Document of The World Bank REPORT NO. ICR 00001008 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-74690) ON LOANS IN THE TOTAL AMOUNT OF US$500 MILLION TO THE REPUBLIC OF TURKEY FOR A COMPETITIVENESS AND EMPLOYMENT DEVELOPMENT POLICY LOAN (CEDPL) APRIL 1, 2009 Private and Financial Sector Turkey Country Department Europe and Central Asia Region TURKEY- GOVERNMENT FISCAL YEAR January 1 ­ December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of March 31, 2009) Currency Unit Turkish Lira (TL) US$ 1.00 1.6670 TL YTL 1.00 0.59 US$ WEIGHTS AND MEASURES Metric System ABBREVIATION AND ACRONYMS BOP Balance of Payments BRSA Banking Regulation and Supervision Agency CAD Current Account Deficit CAE Country Assistance Evaluation CAS PR Country Assistance Strategy Progress Report CBRT Central Bank of the Republic of Turkey CEM Country Economic Memorandum CEN European Committee for Standardization CENELEC European Committee for Electrotechnical Standardization CIT Corporate Income Tax CMB Capital Markets Board CPI Consumer Price Index CPS Country Partnership Strategy DIS Direct Income Support DPL Development Policy Loan EA-MLA European Co-operation for Accreditation - Multilateral Agreement EBA Execution and Bankruptcy Act EC European Commission EIA Environmental Investigation Agency ERL Economic Reform Loan EU European Union FDI Foreign Direct Investment FSAP Financial Sector Assessment Program FX Foreign Exchange GDP Gross Domestic Product GDPA General Directorate of Public Accounting GERD Gross Expenditures on R&D GFS Government Financial Statistics GNP Gross National Product HCP High Council of Privatization IAF-MLA International Accreditation Forum ­Multilateral Recognition Arrangement IBRD International Bank for Reconstruction and Development ICA Investment Climate Assessment ICS Investment Climate Survey ICT Information and Communication Technologies IFRS International Financial Reporting Standards ILAC-MRA International Laboratory Accreditation Cooperation ­Mutual Agreement IMF International Monetary Fund ISPA Investment Support and Promotion Agency of Turkey IPO Initial Public Offering IPPC Integrated Pollution Prevention and Control IPR Intellectual Property Rights ISE Istanbul Stock Exchange ISIC International Standard Industrial Classification ISO International Organization for Standardization IT Information Technology KOSGEB Small and Medium Industry Development Organization M&E Monitoring and Evaluation MEF Ministry of Environment and Forestry MFC Mortgage Finance Corporations MOF Ministry of Finance MYOs Vocational Schools NDP Ninth Development Plan NIS National Innovation System NQS National Quality System OECD Organization for Economic Cooperation and Development PA Privatization Administration PASB Public Accounting Standards Board PDEF Provincial Directorates of Environment and Forestry PEM Public Expenditure Management PFMC Public Financial Management and Control PFPSAL Programmatic Financial and Public Sector Adjustment Loan PIP Public Investment Program PISA Program for International Student Assessment PIT Personal Income Tax PPA Public Procurement Agency PPDPL Programmatic Public Sector Development Policy Loan PSSP Privatization Social Support Project R&D Research and Development SBA Stand-By Arrangement SDIF Saving Deposits Insurance Fund SDR Special Drawing Rights SME Small and Medium Scale Enterprises SOEs State Owned Enterprises SPA Special Provincial Administration SPO State Planning Organization TCA Turkish Court of Accounts TFP Total Factor Productivity TPE Turkish Patent Institute TSE Turkish Standards Institute TTGV Technology Development Foundation of Turkey TUBITAK The Scientific and Technological Research Council of Turkey TURKAK Turkish Accreditation Agency TURKSTAT Turkish Statistical Institute UHI Universal Health Insurance UHIF Universal Health Insurance Fund UME National Metrology Institute UNCITRAL United Nations Commission on International Trade Law VAT Value Added Tax VC Venture capital TL Turkish Lira Vice President: Shigeo Katsu Country Director: Ulrich Zachau Sector Director: Fernando Montes-Negret Sector Manager Gerardo M. Corrochano Task Team Leader: Rodrigo A. Chaves ICR Team Leader: Carlos E. Pinerua Authors: Carlos E. Pinerua THE REPUBLIC OF TURKEY COMPETITIVENESS AND EMPLOYMENT DEVELOPMENT POLICY LOAN CONTENTS Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring 1. Program Context, Development Objectives and Design ......................................................... 1 2. Key Factors Affecting Implementation and Outcomes ........................................................... 5 3. Assessment of Outcomes......................................................................................................... 8 4. Assessment of Risk to Development Outcome...................................................................... 14 5. Assessment of Bank and Borrower Performance .................................................................. 14 6. Lessons Learned..................................................................................................................... 16 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners........................ 16 Annex 1 Bank Lending and Implementation Support/Supervision Processes........................... 17 Annex 2. Program Matrix for the CEDPL................................................................................. 19 Annex 3. The Government's Contribution to the Implementation Completion and Results Report to CEDPL....................................................................................................................... 25 MAP A. Basic Information Competitiveness and Employment Country: Turkey Program Name: Development Policy Loan (CEDPL) Program ID: P074181 L/C/TF Number(s): IBRD-74690 ICR Date: 04/01/2009 ICR Type: Core ICR REPUBLIC OF Lending Instrument: DPL Borrower: TURKEY Original Total USD 500.0M Disbursed Amount: USD 506.4M Commitment: Implementing Agencies: Undersecretariat of Treasury Cofinanciers and Other External Partners: B. Key Dates Process Date Process Original Date Revised / Actual Date(s) Concept Review: 03/16/2007 Effectiveness: 07/18/2007 Appraisal: 05/23/2007 Restructuring(s): Approval: 06/28/2007 Mid-term Review: Closing: 09/30/2008 09/30/2008 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Satisfactory Risk to Development Outcome: Moderate Bank Performance: Satisfactory Borrower Performance: Satisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Not Applicable Quality of Supervision: Satisfactory Implementing Agency/Agencies: Not Applicable Overall Bank Overall Borrower Performance: Satisfactory Performance: Satisfactory i C.3 Quality at Entry and Implementation Performance Indicators Implementation QAG Assessments Performance Indicators (if any) Rating: Potential Problem Quality at Entry Program at any time No None (QEA): (Yes/No): Problem Program at any Quality of No None time (Yes/No): Supervision (QSA): DO rating before Closing/Inactive status: D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) Banking 13 13 Central government administration 15 15 General industry and trade sector 54 54 Housing finance and real estate markets 13 13 Sub-national government administration 5 5 Theme Code (Primary/Secondary) Export development and competitiveness Secondary Secondary Personal and property rights Secondary Secondary Regulation and competition policy Primary Primary State enterprise/bank restructuring and privatization Secondary Secondary Tax policy and administration Secondary Secondary E. Bank Staff Positions At ICR At Approval Vice President: Shigeo Katsu Shigeo Katsu Country Director: Ulrich Zachau Ulrich Zachau Sector Manager: Lalit Raina Gerardo M. Corrochano Program Team Leader: Carlos Pinerua Rodrigo A. Chaves ICR Team Leader: Carlos Pinerua ICR Primary Author: Carlos Pinerua Carlos Elbirt Irem Guceri Paula Genis ii F. Results Framework Analysis Program Development Objectives (from Project Appraisal Document) The CEDPL supports legal, institutional, and structural reforms that promote growth and the creation of more and better jobs in Turkey by helping (a) maintain the currently enabling macroeconomic framework; (b) improve the investment climate - including a large program of privatization of state owned enterprises (SOEs), (c) set the foundations for overhauling labor market regulations in the future, (d) increase access to investment capital, and (e) promote the generation of knowledge and innovation, the adoption of new technologies, and upgrading the skills of the labor force. Revised Program Development Objectives (if any, as approved by original approving authority) (a) PDO Indicator(s) Original Target Formally Actual Value Indicator Baseline Value Values (from Revised Achieved at approval Target Completion or documents) Values Target Years Indicator 1 : Maintain Macroeconomic Stability Value (quantitative or Qualitative) Date achieved Comments (incl. % achievement) Indicator 2 : Improve Investment Climate Value (quantitative or Qualitative) Date achieved Comments (incl. % achievement) Indicator 3 : Increase employment Value (quantitative or Qualitative) Date achieved Comments (incl. % achievement) Indicator 4 : Increase access to investment capital iii Value (quantitative or Qualitative) Date achieved Comments (incl. % achievement) Indicator 5 : Promote the generation of knowledge and innovation, adoption of new technologies, and upgrading of labor force skills Value (quantitative or Qualitative) Date achieved Comments (incl. % achievement) (b) Intermediate Outcome Indicator(s) Original Target Formally Actual Value Indicator Baseline Value Values (from Achieved at approval Revised Completion or documents) Target Values Target Years Indicator 1 : Consumer Price Index (% change) Value (quantitative or 9.23% 7.5% 10.06% Qualitative) Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 