Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14678 PROJECT COMPLETION REPORT TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT (IEDP) (LOANS 2901-0-TU, 2901-1-TU AND 2901-2-TU) JUNE 26, 1995 Industry, Trade and Finance Operations Division Country Department I Europe and Central Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. ACRONYMS AND ABBREVIATIONS Als Administrating Institutions CBs Commercial Banks CBT Central Bank of Turkey DBs Development Banks ERR Economic Rate of Return Eximbank Export-Credit Bank of Turkey FERIS Foreign Exchange Risk Insurance Scheme PSAL Financial Sector Adjustment Loan GDP Gross Domestic Product GOT Government of Turkey IAS International Accounting Standards IEDP Industrial Export Development Project IFRR Internal Financial Rate of Return IGEME Export Promotion Research Center L/Cs Letters of Credit PCBs Participating Commercial Banks PCR Project Completion Report PFIs Participating Financial Institutions PICP Private Investment Credit Project SAR Staff Appraisal Report SLA Subsidiary Loan Agreement SYKB Sinai Yatirim ve Kredi Bankasi t.a. Technical Assistance TORs Terms of Reference TSKB Turkiye Sinai Kalkinma Bankasi TU Turkey WPI Wholesale Price Index FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 26;, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Turkey - Industrial Export Development Project (Loans 2901-0-TU, 2901-1-TU and 2901-2-TUI Attached is the Project Completion Report (PCR) for the Turkey Industrial Export Development project (Loans 2901-0-TU, 2901-1-TU and 2901-2-TU, approved FY89). prepared by the Europe and Central Asia Regional Office, with Part II contributed by the Borrower The three loans, totaling US$300 million, were approved on December 19, 19,S& The project was closed on schedule on June 30, 1993, with disbursements of US$2.37.49 million, representing 95.5 percent of the total loans. The objectives of the project were: (i) to support expansion of Turkey's industrial exports by providing credit to private, export-oriented projects in strategic industrial sectors with international comparative advantage; and (ii) to strengthen the policy and institutionai framework for industrial and export finance and to simplify export finance procedures. The project failed to deliver credit efficiently because: (a) contrary to tie loans' exp,icit intention, subloans took place at highly negative real interest rates, (b) many of thc participating financial intermediaries had low creditworthiness and continue to show negative real rates of return on equity, (c) continued macroeconomic instability provided an inhospitable environment for enterprise growth and loan repayment, and (d) technical assistance programs appeared to be poorly designed. The project, however, helped improve the effectiveness of some of the Financial intermediaries and financed 112 subprojects all of which had high ex ante rates of return. No ex post rates are available. Because of the above shortcomings, project outcome is rated as marginally unsatisfactory and the institutional development impact is rated as modest. Because of the ongoing unstable macroeconomic climate and the heavy fiscal cost of the project in direct and indirect subsidies, sustainability is rated as unlikely. The principal lessons that emerge from the implementation of the project are: (i) f:inancial sector reforms as well as incentives for improved export performance succeed best in an environment of credible macroeconomic policies; and (u) it is difficult to accurately judge project effectiveness in an environment of direct and indirect subsidies. The PCR is comprehensive in its coverage of the performance of the project and principal issues, and its overall quality is good, although it provides little information on actual pertormance of subprojects. No audit is planned. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their offliciai duties. Its contents may not otherwise be disclosed without World Bank authorization. j FOR OFFICIAL USE ONLY TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT (IEDP) (LOANS 2901-0-TU, 2901-1-TU AND 2901-2-TU) PROJECT COMPLETION REPORT Table of Contents Page Nos. Preface . ........................................................ 3 Evaluation Summary ........................................................ 5 PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE ..... ........... 10 Project Identity ..................................................... 11 Project Background . ................................................. 11 Project Objectives and Description ........................................ 12 Project Design and Organization ........................................ 13 Project Implementation . ............................................... 17 Project Results ...................................................... 20 Project Sustainability .................................................. 22 Bank Performance .................................................... 23 Borrower Performance . ............................................... 23 Lessons and Recommendations ......................................... 24 PART II. PROJECT REVIEW FROM BORROWER'S PERSPECTIVE .... ......... 27 Views of the Undersecretariat of Treasury and Foreign Trade .................. 27 Views of Turkish Industrial Development Bank (TSKB) ....................... 28 Views of Turkish Industrial Investment and Credit Bank (SYKB) ................ 29 Views of Turkish Eximbank . ............................................. 30 Views of Export Promotion Center ...................................... 31 Views of Project Implementation and Design as a Whole ...................... 32 Experience gained under the Project ...................................... 32 Views on IGEME'S Performance in the Project ............................. 33 Part III. STATISTICAL INFORMATION ...................................... 35 Related Loans and Credits . ............................................. 35 Project Timetable . ................................................... 36 Loan Disbursements . ................................................. 36 Project Implementation: Selected Indicators ............................... 37 Project Costs and Financing (US$ million) ................................. 38 Project Results ...................................................... 38 Status of Covenants . ................................................. 40 Use of Bank Resources . ............................................... 40 This document has a restricted distribution and may be used by recipients only in the performance of their off icial duties. Its contcnts may not otherwise bc disclosed without World Bank authorization. 