Document of The World Bank FOR OFFICIAL VSE ONLY 1-4/ rLI Report No. 6885-TU STAFF APPRAISAL REPORT REPUBLIC OF TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT December 14, 1987 Industry, Trade and Finance Division Country Department I Europe, Middle East and North Africa Regional Office This document has a restricted distrlbWon and may be used by recipients only in the perfonnance of theilr official duties. Its contents may not otherwise be disdosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Turkish Lira (TL) Value of US$ 1976 T/ IL 16.05 1977 TL 18.00 1978 TL 24.28 1979 TL 31.08 1980 January TL 70.00 1981 January TL 91.00 1982 January TL 139.60 1983 January TL 191.15 1984 January TL 309.20 1985 January TL 451.40 1986 January TL 586.40 1987 Ja:.uary TL 752.93 1987 November TL 950.00 A' Annual averages through 1979. FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS AIs Administrating Institutions cBT Central Bank of Turkey CMB Capital Market Board DYB Devlet Yatirim Bankasi EIB European Investment Bank ERR Economic Rate of Return Ex-Im Bank Export-Credit Bank of Turkey FE Foreign Exchange FERIS Foreign Exchange Risk Insurance Scbeme GDP Gross Domestic Product GNP Gross National Product GOT Government of Turkey IFRR Internal Financial Rate of Return IGEME Export Promotion Research Center IMF International Monetary Fund KfW Kreditanstalt fur Wiederaufbau PCBs Participating Commercial Banks SEEs State Economic Enterprises SPO State Planning Organization SSIs Small Scale Industries SYKB Sinai Yatirim ve Kredi Bankasi TSKB Turkiye Sinai Kalkipma Bankasi FMORMIA USE ONLY REIU IC OF TURKEY STAFF APPRAUEL REPOLT IDUSDIAL EXCPORT DEVELOPMENT PROJEC Tabl2 of Cnstenst Page No. PROJECT SUMIARY .................................,.,...... i I. BACKGROUND ..............,............................... 1 II. TEE MANUFACTURING SECTOR AND POLICIES ........... ...... .... 2 A. Mf_ro-economic Developments in the 80s ........... ,..... 2 B. Impact on Manufae.turing Industry .., .................... 3 C. Policy Issues Affecting the Future Development of Private Inkdustry .................................... 6 D. The Bank's Strategy in the Manufacturing Sector ........ 9 III. THE FINANCIAL SECTOR .................. ..................... 10 A. The Structure of the Financial System .................. 10 B. The Size of the Financial System ....................... 12 C. Credit Growth and Allocation ............., ............. 13 D. Industrial Fiuance . ........ . 4 . .............. .. 14 E. Financial Markets ...... ..............................,. 15 IV* THE PROJECT 17 V.E T. PRJC............................................... 1 A. Project Objectives ....... .............................. 17 B. Project Description and Design ........... ............... 17 C. Technical Assistance ................................... 17 D. Beneficiaries ............................................ 18000*90* i E. Project Cost and Financing Plan ........................ 19 F. Participating Banks and Eligibility Criteria 44444444444 19 V. THE PROPOSED LOAN AND MAIN FEATURES ............4............ 24 A. Amount and Allocation of Funds ............. ............ 24 B. On-lending Rates and Foreign Exchange Risk ............. 24 C. Administration ........ ................................ 25 D. Procurement and Disbursemnts ..... ..................... 26 VI. PROJECTS BENEFITS AND RISKS 44.4............... ............ 27 VII. RECOMMENDATIONS ............................................ 28 This report is based on the findings of an appraisal mission to Turkey in April 1987. TIh mission consisted of Messrs. Dalla (Chief), Banerji, Behbehani, Rocha (EMPID), and Joshi (Consultant). This document has a nstricted disibution and may be used by ncipient osnlyin b pwomas of dhir officl duties. Its contents may not otherwi be disclosed witKWh onu Banakjuthxiaon. Page No. ANNEX 1 - Selected Performance Indicators for the Manufacturing Sector (1979-86) .0. *.***ee.e e* 30 ANNE 2 - Comodity Composition of Exports (1977-87) .... 31 ANNEX 3 - Turkey - Exports by Destination ............... 32 A=EX 4 - Turkey - Shares of Financial Institutions in Total Credit (1980-86) .................... 33 ANNEX 5 - Turkey - Composition of Credit (1980-45) *...... 34 ANNEX 6 - Industrial Development Bank of Turkey (TSKB) ... 35 ANNEX 7 - Industrial Development Credit Bank (SYKB) ...... 50 ANNEX 8 - Terms of Reference of a Proposed Study of Credit Delivery System for Industrial Finance ...... 68 ANNX 9 -- Distribution by Sector of the Nedium-term Rediscounts for Project Finance provided by the Central Bank (1981-86) ................... 70 ANNE 10 - Projected Disburseumntu o**e˘*,**,****,,, 71 ANNEX 11 - Documents in Project File ..................... 72 REPUBUC OF TURKEY !NDUSMRIAL EXPORT DEVELOPMENT PROJECT (IEDP) PROJECT SUMMARY Bomffwemr Turkiy* Sinai Kalkinma Bankasi (TSKB), Sinai Yatirim ve Kredi Bankasi (SYKB), and tAe Government of Turkey (GOT). Guwantw. Republic of Turkey (for the loans to TSBK and SYKB). Private export-oriented industries. Amount: US$ 300 million equivalent consisting of: (i) US$ 150 million for TSKB; (ii) US$ 50 million for SYXB; and (iii) US$ 100 million for the GOT. Terms: TSKB and SYKB will repay the Bank on the basis of composite amortization schedules of subloans. The loan to GOT will be on stLadard IBRD terms. 2*lending Terms: The sub-borrower will be given an option to borrow either in local or foreign currency. In case of the loans denominated in TL, the sub-borrower will be able to borrow at a fixed interest rate specified under the Foreign Exchange Insurance Scheme (FERIS) at the time of borrowing. The interest rate under FERIS is currently 34% p.a. including a spread of 41 for the participating banks. In case of the loans denominated in foreign currency, the participating banks will on-lend at the Bank rate plus a cpread of up to 4% p.a.. The maturity of the subloans would normally not exceed ten years including a maximum grace period of three years. Proisot Descrpton The proposed Project is designed to support Turkey's drive for exoanding exports and to improve the policy and institutional framework relevant to export finance. It consists of a credit component of US$ 298.5 million for on-lending by the participating banks and a technical assistance component of US$ 1.5 million. The credit component will be implemented through the participating banks, which will include two private development banks (TSKB and S m ), and several major private and public commercial banks. TSKB and SYKB will be the direct borrowers of the Bank funds. - il - The coumercial banks will have access to the Bank loan through TSRB and 8YKB, which would perform intermediary functions on behalf of the Government for a fee 0.5% p.a. All sub-projects financed under the Project would be expected to meet the agreed target of exporting at least 201 of incremental production within 3 to 5 years after start-up. The participating banks will be responsible for appraising investment projects in accordance with agreed procedures, and the appraisals will include calculation of the internal financial and economic rate of return. A minimum economic rate of return of 151 in real terms would be required for all sub-projects financed under the Project. The appraisal reports will also include a statement on the environmental impact of the sub-project and measures which would be taken to comply with enviromental regulations in Turkey. The Project includes a technical assistance component of US$ 1.5 million for strengthening the Export Promotion Research Center (US$ 500,000), assisting the Ex-Im Bank in setting up a trade and export credit information system (US$ 900,000), and US $100,000 for carrying out a study of credit delivery system for industrial finance. Goods and services financed under the Project will be subject to standard procurement procedures for projects involving financial intermediaries. Contracts below US$ 2.5 million will be procured through domestic and international shopping with at least three quotations. For contracts above US$ 2.5 million, Limited International Bidding wiAI be required. The proceeds of the Bank funds will be disbursed at the rate of 1001 of the foreign exchange cost for machinery and equipFent of eligible sub-loans and 60t of locally procured goods, the estimated foreign exchange cost. Consultants will be employed in accordance with the Bank's Guidelines. Special accounts will be set up under each loan to facilitate disbursements. Pi=G Private investors $248.5 million Participating domestic banks 50.0 million IBRD 300.0 million Total $598.5 million Bank Fiscal Year FY88 FY89 FY90 FY91 FY92 - (US Million) Annual 5.0 100.7 112.5 61.3 20.5 Cumulative 5.0 105.7 218.2 279.5 300.0 11 1.7 35.2 72.7 93.2 100 0 REPUBUC OF TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT STAFF APPRAISAL REPORT IL BACKGROUND 1.01 Until 1980, Turkey's industrial development strategy was mainly based on capital intensive import substitution in basic industries. The main policy instruments employed were large investments in State Economic Enterprises and high levels of protection to both public and private industries. These policies, combined with an overvalued exchange rate, led to an inward-oriented industrial sector. The industrial sector was hard hit by the oil crisis in the 1970s and by the end of 1970s was facing a severe foreign exchange crisis. Industrial production and capacity utilization declined sharply, inflation surged, and private industrial investment tumbled. To reverse the trend, starting in 1980 the Government adopted a new economic strategy aimed at stabilizing the economy, placing greater reliance on market forces and encouraging private industrial investment. The main elements of the new strategy were: (i) competitive exchange rate; (ii) import liberalization; (iii) export promotion; (iv) deregulation of prices; (v) public sector reforms; and (vi) deregulation of the financial system. These policy initiatives were supported by five SALs, one Financial Sector Adjustment Loan, and borrowings from the IMF. The impact of these policy measures on the economy, industrial sector, exports, and private industrial investment has on the whole been very positive. Between 1980-85, GDP increased at an annual rate of 4.42. Manufactured exports grew by almost 50% p.a. during the same period which more than doubled industry's share in total merchandise exports, from 36% to 752. The average capacity utilization rate increased from 522 in 1 80 to 73S in 1985. Private manufacturing investment rebounded from the depressed level in 1980 and has increased at an annual rate of 6% in real term since 1983. The inflation rate declined from l07% in 1980 to 30% in 1986. 1.02 The export growth during the 1980-86 period was achieved mainly through the increase in teie capacity utilization and modest investment in improving the quality of the Turkish products. Thus far, exports are highly concentrated with five countries (West Germany, Italy, Iran, Iraq, and U.S.A.) accounting for about 50% of Turkey's exports. Also, about half of Turkey's exports are consumer goods (mainly textile, leather, and foods), which are likely to be adversely affected by the trend towards increasing protection in the major importing countries. Moreover, the buoyant local demand has increasingly absorbed a larger share of production. Turkey, therefore, would need to increase its export capacity, diversify markets and products to reduce its vulnerability, and make its exports more competitive by giving exporters sufficient incentives co compete in international markets. The proposed Project aims at supporting the Government in sustaining its export drive and improving the efficiency of the financial system especially for channelling investment credit. The proposed Project consists of two components: (i) a credit component of US$ 298.5 million; and (ii) a technical assistance component of US$ 1.5 million. The credit component is targeted at private export-oriented industries. The credit will be channelled through the two private development banks (Turkiye Sinai Kalkinma Bankasi (TSKB) and Sinai Yatirim ve Kredit Bankasi (SYKB)) and the commercial banking system which will have access to funds through TSKB and SYKB which would perform intermediary functions on behalf of the Government. Investors in Turkey will have an option for the first time to obtain a complete financial packago from a single financial institution. The participation of commercial banks will enhance competition which in turn would improve the efficiency of the system. To enable TSKB and SYKB to compete effectively, the proposed Project includes operational diversification programs for TSKB and SYKB which will allow them to undertake all types of banking activities. Financial restructuring of TSKB has been carried out to a large extent and will be completed by September 30, 1988. The Project would support GOT's plan to improve policy frameworks for export finance, export credit and insurance (para 2.14). The technical assistance component of the Project aims at strengthening export promotion by improving access to information on export market through the newly created Export-Credit Bank of Turkey (Ex-Im Bank) and technical assistance to small aud medium-sized exporters through the Export Promotion Research Center (IGEME). L T MANUFACTURING SECTOR AND POLICIES A. Macro-economic Developments in the 80s 2.01 Until 1980, Turkey's industrial development strategy was principally based on import substitution in basic industries. The main policy instruments employed were large investments in State Economic Enterprises (SEEs) and generous tax and financial incentives combined with high levels of protection which benefited both the public and private sectors. These policies led to rapid industrial growth which increased industry's share in GDP from 13% to 18Z between 1963-77. However, these policies also gave rise to some serious weaknesses, namely extreme anti-trade bias and lack of competitiveness, high capital-intensity, high import dependence particularly for intermediate and capital goods and very low efficiency, particularly in SEEs. These weaknesses became manifest following the first oil crisis in 1974 which resulted in a large baleance of payments deficit in 1977-78 and were exacerbated by the second oil crisis in 1979. Industrial growth declined sharply, capacity utilization rates fell to record low levels and inflation surged. Turkey also faced a severe balance of payment problems which led to a loss of creditworthiness in international financial markets. -3- Polir Changes Since 1980 2.02 In response to this severe crisis, in early 1.980, the Government announced a new economic strategy aimed at stabilizing the economy, placing greater reliance on market forces than on quantitative controls and encou- raging the efficient growth of the private sector. To implement this strategy, the Government initiated wide ranging reforms involving a number of key policy areas: exchange rate (large nominal devaluation followed by continuous adjustment to maintain a competitive e:change rate); import liberalization (elimination of the quota list, shifting imports to the more liberalized list; reduction in guarantee deposits, simplification of regulations and centralization of import administration); export promotion (payment of indirect tax rebates, export credit, priority access to foreign exchanges for duty-free imports of inputs, relaxation of export price concrols and procedural simplifications); price liberalization (deregulation of prices; abolition of price committee and fund; reduction of subsidies); public sector reforms (freeing most SEEs from price controls, rationalizing public investment); financial sector policies (deregulation of interest rates, reduction of selective credits, capital market legislation); monetary policies (control of monetary aggregates to curb inflation); and tax reforms (to increase resource mobilization and restructure investment incentives to promote exports). 2.03 Since 1980, in the context of various Bank-assisted operations, specifically five SALs, one Financial Sector Adjustment Loan, one Agriculture Adjustment Loan, and borrowings from the IMF, these policy initiatives have been further deepened in all areas, although the emphasis has varied in response to economic performance. The thrust of the reforms initiated in 1980 was maintained until 1982 without significant changes. In 1983, the failure to implement effective monetary and fiscal policies led to negative real interest rates. The reform program entered a new phase from early 1984 with greater emphasis on real exchange rate devaluations, rapid import liberalization, maintenance of positive real interest rates for deposits and SEE reforms to improve efficiency and financial viability. Private sector investments were also supported through a number of generous investments incentives while SSE investment in manufacturing were cut back sharply. B. Impact on Manufacturing Industry 2.04 The manufacturing sector's response to the Government's stabilization and liberalization program has been impressive. Annex 1 summarizes the key aggregate performance indicators for the manufacturing sector as a whole. The adoption of a realistic exchange rate and complementary export promotion policies stimulated manufactured export growth to a remarkable extent. Between 1980-1986, manufactured exports grew by almost 31% per year which doubled industry's share in total merchandise exports from 36% to 75% (para 2.07). As a result, in spite of the depressed domestic market, manufacturing emerged as a lead sector growing at an annual average rate of 8.0% (compared to the average GDP growth rate of - 4 - 4.4% p.a.). This high growth increased its share in GDP from 21.31 to 25.0% durint this period. The average capacity utilization rate in manufacturing improved from 52% in 1980 to 751 in 1986. Most of the export growth has taken place in the private sector reflecting its more positive response to the adjustment policies of the Government. Manufacturing output, however, recorded an impressive growth of over 10% due to buoyant domestic demand. 2.05 The improvement in manufacturing exports and output was not accompanied, at least until 1983, by an increase in private investment. Private manufacturirg investment, which had grown steadily at an average annual rate of 11.6 percent during 1972-1977, fell sharply during the economic crisis period 1978-1981, and remained stagnant, thereafter, until 1983. Lower capacity utilizatiod, weak domestic demand and the very high cost and limited availability of investment funds have been the major deterrents (Chapter III). Public investment in the manufacturing sector, grew considerably over the entire period 1972-1980 (with the exception of 1978). Following the adoption of the new policy package in 1980, public investment in manufacturing has been cut back. Preliminary estimates by the State Planning Organization (SPO) for 1984-86 indicate that private industrial investment has increased at an annual rate of 62 p.a. in real terms. Furthermore, the share of private manufacturing investment in total investment rose from 41% in 1980 to 66.22 in 1986. 2.06 The revival of private manufacturing investment can be attributed to higher capacity utilization and improved profitability of firms. Improved profitability, in particular, may have enabled firms to utilize the generous investment tax allowancez and undertake investment programs especially balancing, and modernization, despite the high and rising cost of borrowing in the past few years. The eight sub-sectors with the highest investment growth rates (in descending order) are rubber and plastics (941), leather products (771), measuring instruments (58%), electrical machinery (341), textiles (14b', paper and printing (9%), food and beverages (41), and non-electrical machinery (3%). Of these eight, seven have above average export growth, five have above average capacity utilization and four have above average output growth. It appears that consumer goods have increased their share in total fixed manufacturing investment primarily at the expense* of intermediate goods. Manufactu i Export Performance and Prospects 2.07 The growth in manufacturing export from Turkey has b3en most impressive. Annex 2 shows Turkey's composition of commodity exports for 1980-87 period. Total exports increased from US$ 2.9 billion in 1980 to US$ 7.5 billion in 1986, an annual compounded growth rate of 17%. Manufacturing exports rose from US$ 1.1 billion in 1980 to US$ 5.3 billion in 1986, or an annual increase of 311. The growth rate between 1980-85 was much higher at 491. The decline in exports during 1986 was due to a decline in oil revenues especially in Iran and Iraq (see para 2.08). The decline in exports to Iran and Iraq has been offset, to a large extent, by an increase in exports to EEC countries. During the first ten months cf 1987, - 5 - manufacturing expc,rts increased by 442 in dollar terms over the same period last year. Table i below shows export performance by sub-sector during 1980-86 period. in 1980, three sub-sectors (textiles, agriculture processed products, and chemicals) accounted for about 702 of the total exports. Their shares declined to about 542 in 1986 reflecting rapid growth in other sectors. The share of textiles declined from 42% in 1980 to 34.82 in 1986. It is interesting to note that the fastest export growth during the period has been in new miscellaneous sub-sectors which is classified as others. The three other fastest growth sub-sectors are: iron and steel(692), metal products and machinery (442), hides and leather products (442). The growth of the textile sector has slowed markedly and the increase was ol.y 32 in 1986, reflecting the increased protectionism in the importing countries. Table 1 EXPORT PERFORMANCE OF MANUFACTURING SECTOR (in Million US$) Annual 1980 1986 compounded Amount X Amount % growth rate Textiles 439.8 42.0 1,850.7 34.8 27b Iron and steel 33.9 3.2 803.6 15.1 69X Agriculture processed products 190.2 18.2 666.7 12.5 23S Chemicals 91.9 8.8 350.2 6.6 252 Hides and leather products 49.5 4.7 345.2 6.5 38% Metal products and machinery 29.8 2.8 262.9 4.9 442 Petroleum products 38.5 3.7 178.2 3.3 292 Glass and ceramics 35.9 3.4 157.9 3.0 28S Electrical appliances 11.5 1.1 126.9 2.4 492 Non-ferrous metal 18.3 1.7 111.2 2.1 352 Motor vehicles 50.3 4.8 82.4 1.5 92 Forestry products 8.1 0.8 51.7 1.0 36% Cement 39.6 3.8 26.9 0.5 -6% Others 10.1 1.0 309.8 5.8 772 Total 1,047.4 100.0 5,324.3 100l 0 31% =======Q ===== ==~==:= =: - - Source: State Plauning Organization. 