2 : Current account deficit (% GDP) Value (quantitative or 6.1% Long term decline 5.7% Qualitative) Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 3 : Public Debt / GDP (%) Value (quantitative or 34% Long term decline 29% Qualitative) Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) iv Indicator 4 : FDI (in million USD Value (quantitative or 20,185 Long term 22.046 Qualitative) increase Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 5 : FDI (% of GDP) Value (quantitative or 3.83% Long term 3.36% Qualitative) increase Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 6 : Share of informal sector workers in total Value (quantitative or 47.1% Long term 43.4% Qualitative) decrease Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 7 : Participation of SOEs in GDP (%) Value Reduction as a (quantitative or 1.89% result of 1.58% Qualitative) privatization Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 8 : Budgetary support for SOEs (% of GDP) Value (quantitative or 0.69% Decrease from 0.29% Qualitative) 2006 ratio Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 9 : Time for Registering Firms (days) Value (quantitative or 9 Declining trend 6 Qualitative) Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) v Indicator 10 : Number of procedures to acquire a license Value (quantitative or 25 Declining 25 Qualitative) substantially Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 11 : Share of Corporate Income Tax in Overall Tax Revenues (%) Value (quantitative or 8.2% Increasing due to 9.2% Qualitative) lower informality Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 12 : Employment rates (%) Value (quantitative or 43.2% 46.8% (By 2013, 44.3% Qualitative) CPS matrix) Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 13 : Unemployment rates (%) Value (quantitative or 9.9 Declining over the 9.9 Qualitative) longer term Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 14 : Capital Adequacy Ratio (%) Value (quantitative or 21.60% Maintain current 17.53% Qualitative) ratio Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 15 : Volume of housing finance (as % of GDP Value Inrease as a result (quantitative or 2.90% of deeper financial 4.00% Qualitative) markets Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) vi Indicator 16 : Non Performing Loans/Total Loans Value (quantitative or 3.60% Maintain the 3.77% Qualitative) current ratio Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 17 : Number of patents Value (quantitative or 4,303 Increase from 4,871 Qualitative) 2006 Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) Indicator 18 : Industry-funded R&D in total R&D spending Value (quantitative or 46% Increase from 47.1% Qualitative) 2006 Date achieved 12/31/2006 12/31/2008 12/31/2007 Comments (incl. % achievement) G. Ratings of Program Performance in ISRs Actual No. Date ISR Archived DO IP Disbursements (USD millions) H. Restructuring (if any) Not Applicable vii 1. PROGRAM CONTEXT, DEVELOPMENT OBJECTIVES AND DESIGN 1.1 Context at Appraisal Country and Sector Background. Employment growth and long-term macroeconomic stability are key policy challenges for Turkey. After suffering a major macroeconomic crisis in 2001, the Turkish economy grew at an average of 6.8 % in the period 2002-2007. Output increased more than a third in this period--the strongest growth performance among OECD members. Growth also reduced poverty significantly. The reversal in economic performance was largely the result of five factors: first, broad political stability that helped assure policy continuity during that period; second, a macroeconomic policy framework centered on fiscal discipline and an independent monetary policy, which led to reduced public sector deficits, lower public debt levels, and helped anchor inflationary expectations; third, an improved investment climate associated with the implementation of a number key structural reforms (social security reform, financial sector reform, energy sector reforms, and an ambitious privatization program); fourth, a global economic environment of high liquidity benefiting emerging markets; and fifth, Turkey signaled commitment to improved policies by pursuing EU membership. On the latter, the government's reforms geared towards raising competitiveness, improving financial intermediation, and expanding employment opportunities, which are being supported by the Bank, are fully consistent with the Lisbon Agenda. After the recovery from the 2001 crisis, the country started addressing second and third generation policy issues. Against a background of low employment generation, declining employment ratios, high informality, and comparatively high unemployment, the authorities were determined to sustain rapid growth and to improve the quality of life of its citizens. In 2007, the overall employment rate for ages between 15 and 64 in Turkey was 45.8 percent, significantly lower than the 65.4 percent average in EU-27 countries and far from the Lisbon target of 70 percent by 2010. Unemployment and informality rates were comparatively high as well at around 10 and 47 %, respectively. Employment generation did not occur hand in hand with the growing economy partly due to the massive structural change the country is undergoing, with agriculture shedding large quantities of labor, and partly because of the lack of flexibility in the labor market. In response, the authorities adopted--and are implementing--a comprehensive long term program to modernize the economy: the 9th Development Plan (NDP). The NDP's broad policy vision is "a Turkey which grows in stability, shares her income more equitably, is competitive at a global scale, transforms into an information society and has completed the stage of legal harmonization for EU membership." In order to achieve this vision, the NDP comprises five "development axes" or strategic areas of action, namely: (a) Increasing Competitiveness, (b) Increasing Employment, (c) Strengthening Human Development and Social Solidarity, (c) Ensuring Regional Development and (d) Increasing Quality and Efficiency in Public Services. Rationale for Bank Assistance. In line with the major challenges stated in the NDP, the Competitiveness and Employment Development Policy Loan (CEDPL) was designed to assist the Government in sustaining growth, increasing competitiveness and generating 1 more jobs. The CEDPL program was fully aligned with the NDP (Table 1). The CEDPL was also expected to contribute to the achievements of the outcomes outlined in the 2003 CAS and the 2005 CAS Progress Report (CAS PR), including: (a) making the economy more resilient to crises that disproportionately affect the most vulnerable; (b) making the business environment more attractive with increased emphasis in the knowledge economy, (c) contributing to sustainable economic growth that is critical to pull many of the poor out of poverty; and (d) promoting human development to create opportunities for the poor, including more and better jobs. Reflecting the complexity and nature of reform processes, while designed as a free- standing operation, the CEDPL was embedded in a programmatic framework. More specifically, while the original intention was to prepare this operation as the first in a programmatic series, due to the political uncertainty at that time (to be discussed below), the Government and the World Bank agreed to proceed with it as a stand-alone operation in order to preserve the policy dialogue with the authorities while still acknowledging possible emerging risks to the sustainability of the reform effort and the achievement of the development objectives. Table 1: Elements of the Ninth Development Plan (2007-2013) Supported by CEDPL Enhancing Export Competitiveness, FDI and the Investment Climate Making macroeconomic stability permanent Reducing informality in the economy Increased investments in R&D Simplification of the tax mechanism and transaction costs Improved IPR implementation and enforcement Continuation of the Reform Program for Improving the Investment Environment in an effective manner Reduction in the share of SOEs in national income and employment as a result of privatization Improving Financial Intermediation Increased depth of capital markets Establishment of autonomous regulatory structure for all financial institutions Improvement of accounting and supervision standards in the financial system Activities to encourage corporate governance principles Improvement of minority shareholder rights Expanding Employment Opportunities 2 Reduction of burden (costs) on employment Policies/programs to encourage participation of young and women Labor market with more flexible and active structure by joint evaluation of flexibility and job security Adoption of lifelong learning strategy geared to skill building 1.2 Original Program Development Objectives (PDO) and Key Indicators. Based on the Program Matrix embedded in the CEDPL program document (See Annex 2), the following objectives and indicators were identified for the CEDPL: Objectives Maintaining an enabling macroeconomic framework. Improving further the investment climate. Setting the foundations for overhauling labor market regulations as a way to increase employment Increasing access to capital and credit Promoting the generation of knowledge and innovation, the adoption of new technologies, and upgrading of labor force skills Key indicators Success in reaching the objectives mentioned above was expected to be gauged by the behavior of the following indicators:1 Macroeconomic stability: o Inflation (CPI) o Current account deficit o Public debt ratios Investment climate: o FDI flows (in US$) o FDI flows (% of GDP) 1Because some of the indicators were defined in a vague manner, the team retrofitted the results framework. However, this does not preclude a proper assessment of whether outcomes were achieved. 