3 PROJECT COMPLETION REPORT TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT (IEDP) (LOANS 2901-)-TU, 2901-1-TU AND 2901-2-TU) Preface Thli Project Completlon Report (PCR) covers the Industrial Export Development Project (IEDP), for which a package of loans, (US$150 mililon, US$50 million and US$100 million), totalling US$300 million equivalent, was approved on Dccember 19, 1988. The loans were extended to Lwo development banic (DBs) - Turkiye Sinai Kalkinma Bankasi (TSKB) and Slnal Yatirim ve Kredi Bankasl (SYKB), and to the Government (GOT) for channeling through commercial banks (CBs). The GOT guaranteed the loans to TSKB and SYKB, and these DBs administered the loan for the CBs, on behalf of the GOT. The project closed on schedule on June 30, 1993, with disbursements of US$287.49, representing 95.8 percent of the totlI loans. The PCR's Preface, Evaluation Summary, and Parts I and III were prepared by the Country Operations Division, Country Department I, Europe and Central Asia Region. Preparation for the PCR began during the May 12-29, 1993 Supervision Mission for the Private Investment Credit Project (PICP, Loan 3346-TU), the follow-on project for the IEDP. This PCR was based, among others, on: the President's Report and Recommendations, and Staff Appraisail Report (SAR) of the IEDP and related projects (and/or their PCRs); Loan, Guarantee and Subsidiary Loan Agrcemcnts (SLA); Progrcss and Supervision Reports; Project Correspondence files; internal Bank memoranda and related papers; Financial Statements and Audit Reports of participating linaincial institutions (PFIs); data supplilcd by the GOT and PFIP as part of the PCR preparation process; nnd interviews with Turkith olTiicinls and batnkers, and Bnnk starf who dealt with the project iat varitous Ntics. 5 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT (IEDP) (LOANS 2901-0-TU 2901-1-TU AND 2901-2-TU) PROJECT COMPLETION REPORT Evaluation Summary Objectives and Design 1. The project's main objectives were to: (a) support expansion of Turkey's industrial exports; and (b) strengthen the policy and institutional framework for industrial and export finance. The project included a US$298.5 million credit component and US$1.5 million technical assistance (t.a.) component. The credit component was channelled through participating financial institutions (PFIs), including two DBs - TSKB and SYKB; and eight major private and public participating commercial banks (PCBs) which satisfied the eligibility criteria. TSKB and SYKB served as the Administrating Institutions (Als) for the PCBs in the absence of a direct relationship between them and the Bank. Subloans were denominated either: (i) in local currency priced on a fixed rate basis as determined under the Foreign Exchange Risk Insurance Scheme (FERIS) administered by the Central Bank of Turkey (CBT); or (ii) in foreign currency at the Bank's rate plus an agreed spread. 2. Prior to the adoption of the project's final design and conditionalities, there were a number of key modifications made that would color both the project implementation experience and the development impact of the project. Shortly before appraisal (and consistent with new directions in Bank policies evolving at that time), the Bank suggested that, in addition to the DBs, commercial banks be included as intermediaries of the Bank funds in support of improving the credit delivery system for long-term finance in Turkey. While the GOT agreed to broaden the channels for retailing Bank industrial credits, it preferred to do so under an apex structure, using either the CBT or Export- Credit Bank of Turkey (Eximbank). Following agreement that assigning such a role to these institutions would be inappropriate in an environment of financial sector liberalization and given the independent policy role expected of the CBT, a late-stage compromise arrangement was agreed, appointing TSKB and SYKB as AIs, while channeling the PCB portion of the loan through Eximbank. As late as loan negotiations, two major concessions were made by the Bank which diluted the contribution of the project to the strengthening of the policy framewoiK for industrial and export finance: (a) the condition for variable, market-based pricing for subloans was dispensed with; and (b) policy conditionalities relating to export finance and incentives were eliminated on the assumption that the GOT would continue to pursue them as part of its broader financial sector reform program, supported by the Bank (FSALs I and II, Loans 2714-TU and 2964-TU, respectively). Implementation Experience 3. Changes in the project design and conditionalities caused delays in the negotiations, Board approval, signing and effectiveness of the loan. As a result, PFI pipelines of investment proposals 6 built up awaiting loan effectiveness. Moreover, the investment demand for export modernization and expansion was to some extent artificially high during the period of the loan, aided by extensive GOT subsidies, grants, and other incentives (including FERIS rates, negative in real terms). In the financial sector, ongoing liberalization policies of the GOT were conducive to the development of a more positive environment for the active involvement of PCBs as intermediaries in trade finance. The combined effect of these factors on the IEDP experience was that commitments in the earlier stage of the loan were very rapid, prompting the Bank to initiate preparation of a follow-on operation very early in the IEDP implementation period. The pace of credit commitments subsequently decelerated, however, as a result of several factors including the need to reformulate subprojects due to foreign exchange fluctuations, but notably as a result of the transformation of FERIS into a market-based facility (at higher rates) and the introduction of other sector reforms such as the phase-out of GOT's preferential credits. Nevertheless, the loan funds were almost fully committed by the original commitment date and the original loan closing date was met. Issues 4. The IEDP implementation experience points to a number of issues: (a) the rapid commitment of credits was heavily supported by negative real interest rates and subsidies; (b) there were observed project design weaknesses affecting the credit delivery system; and (c) implementation of the t.a. programs tended to be fragmented and drawn out. During the period when more than 90 percent of the funds were committed, fixed FERIS rates applicable on sub-loans ranged from -12 to - 15 percent in real terms (based on the WPI). Additionally, investment projects benefitted from other subsidized incentive programs of the GOT, including generous cash grants which enhanced the attractiveness of undertaking investment by substantially reducing own funds risked by entrepreneurs. The subsidies/ incentives also resulted in: (i) IEDP investments being heavily skewed towards those subsectors and activities benefitting most from budgetary support; and (ii) budgetary costs in implementing IEDP, representing potential issues related to PFH portfolio management. 5. At the credit delivery level, relationship problems developed between some PCBs and the AIs, as the fees for letters of credit (L/Cs) charged by TSKB and SYKB were considered to be disproportionate to activities regarded as the traditional role of PCBs. The creditworthiness of some of the PFIs themselves had fundamental weaknesses. In addition, the financial condition of the PCBs was under stress, with the auditors' opinions being materially qualified for three of the eight PCBs. Implicit qualifications were disclosed in the notes to financial statements. Notwithstanding the qualifications, none of the PFIs were declared ineligible to continue to participate in the IEDP during project implementation. Moreover, the supervision effort weighed heavily towards the preparation of the follow-on operation. There were only two IEDP supervision missions, both of which took place within about one year from loan effectiveness. This said, the quality of the supervision effort and relationship with the DBs appeared to have been strong. Bank support to PCBs, their compliance with IEDP requirements, and dialogue/resolution of systemic issues (e.g., LAS) could have been more effective if direct PCB/Bank contractual relations existed. 