2.08 Turkey exported to more than 100 countries in 1986. Exports to the OECD countries accounted for 57.6% of total exports followed by Middle Eastern Countries (30.92) and others (11.52). Turkey's largest trading - 6 - partner was Germany (19.42), followed by Italy (7.8S), Iran (7.62), Iraq (7.4X) and U.S.A. (7.4X). Annex 3 shows Turkey's exports by destination for 1980, 1985, and 1986. During the period, Turkey experienced export growth in pract ially all markets. However, exports to the Middle Eastern Countries especially Iran and Iraq increased dramatically from US$ 220 million in 1980 to about US$ 2.0 billion in 1985. In 1986, exports to these two countries tumbled and amounted to only US$ 1.1 billion. Both countries are in arrears in payments to Turkey and are experiencing financial difficulties. Negotiations are at an advanced stage to solve these problems and the prospects are reasonably good. However, the default has discouraged Turkish exporters from selling in these markets. Exports to EECs were basically flat in 1986. This was due both to strong local demands in Turkey, as well as increasing competition in traditional exports, i.e. textiles and leather products and quota problems. 2.09 The strength of the export recovery in 1987 and beyond is a crucial determinant of the pace and nature of Turkey's economic prospects. In 1986, merchandise exports accounted for only 13% of GNP, which is very low in comparison to the East Asian countries which are comparable to Turkey in terms of per cap'ta income and stage of development. Therefore, there is potential for increasing exports from Turkey, provided that other factors are put in place. The Government plans to take several policy measures in the areas of export finance and insurance, and export promotion to accelerate exports (para 2.14). 2.10 The current situation in Turkey suggests a continuation of favorable demand conditions in manufacturing. Manufacturing output grew by some 10 in 1986, which increased the overall average capacity utilization rate in manufacturing closer to 75%. Investmen. demand is likely to increase sharply in sub-sectors which have both high capacity utilization rates and strong export performance. These include textiles and garments, basic chemicals, fabricated metal products, electrical machinery, paper, food and beverages, wooden furniture, and non-electrical machinery of which the first five will probably be the major claimants on available funds. Barring any major economic setbacks, private industrial investment should grow over the next few years at least at a modest rate of 61 p.a. in real term from the 1986 level of TL 1,176 billion (US$ 1,57 billion). On this basis the projected level of private industrial investment for 1987-89 period would be about US$ 5.0 billion, or US$ 1.67 billion p.a. Assuming an average debt-equity ratio of 1:1, the demand for loan funds would be roughly US$ 2.5 billion. The proposed Bank loans of US$ 300 million would finance only 61 of the private manufacturing investment or 12X of the borroving requirement of the private industry during the period. C. Poliey Issues Affecting the Future Development of Private idus 2.11 Although the stabilization and liberalization program pursued by the Government over the past five yesrs has achieved significant reduction of distortions in factor and product markets, and the easing of administrative and regulatory barriers, additional policy measures are - 7 - needed to sustain the growth in private investment and exports. The private sector manufacturing investment study by the Bank -' has identified several areas needing further policy reforms which should help stimulate private sector investment and exports. These policy aspects are summarized below. Trade Polivy Isues 2.12 Export growth haa been fostered by a combination of direct incentive to exporters, import liberalization and real exchange rate devaluation. These policies have substantially reduced the anti-export bias which characterized the policy in the 70s. Since 1985, however, there has been a gradual reduction in the level of direct export subsidies because of pressure from GATT and bilateral trading partners. In order to ensure that the reduction in direct export subsidies does not worsen the competitive position of exports relative to the non-traded goods sectors and to import substitutes, exchange rate adjustments must be accompanied by greater import liberalization. An examination of the Government's import policy in 1986, however, indicates that import protection has marginally increased. Clearly the current levy policy (levies are ad hoc ad valorem fees charged on top of import duties) has introduced some distortions in the import liberalization program and needs to be corrected. The private sector manufacturing investment study (c.f.) makes the following recommendations on the trade regime: (a) elimination of export tax rebates by 1988-89; (b) maintenance of real exchange rate, sufficient to offset the decline in direct export incentives; and (c) rationalization of the import levy list. The findings of the report (para 2.12) were discussed with the Government in October 1987. It is likely that the Government would take these recommendations into consideration in formulating its economic program, which is expected to be announced in April 1988. Export Finance, Export Credt Insurance, and Export Promotion 2.13 Turkey has performed very well in expanding exports. However, the bulk of the increase in exports was achieved by utilizing the existing capacity and selling in less demanding markets. To sustain its export growth Turkey would need to take additional steps to assist the export sector. The Government is aware of this and has taken a number of concrete measures to promote exports. These measures include: conversion of the State Investment Bank (DYB) into the Export-Credit Bank of Turkey (Turk Ex-Im Bank) and the introduction of the Export Finance Scheme on December 1, 1986. However, several additional measures would need to be taken to improve the institutional framework for export. Some of the measures, which would be useful in promoting expotts and making Turkish exporters more competitive, are discussed below: (i) Terms of Export Finance. The maximum term which is availaUle to the Turkish exporters is presently 4 months based on a confirmed 1/ Turkey: Private Manufacturing: Assessmernt of the Impact of Past Policies and Future Adjustment Needs. Report No. 6684-TU, July 21, 1987. irrevocable letter of credit. There is no deferred payment facility available. Turkish exporters are therefore at a comparative disadvantage vis-a-vis exporters from other developing countries such as Korea, Brazil, and India. Most capital goods are generally purchased on a deferred credit basis. Also, the export cycle of all products is not as short as that of garments and textiles. Therefore, the relaxation in terms would be desirable; (ii) Eligibility Criteria. The present eligibility criteria of requiring a proven track record of export for the last three years with a minimum annual export of US$ 1.0 million precludes all new exporters. For Turkey to be able to inLrease and diversify exports it needs freer entry by relaxing the eligibility criteria. Any bona-fide exporter with a confirmed irrevocable letter of credit should have access to the rediscounting faciiity, and the present financing limit of 50% should be increased, perhaps to 80% of the face value of the letter of credit; (iii) Refinancing Procedures. Under the present system each transaction requires the approval of the Central Bank. While the system aims at preventing abuses, it is probably too restrictive, and should be simplified. The Central Bank should consider simplifying the procedures by delegating approval authority to the commercial banks within an agreed limit. The limit can be established based on an application by the interested banks. The banks will then be responsible for monitoring and reporting to the Central Bank. Alternatively, the Central Bank may consider delegating this authority to its twenty three branches; (iv) Export Investment (Project Finance). Export growth in the recent past has been achieved mainly through the increase in capacity utilization. As a number of industries are now operating at a high capacity level Turkey would need to create additional export capacity. Given the very high level of real interest rates, the Government would need to take some corrective measures to make export-oriented investment more attractive. One way to achieve this would be to increase the refinancing percentage for export-oriented projects. Another way of increasing investment in export-criented enterprises would be to increase the outlets which can provide long-term finance for investors. TSKB and SYKB are presently the two major sources of foreign exchange term finance in Turkey. They have played a key role and with the recent improvements in their operations would be able to continue to play an active role. However, Turkey has a well developed commercial banking system with a large network of branches. In a number of developing countries (India, Pakistan, Malaysia, Korea), the commercial banks have become active in project finance in recent years. There is also a general trend toward one stop banking. The role of the commercial banks in project finance in Turkey has been constrained because of the volatility in interest rates and lack of long-term resources. Under the proposed Project, the interested and eligible commercial - 9 - banks would hsve access to the Bank funds through the Administrating Institutions (TSKB and SYKB). An allocation of US$ 100,000 is also made under the technical assistance component of the Project, to carry out a study of the credit delivery system for industry (para 4.05); (v) Exp'rt Credit Insurance and Guarante_. The need for such a facility for a country like Turkey has been established in several previous studies. Such a facility is expected to be provided by the Turk Ex-Im Bank. In several countries the export credit insurance function is carried out by a separate legal entity in order to protect the soundness of the institution. In case of the Turk Ex-Im Bank, the scheme could be operated by the same staff; arid (vi) Export Promotion-IGEME. The Government plans to strengthen IGEME and make it more responsive to the needs of exporters. However, a number of concrete measures are needed to make IGEME a more effective and responsive institution, of which the most important is the need for a greater involvement of pri-rate sector exporters in IGEME's overall management (para 4.03). 2.14 The Government is in agreement with the above-mentioned findings and recommendations, and the Central Bank is in the process of revising its rediscounting scheme for export finance. The revision in the scheme is expected to be extensive and cover the aspects which are discussed above. A draft of the revised scheme is expected to be ready by March 1988. Also, an agreement has been reached with GOT that only eligible commercial banks would have access to Bank funds through the Administrating Inst*tution (para 4.15). D. The Bank's Strategy in the Manufaeturng Sector 2.15 Revival of private investment in the manufacturing sector and more importantly its efficient allocation will depend on the ability of the Government to create and maintain a positive and stable economic environment in which policy distortions are minimized so Lizat market forces can operate efficiently. In particular, distortions involving the exchange rate, interest rates, and prices in factor and product markets as well as policy biases towards preferred market sectors, regions and type of firms, need to be minimized, and eventually eliminated. The Bank's strategy should be to continue to assist the Government to follow through with its program of policy reform aimed at creating a competitive economic environment in which market forces are the principal determinants of investment behavior. 2.16 The Bank has recently completed two studies which analyze policy issues relating to industry. The first entitled "Fiscal Policy and Tax Reform" examines inter alia the incidence of tax incentives on capital investment. The second "Adjusting Public Investment" analyzes the level and composition of public investment and recommends programs for the rationalization of public investment. The latter study also recommends institutional reforms to improve appraisal, monitoring and implementation of public investment. A third study on private sector manufacturing investment - 10 - (c.f.) has identified several issues involving investment incentivec, trade policy and industrial finance which have been briefly summarized in para 2.12. In addition to the above) a study on the agro-industries is under preparation and its findings are expected to be discussed with the Government in late 1987. 2.17 Two projects of immediate relevance to the manufacturing sector have been included in the Bank's lending operations. The first, the Project under consideration, Industrial Export Development Project (IEDP), is designed to increase industrial exports from Turkey. The non-availability of long-term finance at a reasonable cost is a major impediment to private industrial investment (Chapter III) in Turkey. A large share of the resources mobilized by the financial system has thus far been used to finance the budget deficit through larger holding of government bonds by financial institutions. These bonds carry a high interest rate of up to 501 tax free, making them more attractive to the banks than providing term loans to the private industries. The availability of long-term funds under the Project will, therefore, be very important in terms of creating additional capacity in efficient export-oriented industries. The proposed Project, will also support the Government's plan of improving the framework for export finance and export insurance and intensifying export marketing efforts. To increase the flow of credit for private investment, the Government, by June 1988, would consider the merit of introducing a system of floating interest rates (para 3.16). If a reasonable reference rate could be devised, this new instrument may encourage commercial banks to provide some of the longer-term investment finance from their own resources. The proposed Project will be the first Bank-assisted project in Turkey in which the commercial banks are used as the vehicle to reach private industries. This should lead to a more efficient system of providing industrial credit to the private industry. Moreover, the Project will play an important role in assisting TSKB, the principal development bank, in its financial restructuring and operational diversification. 2.18 The causes of high non-preferential interest tates, the issue of crowding-out (para 3.16), and constraints affecting the development of capital and financial markets would be discussed with the Government in connection with the proposed second FSAL. The Bank is also planning an agro-industry project based on the study noted in para 2.16. Since agro-industries have a large export potential, the proposed agro-industry project will complement the IEDP in furthering Turkey's export drive. m. THE FIXANCIAL SECTOR A. The Structure of the Fincial System 3.01 The financial system of Turkey consists of: (i) the Central Bank; (ii) the specialized public banks; (iii) the domestic and foreign c3mmercial banks; (iv) the development banks; (v) the social security system, (vi) insurance companies and credit cooperatives; and (vii) the securities - 11 - market. The banking systo,m dominates the financial system, with a share in total financial assets of approximately 90. The volurie of securities held outside the banking system has grown significantly, but is still marginal. 3.02 At the end of 1986 there were 13 public banks l', 2 private development banks and 40 private commercial banks, of which 24 domestic banks and 16 foreign banks. The total number of bank branches was 6,372 and the number of people employed in the banking system was 151,200. The public banks were established under special law and tend to be fairly specialized in their lending operations. For instance, the Agricultural Credit Bank (TCZB), the largest bank in Turkey, specializes in agriculture lending but it is also active in commeroial banking; Halk Bank (HB) tends to specialize in lending to small- and medium-scale enterprises. Many public banks have a large network of branches and mobilize a substantial volume of resources through deposits. The two private development banks (TSKB and SYKB) cater exclusively to financing of the private sector. TSKB and SYKB have been the major sources of term finance and until recently relied mainly on foreign sources for loanable funds. In addition to the two development banks, there are two public institutions which also specialize in investment financing. The State Investment Bank (DYB)2' and DESIYAB, which provides financing to projects in less developed areas. The latter's resources come mostly from transfers of Turkish workers abroad. 3.03; The number of private domestic commercial banks has not changed since 1978, while the number of foreign commercial banks has increased from 4 to 16. The entry of foreign banks has introduced several new techniques into the financial system - for instance they were active in interbank operations before the Central Bank provided the institutional support for the development of an interbank market, and have also introduced the know-how in securities trading. Practically all of the new foreign banks have limited their participation to a single branch in Istanbul and have concentrated on providing trade finance to prime Turkish companies, which does not require domestic currency funding and is profitable. 3.04 The relative shares of the four bank groups in total bank assets has not change significantly between 1980 and 1986. The public banks account for more than half of total banks' assets. TCZB is the largest financial institution in Turkey and accounted for 24.5% of the total assets of the banking system at the end of 1986. The participation of foreign banks has remained very reduced despite the entry of twelve foreign banks during this period. The Turkish banking system has remained highly concentrated. The share of the four largest banks (TCZB and three private banks) in total banks' assets is around 52X. Within the group of private banks, the share of the four largest banks-' is even higher. I/ Defined as banks which are effectively controlled by the Government. 2/ In March 1987, DYB was converted into the newly created TUrk Ex-Im Bank 3/ Is Bank, Ak Bank, Yapi Kredit, and Pamuk Bank. - 12 - B. The Size of the Financid System 3.05 The size of the financial system and trends in its growtht are summarized in Table 2. The ratios of M2 and M2X (including foreign exchanige deposits) to GDP reached 23.3% and 28.42, respectively, at the end of 1986, which shows considerable improvements in resource mobilization comparedl to the depressed period of the late 1970s. Such rapid increase in financial depth after 1980 is explained by the macro-financial reforms initiated in 1980, which comprised the maintenance of real interest rates on deposits, the reduction of taxes and charges on financial intermediation and lower inflation i'. The progress in resource mobilization is not fully reflected in Table 2. In addition to the larger mobilization of banks' deposits, several new financial instruments, such as corporate bonds and more recently, commercial paper, have been introduced. The government-issued revenue sharing certificates were very well received and some of the banks have been allowed to manage mutual funds. There has also been some revivat in stock market activities. However, the stock market is presently dormant and is not likely to become a major scuirce of funds for the corporate sector for quite some time (para 3.15). 