3 o Share of GDP produced by SOEs o Budgetary support for SOEs o Time for Registering Firms (days) o Share of Corporate Income Tax in Overall Tax Revenue (%) Labor markets: o Employment rates (%) o Unemployment rates (%) Increase Access to Investment Capital/Financial sector: o Capital Adequacy Ratio (%) o Non-Performance Loans as % of the Total o Mortgage financing (as % of GDP) Knowledge and Innovation: o Number of patents o Industry-funded R&D in total R&D spending 1.3 Original Policy Areas Supported by the Program (as approved) In line with the objectives ­and indicators--mentioned before, the CEDPL supported the authorities' program in five policy areas: The maintenance of an adequate macroeconomic framework, such as the framework that had underpinned the rapid economic growth that had begun in 2002. Improving the investment climate to foster the investment and productivity increases required to maintain rapid growth and generate sufficient formal sector jobs to absorb the large supply of labor resulting from the country's demographic dynamics and structural transformation. Laying the foundations for changing labor market regulations--including a diagnosis of labor markets and the discussion of policy options for such delicate reforms. Consolidating the soundness of the financial sector and increasing access to investment credit and other forms of investment capital. 4 Increasing the capacity of the private sector to innovate, adopt new technologies and quality standards as well as a diagnosis of the policies needed for endowing the labor force with better skills, with a view of augmenting competitiveness over the medium and long. 2. KEY FACTORS AFFECTING IMPLEMENTATION AND OUTCOMES 2.1 Program Performance To support measures in the previously mentioned areas, CEDPL included the following prior, core policy actions: The government maintained a satisfactory macroeconomic framework. Bank staff found the existing macroeconomic framework to be satisfactory. IMF Article IV consultations and the sixth review of the Stand-by arrangement had been completed successfully in May 2007. The Borrower had privatized state owned companies and sold state-owned assets with total privatization revenues amounting to the equivalent of US$17.7 billion during 2005 and the first six months of 2006 (compared to $6 billion in the five years prior), under transparent competitive process acceptable to the Bank and with due regard to applicable environmental regulations. These efforts were aimed at minimizing state involvement in economic activities, relieving the financial burden on the national budget, increasing competition, and developing domestic capital markets. The maximum corporate income tax (CIT) bracket had been reduced from about 30 to 20 percent of taxable profits and CIT allowances have been eliminated. CIT rates had been high and complex. Previous CIT investment allowances distorted relative prices of capital and labor in ways which provided artificial incentives to adopt capital intensive and labor saving technologies. The comparatively high CIT rates increased incentives for informality, decreased incentives to hire workers, and, everything else the same, affected FDI negatively. The authorities had completed successfully a functional restructuring of the tax administration framework including: (a) reform of the local tax offices; (b) establishment of a revenue administration responsible for tax collection and with direct authority over provincial and local collection offices; and (c) reforms to the Large Tax Payer Unit aimed at improving collection efficiency while reducing compliance costs for the firms targeted had been completed. In order to bring better access to investment capital in an environment of financial sector stability by reducing state ownership in the banking sector, the authorities had completed an Initial Public Offering (IPO) for about 25 percent of the outstanding shares of Halk Bank. 5 A new law on residential real estate mortgaging had been enacted. The law was drafted following international best practices with the aim of increasing access to housing, boosting investment in construction, and helping banks manage their risks in financing the sector. The Government had taken steps to improve protection of Intellectual Property Rights (IPRs) and facilitate patent application by enacting a law on adoption of the Agreement on Amendment to the European Patent Convention was enacted. TURKAK (Turkish Accreditation Agency) had been accepted as a signatory of European co-operation for Accreditation - Multilateral Agreement (EA- MU) in the areas of calibration, testing, quality system certification and inspection and as a signatory of the International Laboratory Accreditation Cooperation ­ Mutual Agreement (ILAC-MRA) in the areas of testing and calibration. This measure was part of an effort to improve quality standards and thus increase productivity through simplification and rationalization of production and distribution processes. There were other actions or elements included in the program which were not part of the core prior actions but nevertheless played an important role in the outcome of the CEDPL. Among them: IMF Stand-by supported program in place until May 2008. The top Personal Income Tax (PIT) rate reduced from 40 to 35 %. Taxation of wage and non-wage income unified. Number of tax brackets reduced from 5 to 4. A Review of existing business regulations and licensing requirements was undertaken. Curricula for five educational programs were reformed to reflect needed skills and competencies and have been implemented for all students in 9th and 10th grades in 9th and 10th grades in 2006/07. To consolidate the soundness of the financial sector, the Banking Regulation and Supervision Agency (BRSA) published and implemented 24 regulations required for the effective implementation of the 2005 Banking Law. Credit history evaluation and performance disclosure mechanisms were put in place. 2.2 Major Factors Affecting Implementation: Government's commitment. Despite the difficult political environment when the CEDPL was designed and negotiated (see below), the government successfully implemented all prior actions, some of which were socially unpopular with selected organized groups (i.e. privatization of state-owned companies). This testifies to the government's commitment to its reform program. Moreover, the structural reforms completed and supported under the operation were by their nature difficult to reverse (privatization, mortgage law, tax administration), thus limiting the risk of backtracking reforms. Finally, the reforms 6 supported by CEDPL were fully consistent with the Government's own priorities in the areas of competitiveness and employment, thus reflecting a high degree of ownership on the Government's part. Political environment. The CEDPL was negotiated just before the Parliamentary and Presidential elections of 2007 which had created a challenging environment for the government to implement socially difficult reforms, such as measures to increase the labor market flexibility. Labor market reforms were nevertheless implemented as part of the CEDPL 2 operation. Analytical work. The 1993-2004 Country Assistance Evaluation found that little formal economic and sector analysis was carried out up to the late 1990s. Thereafter, the economic and sector analysis have become a larger part of the Bank`s program. This approach has increased the effectiveness of the Bank involvement. As a result, CEDPL, and the specific measures supported by it, were informed by a large number of analytical work that contributed--and continues to contribute--to nourish a permanent and stable policy dialogue in the areas supported by the reform. Specifically, the Bank provided analytical support to the government's program through extensive economic and sector work on the program areas of the CEDPL, including through the: (a) Labor Market Study (2006), which identified flexibility and effective social protection as key policy elements for creating more and better jobs; (b) Country Economic Memorandum (2006), which examined the possible impact of lowering labor taxes on employment creation. (c) Investment Climate Assessment (ICA, in draft form at that time), which identified key constraints to higher investment flows and productivity gains (d) Joint Bank-Fund FSAP (2007), which identified remaining legislative and regulatory policy challenges, and (e) Education Sector Study (2006), which took an integrated view at the education sector, including how it prepares the young for the labor market and how skill mismatches can be reduced. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization. Overall design. Given that this was a stand-alone operation, efforts were made to identify outcomes that could be measured shortly after program implementation. In this regard, the identified indicators were for the most part proxies for longer- term outcomes sought by the authorities. Moreover, the Bank team acknowledged that the attribution of overall development results to reforms supported by CEDPL needed to be fully assessed over time. A more meaningful measure of the program's success would therefore only be possible at the end of a prospective CEDPL 3, when the (CEDPL) program series is completed. Some indicators therefore can only fully assessed by then.2 2For example, indicators related to labor force skills (e.g., number of science and engineering graduates and post-doctoral fellows) and innovation (number of ISO 9001 certified firms and number of accredited testing and calibration laboratories) are linked to long-term horizon decisions by economic agents and thus only adjust to policy changes after some time lag. Short term impacts are marginal at best. 7 Other design issues. Indicators were properly identified but some of them lacked specific targets and baselines, and at times were loosely defined. This made the task of assessing success unnecessarily difficult. Specifically, the supervision team needed to retrofit some of the indicators to allow for a proper evaluation of outcomes. To a large degree, this issue has been addressed during the preparation of a follow-on operation. 