6. Implementation of the technical assistance (t.a.) programs supported under IEDP was highly problematic, and their effectiveness in supporting policy and institutional goals was weak. An initial procedural legal issue in passing on borrowed t.a. funds as a grant, frequent managerial changes and a discovery that its computer needs could be met by an affiliated government center impeded the strengthening of Export Promotion Research Center (IGEME). Portfolio problems at Eximbank inherited from its predecessor and the GOT's midstream decision against Eximbank's restructuring 7 adversely affected the bank's managerial focus and capacity to effectively promote and finance exports. Completion of a credit delivery system study supported by the project was considerably delayed due to unclear Terms of Reference (TORs) and a shift in the lead role for study execution. Project Results 7. The IEDP objective of financing export-oriented industries was largely achieved. Under IEDP, 112 subprojects (100 projected) were financed involving a total investment of US$1.15 billion compared with the appraisal estimate of US$599 million. Based on questionnaires completed by the PFIs, it is estimated that IEDP led to an increase in exports of about US$284 million per annum and created about 16,600 (20,000 targeted) new jobs at an average cost per job of about US$69,650 (US$30,000 appraisal estimate). The lower-than-expected employment and thehigher-than-expected costs resulted from the large share of capital intensive projects financed (e.g., tourism), whose higher costs were largely financed by GOT subsidies/incentives. The subprojects' estimated ex ante ERR and IFRR averaged 36 percent and 35 percent, respectively. Ex post rates are not yet available. However, they are expected to be in line with IEDP requirements (15 percent), but significantly lower than the ex ante estimates. In addition, significant progress was made in restructuring and diversifying the finances and operations of the participating development banks. The IEDP record of accomplishment in terms of support to the desired sectoral policy framework and t.a. components, however, reflected in implementation, was considerably more modest, due to inconsistencies inherent in project design. For example, the fact that FERIS rates only became positive in 1991, after IEDP was nearly fully committed, meant that most IEDP subprojects were financed under negative rates - -- clearly inconsistent with the sectoral policy framework which IEDP was to support. Total budgetary costs to the GOT of the IEDP investments are estimated to have amounted to US$387 million, of which about US$214 million is attributable to the FERIS subsidy. However, no GOT financing of IEDP investments was indicated in the SAR. Similarly, with respect to t.a., confusion and delays related to assigning lead responsibility for the credit delivery study, diluted the utility of its findings to support the policy dialogue/framework. Sustainability 8. Continued term financing for export-oriented enterprises could not be sustained under conditions prevailing during IEDP. IEDP's subborrowers and PFIs continued to be exposed to macroeconomic imbalances, inflationary pressures, currency fluctuations, and high interest rates. Notwithstanding the ongoing implementation (begun in the early eighties) of a program of structural and financial sector adjustment (supported by the Bank) the vicious cycle of high public sector borrowing requirements of the GOT continued to crowd out the private sector from the credit market. Prolongation of the FERIS and other similar subsidies contributed to this and to maintaining investment finance demand at a somewhat artificially elevated level through nearly 40 percent matching of investor/PFI/IEDP funds with GOT funds. Maintaining high investment levels through such budgetary dependence is clearly unsustainable in the longer-term. In addition, largely as a result of the uncertain macro and sectoral framework, eligibility criteria at the PFH level were being breached, both nominally and substantively. Many PFIs exhibited structural weaknesses which threatened their future viability. Nevertheless, the participating development banks were substantially rehabilitated and operationally restructured under the IEDP, and their chances of future viability were enhanced. PFIs generally, however, continue to show negative real rates of return on equity, indicating continued erosion of capital accounts in real terms. In addition, the overall quality of their portfolios remains in question. 8 Performance 9. The credit component of the project was nearly fully committed well within the timeframe defined under the staff appraisal report. The apparent strong credit demand implied by the rapid commitment of the IEDP funds prematurely prompted a quick and significant shift of focus of Bank supervision resources towards the preparation of a follow-on project. The high costs to the GOTs budget of the IEDP investments argues against the wisdom of the Bank's agreement, during negotiations, to the GOT's preference to delay the implementation of a market-based FERIS scheme. The mixed outcome of the t.a. programs indicates that relatively low priority may have been accorded to their preparation and implementation. GOT actions, such as withholding Eximbank restructuring moves, and shifting responsibilities for the credit delivery study, also adversely affected the outcome of the t.a. component. Conclusions and Lessons Leamed 10. Overall, IEDP could be considered to have been reasonably well-implemented, although under conditions which made sustainability of its achievements questionable. Many of the lessons learned from IEDP are common to financial intermediation experience more broadly. The main lessons of IEDP can be summarized as follows: (a) It is not possible to insulate the financial sector from the impact of macroeconomic elements, nor to support longer-term growth through short-term measures and budgetary dependence. IEDP demonstrates that financial intermediation artificially stimulated under such conditions is inefficient, distorted and unsustainable in the longer term. (b) Project design and implementation arrangements should be consistent with project objectives and with objectives in the institutional and policy framework. Using DBs as AIs can be initially useful in familiarizing PCBs with Bank procedures, but such a structure is often problematic as it dilutes the effectiveness of Bank supervision and resolution of systemic issues, as well as efforts to enhance competition in the banking system, including the institution-building of DBs. Similarly, if t.a. programs are to be included, they must be well-targeted and defined, and should enjoy the full support of the government to bring about the desired results. Technical assistance should not be considered marginal in project design and implementation. (c) The success of a project should not be judged too early in project implementation, nor should such judgement be based just on the rate of commitments. More time should be allowed to lapse in a project's implementation period, and other factors considered in order to best define follow-on Bank-supported activities. (d) The legal framework underpinning all arrangements (e.g., related to IBRD/PCB relationship and t.a. subcomponents) must be clear and should support the continuity