterprises must be in the public sector. ASCUs should be considered public sector enterprises for this purpose, based on the following considerations: 1) Until the new law on ASCUs was promulgated, the government had effective control over the management of ASCUs; 2) ASCUs have not had financial autonomy from the govemment; and 3) ASCUs have been used by the government for public purposes. Since ASCs operate essentially as branch offices of the ASCUs, the same justification applies to them. Second, "the design and justification of the project must be based on the increased productivity of the activities remaining in the enterprise or sector after restructuring and on the related development activities". It is clearly true that retrenchment of surplus and over-paid workers in the ASCUs and ASCs will greatly increase productivity of the sector and economy. First, retrenchment will directly increase the productivity of the agricultural sector and economy. An estimated 20-25 percent of the workers in ASCUs as of the start of the retrenchment program were redundant (i.e, produced no added value); with the planned retrenchments, the enterprises will be producing at least as much value, with a much smaller workforce. Laid-off workers will find alternative employment in jobs where they will add real value, thus guaranteeing increased efficiency in the sector and increased output in the economy as a whole. As shown in the tables in section E. 1, these investments in retrenchment will generate high financial and economic rates of return. Second, retrenchment is an essential step in the re-privatization of sales cooperatives and unions, and the private control will in and of itself improve productivity because of the changed incentive structure. Third, the savings from retrenchment will allow the ASCUs to operate more efficiently by providing them a source of working capital. For some of them, it is essential to their survival, since the resources available from the revolving fund would not be adequate for them to continue to operate without a substantial supplement from their own resources. While it is difficult to quantify the last two effects, they will nonetheless result in real productivity improvements in the sector. Finally, the OM states that "an important concern for the Bank is making sure that workers who have received severance packages are not rehired by the same enterprise if it remains in the public sector", although it goes on to note that "Once an enterprise has been privatized, under a well designed restructuring program, the rehiring of previously retrenched workers would be unlikely, since hiring decisions would be disciplined by market forces." Since the ASCUs are in essence being privatized, 39  there would not be any special incentive to re-hire laid-off employees, unless it were economically sensible to do so. Nonetheless, employees paid severance under the project and the ASCUs and ASCs from which they are re-trenched must sign an agreement against re-hiring. G. Main Loan Conditions 1. Effectiveness Conditions Standard loan conditions to effectiveness. 2. Other [classify according to covenant types used in the Legal Agreements.] Loan covenants would require that the government undertake the following actions: 1) Carry out an annual review of i) progress in implementing the reform program described in the letter of development strategy; ii) implementation of previous year's annual Work Plan for the project; and iii) the Annual Work Plan for the upcoming year; 2) Enter, through the Undersecretariat of the Treasury, into a binding protocol with the Ziraat Bank, which shall describe the rights and responsibilities of the Ziraat Bank under the Project; 3) Ensure that the ASCU/ASC Restructuring Board enters into a Cooperation Agreement with each Participating ASCU/ASC; 4) Enter, through the MARA, into a Farmer Transition Support Grant Agreement with each Participating Farmer; and 5) Adopt, no later than July 15, 2001, an Environmental Management Plan satisfactory to the Bank. Conditions for release of the first quick-disbursing tranche would be i) satisfactory performance in the macroeconomic program; ii) satisfactory performance in implementing the general sectoral reform program (as described in the Letter of Sectoral Policy); iii) adoption of a 2001 revised budget that : (a) does not provide for any new direct or indirect agricultural subsidies; and (b) does not increase existing direct or indirect agricultural subsidies, in real terms, as compared to subsidies in effect on January 1, 2001; and iv) initiation of DIS payments, defined as "25% of farmers registered and of these, 50% paid". Conditions for release of the second quick-disbursing tranche would be i) satisfactory performance in the macroeconomic program; ii) submission to Parliament of a draft 2002 budget that: (a) does not provide for credit or fertilizer subsidies; and (b) does not increase other existing direct or indirect agricultural subsidies, in real terms, as compared to subsidies in effect on January 1, 2001; iii) satisfactory performance in implementing the general sectoral reform program (as described in the Letter of Sectoral Policy); iv) further progress in the initiation of DIS payments, defined as "50% of farmers registered and of these, 50% paid"; and (v) by November 1, 2002, or when the other conditions are met, whichever comes first, reduction in TMO wheat purchases to a level satisfactory to the Bank. 40  H. Readiness for Implementation The engineering design documents for the first year's activities are complete and ready for the start of project implementation. Not applicable. The procurement documents for the first year's activities are complete and ready for the start of project implementation. Not applicable. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. The following items are lacking and are discussed under loan conditions (Section G): Not applicable. 1. Compliance with Bank Policies This project complies with all applicable Bank policies. fZV,r John D. Nash fseph R. Goldberg obannes . Linn Team Leader ector Manager pRe