2.4 Expected Next Phase/Follow-up Operation: The Second Competitiveness and Employment Loan (CEDPL 2) was approved by the Bank's Board in December 2008. CEDPL 2 builds on CEDPL and supports specific advances in the implementation of the government's competitiveness and employment agenda to a new stage. CEDPL 2 provides continuity to the CEDPL as evidenced by the implementation of key measures aimed at improving the investment climate, deepening capital markets and the enhancing employment opportunities: Enactment of the new research and development law, reform of customs administration, amendment to the Land Registry Law and satisfactory progress of the privatization program. These measures will improve the investment climate thus contributing to raising exports and FDI; Approval of the new Insurance Law and enactment of regulations to improve corporate governance in the capital markets to help mobilizing domestic and foreign savings; and Enactment of the first phase of the labor market reform and advances in defining competency-based occupation standards as part of the broader strategy to improve employment opportunities 3. ASSESSMENT OF OUTCOMES 3.1 Relevance of Objectives, Design and Implementation The objectives, design and implementation of the CEDPL remain highly relevant with regard to Turkey's and the Bank's development objectives. While Turkey has made significant progress in putting in place a policy environment conducive of higher investment, productivity, employment and growth, the country still faces policy challenges in areas that are key to improving its investment climate, specifically in reducing the cost of starting a business, raising recovery rates from bankruptcy, reducing skills mismatches, and making its labor market more flexible. In this connection, the five policy pillars supported by the CEDPL have, if anything, gained importance in light of the global crisis. Moreover, employment growth--particularly formal employment--is likely to fall in the period to come, which would require a more determined effort to keep medium-term labor market reforms on track, specifically regarding increasing labor market flexibility and enhancing the protection of workers. The CEDPL programmatic series is the corner stone of the Bank's support to the overall structural reform program of Turkey. The policy actions supported under this 8 program are directly linked to five of the development objectives spelled out in the CPS: (i) maintaining macroeconomic stability and sustaining economic growth, (ii) improving the investment climate and decreasing the informality of the economy, (iii) increasing labor market flexibility and improving skills, (iv) maintaining soundness of the financial system, and improving access to finance, and (v) enhancing technology adoption and innovation; The outcomes pursued by the CEDPL series fit into the broader results framework for the CPS. CEDPL became the first in a series of operations designed to support the Government's competitiveness and employment policy reform agenda embedded in the NDP. The CEDPL 2 approved by the Bank's Board in December 2008 not only builds on the reforms supported by CEDPL, but also envisages Bank support for the next steps in the implementation of Turkey's competitiveness and employment agenda under a possible CEDPL 3. In this connection, the Country Partnership Strategy (CPS) discussed by the Board of Executive Directors in February 2008 is fully integrated with--and maps all planned Bank activities into--the Government's NDP. The CEDPL series therefore will continue to be an important instrument of the CPS. 3.2 Achievement of Program Development Objectives Through the measures supported by the CEDPL series, Turkey has made significant progress in putting in place a policy environment conducive of higher investment, productivity, employment and growth. Major achievements in reducing the role of the state in economic activity (privatization) and reducing distortions (lower tax pressures) have made the economy more attractive for investment, particularly FDI. In that context, the overall results of the CEDPL as measured by the behavior of the identified indicators are broadly positive. Nevertheless, economic performance since the approval of CEDPL has been--and will continue to be--affected by global events beyond the authorities' control, most prominently: (a) a surge in commodity prices that lasted until mid-2008; and (b) the ramifications of the global credit crisis that started with the collapse of the housing sector in the United States. The flexibility built in the design of the CEDPL series as a programmatic series will nevertheless help shape the policies to be supported by the Bank in the future in the areas of employment generation and raising competitiveness. A significant number of results indicators associated with the key objectives of CEDPL were identified (see Table II). 13 out of 19 indicators achieved results in line with the targets: Policies to sustain macroeconomic stability were anchored to the IMF Stand- by arrangement that expired in May 2008. The balance of payments current account deficit and the level of public debt declined in 2007, and most likely in 2008 as well. Inflation, which fell to 8.4 % in 2007 (from 9.7 % in 2006), increased again in 2008, mostly as a result of the surge in oil and food prices that reached a peak in mid-2008. There was an improvement in the investment climate as measured by key related indicators. FDI flows continued at high levels, though declined slightly 9 in terms of GDP. The significant package of privatization operations had an immediate effect on microeconomic performance, with the proportion of GDP attributed to SOEs production falling from 1.9 % of GDP in 2006 to 1.5 % in 2007. Perhaps more importantly, the amount of budgetary transfers to SOEs fell to a low of 0.34 % of GDP in 2007. Informal employment has declined in relative terms by about 4 percentage points from 2006 to 2007. Legal framework to start a business was improved to reduce the time needed to collect necessary documents and fulfill other requirements: the number of days to register a business was reduced from 9 to 6 days from 2006 to 20073. In terms of operating a business, incentives to reduce informality were introduced. The reduction in the CIT rate led to an increase in the share of CIT in overall tax revenues from 8.2 % to 9.2 %. Employment indicators point to only limited progress in labor market conditions. The unemployment rate remained unchanged in 2007 from 2006 (about 10 %) and actually increased in 2008 to 12.3 percent as the economy began to suffer the effects of the global crisis. The challenge is formidable as the labor force in Turkey grows by about 4 % per year. A positive development was the approval by Parliament of a Labor Market Reform package in 2008. The Law included a 5 percentage point cut in employer's contributions for pensions, disability, and death insurance which now will be paid by Treasury. This reduces taxes on labor and, therefore, has a positive impact on employment. It also favors formal employment. Financial markets have deepened despite international conditions. Despite the international housing market collapse, the passage of the mortgage law had an immediate positive effect on housing finance, which went from less than 3 percent of GDP in 2006 to about 4 percent of GDP in 2008. Nevertheless, mortgage finance is still below comparable countries (In Mexico, for example, it represents 16% of GDP). Also, banking prudential indicators continue to show the relative strength of the domestic financial market, with capital adequacy ratios exceeding regulatory requirements by a large margin. Asset quality deteriorated very marginally despite a significant expansion in credit. The recent slowdown in the economy, however, is bound to affect more the quality of loan portfolios in the near future. Promotion of knowledge and innovation is working. The Law on Adoption of the Agreement on Amendment to the European Patent Convention was enacted and the Turkish Accreditation Agency was accepted as a signatory of the European co-operation for Accreditation. These improvements in the regulatory framework led to an increase in number of patents of about 10 percent in 2007, with a somewhat smaller increase in 2008. Funding of research and development by the industrial sector, that is, by the private sector, also increased, reaching 47 % of the total expenditures in research and development. 3As measured by the Doing Business indicators in the 2007 and 2008 reports. 10 Table 2: Objectives, Indicators, Results and Contributing Measures4 Objective Indicators Measure/s that contribute to Results Results Baseline Achieved Target (Generally (Generally (Taken from as of end as of end text or policy 2006) 2007) matrix of CEDPL) Consumer Price 9.23% 10.06% 7.5% (Central Index (% Bank Target IMF Stand-By program in change) for 2009) place until May 2008 Maintain Macroecono Current account 6.1% 5.7% Long term mic Stability deficit (% GDP) decline Public Debt / 34% 29% Long term GDP (%) decline FDI (in million 20,185 22,046 Long term Maximum corporate USD) increase income tax bracket reduced from about 30 to 20 % and capital investment CIT FDI (% of GDP) 3.83% 3.36% Long term allowances eliminated increase Restructuring of the tax administration framework including reforms to the Share of 47.1% 43.4% Long term Large Tax Payer Unit Improve informal sector decrease aimed at improving Investment workers in total collection efficiency Climate while reducing compliance costs for the firms targeted Participation of 1.87% 1.51% Reduction as a Privatization of state SOEs in GDP result of owned companies and (%) privatizations state-owned assets sold with total privatization 4In some cases, the contributing measure is in the program but not as a core prior action. 