of dialogue and attention, both within beneficiary agencies and between them and the Bank. (e) Substitutes for market mechanisms at various levels (fixed FERIS subsidies, special treatment of loan losses, etc.) may support short-term objectives, but undermine the 9 attainment of broader, longer-term Bank/Borrower objectives of sound and sustainable economic management, growth and development, as well as the health of the PFIs. Credibility of Bank assistance, at the project and policy levels, can be achieved only if both, Bank and Borrower maintain commitment to shared objectives. (f) If tourism investments are to be considered eligible for financing under such credit operations on the basis of their foreign exchange earning character, the loan documents should then define eligible investments as "foreign exchange earning", or distinguish otherwise between "export-oriented" and "foreign exchange earning" activities. In addition, consideration should be given to whether or not establishing sectoral concentration limits for certain sectors (such as tourism) which may be inherently more vulnerable to exogenous factors (i.e., impact of Gulf war on tourism), should be established. This would, inter alia, limit PFI exposure to special risks of such sectors. 11 TURKEY INDUSTRIAL EXPORT DEVELOPMENT PROJECT (IEDP) (LOANS 2901-0-TU, 2901-1-TU and 2901-2-TU) PROJECT COMPLETION REPORT PART I. PROJECT REVIEW FROM THE BANK'S PERSPECTIVE Project Identity Name Industrial Export Development Project Loan Numbers 2901-0-TU, 2901-1-TU and 2901-2-TU RVP Unit Europe and Central Asia Region Country Turkey Sectors Finance and Industry Project Background 1.1 For most of the decade of the 1980s, the expansion of Turkey's exports resulted principally through higher utilization of existing production capacity. However, by 1988, the constraints of high capacity utilization were reached and it was felt that additional capacity would be required to support continued export growth. Extremely high interest rates and the shortage of long-term funds for investment, greatly influenced by the large government deficits and inflationary conditions (despite the stabilization and adjustment efforts of that decade), had discouraged investment in new capacity. The country's exports were relatively concentrated. Turkey would need to take decisive measures to stimulate investment in new capacity, diversify its export base and enhance product quality. The country's ability to sustain its future growth was greatly dependent on its capacity to service its external debt with higher export levels. 1.2 Manufactured exports, which grew from 36 percent of total exports in 1980 to 71 percent in 1986 and 83 percent in 1992, were the beneficiaries of a fundamental shift in trade policy toward export-orientation. Increased participation in international markets made Turkey a leading export earner among developing countries, while contributing to enhanced productivity in the manufacturing sector through scale economies and learning externalities, particularly for the private sector. The pattern of export-led growth was prevalent across the entire manufacturing sector, as all subsectors increased their outward orientation. The main policy instruments were a significant depreciation of the real exchange rate until 1988, a dismantling of quantitative import restrictions, a lowering of tariffs particularly in 1989, and a provision of a wide array of special incentives including, inter alia, generous subsidies and cash grants for exporters. However, export growth decelerated after 1990, given a real appreciation of the local currency and a surge in domestic demand, in addition to a decline in incentives and subsidies owing to GATT and other (e.g., Bank-supported financial sector 12 reforms) commitments. By 1993, export performance slowed considerably and the current account deficit rose sharply. Project Objectives and Description Project Objectives 1.3 IEDP's main objectives were to: (a) support the country's expansion program for industrial exports; and (b) strengthen the policy and institutional framework for industrial export finance. Project Description 1.4 To achieve its objectives, IEDP was to: (a) provide financial support to private, export- oriented projects in strategic, industrial subsectors with international comparative advantage; (b) improve the institutional framework for export finance and simplify export finance procedures; (c) support TSKB and SYKB, the leading development banks in the country, in their financial restructuring and operational diversification programs; (d) improve the credit delivery system for industrial investment via the inclusion of commercial banks in the retailing of credit under the IEDP and the carrying out of a credit delivery study; (e) intensify export marketing and promotional activities by inducing greater private sector involvement in strengthening IGEME; and (f) establish a computerized trade and export credit information system at the Eximbank. 1.5 TSKB and SYKB borrowed and channeled two of the Bank loans amounting to US$200 million to finance private export-oriented projects. The third loan of US$100 million to the GOT involved a credit component of US$98.5 million for relending through PCBs, with TSKB and SYKB acting as AIs. A t.a. component of US$1.5 million was carved out of the third loan. The t.a. component was earmarked for the defined needs of IGEME (as a grant) and Eximbank, with a portion allotted for a study on the credit delivery system in industrial finance. Participation criteria for TSKB and SYKB were spelled out in the formulation of restructuring programs for these banks. The basis for selecting PCBs, on the other hand were broader, consisting of: (a) sound financial condition and results; (b) unqualified audit by auditors approved by the Central Bank of Turkey (CBT); and (c) adequate capacity for project appraisal. The GOT assumed responsibility for selecting the PCBs. While there were no pre-defined criteria for the selection process, the Bank expected to discuss the selection basis with the GOT.'/ Each PCB had a maximum allocation of US$15 million for making loans to support the subprojects of export enterprises. 1.6 In order for subprojects to qualify for funds under IEDP, they were required to: (a) export at least 20 percent of incremental production within 3 to 5 years; (b) meet appraisal standards based on Bank-approved guidelines; (c) demonstrate ex ante real economic rate of return (ERR) and internal financial rate of return (IFRR) of at least 15 percent, and (d) meet the Bank's environmental See pars. 4 of the Agreed Minutes of Negotiations covering November 17-20 and December 11, 1987. It was agreed that the Treasury would assume responsibility for selecting the PCBs in accordance with agreed criteria. The Bank expected to discuss with GOT the basis for the selection. The criteria required: (a) a sound financial condition and performance; (b) unqualified audited financial statements; and (c) internal capacity for project appraisal and supervision. 