3.06 Although the Turkish financial system has performed well since 1980, it is still very shallow by comparison with other countries at a similar stage of development. The ratio of M2 to GDP in Turkey is 23%, compared to the average of 36% for developing countries at similar income Table 2 TURKEY: DEPTH OF THE FINANCIAL SYSTEM (1) Year Ml/GDP M2/GDP M2X/GDP Credit/GDP 1970 21.0 26.1 26.1 37.0 1978 18.7 21.8 21.8 33.4 1979 16.1 19.4 19.4 25.5 1980 12.4 15.0 15.0 20.1 1981 11.6 17.1 17.1 22.4 1982 11.5 21.9 21.9 24.9 1983 12.1 23.0 23.0 24.4 1984 9.1 21.5 22.7 20.3 1985 8.4 23.0 25.9 17.0 1986 8.4 23.3 28.4 20.3 Source: The Central Bank of Turkey and SPO. 1/ Developments in the financial syo,tem in recent years are documented in more detail in the IBRD reports: Financial Sector Adjustment Loan (No. 6095-TU, May 15, 1986) and Private Manufacturing - Assessment of the Impact of Past Policies and Future Adjustment Needs (No. 6684-TI], July, 21, 1987). - 13 - levels. Also, the ratio of broad money to GDP (including the foreign exchange deposits) is only slightly higher than the levels achieved in the early 1970s. These two factors suggest that there is still ample scope for further progress in resource mobilization. C. Credit Growth and Allocation 3.07 Although the growth of credit is clearly related to deposit mobilization, such correlation is not always direct, as shown in Table 2. Before 1980 credit as a percentage of GDP decreased much faster than broad money. However, between 1980 and 1983, credit grew less than broad money. In 1984, both the ratios of credit and money to GDP fell. In 1985 there was a recovery in deposit mobilization which was not translated into increases in real credit; on the contrary, the ratio of credit to GDP kept declining. Finally, during 1986 credit grew much faster than broad money. 3.08 There are other important factors, in addition to deposit mobilization by the banking system, which explain the behavior of credit duriig this period. First, increases (decreases) in external borrowing by Turk2sh banks result in increases (decreases) in credit for the same level of deposits. The sharp decrease in the ratio of credit to GDP after 1977 is explainied not only by the reduction in the real stock of deposits but also by the strong decrease in external borrowing by Turkish banks - external financing was substantially curtailed ae the country's creditworthiness fell during that period. During 1986 the reverse was truc. increased borrowing from at oad helped explain why the credit stock grew so rapidly during that year. Second, variations in reserve and liquidity requirements also explain different rates of growth between credit and money. For instance, the reductiorn in reserve requirements in 1985-86 also contributed to the higher growth of credit during 1986. Finally, larger voluntary holdings of government bonds by Turkish banks resulted in a decrease in the growth of credit for the same growth of banks' liabilities. The stocks of government bonds held by Turkish banks have increased rapidly since 1984, due to the high net of tax returns offered on these bonds. This factor depressed the growth of credit in 1984 and 1985 and prevented an even higher growth of credit during 1986. 3.09 Regarding credit growth and allocation, the overall picture is mixed. The reduced role of the Central Bank in the financial intermediation process (Annex 4) has helped to reduce the distortions in credit allocation generated by preferential credits. Credit allocation tends to improve as the banks' lending capacity increases (due to lower -eserve requirements) and more credit flows to activities with high returns. However, the increased lending capacity of Turkish banks did not lead to e proportionate increase in credit to the private sector due to the increase in the holdings of Government bonds (Annex 5). The Government bonds carry a high interest rate of up to 50% tax free, which makes it more attractive for the banks to invest in the bonds rather than to make loans to private sector. The ratio of public domestic debt to GDP has increased from 3.3% in 1984 to 5.3% in 1986. - 14 - D. Idustrial FiQanwe 3.10 Although the volume of credit to the private sector has increased in real terms, medium- and long-term industrial credit has remained scarce. Tenm finance in Turkey is provided mainly by investment and development banks, which until recently relied heavily on multilateral and bilateral institutions, and Central Bank's rediscounts for their resources. Domestic resource mobilization by these institutions has been limited. The deposit money banks provide medium- and long-term loans to the extent that these loans are partly rediscounted by the Central Bank (the rediscounted share varies from 50% to 80b of the loan). Medium- and long-term industrial loans financed entirely out of the deposit money banks' own resources are very limited. With the availability of long-term refinancing resources under the proposed Project, the commercial banks are expected to play a more important role in this area. 3.11 Table 3 shows data on total industrial credit, as well as estimates of medium- and long-term industrial credit in Turkey. The table suggests taat the growth in long-term credit has generally been stagnant for three reasons: (1) Central Bank rediscounts have not increased in real terms; (2) development banks have experienced difficulties in mobilizing domestic resources and their utilixation of foreign credits were constrained by the absence of a Foreign Exchange Risk Insurance Scheme (FERIS); I' and (3) deposit money banks have been unwilling to provide long-term loans from their own resources as they do not have long-term resources. TaLle 3 TURKEY: INDUSTRIAL CREDIT, (1980-85) (in 1980 TL billion) Total Medium and long-term industrial credit industrial Change Central Commercial Change Yeiar credit (2 Bank Banks DFIs Total (M) 1981 540 24.4 24 18 153 195 24.1 1982 555 2.7 54 40 174 267 36.8 1983 417 -24.9 62 47 156 266 -0.5 1984 400 -4.0 52 41 142 235 -11.5 1985 457 14.3 52 41 124 217 -7.6 Source: Central Bank and mission estimates. 3.12 In Turkey, development finance has remained overly dependent on the Central Bank's rediscounts and foreign sources. As mentioned above, real 1/ FERIS was introduced in March 1985 as an insurance scheme operated by the Central Bank of Turkey. - 15 - interest rates on term loans have remained very high, discouraging firms from borrowing from financial institutions at non-preferential rates. Although financial expeases are tax deductible in full, the effective cost is still hign. As a result, the demand for Central Bank's rediscounts and FERIS loans is strong. The interest rates on these loans are more reasonable -- 34% (322 + 2% commission p.a.), compared to 60% in the case of the commercial bank lending rates for working capital loans. As the commercial banks do not have access to long-term deposits at a reasonable cost, they have not been able to carry out term transformation as in other countries. As the supply of funds from the Central Bank for rediscounting is limited, the term credit is rationed and borrowers have to wait several months for these loans. This, in turn, has inhibited private industrial investment. To carry out necessary investments the private sector has increasingly resorted to equity financing in recent years. The availability of long-term investment funds under the Project will therefore have a major impact on private investment. E. Finacia Markets 3.13 There has been considerable progress in the area of money and capital markets. First, in May 1985, the Treasury moved to an auction system for selling its securities and at the end of 1986 set up a regular auction schedule, which has enhanced the Treasury's ability to sell its debt. Second, in early 1987 the Central Bank introduced open-market operations. The further development of these operations will enable the Central Bank to control more effectively the money supply. Third, the interbank market is widely considered a success after only one year in operation. Daily volume is estimated to be around TL 150-200 billion compared with TL 4 billion in early 1985. The development of the mArket has enabled banks with excess reserves to lend to banks facing temporary liquidity shortages. Fourth, the corporate bond market is expanding and the first commercial papers were issued in the second quarter of 1987. The development of these instruments will provide the corporate sector a direct access to private savings and will enhance competition in the financial system. 3.14 However, there are still some impediments to progress in the above mentioned areas. In the area of Government securities, for example, the major problem is the restricted distribution of these securities. Most of these securities are held by banks, there being no significant arbitrage activity between securities and deposits. To the extent that the Treasury can broaden its distribution base, drawing savers from financial as well as non-financial assets, it can reduce its overall funding costs. At the same time it can increase the depth of the financial system. Regarding the interbank market, despite its initial success, there are still impediments to further improvements in the liquidity of the banking system. For instance, the transfer of funds between Central Bank's branches is still slow and inadequate. Also, the complete immobilization of required reserves reduces flexibility in the use of reserves. Finally, the market for private securities still suffers from excessive intervention from the Capital Market Board (CMB), there is no external auditing of companies selling securities - 16 - to the public and insufficient disclosure of relevant information to investors. The improvement in the financial markets is one of the important objectives of the Second FSAL. Corporate Securities 3.15 Turkey's embryonic capital market accounted for less than 32 of the financial system in 1986. As of December 31, 1986, there were 375 companies listed on the Istanbul Stock Exchange with a tc.al market capitalization of TL 641.6 billion (US$ 855 million), or roughly 1.62 ef GNP. The sizes of the market is extremely small in comparison to the stock markets in othel developing countries such as Korea, Malaysia, and Thailand. The stozk market in Turkey has not been a major source of investment finance. The growth of the market has been inhibited by several factors: high inflation, low dividends (in real terms), lack of adequate diseloaure requairements and audited financial statements l/ and absence of incentives for family owned concerns to become public companies. High interest rates on other instruments especially treasury bonds and deposits make it less attractive for investors to invest in equities. Since the interest rate for corporate bonds and commercial papers are lower than the commercial banks' lending rates, it is more advantageous for companies to issue bonds and commercial papers. As a result, corporate short-term bonds have increased rapidly f-om TL 16 billion in 1983 to TL tll billion in 1986. The sharp increase in the volume of corporate papers is also due to the new decree allowing corporations to issue commercial paper up to 6 times their equity. The Second FSAL would address some of the important aspects affecting the development of corporate securities markets. These would include auditing of companies on the stock exchange and companies selling securities to the pubiic. 3.16 The financial system has performed relatively well and been able to mobilize more resources. However, the size of the system is small and a large share o' these resources has been channeled towards the financing of the budget deficit through larger holdings of government bonds. The most recent increase in deposit mobilization is due to the foreign exchange deposits and these resources are mainly used for trade financing. Sustained increases in long-term lending to the private sector will therefore depend on: (i) greater resource mobilization by the financial system; and (ii) reduced absorption of domestic financial resources by the government, which is a necessary step for the reduction of market-determined lending rates and increase in the availability of credit to the private sector. The introduction of a system of floating interest rates may also contribute to the increase in credit for private investment, since it would make deposit money banks more willing to extend their own resources for long-term activities. The Government has agreed to consider the merit of floating interest rates under the proposed Project by June 30, 1988. The issue of crowding-out and the Government deficit would be discussed under the Second FSAL. 1/ Starting January 1, 1988, the forty companies which are listed in the first market of the Istanbul Stock Exchange will be required to have their 1988 accounts audited. - 17 - TV. THE PROJECT A. Project Obiectives 4.01 The proposed Project is designed to support Turkey's drive for expanding industrial exports and the policy and institutional framework relevant to export finance. This will be achieved by: (i) providing financial support :o private export-oriented projects in key sub-sectors where Turkey has a comparative advantage; (ii) supporting TSKB, the major private development bank, in its financial restructuring and operational diversification program; (iii) improving the credit delivery system for industry by including commercial banks in the Project; (iv) intensifying export marketing and promotional efforts by strengthening the Export Promotion Research Center (IGEME) through greater private sector involvement; and (v) creating a computerized trade and export credit information system at the Ex-Im Bank. B. Project Description and Desin 4.02 The proposed Project is aimed at financing private export-oriented investments (para 4.06) in Turkey. The Project consists of a credit component of US$ 298.5 million and a technical assistance component of US$ 1.5 million (paras 4.03-4.05). The credit component will be channelled through the participating banks which will include two leading private development banks (TSKB and SYKB) and several private and public commercial banks which meet the eligibility criteria (para 4.98). TSKB and SYKB will be the direct borrowers of the Bank funds. In addition, TSKB and SYKB would manage Us$ 98.5 million on behalf of the Government as Administrating Institutions (Als). The commercial banks would have access to the Bank funds through the TSKB and SYKB (para 4.15). The participating banks including commercial banks will be responsible for appraising investment projects in accordance with Bank agreed standards. All sub-project appraisals will include calculation of Internal Financial Rate of Return (IFRR) or Economic Rate of Return (ERR) and will be subject to a minimum rate of return of 15% in real terms. Each appraisal report will also include a statement on the impact of the proposed investment on environment and the proposed preventive measures where appropriate. All export-oriented industries will be eligible for financing. New enterprises will be eligible under the Project; however, based on the existing pipeline of projects, it is expected that the Project would finance mainly the expansion, modernization, and rehabilitation of the existing medium- and large-scale enterprises. C. Technical Assistance 4.03 §ppprt for Export Promotion Activities. The Project will also support Lhe strengthening of IGEME. IGEME was established in 1960 as a semi-autonomous agency affiliated with the Undersecretariat of Foreign Trade. It has a staff of about 60 professionals. IGEME has been - 18 - responsible mainly for organizing trade fairs in Turkey and arranging visits to foreign trade fairs. It has also prepared a number of country studies for exporters. Thus far, IGEME has not been particularly effective in export promotion. Part. of the proLlem stems from the limited experience of IGEME's staff and poor facilities. Th- private sector is not represented in IGEME's governing board. The Governmeit is committed to addressing these shortcomings. Specifically: (i) IGEME's Board of Directors would be reconstituted to allow representation by private exporters at the same level as Government representation; and (ii) IGEME's management would be strengthened. These changes would require an amendment in IGEME's Act which is outdated. During negotiations, an agreement was reached with the Government that the Government would take all necessary actions to strengthen IGEME, its management structure and procedures by December 31, 1988. IGEME will use the Bank funds to: (a) provide advisory services to small- and medium-sized exporters; (b) train IGEME's staff so that they could service the exporting community more effectively; and (c) upgrade its computer facilities to enable it to better service its clients. The cost of these activities is estimated at US$ 500,000. 4.04 Technical Assistance to the Turk Ex-Im Bank. The proposed Project would include a component to finance: (a) technical assistance needed by the Turk Ex-Im Bank to develop appropriate procedures for provision of medium- and long-term post-shipment export finance, and guarantees and insurance programs and for training staff to implement such program; and (b) a trade and export credit information system to complement its export finance activities. The trade information system would also be used by IGEME for its trade promotional activities. The estimated cost of the technical assistance needs of items (a) and (b) above are about US$ 900,000. The TUrk Ex-Im Bank will borrow these funds from the Government and assume the foreign exchange risk. This arrangement was confirmed during negotiations. 4.05 A study of credit delivery system for industrial finance in Turkey. The channels for reaching private industries under the Project would be increased through the inclusion of commercial banks. This is a step in the right direction. As the private sector is expected to continue to play a major role in Turkish industry, *t is important that investment needs of private industry are met in a most efficient manner. The proposed Project therefore includes US$ 100,000 for a study of the credit delivery system to industry. The study will analyze past financing patterns of industry and efficiency of various channels which tere used to finance industry. Investment needs of private industry in .he late 1980s and 1990s will be assessed and appropriate vehicles for meeting their needs would be identified. During negotiations, an understanding was reached with the Government on the terms of reference of the study (Annex 8) and that the study would start by June 30, 1987 and be completed by the end of 1988. D. Beneficiaries 4.06 Sub-project Eligibility Criteria: Export-Oriented Investments. The last loan made to TSKB in 1982 required that all investment sub-projects - 19 - export at least 402 of the incremental production resulting from investment. This was largely achieved. Given the need to maintain the export drive, there is a need to retain explicit achievement criteria to promote export-oriented investments. However, it is appreciated that the criteria should be flexible enough to avoid excessive concentration in a particular industry group. It is, therefore, proposed that sub-projects financed under the Project should meet the following export achievement targets: expansion sub-projects should export at least 20b of the incremental production within three years of start-up; new sub-projects should export at least 20% of total production within five years of start-up. In case of balancing, modernization, and rehabilitation projects, the borrowing company should be the one that is exporting at least 20% of its sales. Investment projects by sub-contractors, i.e. the companies supplying their products to the exporting companies will also be eligible under the Project. Also, other export-oriented activities such as tourism will be considered on a case by case basis. The Project will include a comprehensive reporting requirement to ensure that the eligibility criteria are complied with by the participating banks (para 5.05). During negotiations an agreement was reached with the Government and participating banks that only sub-projects which meet the above mentioned eligibility criteria will be financed under the Project. E. Proieot Cost and Financing Plan 4.07 The total cost of the proposed Project is estimated at US$ 598.5 million of which US$ 300.0 million is in foreign exchange. The estimate is based on the recent investment trends, pipelines of the participating banks, and their projected lending programs over 1987-89 period. The three proposed Bank loans amounting to US$ 300.0 million will finance about 502 of the project cost. The balance will be financed by the private investors, participating banks, and suppliers credits. The proposed loans to TSKB and SYKB would cover about half of their foreign exchange requirements over 1987-89 period (Annexes 7 and 8). On the basis of recent trends the private industrial investment in Tu:key is estimated to reach about US$ 1.7 billion p.a. during the 1987-89 period with a foreign exchange requirement of about US$ 850 million p.a. The proposed Project would, therefore, finance about 61 of the private industrial investment annually. F. Participatin Banks and Eligibility Criteria 4.08 DFIs. Under the proposed Project, the Bank funds will be channelled through two private development banks and the commercial banking system. TSKB and SYKB have been the major sources of long-term foreign exchange resources for the Turkish industry. TSKB enjoys good standing in the industrial and financial communities. It has developed a cadre of competent staff who are known for their project appraisal skills and experience. During 1980-85, it faced severe financial problems but it has since restored its financial viability (para. 4.11). SYKB is a well managed financial institution and has the institutional capability to play a more active role - 20 - in fioanc'ng medium- and large-scale industries. Participation of both institutions will be subject to the eligibility criteria discussed below. 