11 Budgetary 0.69% 0.34% Decrease from revenues amounting to the support for 2006 ratio equivalent of US$17.7 SOEs (% of billion in the years 2005 GDP) and 2006, under transparent competitive process acceptable to the Time for 9 6 Declining Bank and with due regard Registering trend to applicable Firms (days) environmental regulations. Number of 25 25 Declining Review of existing procedures to substantially registration and licensing acquire a license regulations with the view of unifying and Share of 8.2% 9.2% Increasing due streamlining procedures. Corporate to lower Income Tax in informality Overall Tax Revenues (%) Personal Income Tax rate reduced from 40 to 35 %. 43.2% 43.1% 46.8% Taxation of wages and non wages unified. Employment ( By 2013, Number of brackets rates (%) CPS matrix) reduced from 5 to 4 Maximum corporate income tax bracket reduced from about 30 to 20 and capital investment CIT allowances Unemployment 9.9 9.9 Declining eliminated Increase rates (%) over the Review of existing employment longer term regulations and licensing Curricula for five programs have been reformed to reflect needed skills and competencies and have been implemented for all students in 9th and 10th grades in 2006/07 The authorities completed an Initial Public Offering Increase Capital 21.60% 17.53% Maintain (IPO) for about 25 % of access to Adequacy Ratio the outstanding shares of 12 investment (%) current ratio Halk Bank capital Volume of 2.90% 4.00% Increase as a A new law on residential housing finance result of real estate mortgaging (as % of GDP) deeper enacted financial markets BRSA implementing 24 regulations supportive of the 2005 Banking Law, Non Performing 3.60% 3.77% Maintain the geared towards meeting Loans/Total current ratio international best Loans practices Credit history and performance disclosure mechanism functioning Promote the Number of Increase from Law on adoption of the generation of 4,303 4,871 Agreement on knowledge patents 2006 Amendment to the and European Patent innovation, Convention enacted adoption of TURKAK (Turkish new technologies, Accreditation Agency) accepted as a signatory of and European co-operation for upgrading of Accreditation - labor force Industry-funded 46% 47.1% Increase Multilateral Agreement skills R&D in total from 2006 R&D spending (EA-MU) in the areas of calibration, testing, quality system certification and inspection and as a signatory of the International Laboratory Accreditation Cooperation ­Mutual Agreement (ILAC-MRA) in the areas of testing and calibration 3.3 Justification of Overall Outcome Rating Rating: Satisfactory The development objectives of the operation were and remain highly relevant for Turkey's and the Bank's development agenda. Progress has been achieved in most key indicators, though in some cases the impact of designed policies has been so far modest. In any case, given the nature of the operation, results should also be judged by the consolidation of the reforms supported by CEDPL since they are expected to have full impact after certain time, possibly at the end of CEDPL 3. It is by then that we should 13 expect more definitive evidence on the success or not of the program as a whole. The current global crisis is nevertheless already having a significant effect on employment and economic welfare in general. The challenge for Turkey is to continue to pursue the appropriate reforms in this difficult environment. 4. ASSESSMENT OF RISK TO DEVELOPMENT OUTCOME Rating: Moderate The Turkish Government's proven commitment to its reform program provides comfort that the risks of a policy reversal or an interruption to the ongoing reforms are limited. Nevertheless, some of the remaining risks to the operation's development outcomes encompass: (i) external; and (ii) political risks. Risks to the operation's outcomes encompass: (i) external; and (ii) political risks. External Risks. High financing needs make Turkey vulnerable to a sudden reversal in capital flows, particularly at a time when global appetite for risk is at a low level. The main risk is worsening investor sentiment, whether due to domestic or external factors, leading to an abrupt capital outflow and real depreciation. Were this to happen, stronger fiscal accounts and strengthened financial sector should help Turkey avoid a systemic crisis, but growth and employment in the private sector could suffer a downturn. Political Risks. The single-party Government and its strong parliamentary majority favor political stability and create a positive environment for reforms. Nonetheless, political risks to the reform program remain. These include (i) geopolitical events in neighboring regions; and (ii) slowdown in reforms if it is perceived that such course could ameliorate the impact of international crisis. Specifically, the authorities' appetite for implementing reforms in the area of increasing labor market flexibility might wane given the expected adverse impact of the global crisis on the economy. 5. ASSESSMENT OF BANK AND BORROWER PERFORMANCE 5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Satisfactory. The operation made use of extensive existing analytical work in its design and policy dialogue. This operation was also much in line with stated government development objectives. The operation's identification and design were consistent with the 2003 CAS and the 2005 CAS PR, and closely reflected lessons learned identified in the 1993-2004 Country Assistance Evaluation, particularly as regarded the expected use of a wide set of existing analytical background work. Consistent with the CAS PR, the authorities and the Bank agreed that CEDPL would support key components of the NDP. 14 (b) Quality of Supervision Rating: Satisfactory Since this was a single-tranche operation with only prior actions but framed in a medium term program, a continued policy dialogue with the authorities in the areas of reform was a crucial element in the supervision effort. The supervision of this operation, therefore, was a continuing process that went beyond the ISRs as a formal requirement5. This paved the way for the approval of a follow-on operation (CEDPL 2). The Bank and the country have monitored performance based on agreed upon measures as well as the results framework included in the CEDPL Policy Matrix. However, the indicators and targets in some cases lacked specificity, thus making the task of evaluating outcomes more complicated. (c) Justification of Rating for Overall Bank Performance Rating: Satisfactory This rating is based on the following: (i) the broadly positive results of the operation and the Bank's contribution to it; (ii) the quality of the operation's design, its strategic, long- term view and its support of the NDP, reflecting the fact that the operation was produced in full partnership with the Government; (iii) the extensive use of analytical material to design the operation and facilitate the policy dialogue; (iv) the fact that this operation set the basis for CEDPL 2; and (v) the continued policy dialogue and supervision helped attain most of the objectives of the operation so far. The only shortcoming relates to the inadequate quality of the monitoring and evaluation framework, which made supervision somewhat more difficult. 5.2 Borrower Performance (a) Government Performance See (c) below. (b) Implementing Agency or Agencies Performance See (c) below. (c) Justification of Rating for Overall Borrower Performance Rating: Satisfactory 5An ISR was drafted but not submitted for approval. 15 The Government undertook a number of technically and political complex reforms in a difficult political environment. The program shows continuity and seems to have broad support. The technical preparations for the implementation of these reforms required a tight coordination effort across a number of government institutions. These efforts also reflected an effective and close collaboration between the Bank and the Treasury, and a continuous technical and policy dialogue between Bank staff and the relevant government agencies. 6. LESSONS LEARNED CEDPL offers the following key lessons: Some political difficulties at the time of CEDPL inception and negotiations may have called for a postponement of program negotiations, but looking in retrospect the decision to go ahead was appropriate. It was well supported: a) policy actions--all prior actions--constituted good public policy and were technically and politically difficult reforms; b) these policies were (and still are) difficult to reverse; and c) clearly the relationship with the Government would have been unnecessarily strained if a postponement had taken place, particularly as the Bank had already publicly expressed support for these reforms. The approval of a follow-on operation supporting additional policy actions under the Government's NDP validates this conclusion. Gathering lessons and taking advantage of the dearth of knowledge from previous/ongoing analytical work, investment lending, and other DPLs has been important. Long time relationship with the country provides a good deal of knowledge and experience which has been taken into account when discussing with the authorities, designing the operation and conducting its supervision. Establishing targets for indicators as specific as possible is of first order to monitor the program. The Program Matrix does provide a list of program outcomes and monitoring indicators. Many indicators are amenable to practical monitoring only at the end of the program. To the extent possible, targets should be stated more explicit in the program document. For example, the target of the deepening of financial market could have been more specific based on the experience of comparable countries. 