13 guidelines. Subborrowers had the option of borrowing in foreign currency at the Bank's rate plus a 4 percent spread, or in local currency, at a rate determined under the CBT-administered FERIS. Established in 1985, FERIS was intended to enable the CBT to absorb foreign currency risks on loans by charging a spread between its lending rate and cost of funds. In so doing, FERIS provided investors access to foreign capital without the attendant foreign exchange risks, which had represented a disincentive to investment. The FERIS rate was reviewed twice a year and adjusted as required.2/ A FERIS study, carried out in the context of the Bank-supported FSAL I (Ln. No. 2714-TU), however, had demonstrated that fixed FERIS involved significant costs to the Government. In 1989, the fixed FERIS was converted into a market-based floating rate tied to the cost of government borrowings (floating FERIS). As a result, FERIS rates were expected to become positive in real terms. Project Design and Organization Project Preparation 1.7 IEDP was prepared at a time when Bank policies regarding financial intermediation loans were in transition to a more market-based, sectoral approach,3/ and in the context of the GOT's financial sector reform program, begun in 1986 with Bank assistance (FSAL I, Loan No. 2714-TU, approved June 1986). Under this program, the GOT sought to liberalize the financial sector by enacting reform policies including: (a) the maintenance of real deposit rates and real lending rates on selective credits; (b) reductions in selective credits to decrease subsidies and improve credit allocation; and (c) reduction of reserve and liquidity requirements to reduce the high cost of non- preferential lending. The FSAL I agenda was subsequently reinforced by FSAL II (Loan No. 2964- TU, approved June 1988). In the second FSAL operation, the GOT was committed to improve the mobilization and allocation of funds and to foster financial deepening through: (i) appropriate interest rate policies, including the maintenance of positive rates on deposits and preferential credits; (ii) reduction of non-preferential lending rates through macroeconomic stabilization; (iii) curtailment of preferential credit programs, with a view to abolishing them altogether; and (iv) policy-induced lowering of currency substitution and increasing the maturities of foreign currency deposits. 2J When FERIS rates were fixed, they were non-market based and involved a h avy subsidy element (see FERIS Study, FSAL I). Bank efforts under the IEDP and other Bank operations were aimed at making FERIS more market-oriented. At the time of the IEDP appraisal, the Bank expected the FERIS rates to be positive in light of the GOT's broader commitments under its macroeconomic program to bring down inflation, and under the FSAL's to liberalize interest rates and eliminate subsidized credit. When FERIS was converted to a market-based, floating rate facility in 1 989 (tied to T-bill rates), it was expected that the subsidy element would be eliminated. FERIS floating rates were based on the last three months' arithmetic average of auctioned three-month Treasury bills. 3/ Although O.D. 8.3 was issued only in 1990, prior to its formal issues, internal Bank instructions required all financial intermediation operations to be consistent with the recommendations of a Bank-wide Task Force on Financial Intermediation. Strong justification was required for exception. 14 1.8 At appraisal, the project stipulated loan effectiveness conditions including, inter alia, the introduction of floating FERIS rates (tied to the three-month Treasury bill rate) and the implementation of policy changes related to export finance and incentives. These policy changes concerned: (a) the availability of incentives to export-oriented investments (such as higher rediscount values for export finance papers); (b) the relaxation of eligibility criteria for access to preferential short-term export financing to accommodate new and smaller exporters; and (c) the establishment of an export credit insurance agency. During negotiations, the GOT expressed reluctance to the introduction of floating FERIS rates until market rates stabilized.4/ In order to allow the GOT more time to deliberate this issue, the Bank agreed to a compromise formula: the minutes of IEDP negotiations called for the GOT to consider a variable rate system within six months after Board approval. During negotiations, the GOT also proposed that other policy conditionalities related to export finance and incentives be dropped, since there was no Cabinet in place at that time and, therefore, formal confirmation of commitment on the policy issues could not be made. Given that it was expected that a new Cabinet was likely to continue policy measures to promote exports, and that the policy inputs would be incorporated in the GOT's FSAL II letter of development policies (expected to be forwarded to the Bank within six months following negotiations),5/ the Bank agreed to the GOT's proposal, and at the last minute, the draft loan documents were changed and sectoral policy matters were deleted. 1.9 The lack of long-term funds, combined with the high cost of finance, and the impact on investment activity were key Bank concerns during project preparation. To improve the credit delivery system's efficiency and consistent with the Bank's newer policy directions regarding financial intermediation loans, the Bank urged enhanced competition in the banking system through, inter alia, a leveling of the plaving field between development and commercial banks. Therefore, the Bank sought to include commercial banks as relending outlets under IEDP. The GOT agreed to this arrangement.'/ However, given the limited time for assessing the creditworthiness of potential PCBs, the desirability of maintaining closer policy coordination with the GOT, and the GOT's reticence to guarantee loans to private PCBs, the Bank sought to designate the CBT as the apex institution.7/ Following months ot preparation, the GOT declined the nomination of the CBT as the apex entity 4/ See: (a) the Agreed Minutes of Negotiations dated December 11, 1987; and (b) the December 18, 1 987 memorandum frorn the Director, Country Department 1, EMENA, to the Regional Vice President, EMENA. The Bank and GOT agreed to an arrangement calling for the consideration by GOT of a FERIS floating rate by June 30, 1 988. Based on actual experience, rates tended to move higher and fluctuate in subsequent years. 5 See the December 18, 1 987 memorandum from the Director, Country Department 1, to the Regional Vice President, EMENA. 6/ The feasibility of including commercial banks under the proposed Project was raised during the March 1 2, 1 987 Pre-Appraisal Review Meeting. The March 1 3, 1 987 memorandum entitled 'Proposed Industrial Export Development Project", documents this possibility. 