4.09 18KB. Annex 7 provides a detailed discussion of TSKB's past performance and prospects. Highlights are given below. TSKB was set up in 1950 by a group of Turkish private commercial banks and insurance companies with the objective of providing lung-term fiuancing for private industr> IFC also assisted TSKB as an investor and co-financier and at present holds 2% of TSKB's equity. The Bank has actively supported TSKB's development and as of June 30, 1987, has made 15 credits and loans totalling US$ 532 million to TSKB. The latest loan of US$ 100 million for export industries was approved in February 1982. Since 1980, TSKB has operated in an extremely difficult economic environment. During the 1980-85, TSKB faced severe financial problems because of the massive and successive devaluations which resulted in large non-performing loans. The situation was exacerbated by the lack of domestic resources and the restrictions in its Charter, which prohibited TSKB from diversifying its activities beyond term lending. Because of the low profitability TSKB was unable to build up adequate reserves. It was also difficult for TSKB to raise new capital. As a result, TSKB was undercapitalized in relation to the type of business which it catered to. The high non-performing assets and lack of domestic resources led to tight liquidity position and a negative interest rate spread in 1985 on its existing portfolio. 4.10 The Bank mission, which visited TSKB in October 1986, assisted TSKB's management in devising a comprehensive financial and operational restructuring program to address its fundamental problems so that it could again play an active role in the financial system. The main elements of the financial restructuring plan consisted of: (i) doubling of its share capital from TL 20 billion to TL 40 billion over 1987-88 period; (ii) raising long-term TL resources by TL 20 billion to enable TSKB to lend in local currency; (iii) increasing the spread by an introduction 2% p.a. service charge; and (iv) restructuring terms of the existing quasi-equity loans. The main elements of the operational diversification plan entails offering of a broader range of banking services. Specifically, TSKB plans to offer the following services: (i) working capital finance initially limited to its existing clients; (ii) money market operations; (iii) capital market operations especially comnercial papers and government securities;(iv) lending to non-industrial sectors; and (v) leasing. 4.11 Since October 1986, TSKB's management and the Government have taken a number of concrete measures to implement the agreed financial and operational restructuring program. In January 1987, TSKB's Board of Directors approved an increase in paid-in capital by TL 24 billion over 1987-88 period, and full payment of the first tranche of TL 12 million was completed in September 1987. A new quasi-equity agreement was reached with the Government in May 1987. These arrangements have substantially increased tSKB's capital base. On February 15, 1987 TSKB raised Y 9.5 billion in the Japanese market through private placement on good terms and conditions. The proceeds of US$ 62 million equivalent of the seven year yen issue was swapped in TL with the Central Bank at a rate of 32% p.a. fixed for seven years. This will provide TSKB with long-term domestic resources to carry - 21 - out its diversification program. Effective March 1, 1987 TSKB has started charging a commission of 2% p.a. for all new loans. This will further augment domestic resources. The efforts made by TSKB in improving the quality of its portfolio has begun to bear fruits. Its cash collections in 1986 were above the agreed target and the percentage of non-performing loans declined to 17% of the total rortfolio by the end of 1986. With the increase in cash collections and new resources, TSKB in early 1987 repaid all high cost short-term loans from commercial banks. To enable it to carry out the diversification program, TSKB initiated a reorganization study in November 1986 with the assistance of a consultant from the Morgan Guarantee Bank. The study was completed in January 1987 and the implementation has started. Essentially, TSKB will be transforming itself from a development bank to a merchant bank capable of performing all capital market activities. TSKB has also been successful recently in raising domestic funds by selling its commercial paper. 4.12 The net result of the above actions is that TSKB will become profitable in 1987 and its profitability is projected to increase from 1988 onward. Given the improvement and good prospects, TSKB is in a position to play an active role under the proposed Project. However, to ensure that TSKB continues to make progress it will be subject to the following eligibility criteria: (i) an additional increase in paid-in capital of TL 12 billion is to be completed by September 30, 1988; (ii) approval of the diversification program and near term strategy (1987-88) by TSKB's Board of Directors; (iii) implementation of the diversification program satisfactory to the Bank; (iv) a maximum debt/equity ratio of 10:1 1'; and (v) a minimum debt service coverage ratio of 1.1:1. The Bank will have the right to withhold new commitments if TSKB fails to implement the agreed financial restructuring and operational diversification program. This was reconfirmed during negotiations. 4.13 SYKB. Annex 7 provides a detailed discussion of RYKB's past performance and prospects. SYKB was set up in 1963 by five major commercial banks in Turkey to finance private industrial investment. The Is Bank, the largest private commercial bank in Turkey, owns 60% of SYKB's paid-in capital, which amounted to TL 3.6 billion at the end of 1986. SYKB has, to-date9 received three loans amounting to US$ 135 million from the Bank. These were loans for the textile industries (US$ 15 million); labour-intensive industries (US$ 40 million); and the small- and medium-scale industries (US$ 80 million). The implementation of the loans for textile and labour-intensive industries was delayed somewhat because of the reluctance of the firms to bear the foreign exchange risk. With the introduction of FERIS in 1985, the implementation accelerated and both loans are now fully disbursed. The implementation of the SMI loan, which was approved in February 1986, has been proceeding well. As of December 1, 1987 SYKB had fully committed the loan and disbursements amounted to US$ 39.0 million. 1/ For the calculation of this ratio, quasi-equity would be treated as equity and receivables under FERIS from the Central Bank is to be deducted from outstanding foreign debts. - 22 - 4.14 SYKB is a well-managed financial institution and has built up a cadre of competent staff. During the last few years, SYKB concentrated mainly on providing long-term finance to small- and medium-size industries. It has performed well. In line with the changes in the financial system and the expected demand for funds from large industries, SYKB plans to amend its strategy to enable it to provide a broader range of banking services to the private industry. As a conservatively managed financial institution, SYKB plans to proceed cautiously in its diversification efforts. In this connection, it has prepared a new operational strategy to guide its operations. The appraisal mission is in full agreement with SYKB's management on the proposed strategy. The mission's assessment shows that SYKB will continue to be a sound financial institution (Annex 7). The eligibility criteria applicable to SYKB under the proposed Project would be: (i) approval of SYKB's near term strategy by SYKB's Board of Directors; (ii) preparation and implementation of an operational diversification program; (iii) a maximum debt/equity ratio of 10:1; and (iv) a minimum debt service coverage ratio of 1.1:1. These eligibility criteria were agreed upon during negotiations. 4.15 Commercial Banks. In addition to the two development banks, Bank funds will be channelled through the commercial banking system. This will be the first Bank project in Turkey in which commercial banks are used as a vehicle to reach private industries. As commercial banks are major players in the financial system, their participation would increase the volume and sources of investment funds for export-oriented projects. The overall efficiency of the financial system would improve because of the added competition. Participation by commercial banks has been constrained by the limited project appraisal capacity of most banks and their lack of access to long-term domestic and foreign resources. The introduction of the commercial banks in project finance for export projects will be achieved by providing funds through the two AIs. Under the proposed Project, a Bank loan of US$ 100 million will be made available to the Government. Of this amount, US$ 98.5 million will be for on-lending through participating commercial banks (PCBs) and the balance of US$1.5 million for technical assistance. TSKB and SYKB, would manage the loan funds of US$98.5 million on behalf of the Government for a service fee of 0.52 p.a. Any PCB which meets the eligibility criteria (para 4.19) would have access to the funds for long-term investment financing. The PCB will be allowed to finance up to 100% of the sub-loan at the prevailing FERIS rate (para 5.02). The Government will be responsible for the commitment fee under the Bank loan during the commitment period. However, this cost will be recovered in full by charging a front-end fee of 1.5S to the sub-borrowers. The PCBs would submit sub-loan requests together with the appraisal reports to the Bank through the AIs. 4.16 The Central Bank has been operating the rediscounting facility in local currency for several years. Annex 9 provides a summary of the Central Bank's medium-term rediscounting facility for 1981-86 period. Rediscount loans for industry rose from TL 10.5 billion in 1981 to TL 146.1 billion in 1986. Some major banks such as Is Bank and Ak Bank have been active participants and are well equipped to handle this facility. However, they - 23 - would need to become familiar with Bank procedures. Given its past experiences, the Central Bank would have been a logical choice for chanelling Bank funds to private export-oriented industries. However, the Government has recently decided that the Central Bank should limit itself to the traditional central bank functions of establishing and implementing monetary policies. Given the non-availability of the Central Bank to perform this function, the introduction of commercial banks in project finance will start by using the alternative existing channels which are TSKB and SYKB. Both institutions have considerable experience in project finance and are familiar with Bank procedures. They have also worked closely with several major commercial banks in the past and would therefore be a reasonable alternative to the Central Bank. 4.17 As both TSKB and SYKB would also be direct lenders and are effectively controlled by a major commercial bank, using them as AIs presents a potential conflict of interest problem. Other commercial banks may be reluctant to access funds because of the confidentiality reason. However, the design of the proposed Project includes several safeguards t minimize this problem. First, their role would be reduced to: (a) verify. the eligibility criteria of PCBs; (b) reviewing the eligibility criteria of investment proposals prepared by the PCBs; (c) advising the PCBs on the Bank's procurement and disbursement procedures; (d) maintaining revolving funds and handling disbursements on behalf of the Bank; and (e) providing progress reports on implementation to the Bank. In return for these services, the AIs would receive a management fee of 0.5% p.a. Second, there will be no free limit and each sub-loan will, be submitted for Bank approval. In order to have a meaningful review of these projects, the minimum sub-loan size would be set at US $400,000. Third, to ensure a reasonable distribution of funds among the commercial banks, an initial maximum limit of US$ 15 million per institution would be established. This would provide the Bank with an opportunity to assess the seriousness of the PCB and its project appraisal capability. The proposed initial limit of US$ 15.0 million per PCB is rather small in relation to the size of the potential PCBs especially the five largest banks. However, this will be the first time in Turkey that the Bank's funds would be channeUled through commercial banks. Therefore, a cautious approachi is justified. Also, co-financing with TSKB and SYKB will be excluded and the limit would be reviewed from time to time based on the experience gained and would be adjusted if required. Given that the PCBs do not have access to long-term funds, the availability of the Bank funds would enable them to offer a broader range of financial services to industry. 4.18 Since AIs would not be making investment decisions and be basically acting as agents of the Government, they could not be expected to bear the credit risks. Given that TSKB is still going through a major financial and operational restructuring, it would also not be desirable to have tl;.ise additional debts on its books. The funds, therefore, should be passed on to the AIs under the fund management agreements. During negotiations, an agreement was reached with the Government and the AIs on the fund management agreements which also spelled out the role of the AIs and their obligations. Signing of these agreements would be a condition of loan effectiveness. - 24 - 4.19 Any PCB which would like to have access to the refinanciuig facility would have to meet certain eligibility criteria. These criteria would include: (i) a sound financial condition and performance; (ii) an unqualified audited financial statement audited by external auditors 1'; and (iii) competent staff to appraise and supervise investment projects or agree to build up such a capacity as the lending program justified. The Treasury will be responsible for selecting the PCBs in accordance witli the above mentioned eligibility criteria, which were agreed upon during negotiations. V. THE PROPOSED LOAN AND MAiN FEATURES A. Amount and Allocation of Funds 5.01 The proposed loan package of US$ 300 million equivalent will consist of three separate loans: (i) US$ 150 million for TSKB; (ii) US$ 50 million for SYKB; and (iii) US$ 100 million to the GOT for on-lending through commercial banks (US$ 98.5 million) and technical assistance (US$ 1.5 million) for the Ex-Im Bank, IGEME, and a study of credit delivery system to industrial finance. The loans to TSKB, SYKB and the GOT will be on the Bank's standard variable interest rate. TSKB and SYKB will repay the Bank on the basis of a composite amortization schedule of subloans. The loan to the GOT will have a fixed amortization of 17 years including a grace period of 4 years. Each institution will be able to extend loans to its borrowers for up to 10 years including a grace period of no more than 3 years. The credit risk will be borne by TSKB, SYKB and the PCBs. Out of US$ '.00 million loan, the GOT would ask TSKB and SYKB to manage US$ 98.5 a'lion for on-lending through commercial banks. GOT would on-lend US$900,000 to the Turk Ex-Im Bank for building up the trade and export credit information system and pass on US$ 500,000 to IGEME as a grant. These arrangements were discussed and agreed upon during negotiations. B. On-lending Rates and Foreign Exchange Risk 5.02 The sub-borrowers of the Bank funds will have an option to borrow either in local or foreign currency. In case of loans denominated in foreign currency the sub-borrower would borrow at the Bank variable interest rate plus a maximum spread of 4% p.a. and a commitment fee of 0.75% on undisbursed balances. For loans denominated in local currency, the sub-borrower will have an option to borrow either on a fixed or floating interest under the Foreign Exchange Risk Insurance Scheme (FERIS), which is operated by the Central Bank since 1985. Under FERIS, the spread between the lending rate and the cost of funds to the Central Bank is used to 1/ All commmercial banks are required by the Central Bank of Turkey to have their 1987 accounts audited by external auditors by June 30, 1988. - 25 - provide insurance against foreign exchange risk. The fixed rate uwder FERIS is currently 341 p.a. '" This rate is positive in comparison to the last 12 month average Wholesales Price Index (WPI)l" and is projected to be positive during the life of each sub-loan (8 years including a grace period of 3 years). The FERIS rate is reviewed twice a year by the Money and Credit Committee and adjusted if required. 5.03 As the Government is committed to bring down the inflation rate, it would be undesirable to have sub-borrowers locked in a high interest rate for a period of 8 years. Therefore, under the proposed Project, the Government has agreed to consider the merit of introducing a floating interest rate under FERIS by June 30, 1988. If the Government decides to introduce a floating interest rate then it would be available to sub-borrowers under the Project as an option. C. aton 5.04 Subloam size, free lbmits and review Procedum TSKB and S M . The proposed free limits for TSKB and SYKE under the project are US* 5.0 million and US$ 2.5 million respectively. The limits for TSKB and SYKB have been increased from U84.0 million and US$ 2.0 million respectively, to reflect inflation, exchange rate changes and the change in the client mix which is expected to take place under the proposed Project. It is expected that about 50 sub-projects would be financed by TSKB and 30-40 by SYKB. In addition to the individual free limit, an aggregate maximum limit of US$ 15.0 million equivalent for a single project will apply whether it is finaned individually or jointly by the participating banks. The proposed free limits would give the Bank an adequate control of the quality of appraisal reports and to ensure that only the enterpzises which meet the agreed eligible criteria (para 4.08) will be financed. Partic-pating Commercial Banks. Since the commercial banks have limited experience in preparing project proposals, it is proposed that the Bank review each sub-project from each participating commercial bank, which meets the eligibility criteria (para 4.19). The participating banks would submit their loan requests together with appraisal reports to the Bank through the Administrating Institutions (para 5.01). To allow a meaningful review of the sub-loans, the minimum size of the sub-loan to be financed under the Project will be US$ 400,000 unless otherwise agreed upon by the Bank. The maximum sub-loan size will be set at US, 4.0 million, or 202 of the networth (paid-in capital plus retained earnings of the PCB, whichever is less). _/ Base rate of 281 + 4i spread . 22 commission p.a. 2/ The twelve-month average rate (October 1986 to October 1987) was 292. - 26 - Reportng requirements and audits 5.05 TSKB will be required to submit progress reports acceptable to the Bank. These reports will cover TSKB's financial condition and results, utilization of Bank funds, operational U.argets, achievement of the agreed operational diversification and financial restructuring programs, and training. TSKB will also provide revised financial projections twice a year. TSKB's reporting requirements were discussed and agreed upon during negotiations. SYKB will continue to provide the same progress reports as under the previous loan. However, the coverage will be expanded to include performance of some of the problem companies, its diversification efforts, and semi-annual financial projections. Participating commercial banks will submit quarterly reports on the utilization of Bank funds. The Admini- strating Institutions will be responsible for providing the Bank with the aggregate reports on the utilization of the Bank funds for participating commercial banks on a quarterly basis in a format which is satisfactory to the Bank. Also, the participating banks will be required to submit a quarterly report on export performance of the sub-projects financed under the Project. The reporting requirements were discussed and agreed upon during negotiations. 5.06 TSKB is audited by an external auditor (Arthur Auderson) annually. It will continue to provide a long form audit within 120 days after the close of its fiscal year which is December 31. SYKB has been providing a short form audit until 1986. Starting in calendar year 1987 it will be required to provide a long form audit in a format satisfactory to the Bank. SYKB has been audited by an external auditor (Price Waterhouse) and the accounts have not been qualified. The participating commercial banks will submit their annual financial reports in a format specified by the Treasury. 5.07 Closing Date. Based on the pipelines of the participating banks, it is expected that the credit component of the Project will be committed within three years after Board approval and disbursed within five years. Therefore, it is proposed that the last date for submission of sub-loan applications to the Bank will be December 31, 1990. The same date will apply to the technical assistance component. The closing date of the three loans will be December 31, 1992. D. Procurement and Disbursements 5.08 Goods and services financed under the proposed Project will be subject to standard procurement procedures for projects involving development finance institutions. For contracts below US$ 2.5 million, the present comercial practice of local and international shopping with at least three quotations will be followed. Limited International Bidding (LIB) would be required for individual contracts for equipment and civil works above US$ 2.5 million. Project sponsors would seek bids from a list of potential suppliers broad enough to ensure competitive prices. Sponsors would notify embassies and trade representatives of Bank Group member countries and Switzerland represented in Turkey. Advertisement in the international press will not be required. The participating banks will be - 30 - ANNEX 1 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT SELECTED PERFORMANCE INDICATORS FOR THE MANUFACTURING SECTOR (1979-1986) 1979 1980 1981 1982 1983 1984 1985 1986 Real Percentage Growth Rate Production Total N/A N/A N/A 8.8 9.8 11.3 4.4 11.3 Private to" 4.2 10.3 12.9 8.9 11.1 Public It " 15.4 9.3 9.2 -1.7 11.5 Gross Value Added Total -5.3 -6.4 9.5 5.4 8.7 10.2 5.5 9.0 Exports Total -10.3 33.4 118.6 49.7 6.7 40.6 18.7 -11.2 Capacity Utilization Private 52.6 59.8 72.6 66.8 69.6 72.1 72.7 72.7 Manufacturing Investment Total -10.5 -1.5 -5.8 -8.9 0.6 3.9 -1.4 -4.6 Private -31.8 -14.1 -2.0 0.6 1.0 6.5 4.6 6.7 Public 23.5 9.8 -8.5 -15.9 0.3 0.0 -11.9 -26.7 Employment (1000 units) Total 593 554 539 547 567 602 590 N/A Private 315 315 373 327 356 380 378 N/A Public 278 239 216 219 210 222 212 N/A GDP at factor Costs -0.6 -0.5 3.6 4.5 3.9 6.0 4.2 7.3 Source: SPO, Main Economic Indicators for value added, investment, exports and GDP. SIS. Indexes of Industrial Production for output and Manufacturing Industry Quarterly for employment, ISO. The Manufacturing Industry for capacity utilization rates, - 29 - 7.02 Agreement was also reached with the Government, TSKB and SYKB that the maximum aggregate exposure under the three loans to a single project will be US$ 15 million equivalent (para 5.04) 7.03 Agreement was reached with the Government that the initial maximum limit per participating commercial bank would be US$ 15 million under the commercial banking component unless otherwise agreed by the Bank (para 4.17). 