7. COMMENTS ON ISSUES RAISED BY BORROWER/IMPLEMENTING AGENCIES/PARTNERS Borrower/Implementing agencies See Annex 3. 16 ANNEX 1 BANK LENDING AND IMPLEMENTATION SUPPORT/SUPERVISION PROCESSES (a) Task Team members Names Title Unit Responsibility/ Specialty Lending Rodrigo Chaves Task Team Leader ECSPE Mediha Agar Economist ECSPE Gokhan Akinci Sr Invest. Policy Off. CICIG Ayse Seda Aroymak Sr Financial Management Specialist ECSPS Dilek Barlas Deputy Executive Secretary IPN Pinar Baydar Program Assistant ECCU6 Furuzan Bilir Operations Officer ECCU6 Steen Byskov Financial Sector Specialist ECSPF Banu Demir Consultant LCSPE Michael Edwards Lead Financial Sector Specialist ECSPF John Gabriel Goddard Economist ECSPF Vinod K. Goel Consultant EASPR Kamer Karakurum-Ozdemir Economist ECSPE Selma Karaman Program Assistant ECCU6 Maureen Anne McLaughlin Lead Education Specialist ECSHD Marialisa Motta Manager CICRA Zafer Mustafaoglu Senior Economist ECSPE Jean-Louis Charles Racine Private Sector Development Specialist ECSPF ICR Carlos E. Pinerua Task Team Leader ECSPF Irem Guceri ETC ECSPF Carlos Elbirt Economist ECSPF (b) Staff Time and Cost Staff Time and Cost (Bank Budget Only) Stage No. of staff weeks USD Thousands (including travel and consultant costs) Lending FY03 21 157.74 FY04 20 174.36 FY05 48 270.96 FY06 51 372.61 FY07 65 436.21 FY08 0.00 Total: 205 1411.88 17 Supervision/ICR FY03 0.00 FY04 0.00 FY05 0.00 FY06 0.00 FY07 -0.23 FY08 13 45.93 FY09 6 27.27 Total: 19 72.97 18 ANNEX 2. PROGRAM MATRIX FOR THE CEDPL Issue CEDPL Possible Future Policy Actions Under Expected Program Outcomes & (Prior actions in bold) the Government's Medium-Term Plan Monitoring Indicators Program area I: Macroeconomic Framework A stable macroeconomic The Government has maintained an Maintaining an adequate macroeconomic A stable macroeconomic framework. environment is required for adequate macroeconomic framework. framework. investment and growth. To be monitored by the evolution of key macroeconomic variables-- including (a) real interest rates, (b) inflation ­ CPI and PPI, (c) CAD, and (d) Public Debt/GNP. Program area II: Investment Climate The provisions of the current A satisfactory draft Commercial Code Completing the process to put in place a Commercial Code, a key element of broadly compliant with the provisions of Commercial Code broadly aligned with the business environment, could be the EU Acquis Communautaire on the provisions of the EU Acquis improved by bringing them closer commercial matters was submitted to the Communautaire on commercial matters. to international best practice and Parliament for approval. EU requirements. The Ministry of Industry and Trade has Foreign and domestic investors have issued a circular defining and classifying stronger incentives to invest in SMEs in compliance with EU Turkey and to do business in the Regulations and a website providing formal economy. useful information for SMEs including applicable regulations and business To be monitored by the evolution of opportunities has been created under the key variables--including (a) FDI domain www.kobi.org.tr flows/GNP, (b) a declining time and Registration and licensing Reviews of existing registration and Implementing recommendations adopted cost of registering firms, (c) procedures for business activities licensing regulations have been by the authorities, if any, from the increasing share of formal sector have been simplified and costs conducted with the view of unifying and reviews of existing registration and workers, and (d) decreasing number reduced but there is still room for streamlining licensing procedures for the licensing regulations. of licenses. bringing them closer to entire country. international best practices. A pilot test of electronic linking of government agencies in charge of 19 Issue CEDPL Possible Future Policy Actions Under Expected Program Outcomes & (Prior actions in bold) the Government's Medium-Term Plan Monitoring Indicators company registration is underway in Ankara. Progressing with electronic registration and trade registries offering a majority of their services to firms online. Economic performance has been Turkey privatized state owned Implementing a privatization program While the performance of SOEs has hindered by the poor financial companies and sold major state-owned depending on market conditions. improved, the risk of future poor results, overstaffing, dependence on assets in the years 2005 and 2006 with performance has been reduced subsidies and unilateral budget a total value of sales amounting to US$ through privatization. Efficiency transfers, and protected markets of 17.7 billion and under a broadly would be supported as private sector state owned companies. transparent process which was agents compete in an environment not consistent with acceptable competitive distorted by the state as owner of practice and environmentally industrial and service companies. responsible. To be monitored by a declining share of GNP produced by SOEs. CIT has been high and complex CIT has been reduced from about 30 Reducing and simplifying further CIT, if The new CIT regime reduces while CIT investment allowances to 20 percent of taxable profits and appropriate. incentives for informality. have created distorted incentives to capital investment CIT allowances adopt capital intensive and labor have been eliminated. To be monitored by the evolution of saving technologies. the share of CIT in overall tax revenue. PIT has been high and complex, PIT has been reduced from 40 percent to Further reform of PIT, if appropriate. The new PIT regime reduces which has increased incentives for 35 percent of taxable income while the incentives for informality. informality, especially for the self- taxation of wage and non-wage income employed. has been unified. The number of To be monitored by the evolution of brackets has been reduced from 5 to 4 PIT in overall tax revenue and the and the treatment of income from incidence of unregistered self- financial instruments has been employment. harmonized. The tax administration could A successfully functional restructuring Developing a unified declaration form for Informality is reduced while tax improve its enforcement of tax of the tax administration including (a) taxes and social security contributions collection increased. legislation and collection of tax reform of the local tax offices; (b) and an action plan to improve collection 20 Issue CEDPL Possible Future Policy Actions Under Expected Program Outcomes & (Prior actions in bold) the Government's Medium-Term Plan Monitoring Indicators payments which will reduce establishment of a revenue of social security contributions and To be monitored by the evolution of informality in the economy by administration responsible for tax arrears. direct taxes in overall tax revenue. making under-reporting of revenues collection and with direct authority and unregistered activity less over provincial and local collection attractive strategies. offices; and (c) reforms to the Large Tax Payer Unit aimed at improving collection efficiency while reducing compliance costs for the firms targeted has been completed. The total amount of state aid is not Satisfactory state aid control legislation Developing (a) state aid control Better incentives for investment due known and the legislation in place in conformity with EU directives has legislation in conformity with EU, (b) an to less uncertainty and more on the subject deviates from the EU been drafted. inventory of state aid and, (c) a plan for competition which supports more Acquis Communautaire. phasing out distorting state aid and efficiency and growth. keeping overall amounts in line with EU average. To be monitored by the evolution of the amounts of tax expenditures and the number of state aid programs. FDI in Turkey has been low which An Investment Support and Promotion Strengthening the ISPA. The number and quality of jobs has means that Turkey has not benefited Agency of Turkey (ISPA) has been benefited from stable and larger FDI from the increases in investment established and progress includes: (a) flows. and productivity normally incorporation of the agency, (b) issuance associated with higher levels of of secondary legislation, (c) recruitment To be monitored by the evolution of FDI. of staff, and (d) clear definition of goals annual FDI flows as percentage of and business model. GNP. A website providing comprehensive information for foreign investors has been created under the domain www.investinturkey.gov.tr. Program area III. Labor Markets The performance of labor markets A program of labor market reform has Pursuing a comprehensive labor market Turkey is utilizing a greater share of has been characterized by (a) low been adopted as one of the five strategic reform package including (a) making working age population, providing rates of labor market priorities (development axes) of the labor markets more flexible, (b) employment to more of those who do participation-- especially among NDP. providing increased opportunities for participate in the labor force, and 21 Issue CEDPL Possible Future Policy Actions Under Expected Program Outcomes & (Prior actions in bold) the Government's Medium-Term Plan Monitoring Indicators women; (b) comparatively high increased labor market participation ­ supplying more formal sector jobs unemployment rates--especially especially for women and youth, (c) affording protection to workers. among the young; and (c) there is a making labor a more attractive factor of high incidence of informality. production, and (d) increasing protection To be monitored by the evolution of for all workers relative to the protection unemployment