7/ The Appraisal Mission of April 1 4-30, 1987 developed the concept of retailing the sub-loans via a 100 percent rediscounting facility made available by the CBT to the participating commercial banks. TSKB and SYKB were to serve as agents to review the subprojects for the CBT and make appropriate endorsements, a function for which the DBs would have been paid a 1 percent fee. 15 and instead suggested that the function be performed by Eximbank.5/ The GOT later withdrew this suggestion in view of the priority it attached to having Eximbank focus on short-term export finance and insurance. In the absence of GOT agreement to allow for direct Bank lending to PCBs, as a last resort (one month before negotiations) the Bank and the GOT agreed to an arrangement which called for TSKB and SYKB to act on behalf of the GOT`/ for the administration of the PCB credit component, despite the potential for conflict of interest inherent in such an arrangement. The funds, however, were to be channelled through Eximbank under a Subsidiary Loan Agreement SLA before being onlent to PCBs. 1.10 The IEDP t.a. component was defined in broad terms at an early stage of project preparation and evolved into a tentative program that needed more tightly-knit elements. The TORs for the March 1987 appraisal mission called for a special write-up and action program on IGEME. The appraisal mission aide-memoire listed action items to strengthen IGEME, but did not include the annex specified in the TORs, and discussed the general need for Eximbank t.a., but did not provide clearly for the specifications. A key item in IGEME's action agenda, calling for the reorganization of its Board and management to make it more commercial in orientation, was deferred during negotiations. Technical assistance for a study of the industrial credit delivery system was proposed, the TORs for which were to be defined during negotiations. This requirement was not fully satisfied until a much later stage. Project Design 1.11 Although IEDP's objectives were dual, focussed on support to industrial exports as well as on ensuring an appropriate policy and institutional framework for export finance, the project's design (both, in terms of funding and conditionality) ultimately emphasized primarily the immediate availability of medium/long-term credit for export-oriented investments in Turkey, and the diversification and restructuring of TSKB and SYKB. The project consisted of a credit component totalling US$298.5 million and a t.a. component of US$1.5 million. With respect to TSKB, the project design consisted of a financial restructuring of the bank whose financial position had been adversely affected by, inter alia, massive devaluations in the past, and whose survival was in jeopardy. The project also called for a Bank-approved diversification program for TSKB and SYKB and for these banks to meet the following eligibility criteria to participate in IEDP: (a) a maximum debt/equity ratio of 10:1; and (b) a minimum debt service cover ratio of 1.1:1. The diversification 8/ On September 8, 1 987, 5 months after appraisal and 2 months before negotiations, the Turkish Embassy in Washington, D.C. conveyed the views of the GOT that: (a) the new CBT Governor wanted to limit its role to traditional central banking functions of formulating and implementing monetary policies; and (b) the Eximbank be designated as the apex organization. See: (a) the September 1 6, 1 987 memorandum from the Chief, Industry, Trade and Finance Division, to the Director, Country Department I; and (b) the September 24, 1 987 memorandum from the Director, Country Department 1 to the Regional Vice President, EMENA. 9/ The Bank considered direct lending to selected PCBs as an option but the GOT was not prepared to provide a guarantee as this would serve as a precedent, with lendings to TSKB and SYKB as the only exceptions. The GOT also suggested reducing the loan package from US$300 million to US$200 million and eliminating the PCBs and reallocating US$100 million to TSKB and SYKB. At that point, the Bank decided to have TSKB and SYKB serve as the relending channels, an arrangement that the Bank's senior management viewed as "not a aood solution". See the October 5, 1 987 memorandum from the Director, Country Department 1 to the Regional Vice President, EMENA. 16 program of TSKB involved entry into working capital finance, money and capital market-type operations, lending to non-industrial subsectors, and leasing. SYKB's diversification plans were more modest, with leasing activities being limited to an indirect portfolio investment in a joint-venture leasing company. 1.12 As indicated above, the evolving and eventually divergent views that developed between the Bank and the GOT before Board presentation prompted compromise agreements which affected the project's ultimate design. The sectoral policy support provided by the project was significantly weakened. Deferring the adoption of a market-based FERIS to a later date resulted in below market pricing of subloans (negative rates of interest), clearly inconsistent with ongoing Bank/GOT efforts under the FSAL program and fiscal objectives. With respect to administration/ implementation aspects of the project's design, an expedient mechanism (AIs and Eximbank) was agreed in order to facilitate the inclusion of CBs under IEDP; this arrangement was also not entirely consistent with the GOT/Bank shared objectives to improve, in a sustainable manner, the efficiency of the credit delivery system, and enhance competition among Turkish banks. As the AIs in the IEDP, the role of TSKB and SYKB included the: (a) verification of the eligibility of PCBs; (b) reviewing PCB compliance with eligibility criteria of sub-projects; (c) provision of advice to the PCBs on the Bank's disbursement procedures and maintenance of the Bank's loan accounts; and (d) submission of implementation reports on the PCB subcomponent to the Bank. There was an inherent conflict of interest in the role of the AIs vis-a-vis the PCBs since: (i) all of the PFIs were retailers of funds; (ii) the AIs were supposed to review the eligibility of PCBs and their subprojects; and (iii) all of the PFIs had internal capability for opening L/Cs.10/ 1.13 The t.a. program had three basic elements. First, IEDP would support export promotion activities by carrying out an agenda to strengthen IGEME, its management structure and internal procedures. IGEME would utilize US$500,000 to: (a) provide advisory services to small- and medium-sized exporters; (b) train the staff so that they could service more effectively the export sector; and (c) upgrade its computer facilities to improve the quality of service to clients. Second, the Eximbank t.a. of US$900,000 would be aimed at the development of: (i) appropriate procedures for the extension of post-shipment export finance; and (ii) a trade and export credit information system. Third, US$100,000 of the IEDP t.a. funds were earmarked for a study of Turkey's industrial credit delivery system, given the GOT's macro and sectoral objectives and its broader policy dialogue with the Bank. Efficiency of the banking system was seen as key to meeting the financial requirements of private industry. Project Implementation Implementation Schedule 1.14 Changes in the project design and related conditionalities delayed loan negotiations, Board approval, signing and effectiveness by about three months. Nevertheless, soon after effectiveness subloan commitments built-up rapidly"/ owing in part to pent-up demand from the PFls, but 10/ The two supervision missions partly monitored the issue of conflict of interest and looked into the comments of PCBs, e.g., the desire for a direct PCB-Bank relationship and the sharing of L/C fees charged by the Als. 1 August 8, 1988 memorandum of the Task Manager, EM1 ID, to the Division Chief, EM1 ID. 17 apparently also to PFI efforts to accelerate commitment of IEDP funds before the expected market- oriented changes in the FERIS scheme were made. By about four months post-effectiveness, commitments had been so rapid that Bank staff expected the loans to close two years ahead of schedule. During the first supervision mission (about seven months after effectiveness) commitments stood at US$202 million or more than double appraisal expectations, and covered about 100 subprojects. By that time, a total of six major commercial banks had qualified as PCBs. Ongoing liberalization policies of the GOT were conducive to the development of a positive environment for the active participation of commercial banks as intermediaries in trade finance, funded significantly out of foreign currency deposits and related sources. Moreover, IEDP effectiveness occurred at a time when investment demand for the modernization and expansion of export industries was buoyant, partly due to the GOT's adjustment programs, but more directly influenced by the generous subsidies available to exporters under the GOT's investment incentive programs. 