7.04 The proposed Project of US$ 300 million equivalent is suitable for Bank financing on the terms and conditions outlined above. - 28 - VIL RECOM EAnDATIONS 7.01 During negotiations, agreements were reached with the Government and the implementing agencies on the following: Government (i) There will be greater involvement of the private sector in IGEME. The Government will take necessary steps to strengthen IGEME's management by December 31, 1988 (para 4.03); (ii) The credit component under the Government loan will be passed through TSKB and SYKB to eligible commercial banks under fund management agreement. The AIs would receive a management fee of 0.52 p.a. of assets under management. Signing of these agreements would be a condition of loan effectiveness (para 4.18); (iii) The eligibility criteria for participating commercial banks (para 4.19); (iv) The participating intermediaries will finance only private export-oriented investments (para 4.06); (v) The sub-borrower will borrow at a fixed rate specified under FERIS at the time of borrowing. The Government would consider the merit of introducing a system of floating interest rates by June 30, 1988 (Para 5.03); (vi) The Government will pass on US$ 500,000 to IGEME as a grant (para 5.01); (vii) The participating banks under the Project will receive a spread of 41 under FERIS, which is available to all banks. In addition, the intermediaries will charge an annual commission of 21 p.a. (para 5.02); (viii) The terms of reference of the credit delivery system for industrial finance and timing of its implementation (para 4.05); TSKB and SYKB (ix) The eligibility criteria for TSKB and the Bank's right to withhold new commitments if TSKB fails to implement the agreed financial restructuring and operational diversification program (para 4.12); (x) The eligibility criteria for SYKB (para 4.14); (xi) Reporting requirements for TSKB, SYKB and the participating commercial banks (para 5.05). - 27 - required to maintain records of the method of procurement. The proceeds of the Bank loan would be disbursed at the rate of 100S of the foreign exchange cost for machinery and equipment of eligible sub-loans 100% of overseas training, and 60% of locally procured goods, which is the estimated foreign exchange cost. Special accounts will be established for TSKB and SYKB to facilitate disbursements. Disbursements by the participating commercial banks would be handled through the Ala. VX PROJECTS BENEFrTS AND RISKS 6.01 Benefits. The proposed Project would be beneficial to the country in several ways. First, it would assist the Government in maintaining the growth of private industrial investment through the availability of foreign exchange for investment. Second, the export growth should accelerate with the additional export capacity, simplification in export finance procedures, availability of export finance and credit insurance on more competitive terms, and strengthening of the export promotion institutions. Third, the credit delivery system for industrial finance is expected to improve with the proposed operational diversification and financial restructuring of TSKB. Fourth, the efficiency of the financial system will be enhanced with the participation of the commercial banks in the Project, and the financial services to the investors should improve with the increased competition. Fifth, the Project would assist SYKB's efforts in diversifying its operations from SSIs to larger enterprises with the availability of Bank funds. This, in turn, will create additional competition for TSKB. Based on the past experience, the proposed Project is expected to create about 20,000 new jobs with an average investment cost per job of about $30,000, which is reasonable. All sub-projects financed under the Project would be subject to a minimum economic rate of return of l5S at the time of appraisal. 6.02 Risks. There are two specific project risks. First, private industrial investment may slow down if the macro-economic conditions deteriorate and if, in particular, inflation accelerates. This could lead to a slow down in the commitment and disbursement rates. However, the Government is expected to continue its program of controlling inflation, maintain a realistic exchange rate, provide adequate export incentives and promote exports. Furthermore, the participating banks, especially TSKB and SYKB, have a large pipeline of projects which are at an advanced stage. Second, the comnercial banks are accustomed to making loans based on collaterals and are not familiar with Bank procedures. Therefore, a significant delay in implementing the commercial bank component could occur. However, this risk will be minimized as they would be assisted by TSKB and SYKM and through extensive training of the staff of participating commercial banks. Also, the large banks do have capable staff and they should be able to familiarize themselves with Bank procedures in a short period. In summary, the Project does entail risks, but the commitments sought from the Government and implementing agencies are adequate safeguards and they should minimize these risks. - 32 - ANNEX 3 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT EXPORTS BY DESTINATION (Amount in US$ Million) 1980 1985 1986 Amount 2 Amount 2 Amount % OECD Countries EEC Countries West Germany 604 20.8 1,391 17.5 1,444 19.4 France 164 5.6 162 2.0 299 4.0 Italy 218 7.5 502 6e3 580 7.8 United Kingdom 105 3.6 539 6.8 334 4.5 Others 209 7.2 610 7.7 606 8.1 Sub-total 1,300 44.7 3,204 40.3 3,263 43.8 Other OECD Countries USA 127 4.4 506 6.4 549 7.4 Switzerland 125 4.3 128 1.6 162 2.2 Others incl. Japan 127 4.4 268 3.4 318 4.3 Sub-total 380 13.1 902 11.3 1,029 13.8 Total OECD NA4 U A1aA X a2A U2A Middle Eastern Countries Iran 85 2.9 1,079 13.6 564 7.6 Iraq 135 4.6 961 12.1 553 7.4 Saudi Arabia 44 1.5 430 5.4 357 4.8 Others 362 12.4 777 9.8 831 11.1 Total 21. 3.27 LAQ2 2 Others Countries km ŁQ2 l;M; TOTAL JI21Q LbQZ 2 2.1Q Source: SPO. INOUSTRIAL EXPORT DEVELOPMENT PRO3ECT Coamditv Camosition of Exoorts (In 4illions of US $) CJ 1980 1981 1982 1983 1984 1985 1986 Agriculture and Livestock 1,671.7 2,219.4 2,141.2 1,880.9 1,748.9 1,719.4 1,885.6 Cereals and pulses 181.0 326.1 337.3 376.3 267.0 234.4 245.8 Nuts, fruits and vegetables 753.9 795.1 648.6 590.7 646.1 623.6 820.1 Hazelnuts 394.8 301.8 240.7 245.0 304.8 255.4 378.0 Raisins 130.3 130.2 100.3 71.4 62.3 74.0 102.9 Others 228.8 363.1 307.6 274.3 279.0 293.3 339.2 Industrial crops 605.9 813.4 741.6 531.5 492.5 596.3 494.7 Tobacco 233.7 395.0 348.3 237.8 216.4 330.1 270.2 Cotton 322.6 348.3 296.6 196.5 168.1 169.8 138.8 Others 49.6 70.1 96.7 97.2 108.1 96.3 85.7 Livestock products 108.2 258.2 389.7 362.1 322.9 244.2 285.3 Fishery products 22.7 26.6 24.0 20.3 20.3 21.0 39.7 Mining and quarry products 191.0 19'.4 175.3 188.9 239.8 24U.8 246.9 Industrial products 1,047.4 2,290.1 3,429.4 3,658.3 5,145.0 5,99- 7 5,324.3 Agriculture-based processed products 190.2 411.6 568.2 669.7 808.6 646.6 666.7 Textiles 439.8 802.8 1,056.3 1,299.1 1,875.4 1,789.5 1,850.7 Forestry products 8.1 19.7 33.4 14.8 23.7 105.8 51.7 Hides and leather products 49.5 82.1 111.4 192.1 97.5 107.9 345.2 Chemicals 91.9 165.6 208.3 197.2 270.0 373.5 350.2 Petroleum products 38.5 107.0 343.9 232.4 408.8 372.0 178.2 Cement 39.6 198.5 206.6 80.6 56.0 43.7 26.9 Glass and ceramics 35.9 102.1 103.7 108.2 146.0 190.0 157.9 Non-ferrous metal 18.3 29.8 44.6 78.9 85.5 115.5 111.2 Iron and steel 33.9 100.2 362.2 407.2 576.4 968.8 803.6 Metal products and machinery 29.8 85.0 143.0 122.8 134.5 450.4 262.9 Electrical appliances 11.5 26.1 75.2 69.0 99.6 119.0 126.9 Motor vehicles 50.3 117.5 110.2 126.3 134.9 146.6 82.4 Others 10.1 42.1 62.4 60.0 428.1 565.4 309.8 TOTAL EXPORTS 2,910.1 4,702.9 5,U74.9 5,728.1 7,133.6 7,958.0 7,456.8 …______ ------- _____ _ ------- ------- ------- Source: State Planning Orgmaniatien. - 33 - ANNEK 4 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT SHARES OF FINANCIAL INSTITUTIONS IN TOTAL CREDIT, 1980-86 (in 2) Deposit Investment money development Central Bank banks banks Total 1980 54.8 37.9 7.3 100.0 1981 44.4 47.2 8.4 100.0 1982 34.4 54.8 10.8 100.0 1983 35.9 53.8 10.3 100.0 1984 30.1 58.4 11.5 100.0 1985 20.6 69.5 9.9 100.0 1986 16.9 73.7 9.4 100.0 Source: The Central Bank of Turkey. - 34 - ANI 5 TUREY INDUSTRIAL EXPORT DMLOPMENT PROJECT TURKEY:, COMPOSITION OF CREDIT (1980485) (TL Billion) Public Administration Bonds Total Direct Held by Public Total Chg. Priv. Chg. Cred.& Chg* Year Credit Fin. Inst. Total Etern. ?ublic (X) Sector (22 Bonds 1%) 1981 279 111 390 549 939 35 19231 79 2,170 56 1982 283 192 475 646 1,121 19 1,738 41 2,859 32 1983 377 212 589 711 1,300 16 2,338 35 3,638 27 1984 583 686 19269 485 1,754 35 3,164 35 4,918 35 1985 1,070 1,469 29539 868 39,107 94 5,176 64 8,583 75 1985 12.5% 17.1S 29.6% 10.1% 39.71 60.31 100.0l Source: Central Bantk - 35 - ANNE 6 Page 1 of 9 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT INDUSTRIAL DEVELOPMENT BANK OF TURKEY (TSKB) 1. TSKB was set up in 1950 by a group of Turkish commercial banks and insurance companies with the objective of providing long-term financing for private industry. IFC also assisted TSKB as an investor and co-financier and at present, holds about 2S of TSKB's equity. The Bank has actively supported TSKB's development and as of June 30, 1986, has made 15 credits and loans totalling $532 million to TSKB. The latest loan of US$100 million for export industries was approved in February 1982. Review of Past OBerations 2. Table 1 below provided a summary of TSKB's operations from 1981-86. Since 1980, TSKB has operated in a very difficult economic environment. Inflation has been extremely high and volatile. Interest rates have steadily increased and are now at very high real level,. DomeLtic demand has generally been depressed and private investment has remained fairly stagnant. TSKB's lending during 1981-86 averaged $53 million p.a. but its operations have decreased overtime in real terms. Its share of private industrial investment was estimated at about 6S in 1986 and averaged about 71 during 1981-85. TSKB's importance in financing industrial investment has been reduced somewhat since 1980, due to the faster growth of other development banks and more active financing of industry by commercial banks. Because of its severe portfolio problems (para 5) and lack of domestic resources TSKB has not been able to diversify its activities. The financial system in Turkey has been changing rapidly because of the recent liberalization measures, TSKB has been falling behind in diversifying its operations and meeting the competition. Table 1: TSKB: Summary of Operations 1981 1982 1983 1984 1985 1986 Commitments Foreign currency (US$ Million) 56 40 11 118 33 62 TL equivalent (billion) 8 8 3 49 19 45 TL lending 1 1 3 11 20 21 Total (TL billion) 9 9 6 60 39 66 === _= = c m c Private manufacturing investment 138 183 238 373 767 1176 TSK's share (2) 6.2 4.5 2.6 16.0 5.0 5.7 Source: TSKB - 36 - ANNEX 6 Page 2 of 9 3. TSKB was constrained by the limitation in the Banking Law which disallowed development banks from accepting deposits from public or issuing negotiable instruments. This constraint was removed in 1985 when the new banking law was promulgated. Under the new banking law, TSKB and other DFIs are allowed to mobilize funds from capital markets by issuing notes, bonds and other negotiable instruments to other institutions and public. Also, the law provides that funds received by DFIs from banks and the public will not be considered as deposits and, therefore, not subject to reserve requirements. TSKB has taken full advantage of this feature and has up to March 31, 1987 raised TL 50 billion by issuing one year notes to the public. However, the total amount of notes TSKB can issue is limited to three times its net worth. The limit is imposed by the Capital Market Board. TSKB's ability to raise additional resources from the capital markets has been enhanced substantially with the recent increase in paid-in capital (para 11). Up to the end of 1986 TSKB utilized the proceeds of the notes to meet its liquidity requirements and to reduce its high cost borrowings from commercial banks. Starting in March 1987, TSKB has become an active participant in the money market and the proceeds from notes are used to invest in the commercial papers and inter-bank markets. Past Financial Performance 4. Table 2 summnarizes TSKB's financial performance since 1983. TSKB's lending has suffered a decline in real terms during this period. Because of the rapid TL devaluation, total debt obligations, which were mainly in foreign exchange, increased from TL 125 billion in 1983 to TL 395 billion in 1986. However, TSKB's net worth increased from TL 7 billion to TL 27 billion, resulting in very high effective total debt/equity ratios during the same period. Without the capital increase in late 1986, the effective debt equity ratio of TSKB would have been well over 20:1. Its spread was inadequate to generate a sufficient surplus to build up its capital base and in fact declined from 6% in 1981 to about 2% in 1985.1/ Because of the high proportion of non-performing loans in its portfolio on which it accrued interest, its real spread was negative. TSKB, however, continued to report a net profit in each year during 1983-85, paid taxes and dividends. As its liquidity problems mounted, TSKB had to resort to medium-term and short-term borrowings at high interest rates between 50-90% p.a. and these borrowings reached TL 39 billion by the end of 1986, further eroding its profitability and liquidity. Because of recent changes in Turkish accounting rules on interest accrual, TSKB can no longer accrue default interest on arrears until they are collected. This led to further deterioration in reported profit. 1/ Under the Export Industries Loan (1982), the Government agreed to give TSKB a spread of 5.5S under FERIS. However, the spread was reduced to 42. Since TSKB has to pay 12 for the exchange conversion fee, the net spread under the Bank loan is only 3X, which is inadequate. - 37 - ANNEX 6 Page 3 of 9 Table 2 TSKB: PAST FINANCIAL PERFORMANCE (TL. Billion) 1983 1984 1985 1986 Total assets 140 229 315 440 Total borrowings 125 202 282 395 Short-term borrowings 4 2 10 27 Medium-term high cost 6 18 14 12 commercial bank loans Interest rate spread (X) 2.4 3.2 2.4 -1.0 Arrears 24 44 56 58 Quasi-equity 6 6 15 26 Portfolio at risk (X) 46 39 30 17 Net income 1.8 2.7 1.3 1.1 Net worth 7 11 18 27 Debt/equity ratio (IBRD basis) 1/ 9.8 11.5 8.2 6.9 Total debt/equity ratio 17.9 24.3 15.7 14.6 1/ IBRD definition allows quasi-equity to be included in equity. Portfolio and Arrears 5. TSKB faced a significant arrears problem until late 1986 but the trend has since been improving. Initiatives taken by TSKB in 1985 and additional measure taken since October 1986 (para 11) are beginning to bear fruits. Table 3 presents the evolution of arrears since 1983. Although arrears in absolute terms have increased from TL. 24 billion at the end of 1983 to TL. 68 billion as of December 31, 1986, total arrears has been contained. The percentage of portfolio at risk has also declined from 45.92 at the end of 1983 to 17% at the end of 1986 (Table 3). The total number of non-performing accounts has decreased from 164 in 1983 to 126 in 1986. Of the 126 accounts, TSKB has taken legal actions against 105 and it should begin to benefit from these efforts over the next few years. Furthermore, the performance of the accounts under FERIS has been much better with the collection ratio well over 952. 6. TSKB's arrears problem started in 1978 when the Turkish Lira was devalued by 332 against the US$. The problee was exacerbated by the unila- teral abandonment of the foreign exchange guarantee scheme in 1979 by the Government. About 552 of TSKB's loan portfolio was affected by arrears at the end of 1980. The difficult economic conditions adversely affected most of TSKB clients, particularly those who could not export. The continuous devaluation of the Lira during 1980-85 to maintain a realistic exchange rate resulted in an explosive increase in the Lira equivalent of foreign currency - 38 - ANNEX 6 Page 4 of 9 denominated debt. High inflation and very high real interest rates after 1983 further depressed the profitability of most industrial enterprises and reduced their ability to service ballooning debts. TSKB's portfolio problems worsened during 1983 and by the end of 1984, about 462 of its portfolio by number was in non-performing accounts (Table 4). Table 3 ARREARS OF PERFORMING AND NON-PERFORMING LOANS (TL. Billion) 1983 1984 1985 1986 o-f of of of Eff. which Eff. which Eff. which Eff. which Portf. Arr. Portf. Arr. Portf. Arr. Portf. Arr. Non-performing Loans (A) 55 23 78 42 85 52 68 57 Performing Loans 67 1 130 2 201 5 328 5 Total (C) 122 24 208 44 286 57 396 62 = == =~~~~ = =2= Portfolio at risk (A/C)(W ) 45.9 38.5 30.0 17.2 7. A breakdown of TSKB's loan portfolio and arrears by major sub-sectors is given in Table 4. As of June 30, 1986, TSKB's total loan portfolio amounted to TL. 331.6 billion. Loans to the three major !tub-sectors (textiles, electrical products and electronics, and wood products) accounted for about half of TSKB's portfolio. Loans to the textiles sector accounted for 291 of the portfolio. A distribution of TSZ3's arrears by sector shows a pattern similar to that of its portfolio. As of June 30, 1986, TSKB's total arrears amounted to TL. 67.3 billion. Three sub-sectors accounted for 51% of the arrears in the following order: textiles (261); electrical and electronic (121); and wood products (131). The food sub-sector accounted for another 111 of the arrears. The arrears problem in the textiles sector, the largest industrial sub-sector in Turkey, is mainly confined to firms which primarily cater to the local market. Domestic demand for textiles has been depressed during the past few years because of the demand management policies pursued by the Government which has sharply reduced real wages. The sharp increase in debt service requirements and lower domestic sales led to large losses and - 39 - ANNEX 6 Page 5 of 9 decapitalization of several large textile firms such &a Dokusan and Turbman. These firms now need large cash infusions which are beyond the means of the present owners; a change in product mix is needed to enable theo to export. In some companies, new management is also needed. In the electrical and electronic products sub-sector, the problem appears to be technical in nature. Product technical specifications are often not internationally competitive and prices are also high. Table 4 TSKB: BREAKDOWN OF PORTFOLIO AND ARREARS BY SECTOR Outstandian Arrears Sector (6/30/86) 1986 1985 1984 1983 1982 (June) (Z1) Textiles 29 26 21 16 18 20 Electrical and Electronic 12 12 13 14 12 8 Wood Products 8 13 19 21 18 14 Food 6 11 11 7 11 11 Metal Products 5 6 4 5 6 4 Machinery Manufacturing 2 6 6 5 4 5 Others 38 26 26 32 31 38 Total 100 100 100 100 100 100 Total (TL Billion) 331.6 67.3 56.0 43.8 24.3 16.5 Source: TSKB 8. Table 5 provides a breakdown of TSKB's portfolio and arrears by geographical locations. As of June 30, 1986, loans to three regions (Marmara, Agean and Mediterranean) accounted for about 75S of total portfolio. During the late 1970s, TSKB expanded its lending activities in the less developed regions (Eastern Anatolia and Southeastern Anatolia) in line with the Government's policy of promoting industries in less developed areas. Because of infrastructural and other problems, arrears of loans in less industrialized regions are proportionately more than their share in the total portfolio. As of June 30, 1986, TSKB's outstanding loans to the two less developed regions amounted to 52 of the total loan portfolio while the two regions accounted for about 141 of the total arrears. However, in relative terms, the impact of leading to the less developed areas has been less severe on TSKB than the impact of devaluations. - 40 - ANNEX 6 Page 6 of 9 Table 5 TSKB: BREAKDOWN OF PORTFOLIO AND ARREARS BY GEOGRAPHICAL LOCATION Outstanding Arrears Region (6/30/86) 1986 1985 .984 1983 1982 (June) (2) Marmara 53 31 27 31 31 29 Agean 12 9 7 10 12 14 Mediterranean 9 7 7 6 7 7 Central Anatolia 11 18 19 19 19 21 Black Sea 7 21 28 21 19 16 Eastern Anatolia 2 9 8 8 8 9 Southeastern Anatolia 3 5 4 5 4 4 Commercial Bank 2 0 0 0 0 0 100 100 100 100 100 100 .