rates, labor market of existing jobs. participation rates, and share of the labor force working in the formal sector. Program area IV. Credit and Capital Markets The authorities completed successfully Increasing private sector participation in an IPO for about 25 percent of the the ownership and control of the state shares of Halk Bank. banks. BRSA has adopted, published, and is Putting in place all regulations required implementing 24 of the regulations for implementing the 2005 Banking Act Historically, the banking sector has required for the effective implementation and progressing in the implementation of The financial sector continues dominated the entire financial of the 2005 Banking Law. the Basel II Banking Accord. supporting macroeconomic stability sector and provided small amounts Making the legislation for insurance and credit and capital markets have of investment capital to the markets and for the pension savings and developed in a way that contributes to productive sectors of the economy investment system more compliant with investment and growth. and has been a source of fiscal the EU Acquis. losses and/or macroeconomic instability. To be monitored by the evolution of A system for disclosing credit history Putting in place a system for disclosing (a) soundness indicators for the and performance of consumers (credit the credit history and performance of financial sector, (b) measures of Another factor limiting access to scoring or reporting) is functioning corporate borrowers. financial deepening and access to credit services and equity markets is financial services, and (c) effective the underdevelopment of key use of assets as collateral. institutional and legal elements for A detailed diagnosis of the regime for Establishing legislation for better using the functioning of modern financial using movable assets to secure movable assets to secure transactions and services such as credit bureaus, transactions has been prepared and its the operation of an internet based filing good collateral laws, and protection recommendations have been reviewed. archive for security interests. of shareholders. 22 Issue CEDPL Possible Future Policy Actions Under Expected Program Outcomes & (Prior actions in bold) the Government's Medium-Term Plan Monitoring Indicators A satisfactory new law on residential Issuing sub-regulations required for the Increase in mortgage lending, real estate mortgaging has been regulatory, supervisory, and institutional lowering of spreads, and development enacted. framework for secondary mortgage of mortgage securitization. market institutions. The depth and functioning of A study of the observance of OECD Bringing about better observance with Deepening of capital markets as capital markets and their ability to Corporate Governance Principles with the OECD corporate governance measured by, for example, market channel investment capital to the the collaboration of the relevant Turkish principles. capitalization to GNP ratios. real sector depend significantly on authorities and stakeholders has been the system for governing completed. corporations and protecting shareholder rights. The country's capital markets are yet to realize their full potential because of areas where corporate governance could be improved. Program area V. Innovation, Knowledge, Technology Adoption, Labor Force Skills Low levels and quality of outputs of Promoting innovation and technology public and private R&D, limited absorption through better (a) innovation R&D commercialization, low levels infrastructure; (b) access to finance for of technology absorption and low innovation; (c) capacity to innovate at the number of technical graduates and university and firm level; and (d) researchers constraint productivity regional utilization and impact of existing of Turkish firms. innovation programs. Increasing innovation and use of A low number of patents filed by A law on adoption of the Agreement Developing IPR legislation aligned with technology by firms will improve Turkish inventors nationally and on Amendment to the European the EU Acquis in areas including: (a) firms' productivity and facilitate internationally, incomplete Patent Convention has been enacted. Patent and Intellectual Property Law, (b) creation of new firms, in turn alignment of IPR legislation with Geographical indications Law, (c) contributing to creation of more and Acquis requirements, and Industrial Design Law, and (d) Trade better jobs. inadequate IPR enforcement limit Marks. investments, innovation, and This outcome will be monitored by competitiveness of Turkish firms the evolution of key variables-- and thus employment potential. including (a) industry-funded R&D, Limited use of quality standards by TURKAK has been accepted as a TURKAK becoming a signatory of the (b) joint projects between universities Turkish labs and firms (particularly signatory of EA-MLA in the areas of EA-MLA in the areas of product and private firms; (c) numbers of 23 Issue CEDPL Possible Future Policy Actions Under Expected Program Outcomes & (Prior actions in bold) the Government's Medium-Term Plan Monitoring Indicators in the service industry and among calibration, testing, quality system certification and environmental science & engineering graduates and SMEs), incomplete alignment of certification and inspection and as a management system certification and as a post doctoral research fellows, (d) legislation on standards with EU signatory of the International signatory of the International number of patents issued, (e) requirements and institutional Laboratory Accreditation Cooperation Accreditation Forum ­Multilateral increased numbers of ISO 9001 shortcomings in the NQS and ­Mutual Agreement (ILAC-MRA) in Recognition Arrangement (IAF-ML) in certified firms, (f) number of Metrology Systems limit firms' the areas of testing and calibration. the area of quality. accredited testing and calibration export, creation of supply chains, laboratories, and (g) proportion of competitiveness and growth and A revised TURKAK law consistent with Establishing TURKAK legislation UME's calibration services provided ultimately generation of high EU Acquis and EA-MLA requirements consistent with EU Acquis and EA-MLA to laboratories and primary calibration quality jobs in the modern sectors has been drafted. requirements. services. of the economy. TSE becoming a member of CEN and CENELEC. Enhancing the independence of the Standardization departments at TSE. There is a mismatch between the set Curricula for five programs have been Revising curricula in a number of Better employability of high school of skills demanded by the private reformed to reflect needed skills and secondary and vocational areas and and MYOs graduates. sector and the set of skills acquired competencies and have been implementing them in pilot schools for by the large majority of the working implemented for all students in the 9th - selected grades. Introducing curricula for There are efforts underway to assess force in the country's educational 10th grade in the 2006-2007 school years. programs for students in the higher the effects of revised curricula. system. grades of secondary school. The Vocational Qualification Authority Law was approved in October 2006 to Revising standards and certification link education and qualifications in requirements for a significant number of technical and vocational fields with vocational and technical occupations. occupational needs and standards. The certificates developed through this process will be recognized in the EU. 24 ANNEX 3. THE GOVERNMENT'S CONTRIBUTION TO THE IMPLEMENTATION COMPLETION AND RESULTS REPORT TO CEDPL Introduction 1. The Competitiveness and Employment Development Policy Loan (CEDPL) is the first in a series of programmatic loans in support of the Government's comprehensive reform program aimed to promote growth while generating employment, ensuring social inclusion and enhancing competitiveness. The CEDPL series constitute the essence of our collaboration with the World Bank (the Bank) in the areas of (a) maintaining an enabling macroeconomic framework; (b) improving investment climate, (c) reforming the labor market, (d) maintaining the financial sector stability and increasing access to investment capital and (e) generating knowledge and innovation, upgrading the skills of the labor force and strengthening the quality of education. 2. Our comments about the implementation of the structural reform program supported by CEDPL are as follows: Macroeconomic Framework 3. A satisfactory macroeconomic framework has been maintained during the CEDPL program. The Government has implemented a series of macroeconomic and structural policies in order to increase the competitiveness of the economy and to achieve a sustainable and equitable economic growth. 4. These policies had a remarkable impact on Turkey's economic and social development in the past years. The economic growth averaged about 7 percent and poverty rate dropped by approximately 8.5 percentage points between 2002 and 2007. 5. Moreover, a combination of sustained stabilization efforts and steadfast implementation of structural reforms made it possible to keep the inflation under control, to improve the outlook for debt sustainability and to reduce macroeconomic vulnerabilities. 