1.15 The second IEDP supervision mission (about one year after loan effectiveness), reported commitments of US$262 million or 88 percent of the total IEDP credit component. By then, eight PCBs were participating in the project (Akbank, Disbank, Ekonomi, Garanti, Iktisat, Is Bank, Vakifbank and Yapi Kredi), and the Bank began to prepare a second IEDP. However, the fast rate of IEDP commitments subsequently decelerated markedly as foreign exchange fluctuations impacted negatively on investment decisions, and certain financial sector reforms were introduced (including the shift to a market-based FERIS scheme, and the phase-out of specialized credit facilities of the Central Bank). These measures dampened what now appears to have been a somewhat artificially elevated level of investment demand. Despite the slowdown in demand for IEDP funds, commitments under the loan by then were already sufficiently high that the Bank funds were almost fully committed by the original commitment date (December 31, 1990), and the original loan closing date (June 30, 1993) was met. 1.16 The restructuring and diversification of TSKB were successfully launched, and substantial progress toward the transformation of this DB into a more viable financial intermediary was attained. When a deterioration in TSKB's financial position, caused by adverse portfolio developments occurred, shareholder banks infused a significant amount of subordinated capital. By loan closing, TSKB's debt/equity ratio stood at 5.7:1, the same level as at the commencement of IEDP and well within the maximum allowed under the project (10:1). At the same time, revenues from non- traditional sources, especially working capital loans, far exceeded appraisal estimates. SYKB also attained satisfactory progress in its restructuring program, although its diversification oves tended to be more conservative and modest. While the IEDP aims with respect to implementing restructuring and diversification programs for TSKB and SYKB were largely achieved, the real rates of return on equity of these banks remained negative, being -2.5 percent and -11.7 percent in 1992, respectively."2/ However, the extent to which these DBs have attained sustainable full viability, and to which the playing field between development and commercial banks has been levelled (and the credit delivery system improved as a result), remained uncertain. 12/ Achieving a real rate of return on equity was not a prescribed financial covenant under the IEDP. This covenant, together with others, were introduced in subsequent and follow-on projects in Turkey. 18 1.17 The IEDP SAR had anticipated that the GOT would take steps to strengthen Turkey's export promotion agency (IGEME), in management and procedures within a year from the IEDP Board approval. After loan effectiveness, however, the GOT encountered a legal procedural technicality in transferring borrowed t.a. funds to IGEME as a grant, an issue that the GOT eventually rectified through the budgetary process. (Prior to the conversion of IGEME to a more commercially-oriented agency, it was not expected to have the capacity to repay borrowed funds). Even then, the funds allocated for t.a. for IGEME could not be used as planned due to frequent management changes. Finally, it became evident that IGEME's computer needs could be met through the facilities of an affiliated GOT center. Consequently, only US$100,000 out of the original US$500,000 were retained to fund training and consulting services for information systems to improve IGEME's operations, and US$400,000 were reallocated to the IEDP's credit component for relending by banks. After the completion of limited consulting services, IGEME used US$370,000 of its own resources to purchase computer hardware for its information systems. However, at the time of IEDP closing, the computer system was still not functioning and the technology had already become somewhat outdated. Consequently, in May 1993, IGEME requested the Bank to reallocate back to it the t.a. funding for supportive equipment for hardware. Although the Bank indicated its willingness to consider this proposal, the GOT did not follow-up with the required formal request to the Bank to reallocate the loan proceeds and extend the loan closing date to support IGEME's request. 1.18 As with the IGEME experience, changes in management and reorganization, and the resulting difficulties in focussing on concrete t.a. specifications initially hampered implementation of the Eximbank's t.a. program. The GOT itself decided against the restructuring of Eximbank 20 months after the effectiveness of IEDP and notified the Bank accordingly. Managerial focus was also hindered by portfolio problems that the Eximbank inherited from its predecessor, the State Investment Bank, which had provided project financing for state enterprises. These internal problems detracted attention from the principal task of the promotion and financing of exports. Eximbank used its allocation of t.a. funds mainly for purchasing personal computers and training since its management perceived these items as important for raising its volume of operations. Despite the indicated complications, by IEDP closing, Eximbank was able to build a significant portfolio of export credits and export credit insurance, owing largely to GOT intensified support for export incentives during the period, and to Eximbank's access to bilateral sources of funds. 1.19 Completion of the credit delivery study, originally scheduled to occur about eight months following effectiveness, suffered considerable delays. First, the original TORs for the study were so broad that they tended to generate different interpretations from various quarters, and eventually had to be revised. Second, there was a problem of sponsorship of the study. Responsibility for the study initially shifted from one unit to another within the Treasury. Recognizing the significance of the subject to the entire financial system, lead responsibility for the study was finally assigned to the CBT. The study was completed in March 1990, 15 months behind schedule. By this time, the issues which it raised, while providing useful insights, were marginal to the implementation of IEDP and to preparatory work of subsequent projects. Moreover, expectations that its findings would support aspects of the GOT's broader financial sector reform program were dashed due to its delayed completion and with the GOT's eventual incomplete implementation of the FSAL program. Issues 1.20 With respect to the IEDP credit component, the initial rapid commitment of IEDP funds and the subsequent deceleration of commitments raises a number of issues. First, the rapid commitments 19 occurred at a time when FERIS rates were fixed at levels that were significantly negative in real terms, suggesting that pricing to both the PFIs and the sub-borrowers was below market, despite the fact that: (a) FSAL I supported reforms that included, among others, the maintenance of positive lending rates on selective credits; and (b) IEDP and subsequent agreements with the Bank reinforced this position generally, and with respect to FERIS, specifically. The fixed FERIS rate was increased from 32 percent in 1987 to 43 percent in 1988. Nonetheless, FERIS rates in real terms, based on the Wholesale Price Index (WPI), averaged -15 percent in 1988 (the year IEDP became effective), - 12 percent in 1989 and -6 percent in 1990 (following its conversion to a floating rate). The average FERIS rate rose from 42 percent in 1990 to 64 percent in 1991 and 72 percent in 1992, with only the latter two years yielding positive real interest rate levels of about 6 percent. By the time the GOT introduced market-based floating FERIS rates in 1989 as agreed under IEDP, more than 90 percent of IEDP funds had already been committed. 