= = = ==== Source: TSKB 9. TSKB initially believed that the Government would assist the industrial companies which were affected by the devaluations, but this did not materialize. TSKB has, since 1985, taken a number of concrete measures to address the deteriorating trend in its portfolio. These measures include: (i) rescheduling the accounts which have been facing short-term problems; (ii) assigning hard core problem cases to the investment divisions for major financial restructuring; (iii) taking swift legal actions to liquidate firms which cannot be salvaged; and (iv) coordinating its activities more closely with other creditors. Also, a permanent Management Review Committee has been set up to review the financial restructuring proposals and monitor action programs. TSKB's Board of Directors has also become much more involved in reviewing restructuring of firms in arrears. Since many of TSKB's Board members are chief executives of major comuercial banks, their involvement has helped TSKB's management in addressing the arrears problem. To ensure that TSKB does not face the same problem in the future, it needs to institutionalize its portfolio restructuring activities. Financial and Operational Restructuring of TSKB 10. A Bank mission which visited TSKB in October 1986 devised a comprehensive financial and operational restructuring program to address TSKB's fundamental problems and to restructure TSKB financially so that it - 41 - ANNEX 6 Page 7 of 9 could again play an active role in the financial system. The main elements of the financial restructuring plan consisted of: (i) doubling of its share capital from TL 20 billion to TL 40 billion over 1987-88 period; (ii) raising long-term TL resources by TL 20 billion to enable TSKB to lend in local currency; (iii) increasing the spread by an introduction 2% p.a. commission/service charge on all new loans starting April 1, 1987; and (iv) restructuring terms of the existing quasi-equity loans. The main elements of the operational restructuring plan entails offering of a broader range of banking services. Specifically, TSKB plans to offer the following services: (i) working capital finance initially to its existing clients; (ii) money market operations; (iii) capital market operations especially commercial papers and government securities;(iv) lending to non-industrial sectors; and (v) leasing. 11. Since October 1986, TSKB's management and the Government have taken a number of concrete measures to implement the agreed financial and operational restructuring program. In January 1987 TSKB's Board of Directors approved the increase in paid-in capital by TL 24 billion over 1987-88 period. Full payment of the first tranche of TL 12 billion was completed in September 1987. A new quasi-equity agreement has been reached between the Government and TSKB. Effective March 1, 1987 TSKB has started charging a commission of 21 p.a. for all new loans. On February 15, 1987 TSKB raised Y 9.5 billion in the Japanese market through private placement on good terms and conditions. The proceeds of $ 62 million equivalent of the seven year yen issue was swapped in TL with the Central Bank at a rate of 32b p.a. fixed for seven years. This arrangement will provide TSKB with domestic resources to carry out its diversification program. The efforts made by TSKB in improving the quality of its portfolio has begun to bear fruits. Its cash collections in 1986 were above the target and the percentage of non-performing loan declined to 171 of the total portfolio by the end of 1986. With the increase in cash collections aud new resources, TSKB in early 1987 repaid all high cost short-term loans from commercial banks and was liquid. It has started to participate in the inter-bank market. To enable it to carry out the diversification program, TSKB initiated a reorganization study in November 1986 with the assistance of a consultant from the Morgan Guarantee Bank. The study was completed in January 1987 and the implementation has started. TSKB has also been successful in raising domestic funds by selling its commercial papers. 12. The net result of the above actions is that TSKB will become profitable in 1987 and its profitability is projected to increase from 1988 onward. Table 6 provides a stumary of the impact of the restructuring plan on TSKB's financial results for 1987-91 period. TbKB's projected financial results and condition for 1987-91 period are given in the attachment 1 of this Annex. Given the improvement and good prospects TSKB is in a position to play an active role under the Bank project. - 42 - ANNEX 6 Page 8 of 9 Table 6 TSKB: PROJECTED FINANCIAL RESULTS AND CONDITION (TL Billion) 1986 1987 1988 1989 1990 1991 (actual) Total assets 440.0 562.0 667.0 772.0 929.0 110.0 Total borrowings 395.0 494.0 583.0 678.0 821.0 979.0 Notes 27.0 35.0 43.0 53.0 52.0 48.0 Net Income 1.1 6.5 10.3 13.3 18.4 27.9 Net Income/avg. networth (S) 4.9 19.4 22.6 25.1 33.5 45.8 Provisions/total portfolio () 5.0 5.0 4.0 5.0 5.0 5.0 Average spread on loan portfolio (2) -1.0 -2.0 -1.0 1.0 2.0 3.0 Other income/average total assets (2) 4.0 6.0 5.0 4.0 4.0 4.0 Gross earnings/average total assets (X) 1.9 2.7 3.0 3.5 3.9 4.9 Quasi-equity 26.0 35.0 43.0 53.0 52.0 48.0 Net worth 27 4.0 52 54 56 66 Debt/equity ratio 1/ (IBRD Def.) 6.9 6.1 5.7 5.9 7.1 8.2 Debt service coverage ratio negat 1.1 1.1 1.2 1.2 1.2 I/ Quasi-equity is included ia equity and deducted from total debts. Source: TSKB and Mission's estimate. 13. To ensure that TSKB continues to make progress it will be subject to the following eligibility criteria: (i) completion of the financial restructuring plan. Full payment of the capital increase of an additional TL 12 billion to be completed by September 30, 1988; (ii) approval of the diversification program and near term strategy (1987-88) by TSKB's Board of Directors; (iii) implementation of the diversification program satisfactory to the Bank; (iv) a maximum debt/equity ratio of 10:1"'; and (v) a minimum debt service coverage ratio of 1.1:1. Diversification of Future Operations 14. To survive and prosper in the rapidly changing financial system in Turkey, TSKB needs to diversify and offer a broader range of banking services. ^omercial banks are able to provide a "one-window" banking 1/ Quasi-equity is to be treated as equity and receivables under FERIS from the Central Bank to be deducted from outstanding foreign debts. ANNEX 6 Page 8 of 9 _______ 91 Total i / .0.0 Total 1 9.0 Notes IA °8.0 Net In( W7.9 Net In( 5. 8 Provis:. 5.0 Averagt portiv 3.0 Other :J tota' 4.0 Gross asse 4.9 Quasi-. '.8.0 Net wo 56 Deb tie (IBR 8.2 Debt s 7' 1.2 j/ Qu Source 13. !Ct to the restrit ial TL 12 te divers I of Direct ;ory to the minimn Divert 14. n in Turke: servi, 1/ Is ts. - 43 - ANNEX 6 Page 9 of 9 service which should also be provided by TSKB. Specifically, the areas which TSKB should consider entering are: (il merchant banking and underwriting; (ii) working capital finance initially to its existing clients; (iii) leasing; (iv) trade financing, especially preshipment and exchange transactions; and (v) money market operations. TSKB has a good name in the market, and is in a position to diversify if it so desires. TSKB's diversification plans and specified actions which TSKB will take during 1987-89 were discussed and agreed upon negotiations (Attachment 2 of this Annex). Implementation of the agreed program will be a condition of further commitment of the Bank's funds. Organization Strengthening 15. The mission feels that TSKB's organization structure has become somewhat unwieldy and needs to be streamlined. TSKB's important operations are concentrated in a single department -- the Loan and Investment Department which is responsible for: (i) processing of loans and equity investments, (ii) restructuring of projects in difficulty, and (iii) project foll3w-up. This approach has resulted in project supervision being given low priority. For a comparatively small institution like TSKB, a functional organization structure would be more appropriate. However, any organization plan that is developed should be sufficiently flexible to incorporate, as needed, the new operations TSKB is contemplating and which the mission strongly supports: short- and medium-term loans for working capital purposes, lease financing, underwriting/sale of stocks, shares and other commercial paper. In November 1986, TSKB initiated a study of its organization with the assistance of a consultant provided by the Morgan Guarantee Bank of New York. The study was completed in January 1987 and implementation has started. It is expected that implementation will be completed by June 30, 1988. The new organization is well thought out and if implemented properly would enable TSKB to diversify and operate more efficiently. * -.44-. ~~~~ANNEX 6 TSKB ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~AttachmentI TSKB ~~~~~Page 1. of 5 PROJECTED INCOM4E STATEMENS (1987-1991) (TL Billion) INCOHE STATEMENT 1986 1987/1 99/1 1987 Total 1988 1989 1990 1991 INCOME linterest on Loan Portfolio F/X Loans 20.3 18.4 4.5 224.9 17.8 14.6 12. 6.5 Feris LoanS (ENISt,f 212.5 30.0 9.4 39.4 34.4 28.3 :I;2 144.0 Feris Loans tkd.) 0.0 0.0 2.3 2.3 38.2 73.4 11 6.2 160. 0 Rea. Cent.9. Redi sc. Loans (Exi st)1 8.3 8.9 .3.0 11.9 9.8 8.3 6.1 4.1 Reg.CentJ.P..dis;,.Loans(Add., 0.0 0.0 I. 0.1 3.2 8.2 I15.9 24.4 Spec,a' Redisc.Loans * L.5 1.4 02 1.7 11 0.6 0.2 . Reiched:;1nq lExist.i 8.2 13.21 3J.1 16.3 14.0 11.7 i,b 4, Rscheou1ina (Additional) .0 ,0 0.4 0.4 7.4 10.7 11.0 9.21 FIX Working Cacital Loans 1 0.9 0.0 0.0. 0.0 0.0 0.0 0.0 (.C. TL Workiiq Caiotal Loans 1.9 0.0 0.10 0.0 1.3 5.4 12.0 18B.0 We4ult Interist 11.5 5.1 0.8 5.9 3.0 2.5 2.0 2'.C Total 1 6.1 77.0 23.9 100.9 1,10. I 1 6Z.36 201.-t. 2 4!. 5 0.0 gross Capt. 8ains &Di-,.Inc. 1 3.2 4.6 0.71 5.3 5.2 5.0 2v 3.4 Commistons,,harges Ot-her Isnc. 10.2 1. 6 8.9 22.5 23.7 21.3 A., 33.5 T~OTAL 11 89.5 95.2 33.5 128.7 1959.0 189.4 232.' EXPENSES 0 Intres Ex ss0.0 F/!X Delt. 1, 11.1 3. 2 14.3 12.6 10.6 7,q 5.6 Faris Debt (Evist.) 19.3 26.7 8.2 34.9 30.1 24.7 18,6 12.4 Feris Debt i4oa.) ( .0) 0.0 1.9 1.9 32.0 60.0 937. 126.9 TL. Borro"Ing 720.0 Reg.CIent.8.Redisc.Loans(Exist)l 7. 7.0 2.' 9.4 8.7 6.9 5.0 Req.Cent.O.Redisc.LoansiAdd.) 0.0 0,0 0.0 0.0 2.0 5.0 101.10 15.8 Soecia'l R?diSC,L0arnS 2l.1 1.3 03 1.6 1.0 0.5 0. 2 l.0 Notes;nst) & Other Market Res.; 0.0 0.0 0.5 0.5 3.5 11.4 20.2 221.1 TL.Debt for Refinancing 0.0 9uasi-Eauit~ Lo-ans 5.0 4.5r% 1.5 6.0 6.9 8. 5 1 3.0 ( 12.51 Treasury Loans 1 .14 0.6 0.1 0.7 0.3 0.14 0.2 3.1 Noteslnet) & Other Market Res., 7.3 111.6 31.6 145.2 15.7 9,2 1.4 0.0 T8KB Bonds 5.3 2.5 0.6 3.1 1.2 0.0 0.0 0.0k Jananest Yen, Bonds 8.8 4.3 0.0 4.3 0.0 0.0 M. . Coinerciai Bank Loans 7.8 1.0 0.1 11.1 0.4 0.3 2 0 Advances i 0.6 9,4 .3.9 13.3. 15U.6 45.6 115.6 14.q Rehabilitation Loans 1 1.0 2.2 t. 7 2.9 2.5 1.6 0,7 V. 2 Personne'L Exoenses 1 3.0 31.0 14.2 4.2 6.0 7.8 9.8 12.2 Adain. & Other Exoense-s 2.0 1.3 0.5 1.8 2.3 2.7 3.2 3.8 TOTA'L 1 82,.5 86.5 28.7 115.2 140.7 165.0 197 Eross Earnings 7.0 8.7 4.8 13.5 18." 24.9 330 49.! Dross Earnings for the Whole Year ,13.5 131.5 18.3 24.9 33.0 4q.5 ProviSionS Tax Free 0.0 0.0 7.0 7.0 8.0 7.0 7.0 7.0 Provisions Subjett to Tax 1 0.0 0.0 0.0 0.0 0.0 0.0 0.". Pro-fit for the aweriod 11 7.0 8.7 6.5 6.5 10.3 17.9 :6.0 42.51 Taw i 0.0 0.0 0.0 0.0 0.0 4.6 7.8 '14.7 Net Profit 1 7.0 8.7 6.5 6.5 10.3 13.3 18.4 27.P Dividend I 0.0 0.0 6.1 6.1 7.8 11.5 16.1 18.4 ;otaned Earn:igs 1 7.0 8.7 0.4 0.4 2.5 . .8 2.3! 5.5 Other Incose Fran'-end ree 11 1.4 0.4 0.9 1.3 1.8 2.9 4.4 5.5 Reven,jes an Liauxd Assets 1. 2.2 8.7 21.3 11.0 6.9 9.2 142.2 14.3j Fees & Co.a.froa Bankg.Servs. I 1.4 14 0.4 1 .8. 2.8 5.2 7.9 10.2 Par,t.. Differences 24.5 11.1 0." 1.4 1.0 1.0 0.7 0.5 Provisions Released . . 2.7 44 6.3 0.0 0.0 0.0 Intereit Accr.for Past Years 0.0 0.0 3.1 3.1 5.9 0.0 0.0 0.0 Loss on Loans 1 -0.1 -0.2 -1.9 -2.1 -3.6 0.0 0.0 0.0 Others 0.6 0.5 1.6 1.5 2.5 3.0 3.0 3j.0 I' < .~~~~~~~~~~~~~~~~~ \~~ d -45- ANNEX 6 Attachent 1 Page 2 of 5 TSmB 1lJCTED BALANCE SuITS (1987-1991) (St BiLon) UAE SlET I 1984 19871 19M/M 1987 Total 1960 1999 190 1991 ma a maauaaas:auauuamwuuauuu msspsuau auuaaaUa awusaaaasaautai_sam uswaa sum asmaa PSTS Cashbanks 24.7 14.2 13.1 13.1 15.4 21.7 37.4 44.4 Narketable SecuritielBov.8. I 1.6 13.3 13.3 13.3 13.3 23.3 28.3 M3 Other Current Assets 1 7.1 14,9 21.1 21.1 23.6 27.6 31.0 35.0 . *..-....- .... .- C.. .. . . . *.. .. .C . ........ .S..*.. TOTAL Current Acsts 40.4 44.4 47.5 47.5 52.5 72.6 96.7 119.9 Loan Portfolio * 0.0 fIl Loans 0.0 Non Forts 114.6 119.1 129.4 129.4 115.7 U.3 54.2 33.' Faris (Existing) 112.7 126.1 124.0 124.0 105.4 82.9 s5.1 35.5 Faris (A4ditional: 0.0 0,0 49.2 49.2 157.1 297.5 462.4 640.7. Short Tore Vork.Capt.Loans ' 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 II- -..... -- - .. -.--- ------.. - a. -. ----. -. Total 1 227.3 245.2 302.b 302.4 378.4 454.7 574.7 710.1 TL. Loants 0.0 Re.q.Cnt.6.Radiuc.Lo.nm(Eximt)1 29.4 35.0 33.8 33.8 28.4 22.3 15.2 8.7 Rsqt Cent.D.ediKc.Lo&nsIAdd.1 I 0.0 0.0 2.0 2.0 14.0 34.0 68.6 105.9 Special Redist,Loans 1 14.7 11.1 10.1 10.1 6.5 2.8 0.7 0.3 hfinaninnq4Reucbd. Exist.) 59,1 64.b 60.7 60.7 42.3 26.3 10.5 1.1 Refinancing(euch.d. Add,) 0.0 0.0 23.3 23.3 58.7 59.7 50.7 41.7 eftinancing (Others) 4.4 4.9 4.9 6.9 4.9 6.9 6.9 4.9 Norking Capital Loans 1 0.3 0.0 0.0 0.0 5.0 20.0 40.0 60.0 -- - .. -- -. -. -- -. -.. -------- -- -- - -- -- - -- -- -..-------- --------.. ...... Total 107.9 117.6 134.6 136.8 161.8 172.0 192.6 224.5 0.0 Arrears 57.9 75.4 59.9 59.9 59.9 59.9 54,9 49.9 - ------- ---- ----- ---- ---- CC ee-.-------- TOTAL LOAN PURYPOLIO 393.1 438.2 499.3 499.3 600.1 689.4 824.2 984.5 0.0 Participations 16.2 17.3 17.6 17.4 19.1 22.1 26.1 30.1 -) Provisions 1 20.9 19.3 23.6 23.6 25.3 32.3 39.3 46.3 TOTAL PORTFOLIO M 3.4 434.2 493.3 493.3 593.9 478.4 911.0 946.' 0.0 Fin Astets 5.5 8.8 12.3 12.3 11.2 11.5 11.5 11.5 Prepaid Tavs 1 2.9 3.0 3.0 3.0 3.0 3.0 3.0 3.0 Propald Ew.,onm I others 2.3 5.6 5.7 5.7 5. 4.9 .9 6.9 TOTAL ASTS 439.5 490.0 561.8 561.6 46.5 M.4 929.1 110.4 _-_ l a s s~~~~~raauuasuamaa _ _ _ __m_ _suauaa - 46 - ANNEX 6 Attachment 1 Page 3 of 5 TSKB PROJECTED BAhNCE Sum.~s (1987,1991_) (TL Billion) :: zr:.::gg:3:u2zgu33sauaa sanauss aiun3u azula31l.acgte s#uatuu23t282 :z2t: 2:z:z2u3z: LIAlILITES 198711 '87/II 87 88 89 90 91 J Current liabilites 14 17.1 217 2.0 7 32 . 0 1 M Tax and Dividend 0.8 0.0 6.1 b.1 7.8 16.1 23.7 33.l 1 Total Current Liabilites 1 16.9 21.0 28.1 29.1 30.8 40.0 51.7 65.1 Resources 0.0 FIX Non-Feri Debt 131.6 136.1 146.4 146.4 132.7 103.3 73.2 50.9 Feris Debt (Existing) 112.9 127.0 124.9 124.9 106.5 83.8 59.0 36.4 Peris Debt (Additional) 1 0.0 0.0 49.2 49.2 157.1 287.5 462.4 640.7 ' Short Term Work.Capt.Dhbt 1 1.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1 I~~~~~~~ ----- - *- _ -- - ----- ----- - --- Total FIX Debt 245.7 263.1 320.5 320.5 39.3 474.6 594. 728.0 TL. Lending Resources 0.0 Notestnet) I Other Narket Res. 0.0 3.4 4.4 4.4 9.4 Ł3.4 J7.4 65.4 Reg.Cent.D.Redisc.Loans(Exist)1 28.4 30.8 29.6 29.6 24.4 18.7 13.2 8.3 1 Reg.Cent.I.Redisc.Loans(Add.) 0.0 0.0 1.0 1.0 11.0 2b.0 53.8 83.6 1 Special Redisc.Loans 15.4 12.0 11.0 11.0 7.2 3.5 1.4 1.0 5 - -. --- -- . -. --- - .. -- - ----- -- -- - ---- - --- --- Total TL. Lending Resources 43. 46.2 44.0 46.0 52.0 91.6 125.8 158.3 : ~~~~~~~~0.0 TL. Refinancing Resources 0.0 lusi-Equity Loans 1 26.1 30.8 35.4 35.4 43.4 52.8 51.6 48.0 1 Treasury Loans * 3.3 3.0 2.0 2.0 0.7 0.4 0.4 0.4 1 Notesinet) & Other Narket Res.1 27.4 30.5 26.8 26.8 35.8 7.0 0.0 0.0 1 TSKB Bonds 7.7 4.7 4.7 4.7 0.0 0.0 0.0 0.0 Japanne Yen Bands 1 18.7 0.0 0.0 0.0 0.0 0.0 0.0 O 0 . Coarcial Bank Lodns 12.1 0.5 0.5 0.5 0.5 0.5 0.5 0.5S Advances 1.2 47.4 47.4 47.4 47.4 47.4 47.4 42.7 Rehabilitation Loans 9.4 10.7 10.7 10.7 7.4 4.1 0.8 0.8 Total TL. Refinancing Resource' 105.9 127.6 127.5 127.5 135.2 112.2 100.7 92.4 TOTAL FIX & TL.DEBT 395.4 436.9 494.0 494.0 583.5 678.4 921.1 979.7 1 0.0 Pro.ision for Retiresnt ' 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Registered Capital 24.0 36.0 36.0 36.0 48.0 48.0 48.0 48.0 Paid-in Capital 1 22.6 28.1 36.0 36.0 46.0 46.0 46.0 46.0 Reserves 1 4.2 3.2 3.2 3.2 3.6 6.1 7.9 10.2 t Retained Profit *o. the Period 0.3 8.7 0.4 0.4 2.5 1.8 2.3 9.5 Total Equity 27.1 0.0 39.6 39.6 52.1 5.9 56.2 65.7 1 T * LALT EIc49 S98.0 C1. . 8. .. ccc2 929.1 |n.6 TOTAl. LIADILITES . EIU!? ' 439.5 498.0 U61.8 561.8 666.5 772.4 929.1 1109.6 ' =2823 IiI aau sau as22aaa88u3a2s232, - 47 - AM= 6 TSKB Attacbment 1 PROJECTED FIND FLOWS (1987-1991) Page 1 of 4 (TL Billion) 7L.FUNDS FLU : 1994 198711 1987111 1"7 Total 19980 199 1990 1991 SOUCES i Profit Qefore Prov.,hpr.% Tax t 0.0 0.0 4.8 18.3 24.9 33.0 49.5 Increase in Paid-in Capital i 0.0 0.0 7.9 10.0 0.0 0.0 0.0 Sale from Participitions 0.0 0.0 0.2 1.0 1.0 0.0 0.0 1L. Rfinancing Rources Guasi-Equity Luons i 0.0 0.0 4.4 8.0 10.0 0.0 0.0 Treury Loans . 0.0 0.0 0.0 0.0 0.0 0.0 0.0 otesinet) & Dther Narket Res.! 0.0 0.0 -3.7 9.0 -28.8 -7.0 0.0 TSKB Bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Japanese Yen Bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Coiaercial Bank Loans 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Advances 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Rehabilitation Loans 0.0 0.0 0.0 0.0 0.0 0.0 0.0 T. esources for Lending Notes(net) 6 Other Narket Res.O 0.0 0.0 '.0 5.0 34.4 14.0 8.0 Cent.lank Rediscounting Cred. 1 0.0 0.0 1.0 10.0 15.0 28.0 32.0 / llorkin Caplital Debts : 0.0 0.0 0.0 0.0 0.0 0.0 0.0 TL.Loun Cal ctions (Lending) ' 0.0 0.0 2.2 9.0 9.8 9.6 9.7 TL.Loan Collections (Refinancing) 0.0 0.0 3.9 21.4 25.0 24.8 18.4 serease in Arrears 0.0 0.0 15.5 0.0 0.0 5.0 5.0 ernas in Working Capital Loans 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Unpaid real Interast for FIX Borroring 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Dcrease in F/IX Dposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 lacrease in Fixed Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 ncrease in Current Lability 0.0 0.0 1.0 1.0 0.9 4.1 4.0 TOTAL 1 0.0 0.0 38.4 92.7 91.5 111.5 126.6 TL.Dt Repaymnt (Lending) 0 0.0 0.0 2.2 9.0 9.4 7.8 7.5 L.Debt Repayment IRefinancing) 0.0 0.0 1.0 9.3 1.2 4.5 9.3 TL.Dhbt Early Repayment 0.0 0.0 0.0 0.0 0.0 0.0 0.0 T.Lendin 0.0 0.0 2.0 12.0 20.0 3.t0 40.0 Vorking Capital Loans I 0.0 0.0 0.0 5.0 15.0 20.0 20.0 ResK ulingo 0.0 0.0 23.3 38.4 10.0 0.0 0.O Inrase tn Arrears 0 .0 0.0 0.0 0.0 0.0 0.0 0.0 Participations 0.0 0.0 0.5 2.5 4.0 4.0 4.0 Tax 0.0 0.0 0.0 0.0 0.0 4.6 7.6 Dividend ' 0.0 0.0 0.0 6.1 7.8 11.5 16.1 Increas in Fixed4Other Assets ' 0.0 0.0 3.5 -1.1 0.3 0.0 0.0 Increase.in Current Assets 1 0.0 0.0 4.2 2.5 4.0 3.4 4.0 F/I Purcnase for Lending (Jap.Yen) 0.0 0.0 0.0 5.0 0.0 0.0 0.0 Decrease in Provisions 0.0 0.0 2.7 6.3 0.0 0.0 0.0 Increase in 6overnrent Donds(Legal) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Increase in Sovern.Bonds & Notes (Frne).1 0.0 0.0 0.0 0.0 10.0 5.0 10.0 Incease in Prepaid hlp. & Others 0.0 0.0 0.1 0.2 1.0 0.0 0.ft Repaymnt of Japanese Bonds 1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 TOTAL 1 0.0 0.0 39.5 90.2 85.7 95.8 117.5 sILamusRI rm Dcese :u i Uuuu:u38:z8u:3z25::s5 s:32s 15.7 9.2:a g IL. CMIIN Increas IflecreaseI I 0.0 0.0 -l.l 2.5 4.1 15.7 9.2 _ _ S SX :="tSl:SSSSSW S#$S SS S S - 48 AMN 6 Attacient 1 Page 5 of 5 TSKB PROJECTED KEY RATIOS (1987-1991) ANALYTICAL RATIOS 1986 198711 1987111 1987 Total 19$9 1989 19" 1991 ___ ._,_.___. ., .. ....._.__..................... ----------- - --------- ---- - - --........................ - --- -,. ----------. -... -... ---*., Debt Equity Ratio (Limit 10tHl 6.9 5.7 6.1 6.1 5.7 5.9 7.1 8.2 Current Ratio 2391 211% 1692 1692 1702 1812 1872 1942 Arrear/Loan Putfolio 17% 21% 14% 142 112 10 72 52 Provisions/Total Portfolio 52 4% 52 52 42 52 52 st Provisions/Arrears 3 26% 262 39% 392 422 542 722 932 Arrears/Equity + Provisions 1212 1272 951 951 771 692 571 452 Receivables/Average Portfolio n.a. 5S 52 5% 52 52 41 41 Acount Payables/Avq.Debt Portfolio n. a. 52 5s 5s 42 4% 42 42 Foreign Currency Loans/Total Asmets 1 522 492 542 542 572 592 622 642 Local Currency Loans/Total Assets 252 242 242 24% 242 222 212 202 Equity Participationu/Total Assts 4% 32 32 32 32 3% 32 32 overnmnt Loins/Total TL. Debt 562 78% 791 79% 76% 75 742 742 Capital Market Borrovings/Total TL.Deit 36X 222 212 21X 242 25% 252 262 Coasercial lank Loans/Total TL.Debt I % 0i 0 02 0% 01 0% 02 inturist Incoue/Avg.Loan Portfolio I n.a. 192 1% 232 241 25% 27J 272 Ittrest Expenses/Ayl.oebt Portfolio n.a. 202 12 25% 25% 242 252 242 Return on Refinancing Portfolio n.a. 142 122 172 162 172 19% 212 Avg.Cost of Refinancing Reources n.a. 31X 332 402 32% 29% 291 292 Other Incou / Avg.Total Assets n.&. 