6. Having taken into account the downside risks stemming from the global crisis and slowdown in the world economy, Turkey's main focus is to mitigate the adverse impacts of this turmoil on our financial markets, real sector and fiscal stance. Therefore, the volatility in the global markets and its effects on Turkish economy is being closely monitored and policy responses are being designed and implemented. Investment Climate 7. The Government gives utmost importance to a strong investment climate for sustaining economic growth. Therefore, improving the investment climate is one of the main strategic goals of our Development Plan. 8. Implementation of structural reforms to improve the investment climate is a necessary condition for increasing domestic and foreign direct investments. To this end, 25 the Government is aiming to improve the investment climate through, inter alia: (a) removal of administrative obstacles encountered by firms in all phases of investment process; (b) reducing and simplifying the Corporate Income Tax and Personal Income Tax (CIT and PIT) and improving effectiveness of the tax administration; (c) monitoring and adjusting state aid as necessary; (d) implementing a large program of privatization of state-owned enterprises; (e) establishment of the Coordination Council for the Improvement of Investment Environment in Turkey (YOIKK) and (f) improving corporate governance. 9. A significant progress has been achieved in these areas over the recent years which can easily be tracked by record-high FDI inflow figures and privatization revenues. Turkey has attracted USD 60 billion of FDI inflows for the last three years and privatization revenues amounted to about USD 26.7 billion between 2005 and 2008. 10. The Government will further enhance the investment environment to induce both domestic and foreign investors to invest more in Turkey. In this respect, the Committee for the Improvement of Investment Climate (YOKK), which follows the implementation effectiveness of structural reforms and reports the progress to the Government, aims to rationalize the regulations about investments, develop policies to improve investment climate and remove obstacles faced by investors. Labor Market 11. During 2002-2007 period, the Turkish economy grew by approximately 7 percent on average, whereas employment did not follow an increasing pattern; a situation which can be defined as "jobless growth". This is mainly due to the decline in the rural employment in parallel to the structural transformation of the Turkish economy and to the shift from a labor intensive industrial production structure to a more capital intensive one. 12. Therefore, generating more and better jobs has been identified as one of the main priority areas of Turkey, as it is stated in the Ninth Development Plan. A comprehensive reform agenda on labor market has been designed to this end and the Government has already started implementation of the first phase of this agenda. 13. Within this framework, the enactment of the Labor Market Reform Law confirms the strong commitment to improve the labor market. The law aims to increase employment through, inter alia; reducing the financial and non-financial burdens on formal employment, encouraging the employment of women and young, strengthening active labor market programmes, designing vocational education policies based on the needs of labor market, and ensuring the employment in least developed regions. With the impact of both the reforms realized in the labor market and the active labor market policies being carried out, the future growth is expected to be reflected in employment. 14. Moreover, the Government increased its support to private sector and especially to SMEs by increasing the availability of financial sources and providing incentives for short-term employment. In this respect, Small and Medium Sized Industry Development Organization (KOSGEB) and Ziraat Bank (a State Owned Bank) have programs to provide concessional loans to SMEs and exporter SMEs. In addition, Turkey's Eximbank increased its funding and insurance programs targeted to exporters. The aim is to mitigate 26 the impacts of the global slowdown on the private sector, decrease their vulnerability to external shocks, and with the consideration of SME's share in employment (about 77 percent), prevent the lay-offs to the extent possible. Credit and Capital Markets 15. The Government recognizes the importance of improving firms' access to finance and ensuring confidence and stability in financial markets in order to strengthen Turkey's competitiveness. In this respect, a comprehensive reform program has been implemented in financial sector through enhanced regulation and supervision. 16. The fluctuations in global markets are considered as a stress test for the financial sector. As a result of this stress test, it has been proved that our financial sector has preserved its strong outlook in financial stability, mainly due to measures taken after the 2001 economic crisis. The positive 2008 year-end figures released by banks prove that Turkish financial sector maintained its health even in the course of the global crisis. These figures have also enhanced confidence to the sector and increased the strength of Turkish banks by conveying the message that the Turkish banks were well prepared against the crisis and do not have liquidity problems. The capital adequacy ratios of Turkish banks also remain robust (at around 18 percent on the average as of end-2008) which is a key indicator that the Turkish financial sector will make it through 2009, maintaining its strength. Innovation, Knowledge, Technology Adoption, Labor Force Skills 17. The Government acknowledges the need to base our growth dynamics on productivity increases and on creating new comparative advantages in order to sustain and strengthen our competitiveness on the global arena. To this end, placing an emphasis on innovation, increasing scientific and technological capacity, improving human capital, and effective usage of information and communication technologies are our priority areas. 18. In Turkey, the share of R&D expenditures in GDP was 0.71 percent in 2007, while it was 1.84 percent for the EU average in 2006. Our aim is to increase the share of R&D expenditures and reach at 2 percent of GDP in 2013. On the other hand, the weight of private sector in R&D investments is increasing. The rate of private sector's R&D activities in Turkey, which was 24 percent of the total in 2004, increased to 41 percent by 2007. However, this figure still lags quite behind the EU-27 average of 64 percent in 2006. Another issue is to overcome the shortage of researchers. In Turkey, ratio of R&D personnel to total labor force was 0.43 percent in 2006 which is well below the EU average of 1.33 percent in 2006. 19. In this respect, the enactment of the law on Research and Development is a very important step to encourage R&D investments which in turn will contribute to our international competitiveness. By implementing necessary policies related to R&D activities; it is aimed to increase the share of R&D investments in GDP, expand the production of high-value-added goods and services, decrease costs through productivity gains, support the employment of qualified research personnel, facilitate the inflow of 27 R&D based FDI, establish, and support pre-competition cooperation projects. Furthermore, several programs and projects have been initiated since 2005 to educate researchers inside and outside the country to overcome the shortage. Consequently, a substantial improvement has been observed in the (full-time equivalent) number of researchers from 39,9 thousand in 2004 to 63,4 thousand in 2007. General Comments 20. We consider the design of CEDPL I to be very well in line with our development objectives and priorities that are embedded in our main policy documents. "Increasing competitiveness" and "increasing employment" being two of five development axes of the 9th Development Plan, illustrates this strong relationship. 21. Furthermore, the program areas of CEDPL I are well identified and their complementary nature is well established. "Improving the business environment", "improving the financial system" and "improving R&D and innovativeness" are all sub- pillars of 9th Development Plan. 22. In this context, we extend our appreciation to the Bank for its support to our reform program through the CEDPL series. Furthermore, we commend the Bank for its approach in terms of customization and alignment, which are prerequisites for ensuring country ownership. Since the satisfactory implementation of the development policy operations depends on government-led initiatives, ensuring the country ownership is a critical aspect of the design process. 23. With respect to the design of the CEDPL I, another issue of importance is the structure of prior actions. The CEDPL I contains only eight prior actions that are considered to be the most critical policies to achieve its objectives. In this respect, we welcome the decrease in the number of prior actions of development policy loans, which is of great importance for an effective implementation. 24. We appreciate the analytical and advisory work of the Bank which significantly contributes to the policy dialogue in several reform areas supported by the CEDPL series. Strong links between analytical studies and Bank lending, provided the foundation for a well-designed development policy operation. Furthermore, the analytical framework served to provide a basis for the design of our reform program and its effective implementation. 25. The CEDPL series is a well designed development operation in its programmatic nature. As the government continued implementation of its reform agenda, the prior actions defined for the CEDPL II has been met and the agreement for the loan was signed on December 17, 2008. The CEDPL II can be considered as a good sign of continuity of a well designed and precise programmatic operation. 26. We would like to underline the importance of having a constant policy dialogue based on country's needs and priorities. In this respect, we would like to have the continued support of the Bank on sectoral Development Policy Loans, in addition to on- going series of operations. We especially welcome the prospect of the CEDPL III which 28 will deepen the support of the Bank in the areas of enhancing competitiveness and increasing employment. 29