4% 71 62 5% 42 42 4X Other Incou/Net Interest Revenue -957% -350% -310% -3352 -12899 209% 2092 1282 $ross Earnings/Avg.Total Assets tn.a. 1.9% 0.2% 2.7% 3.0% 3.5% 3.91 4.91 Dividnd/Paid-in Capital 6% 0b 202 20b 20X 251 352 40a Payout Ratio 0% 0% 942 942 75% 87% 87% 662 Net Profit/Avg.Equity n.a. 25.9% 4.1% 19.42 22.6% 25.1% 33.52 45.82 Non-interest Expenses/Avg.Total Assets n.a. 0.92% 1.301 1.20% 1.36% 1.46% 1.52% 1.57% DObt Service Coverage Ratio n.a. n.a. na. 1.1 1.1 1.2 1.2 1.2 :zSg3z333uRz823sBZ~g3Zu2u3uuu:u8az:"ls2tsas:gs:sXssss:t:s::ss 1ss: s:::ss: s TUM1 Lmu "T S PmEci Dec~er 1, *1987 AC~TXIIII PUM FOR DT FIF 4 OF SEIM= trea of Activity Ermvisaed Action or Activity StenR Alrekdv Taken Cwittraints Timtable P Actiomn A Lending for Nediun tenr working capital TSKB has started to lend for First Issue of client CP non-investment loans to clients. underwriting working capital requiriemnt *envisaQed in Pay-June 1987. purposes. of bonds and camercial clients in 19P7, ma1nly in Direct lending will commence papers of clients. the form of purchasing the in June 19B7. commrcial papers issued by the cmnpanies or standing ready to finance a specific transaction to be undertaken by its clients. These oper- atins will continue and increase in the couing year. Lending in Foreign and local Selected projects in TSKB's limited knuw-how Already started. non-manu- currency loans for construction/contracting and experience In facturing investment purposes. have been financed in 1986 financing non-manufacturing sectors. Various tourism projects sectors will allow a are under appraisal. gradual increase of their I activity. Money and Sale and servicing of T5KW 7513's limit for Issue Developments in the Marketing of client CP's I Capital Market notes or TSKB uaranteed has already been extended. financial system till is expected to comense Intermediation notes as well as under- Discussions with potential determine the volume of in MaY-Juno 1987. writing of cozm2rcial paper CP issuers are under way. activity. issued by clients. Sale of stocks from TSKS's activities in Ist. Trading volume in Ist. Advisory services to TSKS's equity portfolio Stock Exchange have St. Exch. still low. clients coinence as will be promoted. Advisory been increased. Block sales Volume will also depend TSKB's new promises come services will be introduced. are being prooted. on improvements in general in service in early economic conditions. 1968. IV. Treasury Interbank deposit dealing, TSKS has already started System and personnel TSB plans to brine in Operations open market operations. operations in these areas development requirements exPertise to restructure dealing in government on preliminary basis will be met within 1987. its dealing and trading securities, activities. V. Lease * Active involvement through Final negotiations to The new :@mpany will financing the establisNuent of a establish a leasing company start operations in joint venture, including Is Bankasi. IFC, earlv 1988. Societp Genef,1e an Svr have been concluded. VI Consultancy Active involvement in TSKB has participated Demand for consultancy and and Advisory the privatization of SEE's. in the preparation of the advisory services from 0 Services Master Plan. and currently private sector firm will working on the privatization take time to develop. of spmcific SEE. - 50 - ANNEX 7 Page 1 of 14 TURKEY INDUSTRIAL EXPORT DEVELOPMEWT PROJECT SDNAI YATIRIM VE KREDI BANKASI I. INSTITUTIONAL ASPECTS Background and Ownership 1. SYKB was established in 1963 as a development banking company by five major commercial banks in Turkey. The paid-in capital TL 4 billion is distributed in the following: ls Bankasi has 601 of paid-in capital and the remaining 401 share is equally divided among the other four banks..' Originally, SYKB was set up as a sister organization to TSKB for providing working capital loans to TSKB clients but since late 70s, SYKB has had a shift in its lending policies and has had a growing role in meeting the investment financing needs of the private industrial sector. Organization and Management 2. SYKM is governed by a compact Board of Directors comprising six members, a representative each of five shareholder banks and the General Manager of SYKB. Is Bankasi representative is the Chairman of SYKB's Board. The Board is responsible for deciding general policy matters and approving in principle loan applications based on the appraisals made. 3. True to its character, SYKB has adopted a simple organizational structure. In view of relatively small staff size (total staff of 118 including 75 professionals), SgKB'I organization is horizontally arranged into seven departments. Its three operations departments (technical, financial and economic) are responsible for appraising projects and their supervision. The treasury and resource mobilization functions are entrusted to the loans and accounting departments. In addition, SYKB has a legal department and a personnel and control department. The personnel department looks after only the routine matters, whereas the real personnel functions (staff selection, training, assessment and promotion) are performed by the respectiv, department heads. 4. SYKB has been able to keep the real salaries of its employees at a competitive level and the staff turnover is very low and morale high. SYKB recognizes the need for training to its staff members and deputes its officers to short courses, seminars and workshops in Turkey and abroad. For 1/ Ak Bank, Garanti Bankasi, Vakiflar Bankasi, and Ticaret Bankasi. 00 57 R - 51 - ANNEX 7 Page 2 of 14 instance, SYKB's Board approved that 15 officers be sent abroad during 1986 and 1987 far training in technical and banking skills. SYKB has not been following a policy of staff rotation in the past. A system of rotation of staff as between key operational departments is necessary for healthy growth of both the officers and the organization. 5. Notwithstanding the organizational competence, it would be necessary to look ahead and, in terms of near term objectives especially resource diversification, some organizational changes would seem necessary. Thus, a small cell needs to be set up to look at international capital markets as also the national markets of Japan, Germany and Switzerland and explore possibilities of augmenting resources from these liquid markets. Going by the experience of development banks in other similar countries, it takes time and staff input to understand the working of international markets and cultivate banking and merchant banking contacts for effective mobilization of resources. Yet another organizational change that needs to be seriously considered is in respect of supervision and follow-up function. As the size of loan operations increases, it becomes necessary to closely monitor the loan portfolio by assigning special staff. A separate sub-division with four officers could be set up under the financial analysis department and staff could be rotated between appraisal and supervision so as to provide the concerned staff exposure to both these important dimensions. SYKB has agreed to bring about changes in its organizational structure as suggested above. Operating Policies, Procedures and Standards 6. Policies: SYKB adopted a Policy Statement in March 1986 which exisures sound lending operations. The statement, provides, inter alia, for conducting sectoral and sub-sectoral studies to identify priority development areas and viable projects with high economic priority. It further stipulates that SYKB will finance projects whose majority control is vested with the private sector and provide up to 602 of the fixed Investment cost of the project; its total exposure in an enterprise will not normally exceed 20% of its own net worth; equity investment will not exceed 252 of the enterprise's capital and 102 of its own net worth; and it will not carry foreign exchange risk. SYKB's lending terms vary from project to project but in general the working capital loans are up to 5 years and investment loans are up to 15 years including grace period. SYKB follows conservative lending policies by requesting its clients to provide collateral and bank guarantees. S M's collateral policies seem adequate and reasonable. Over 80S of SYKB loans are covered by collateral and/or bank guarantees. 7. Appraisal: SYKB's appraisal procedures are satisfactory as indicated by the review of subprojects financed under the Bank's loan. Appraisal includes assessment of the management capability and creditworthiness of the applicant and economic, financial, technical and marketing viability of the proposed project. Economic rates of return are - 52 - ANNEX 7 Page 3 of 14 calculated for all projects with total investment cost more than US$750,000 and generally projects must yield and ERR higher than 15%. 8. Supervision: SYKB's staff now makes periodical visits to projects and monitors the cost and financing of projects under implementation and the financial performance of projects in operation. Supervision reports are generally comprehensive and satisfactory. In 1986, SYKB compiled about 160 supervision reports out of total number of 208 firms in its portfolio. Nowever, with the deterioration of arrears on its portfolio (para. 20-22), there is scope for further strengthening of the project supervision by increasing the frequency of visits to firms operating and monitoring non-financial aspects of projects (including technical and marketing aspects). In this light, SYKB, in assisting its borrowers, should resolve disputes between major shareholders, arrange for mergers and takeovers and securing additional equity and loan financing from local and foreign sources. SYKB has agreed to establish a new section for supervision activities under its Financial Analysis Department with the responsibilities of reappraising problem projects and assisting its borrowers in developing and implementing restructuring programs. Initially, SYKB will allocate four financial analysts for supervision supported by engineers, with rotation every six months in order that officers have exposure to both appraisal and supervision. SYKB will increase number of staff in the new supervision unit as becomes necessary. Procurement and Disbursement Procedures 9. SYKBts procurement procedures are designed to ensure economy and efficiency. SYKB ensures that competitive bidding procedures appropriate to each project are adopted by clients who in Turkey are generally well informed of the equipment available. Normally at least three bids from suppliers in different countries are required for purchase of imported goods. For contracts in excess of US$2.5 million financed under the proposed loan, SYKB requires a limited international competitive bidding. For local procurement, adequate domestic shopping is required. These procurement procedures are consistent with those adopted by other Bank assisted DFCs providing loans to and are considered satisfactory. Disbursement procedures, which are made on the basis of invoices and evidence of shipment, are also satisfactory. II. PAST PERFORMANCE AND IMPACT SYKB's Role in the Economy 10. SYKB as one of two major DFCs has had a significant role in meeting investment needs of private manufacturing sector. Since its inception in - 53 - ANNEX 7 Page 4 of 14 1963, SYKB has provided TL 94 billion of financial assistance (foreign and local currency) to about 1,620 projects. In particular, SYKB has played an important role in providing financing (investment loans and working capital), to small- and medium-scale industry. During 1982-1986 period, SYKB's financial support to manufacturing sector has created about 30,000 jobs (para 12). The total investment by private manufacturing sector during 1982-1986 amounted to about TL 1,800 billion and SYKB's share in that was about 4.5X. Although initially this may not seem significant, the SYKB's share of investment in the private manufacturing becomes more significant when investments are isolated by SMI and non-SMI sector. Past Operations and Economic Impact 11. Review of Past Operations: Summary of SYKB's past operations are presented in Table 1. Total loan approvals of SYKB have increased from TL 5.1 billion for 81 projects in 1982 to TL 40.4 billion for 88 projects in 1986, i.e. 68S increase p.a. in nominal terms. Foreign currency loan approvals were 732 of total loans during the 1982-1986 period, with the relative share increasing from 70% in 1982 to 852 in 1986, mainly because of the availability of new foreign currency resources to SYKB and the introduction of the Foreign Exchange Risk Insurance Scheme (FERIS). Impact and Structure of SYKB's Operations 12. SYKB's promotional activities include the identification and development of and assistance to SMI projects of high economic priority. To achieve these objectives, SYKB has completed studies of various industrial sub-sectors, including textile goods, forest products processing industry, meat processing industry, and marble extracting and processing industry. The above studies have led to the identification and financing of a large number of sub-projects, some of which are export-oriented. SYKB recently completed the study of the cotton yarn and fabric industry in Turkey. The projects assisted by SYKB have high labor-intensity. During the 1982-1986 period, 30,000 direct jobs were created by projects financed by SYKB, with an estimated average cost per job (excluding land and buildings) of about US$11,000. SYKB has played a positive role in the development of small and medium-scale industry. However, in line with the changes in the financial sector, it has started to cater on medium-scale industries as well. SYKB financed 370 projects from 1982 through 1986. The subsectoral distribution of projects financed by SYKB during 1982-1986 is presented in Table 2. Fixed investment loans were 60% for expansion and 402 for new projects. 13. SYKB's overall sectoral distribution of outstanding investments is presented in Table 3. It can be observed that textiles is one of the major subsectors financed by SYKB. In particular, during the 1982-1986 period, SYKB's investments in the textile sector accounted on the average for 352 per annum (Table 2). In contrast, SYKB's outstanding loan in the textile - 54 - ANNEX 7 Page 5 of 14 SYKB TABLE 1 SUMMARY OF PAST OPERATIONS AND KEY FINANCIAL RESULTS (Amount in TL Billion) Year ending December 31 1982 1983 1984 1985 1986-' O.perations Loan Approvals - Local Currency 1.5 3.9 2.2 8.5 6.2 - Foreign Currency 3.6 4.1 14.6 4.3 34.1 Total 5.1 8.0 16.8 12.9 40.4 Loan Commitments 3.9 4.3 15.7 5.5 25.7 Loan Disbursements 3.6 3.4 15.7 5.3 24.5 No. of Operations 81 66 83 52 88 Financial Condition and Results Cash and short-term deposits 0.1 0.5 0.3 0.6 4.0 Loans (net) 8.6 12.6 17.8 33.9 52.1 Equity Investments 0.2 0.2 0.4 0.5 0.8 Short-term Borrowing 0.2 0.1 0.0 0.0 6.5 Medium and Long-term borrowings 8.4 12.6 17.0 33.3 54.9 Net worth 1.0 1.2 3.5 4.4 6.5 Total Assets 10.2 15.1 21.6 39.7 73.4 Net Profit (after taxes) 0.4 0.5 0.8 1.1 1.7 Key Ratios Net profit/avg. total assets (%) 4.7 4.0 4.5 3.5 3.1 Net profit/avg. net worth b 44.4 45.5 35.3 27.4 32.0 Administrative expenses/ avg. total assets (2) 1.9 1.9 1.9 2.1 1.4 Debt/equity ratiol' 8.3 9.6 6.4 6.4 8.0 Debt Service Coverage Ratio 1.4 1.5 1.2 1.5 1.3 Unaudited. IBRD definition Source: SYKB - 55 - ANNEX 7 Page 6 of 14 sector was about 25% per annum during the same period. Other subsectors, each of which represents over 10% of the outstanding loans during the same period are: machinery/metal products/electronics, chemical/ plastic/rubber, and food. The combined percentage of the outstanding loan in the above-listed subsectors is in the range of 68% (1982) to 712 (1986). There are two main reasons for the concentration of inv-stment by SYKB in these subsectors. First, SYKB has made a commitment and promotional effort towards development of export-oriented projects. Second, these are subsectors which have either experienced the fastest growth rates in exports, or had a major share of exports of the Turkish economy in the last five years. However, the consequence of concentrating SYKB's loan portfolio in the above subsectors has also led to concentration of SYKB's arrears in these subsectors. As of December 31, 1986, these four subsector groupings accounted for 71% of SYKB's total arrears (para 17). Table 2 SYKB: SECTORAL DISTRIBUTION OF INVESTMENTS (%) (198.-1986) 1982 1983 1984 1985 1986 Food 16 15 14 12 8 Textiles 37 25 46 20 48 Machinery/Metal Products/Electronics 27 15 8 30 11 Chemicals/Plastics/Rubber 5 9 17 11 14 Cement, Earthenware, Glass 6 2 6 6 3 Forestry Products and Pulp Paper 3 10 2 7 1 Vehicles 3 4 5 8 1 Others 3 20 2 6 14 TOTAL Source: SYKB. 14. Bank-financed Operations: SYKB has, to date, received three loans from the Bank in support of (i) the development of the textile industry, US$15 million (Loan 1755-TU); (ii) the labor-intensive industries, US$40 million (Loan 1952-TU); and (iii) the small and medium-scale industries, US$80 million (Loan 2647-TU). Due to the reluctance of firms to incur foreign exchange risk, the last date for loan commitments under the textile projects was extended twice. With the introduction of FERIS, the loan was almost entirely committed by December 1984, with about US$14 million disbursed, and the remaining amount cancelled. The last date for commitments under the loan for the labor-intensive industries project was - 56 - ANNEX 7 Page 7 of 14 also extended twice (December 31, 1985) for the same reason. This loan was also fully committed soon after the introduction of FERIS. SYKB has approved 112 sub-projects (net of cancellations) with a total amount of US$40.0 million (100X) under the Bank loan for labor-intensive industries. Sub-loan disbursements amounted to US$39.6 million, which corresponds to 99% of the total loan amount. Sub-projects assisted under the loan created about 14,000 jobs at an average cost of $12,744 (excluding land and buildings). At least one-third of the loan for labor-intensive industries was earmarked to finance SSI sub-projects defined as enterprises with assets, excluding land and buildings, not exceeding US$350,000 in the case of new sub-projects, and US$500,000 in the case of expansion of sub-projects"'. About 362 of the loan amount has been approved for SSI sub-projects. Table 3 SYmK: SECTORAL DISTRIBUTION OF OUTSTANDING LOANS 1982-1986 PERIOD 1982 1983 1984 1985 1986 Food 7 10 12 12 10 Textiles 16 17 31 28 34 Machinery/Metal Products/Electronics 31 26 20 20 17 Chemicals/Plastics/Rubber 14 13 13 13 12 Cement, Earthenware, Glass 9 7 4 5 4 Forestry Products and Pulp Paper 7 7 3 5 3 Vehicles 3 5 5 5 4 Other 13 15 12 12 18 TOTAL Source: SYKB. 15. The latest loan to SYKB, the small and medium-scale industries project (approved in May 1986) has been committed and disbursed at a rapid rate. Currently, SYKB has approved 103 sub-projects (net of cancellations) with a total amount of US$56.7 million (about 71S of SYKB's share of the loan). The disbursement has been about US$25 million and ahead of schedule. Sub-projects assisted under the loan would create about 20,000 jobs at an 1/ December 31, 1980 prices. - 57 - ANNEX 7 Page 8 of 14 average cost of US$12,000 each (excluding land and buildings). The major industrial sub-sectors which have been beneficiaries of Bank-funded loans are textile, chemical, machinery, food, metal products, and marble industries. The majority of these projects are located in Istanbul (321), Tekirdag (11X), Bursa (101), and Izmir (91). The ERR and IFRR were calculated for sub-projects with a fixed investment of above US$750,000 each, ranging between 30% to 60S and 351 to 701 respectively. SYKB's performance in utilizing the loan as reflected by good quality of sub-project appraisal, financing of a large number of SSI sub-projects and low cost per job has been very satisfactory. Past Financial Results and Condition 16. Profitability. SYKB's financial statements for 1982-1986 are given in Attachment 1 of this Annex and a sunmmary is given in Table 1. Net profit increased from TL 0.4 billion in 1980 to TL 1.7 million in 1986, 32% of net worth. SYKB's administrative expenses in relation to total assets declined from 1.92 in 1982 to 1.41 in 1986 due to increase in volume of business and effective cost control. This is satisfactory. SYKB's average interest spread on assets for the last few years has been about 10 p.a. due mainly to low interest rate on loans from its shareholders. In 1977, the shareholders agreed to forgo interest on their loans in lieu of higher dividends on their equity investment. As a result, SYKB's dividend payout ratio was 80:20 in 1986 as compared to the limit of 82:18 permitted by SYKB's Articles of Association. The actual returns to shareholders in nominal terms on their investments in SYKB has been in line with interest rates on term deposits or other financial instruments in Turkey. SYKB's total assets increased from TL 10 billion at the end of 1980 to TL 73 billion at the end of 1986. In nominal terms they increased by over 600%. The paid-in capital has increased from TL 400 million at the end of 1982 to TL 3.6 billion a, the end of 1986. In November 1987, SYKB's Board of Directors authorized an increase in capital from TL 4 billion to TL 12 billion to be paid-in as required. Throughout this period SYKB's debt/equity ratio has remained within the limits agreed with the Bank under different loan agreements. The long-term debt/equity ratio has gone up from 6:1 at the end of 1984 to about 8:1 at the end of 1986 which is within the maximum limit of 10:1 agreed with the Bank under the Small and Medium-scale Industry project (2647-TU). 17. Portfolio and Arrears. Notwithstanding the difficult economic condition, SYKB has built up a sound portfolio. However, SYKB's arrears have increased over the past few years. This is primarily due to the consecutive devaluations of the Lira during the last few years, very high real interest rates and corporate insolvencies. SYKB has performed reasonably well during this difficult period by: (i) following a conservative lending policies; (ii) financing mainly expansion and export-oriented projects which have higher returns; (A..) avoiding foreign - 58 - ANNEX 7 Page 9 of 14 exchange risk by seeking coverage under FERIS for a large share of its portfolio; and (iv) seeking adequate collaterals. Table 4 presents the trend in arrears of more than 6 months. Table 4 ARREARS OF PERFORMING AND NON-PERFORMING LOANS (TL Billion) 1984 1985 1986 3/31/87 EP 1/ Arrears EP Arrears EP Arrears EP Arrears Non-performing Loans(A) 2.1 0.4 2.2 1.1 7.0 2.7 6.8 4.5 Performing Loans(B) 15.7 1.3 31.7 2.2 45.1 3.5 61.0 2.0 Total(C) 17.8 1.7 33.9 3.3 52.1 6.2 67.8 6.5 Port. at risk (A/C) 11.8 6.5 13.4 10.0 Source: SYKB 1/ EP - Effective Portfolio. 18. Performing loans are defined as loans with minor or no problems and with little or no arrears. Non-performing loans are defined as loans in court or with serious arrears problems over six months. A distribution of SYBK's arrears by sub-sectors at the end of 1986 shows a similar pattern to that of its portfolio. Four subsectors accounted for 71% of the arrears in the following order: textiles (31Z), food (17%), machinery/metal products/ electronics (162) and chemicals (7X). SYKB's arrears of non-performing loans have increased considerably since 1984. Many of these arrears are associated with firms which had borrowed in foreign currency and had undertaken foreign currency exchange risk under line of credits available from the Bank, EIB and other foreign currency sources prior to the introduction of FERIS. Furthermore, some of the recent year arrears are attributed to: (i) delays in the completion of subprojects, and (ii) short-term capital loans are presently costing an interest of up 70-85 percent to the enterprises. To overcome this problem, since mid 1985, SYKB has increased the penalty interest rate on overdue payments to 701 from 622. SYBI also allows 6 months for delay in debt-servicing and thereafter it normally enforces the bank guarantee. The bank guarantee letters and - 59 - ANNEX 7 Page 10 of 14 promissory notes generally cover about 80 percent of SYKB's portfolio and the remaining is covered by mortgages and promissory notes. Also, it seems SYKB has been able to contain the level of arrears. Total arrears as of percent total loan portfolio and portfolio at risk-' have declined in the first quarter of 1987. SYKB plans to increase its provisions for bad debts by TL 1.7 billion in 1986 and TL 2 billion in 1987, which is adequate to cover the possible write-offs. 19.. SYKB's cash collection as a percentage of total due for collections has remained around 70% for the last two years. However, the performance of the accounts under FERIS has been much better, with the collection ratio of about 95b in the first quarter 1987. To maintain its financial soundness SYKB should undertake evaluation of its ten hard core problems with the view to restructure these projects. SYKB has agreed to keep the Bank informed of the progress of the ten major cases which constitute about 50% of arrears on quarterly basis. SYKB will continue with the agreement reached under the textile project to maintain at least 5% of its net annual income as a provision for bad and doubtful loans and investments, up to a maximum of 2% of its loan and equity portfolio. To achieve better arrears control, SYKB proposes to reorganize its supervision activities to give greater emphasis to project implementation and supenrision(para 8). 20. Resources. SYKB's resource mobilization thus far has been mainly focussed on Central Bank rediscount facilities and own sources in the form of paid-in capital and reserves for domestic currency financing requirements, and the Bank, and to a lesser extent, EIB for foreign currency financing requirements. Of the domestic resources, SYKB has approved TL 20.6 billion and has a deficit of about TL 1.0 billion which can be covered by drawing on Central Bank rediscount facility. In 1986, for the first time, SYKB successfully issued its own bonds in the domestic market reflecting acceptance of SYKB as a solid and mature institution by the local capital market. SYKB could also utilize this option to meet its domestic resource financing requirements in the future. III. PROSPECTS Future Role and Diversification Program 21. The development plan aims at increasing industrial investment in the private sector at 7% p.a. Also it is envisaged that the industrial production will increase by 7.32 p.a. over the nest several years. In this light, SYKB will have an important role to play in industrial growth and investment in the coming years. The Turkish Government will continue with - 60 - ANNEX 7 Page 11 of 14 its effort of continued improvement in the investment climate by providing incentives to promote private industrial investment especially in export-oriented industries. While SYKB will continue with its primary role as a major DFI's by providing financing to private manufacturing sector, SYKB plans to diversify its operations into non-manufacturing sectors and financial services such as tourism sector and leasing. As a start, SYKB plans to participate in the share of a leasing company to be established jointly with national and international financial institutions. In the near future operational role, SYKB will give high priorities to export-oriented industries. 22. SYKB plans to diversify its resource mobilization activities in the following ways: (i) in its support of expanding the domestic capital market, SYKB will promote public participation in investment through the issuing of its own bonds, taking advantage of the confidence that it enjoys within the domestic market, and (ii) SYKB will seek to obtain lines of credit abroad from new sources. SYKB has started a dialogue with several German banks for obtaining HERMES-backed credits and is exploring possibilities of obtaining further resources from EIB. To support its new operations, SYKB will focus its staff recruitment to professionals with experience in large-scale project appraisal. To prepare staff for planned diversification programs, SYKB has developed a well-balanced program of internal end external training. SYKB's Board has approved overseas training programs for 15 members of its professional staff for 1987-1988 period. Currently, SYKB is evaluating the domestic training programs offered by the Center of International Banking Studies (CIBS) established under FSAL I.. Furthermore, to meet its resource diversification program in the futture, SYTB plans on the establishment of a resource mobilization unit within the Loans Department with initial staff of 2 in 1987 and to be fully staffed by 1988. SYKB's new plans are reflected in its revised Financial and Operational Strategy Statement, which was discussed and agreed upon during negotiations. Future Operations 23. Operational Forecast. SYKB's future prospects are good. SYKB's share in the private sector manufacturing investment requirement in the manufacturing sector during 1987-1991 is estimated at 4X, which is a reasonable target. A summary of projected operations and key financial results are given in Table 5. 24. SYKM's loan approvals are projected to increase at a real rate of 25-30 p.a. assuming an inflation rate of 30-35b p.a. This growth rate is attainable for the following reasons: (i) private industrial investment in Turkey is expected to continue to grow at a real rate of 62 p.a.; (ii) SYKB's marketing and promotional capabilities, and (iii) SYKM's strong pipelines. - 61 - ANNEX 7 Page 12 of 14 Table 5 SYKB: SUMMARY OF PROJECTED OPERATIONS AND KEY FINANCIAL RESULTS (Amount in TL billion) Year ending December 31 1987 1988 1989 1990 1991 Operations Loan approvals Loan Currency 13.0 16.0 22.0 24.0 41.0 Foreign Currency 24.0 50.0 103.0 162.0 229.0 Total 66.0 125.1 186.0 Commitments 40.5 71.5 117.0 177.0 260.0 Disbursements 41.5 69.0 105.0 163.0 244.0 No. of Operations 86 87 98 141 196 Financial Condition & Results Cash and short-term deposits 0.2 1.3 1.9 1.9 2.3 Government bonds 6.1 10.0 15.0 24.0 36.0 Loans (net) 100.1 157.6 251.0 392.2 601.0 Equity Investments 1.0 1.0 1.1 1.2 1.3 Short-term Borrowings 8.0 14.2 23.1 35.1 53.7 Long-term borrowings 95.1 144.0 225.4 356.4 544.0 Net Worth 9.8 17.0 28.3 38.2 57.3 Total Assets 112.9 175.3 277.0 429.8 655.1 Net Profit (after taxes) 5.4 11.0 17.7 24.0 36.7 Key Financial Ratios Net profit/average Total Assets (b) 5.5 7.0 7.8 6.7 6.8 Net profit/average net worth (X) 51.0 53.0 50.0 44.0 48.0 Adm. Exp./Avg. Total Assets (2) 1.2 1.1 1.0 0.9 0.8 Long term debt/equity ratio 1/ 9.8 8.5 8.0 9.3 9.5 Debt service coverage ratio 1.2 1.2 1.2 1.2 1.2 1/ IBRD definition. Source: SYKB. - 62 - ANNEX 7 Page 13 of 14 The project pipeline of SYKB as of November 1, 1987, consisted of loan applications for US$34 million equivalent in foreign currency and TL 5 billion (US$7 million) in local currency. The projects included in the pipeline are mainly subsectors with strong export share/growth base such as, textile (352), metal products/machinery/electronics (20%), chemicals (101), and leather and hides (91). Proiected Resource Requirements and Financing Plan 25. During 1987-1989, SYKB plans to lend about TL 230 billion with about TL 180 billion (US$158 million equivalent) in foreign exchange. As of April 30, 1987, SYKB's untied foreign exchange resources available for new commitments consisted of the remaining of the credit line from the Bank US$ 24 million. To meet its lending targets, SYKB expects to raise resources by increasing foreign currencies from its traditional and new sources. The proposed Bank loan of US$50 million plus the remaining of the existing SMI loan (US$24 million) will meet portion of the foreign currency requirements. SYKB has opened dialogue with German banks for obtaining Hermes-backed credit (US$50 million). SYKM is planning to approach its Governments for approval shortly after certain clarifications are obtained from the bidding banks. SYKB plans to meet the remaining resource gap (US$34 million) through open markets sources (such as the Japanese Capital Market) and EIB. With the background of successful resource mobilization in the domestic market, the time seems appropriate for SYKB to test international markets by raising a medium-term foreign currency credit. While continuing with its efforts of getting funds from Germany (HERMES credits) and EIB, SYKB must focus its attention on international credit markets, namely, the euro-currency market. Towards this objective, the proposed resource cell must keep a watch on these markets, create a data base (exchange rates, interest rates and the liquidity), and cultivate contacts with banks and merchant banks locally and abroad. In view of a sound balance sheet and operational efficiency demonstrated by SYKB, it should be possible to raise medium term credits from Euro-markets. 26. Total local currency loan commitments of SYKB during 1987-1989 period are estimated at about TL 51 billion. SYKB plans to meet its local currency requirements largely through increases in paid-in capital and retained earnings, borrowings from central bank, and proceeds of issued bonds. To meet its resource mobilization program, SYKB will create a resource mobilization unit within the Loans Department. The equity investments of SYKB are expected to remain low (TL 800 million in 1986) and would increase at an average rate of 101 p.a. during 1987-1991. Prolected Financial Condition and Results 27. A sunmmary of SYKB's projected financial results and condition is provided in Table 5. Attachment 2 provides details. SYKB is expected to continue to be a sound financial institution over the next few years barring - 63 - ANNEX 7 Page 14 of 14 major adverse economic problems in Turkey. SYKB's total assets are projetted to grow at an annual nominal rate of 552 from TL 113 billion in 1987 to TL 655 billion in 1991. Loans are projected to grow from TL 52 billion in 1986 to TL 601 billion in 1991. The growth in assets will be financed mainly by medium- and long-term borrowings which will grow from TL 54.8 billion in 1986 to TL 544 billion. SYKB's financial structure will continue to be sound with debt/equity ratio below the 10:1 debt/equity limit during 1987-1991 period. SYKB will maintain 10:1 debtiequity ratio and lower by increasing its equity mainly through increase in paid-in capital and retained earnings. SYKB's paid-in capital is projected to increase from TL 4 billion in 1987 to TL 25 billion in 1991. SYKB's profit after tax is also expected to increase by at least five times from TL 4 billion in 1987 to TL 22 billion in 1991. The return on equity is expected to be in the range of 50S during 1987-1991 which is satisfactory. With higher operating volume and an expected increase in loan size, administrative expenses as percentage of total assets are projected to decline from 1.22 in 1987 to 0.81 by 1991. The liquidity position of SYKB will continue to be satisfactory. The Debt Service Coverage Ratiol' would remain above 1.1 between 1987-1991. Also, SYKB expects cash collection performance to improve greatly over the next three years. SYKB's estimates are that average cash collection during 1987-1988 period will increase to over 901. The cash collected as percent of fallen due for the first quarter of 1987 stood at 91X. Provisioos will remain at 52 of total loans outstanding during 1987-1991 period 1which is satisfactory. zl 1/ DSCR * (Net Profit After Tax + Non-Cash Charges (Depreciation + Provisions) + Loan Collections + Interest (1-tax rates))/(Principal Repayments + Interest(1-tax rates)) - 64 - AMNEX 7 Attachment 1 Page 1 of 2 TURKEY SYKB INCOME STATEMENTS (1982- 1986) (TL 100,000) 1982 1983 1984 1985 1986 INCOME Interest and charges 1,781 2,798 4,652 9,630 14,731 Income from other investments 42 123 128 210 1,435 Other income 47 43 331 190 763 Total Income 1 EXPENSES Interest and charges 1,008 1,672 2,715 5,873 10,065 Provision for losses 31 176 629 1,360 1,696 Administrative expenses 155 243 355 638 807 Other expenses 29 50 79 183 1,955 Total Expenses Income Before Taxes 647 823 1,332 1,976 2,406 Less Income Taxes 251 311 512 898 657 Net Income Source: SYKB - 65 - AMX 7 Attachment 1 TURKEY Page 2 of 2 SYKB BALANCE SHEETS (1982-86) (TL Millions) Year Ending December 31 1982 1983 1984 1985 1986 ASSETS Cash and due from banks 156 509 317 591 4,058 Sundry receivables 681 1,205 2,364 3,834 9,286 Treasury bonds 0 0 0 0 5,826 Other current assets 116 139 172 309 396 Total current assets Loans and Investments Loans Principals outstanding 8,703 12,891 18,717 36,183 56,146 Less provisions (108) (283) (909) (2.263) (4,010) Loan portfolio (net) Investments Equity (cost) 207 245 450 519 788 Government bonds 300 240 234 210 114 Total investment m Hi m2 22Z Fixed assets (net) 190 189 266 353 818 Total assets Lk LIABILITIES AND EQUITIES S-T bank borrowings 200 52 4 0 0 Other payables 261 369 555 892 4,793 Taxes due 255 355 516 933 657 Bonds issued by SYKB 0 0 0 0 6,553 Total current liabilities Jz J&M 22; Medium and Long-terrn Loans Local currency 3,249 5,016 7,924 20,548 38,070 Foreign currency 5,164 7.621 9.071 12,786 16,801 Total long-term debts 8,413 12,537 16,995 33,334 54,871 Staff Retirement Funds 60 69 78 153 51 Total Liabilities 235.312 i NET WORTH Paid-in capital 400 800 2,000 2,785 3,595 Reserves 154 252 393 600 745 Retained earnings 360 - 690 912 1,749 Reevaluation surplus 142 142 381 126 408 Total Net Worth I&M 1.2 I&W L-W AA2 Total Liabilitics and Net Worth Source: SYKB - 66 - ANNEX 7 Attachment 2 Page 1 of 3 TURKEY SY PROJECTED INCOME STATEMENTS (1987-1991) (TL 100,000) 1987 1988 1989 1990 1991 INCOME Interest and commissions 29,729 45,939 70,516 92,448 132,869 Comnitment fees 91 130 167 216 42 Other commissions 1,107 1,931 2,505 3,451 8,724 Other income 329 319 350 377 408 Total Income 9 EXPENSES Interest and charges 18,794 27,798 41,551 53,907 78,440 Interest and securities 3,038 3,131 4,942 5,822 8,971 Personal expenses 1,210 1,585 2,261 3,180 4,340 Provisions for losses 2,022 3,175 59048 7,883 12,055 Depreciation 51 51 51 51 51 Other expenses 744 1,728 1,977 1,693 1,441 Total Expenses 25a85 &iJ2 Z A 105. Income before taxes 5,398 10,852 17,707 23,956 36,745 Less Income Taxes 1,233 3,742 6,467 9,175 14,063 Net Profit ilLL UAQ Source: SYKB - 67 - ANE 7 Attachment 2 Page 2 of 2 TURKEY SYKB PROJECTED BALANCE SHEETS (TL Million) 1987 1988 1989 1990 1991 ASSETS Cash and dues from banks 194 134 194 187 228 Bonds 6,105 9,550 15,158 23,652 36,153 Receivables 2,990 4,577 6,976 99750 14,046 Loans 107,700 168,329 266,826 416,242 636,602 les provisions (6,013) (9,165) (14,186) (22,038) (34,057) Loans (net) 101,747 159,164 252,640 394,204 602,545 Participation 918 19018 1,118 1,218 1,318 Fixed asgets (net) 907 876 845 814 783 Total assets 11ZJW a2naLa2 2a22 2J&iA 6 LIABILITIES AND NET WORTH Taxes on profit 1,233 3,742 6,467 9,175 14,063 Bonds 6,105 9,550 15,158 23,652 36,153 Miscellaneous 610 924 1,446 2,286 3,489 Total short-term debts 7,948 14,216 23,071 35,113 53,704 Term loans EIB & AID 7,704 6,877 249,220 62,346 110,900 IBRD 75,627 109,038 134,438 162,422 194,396 HERMES 0 13,063 41,800 78,563 119,650 Central bank 11,760 15,068 18,683 22,247 26,899 Other sources 0 0 6,270 30,778 92,077 Total term loans 95,091 144,046 225,411 356,356 543,922 Staff retirement fund 70 93 120 151 187 Net worth Paid-in capital 4,000 7,370 13,051 17,000 25,000 Legal reserves 1,077 1,872 3,302 5,580 8,607 Revaluation surplus 510 612 734 845 971 Profit after taxes 42165 7,110 11,240 14,781 22,682 Total Net worth 9,752 16,964 28,327 38,206 57,260 Total liabilities and Net worth XULl Source: SYKB - 68 - ANNEX 8 Page 1 of 2 TURKEY bdustrial Export Development Project (IEDP) A Stud of the Credit Delivery-System for hndutri Finance Terms of Reference ObQietyi 1. Private sector is expected to play a major role in Turkish industry over the next few years. The role of the private sector in the manufacturing industry will be crucial especially if the export drives were to be sustained. It is, therefore, important that the private sector is provided with adequate investment funds in a most efficient manner. The study aims at analyzing investment needs of private industry during the late 1980s and 1990s and identifying vehicles which could be used to satisfy the investment requirement. Scone of the stwdy and methodology 2. The study will carry out a review of the past financing pattern of private industry in Turkey. It would discuss the importance of various sources of financing (equity, retained earnings, domestic loans, foreign loans, supplier credits, and other sources). It will assess the roles of the concerned intermediaries, i.e development banks, commercial banks, merchant banks, bilateral and multilateral institutions, as well as the capital markets. The study will review the performance of these intermediaries within the overall macro-economic environments which prevailed in Turkey during 1977-1986. 3. The consultants to ba employed by the Treasury would rely on past reports produced by Turkish and international organizations. This review is to be supplemented by interviews of 30 major industrial firms in Turkey and major financial intermediaries and monetary authority. The consultants would also draw on experience of other countries with similar stage of economic development. mentof th stud 4. The study would be managed by a task force to be formed by the concerned Turkish organizations. This could include the Treasury, Central Bank of Turkey, TSKB, 8YKB, Bankers' Association of Turkey, and the Chamber of Comuarce and Industry. The consultants employed by the Government under the Industrial Export Development Project would work with the task force. The study 'tould commence in July and is expected to be completed by December 31, 1988. - 69 - ANNEX 8 Page 2 of 2 Esimated cost 5. The cost of the study is estimated at US$100,000 and will be in included in the technical assistance component of the Industrial Export Development Project. - 70 - ANNEX 9 TURKEY INDUSTRIAL EXPORi DEVELOPMENT PROJECT (IEDP) DISTRIBUTION BY SECTORS OF THE MEDIUM-TERM REDISCOUNTS FOR PROJECT FINANCE BY THE CENTRAL BANK (1981-86) (TL Billion) 1981 1982 1983 1984 1985 1986 Total Tourism 0.0 0.0 0.5 0.6 6.7 18.5 26.3 Manufacturing 10.5 27.4 30.5 51.2 108.2 146.1 378.7 Others 15.1 33.0 20.4 20.1 25.5 17.5 133.2 Total 25.6 60.4 51.4 71.9 140.4 182.1 538.2 =uU= a= =- ==m= Source: Central Bank of Turkey. - 71 - ANN 10 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT PROJECTED DISBURSEMENTS (US$ million) FY88 FY89 FY90 FY91 FY92 TSKB Commitment 20 80 25 25 Disbursements 5 55 SO 25 15 Cumulative 5 60 110 135 150 SYKB Commitment 10 30 10 Disbursements 0 25 19 6 Cumulative 0 25 44 50 COMMERCIAL BANKS Commitment 0 30 !0 18.5 Disbursements 0 20 43 30 5.5 Cumulative 0 20 63 93 100 TECHNICAL ASSISTANCE Ex-Im 0 0.40 0.40 0.10 0 IGEME 0 0.15 0.15 0.05 0.05 Study 0 0.1 Total 0 0.65 0.55 0.25 0 Cumulative 0 0.65 1.20 1.45 1.50 TOTAL Annual 5.0 100.7 112.5 61.3 20.5 Cumulative 5.0 105.7 218.2 279.5 300.0 June 24, 1987 - 72 - AEX 11 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT SELECTED DOCUMENTS AND DATA AVAILABLE IN PROJECT FILE 1. Turkey: Private Manufacturing: Assessment of the Impact of Past Policies and Future Adjustment Needs. Report No. 6684-TU, July 21, 1987. 2. Turkey: Financial Sector Adjustment Loan (No. 6095-TU, May 15, 1986) and Private Manufacturing - Assessment of the Impact of Past Policies and Future Adjustment Needs (No. 6684-TU, July 21, 1987). 3. Detailed Operational and Financial Projections of TSKB and SYKB. 4. Consultant report on Export Promotion Research Center (IGEME). 5. Consultant report on Export Credit, Guarantee and Insurance Needs in Turkey, July 1986. 6. Consultant report on Money Market in Turkey, March 7, 1986. JO- t>% ~~~~~~~~~~~~30'R 3S° BULGARIA > / s ~~~~~~~~~~~~~~~~~~ -SINOP Ivilingr KlRKLARELI ZONGULDAK. KASTAMONU ? OPinorhisor ZONOULDAK_0Yj ~~~~Kastornvj /\ oboTh' fOOLA 0 < S ~~omirkop - ~" ISTA~NBUL ERBLI "SA \ , _ . J Ut KO~~~~~~CAELI SAKARYA> ootoo<- GREECEJI ( ,TE KIR O -- 2,1 - ( :s e Tkirdo iStAt L ADAPAN ARI CORUM , I E. BOLU - \A/ ANKARA 0 ~~~~~~~~~~~~' AKARAMA 40 ANAKKALE \ SurlIK -o* I 7SALI KE JR - ;S@ tX YOZ ALIKE'SIR ~~~~~~ESKISEHI KIRSEHIR -.....;g) KUTAHYA 118\1 AYUNT> gf ,gMANISA :AF.roN ,) / ruz J ,} NEVSEHIR NIGDE 3 OTir<, > S"ensDYMN MARDIN I1 t R A Q) ADANA >;Uf -p˘) TOPRAKKAL Ev IAA URFA GAZI URAP * Mosul, Boghdad, .ISltENDERU <4S~v'',s HAT To Boghdod TURKEY INDUSTRIAL EXPORT DEVELOPMENT latc,k.o SYRIAN ARAB REPUBLIC PROJECT 69 NATIONAL CAPITAL 0 CITIES AND TOWNS - MAJOR HIGHWAYS I § RAILROADS -. - -PROVINCE BOUNDARIES INTERNATIONAL BOUNDARIES 40O OCTOBER 19B