1.21 Second, the GOT's various subsidies and investment incentive programs also heavily influenced the application of IEDP funds across subsectors and activities. Twenty six percent of project costs financed under IEDP related to subprojects in capital-intensive tourism activities, and 25 percent related to textile activities. With cash grants representing 25 percent to 40 percent of equity capital or 13 percent to 20 percent of project costs based on an average debt/equity ratio of 1:1, investment decisions had to have been heavily skewed towards those activities benefitting most from such subsidies. Aside from questions which such a pattern raises with respect to efficiency in credit delivery and resource allocation, if IEDP was to support export-oriented activities in which Turkey had a natural comparative advantage, then the rationale for such extensive budgetary support comes into question. Third, as a result of the FERIS and other financial subsidies, it is estimated that total budgetary costs of supporting US$1.15 billion of new investments under IEDP amounted to about US$387 million, more than the total Bank loan. The IEDP financing plan specified no GOT contribution to project financing in part because the FERIS subsidy was expected to be eliminated under the project. Thus, at a time when high public deficits were already creating inflationary interest rate and currency pressures, financial subsidies extended to investments financed under IEDP exacerbated already difficult macroeconomic conditions. Fourth, to the extent that budgetary funds to support GOT commitments to investments financed under IEDP have been available, then the impact of these on the investments may be limited to those described above. However, GOT funds availability has been tenuous, and for some activities/subsectors, completion of investments has been difficult, giving rise to concerns over what the ex post results of the investments could be, and over potential ramifications for the portfolios of concerned banks. 1.22 With respect to the structure of the World Bank loan, some PCBs had expressed a preference for a more direct relationship with the Bank, and took issue with the centralization of disbursements through TSKB and SYKB out of concern for confidentiality and the potential for conflict of interest. Most PCBs indicated that central to the conflict-of-interest issue was the front-end fee of 3 percent charged by TSKB and SYKB on letters of credit opened for a service that some PCBs felt they were better equipped to perform as commercial banks. During project implementation, however, indications are that some PCBs appeared to have found the relationship with the AIs to have been constructive since it helped them to become familiar with Bank procedures. 1.23 A review of the creditworthiness of the PCBs and detailed determination of their eligibility to participate or continue to participate in IEDP was not the subject of supervision efforts, although all PCBs were required as part of IEDP financial covenants to submit to the Bank annual, unqualified, audited financial statements. Compliance by the PCBs with this covenant was weak and 20 a number of them were frequently late in submitting reports. Moreover, the audits of all of the PCBs were explicitly qualified for non-compliance with the International Accounting Standards (LAS) 29 which requires the adoption of inflation accounting. The GOT, however, has viewed the inflation condition spelled out in LAS 29 to be inapplicable to Turkey, despite cumulative inflation rates exceeding the LAS threshold of 100 percent for over three years. In addition, audit reports of some of the banks included other explicit qualifications relating, among others, to capital adequacy (Iktisat) and adequacy of provisions (Is Bank and Vakifbank). In other cases, anomalies appeared: the external auditors of Is Bank, for example, certified that the bank's financial condition was satisfactory, while heavily qualifying the audited statements for material items. Implicit qualifications were also contained in the notes to all of the PFIs financial statements. Such qualifications concerned, for example, questionable bookings such as increases in paid-up capital arising from the revaluation of assets. Despite the qualifications, the Bank did not declare any of the PFIs ineligible to continue to participate in IEDP. IEDP was formally supervised only twice, and both missions took place during the first year of implementation. Moreover, a significant share of these missions' efforts was devoted to the preparation and identification of a follow-on project. The implementation experience indicates that the limited amount of supervision of IEDP aside, Bank support to PCBs and their compliance with, e.g., reporting requirements, as well as dialogue/resolution of systemic issues (e.g., LAS, and audit quality) would have been more effective if formal PCB/Bank contractual relations existed. Otherwise seen, the progress made with respect to DB restructuring and diversification confirms the value of developing direct, ongoing relationships between the Bank and PFIs. 1.24 Finally, in contrast to the rapid rate of credit commitments, various issues impeded implementation and attainment of goals related to the technical assistance provisions of IEDP. While the IEDP t.a. component was aimed at supporting improvements in the policy and institutional framework related to export finance, the project included provision mainly for the development of information systems of Eximbank and IGEME. No formal measures to improve the menu of export finance and other related support mechanisms were called for. GOT and Bank attention to the preparation of this component appears to have been weak relative to the attention paid to preparing the credit and bank restructuring component. The lack of specifications for t.a. components prevented a focussed approach during implementation, and caused delays in t.a. output which diminished their utility. There was evidently a need for more deliberate and coordinated monitoring of the progress of t.a. programs to ensure that original objectives may be met. Project Results Objectives 1.25 IEDP successfully enhanced availability of medium/long-term credit for export-oriented investments in Turkey during the IEDP time period. The project also contributed positively to enhancing competition in the banking system and improvement in the credit delivery system through the: (a) restructuring/diversification of TSKB and SYKB; and (b) inclusion of PCBs in the project. Success in these areas, however, is dampened by the somewhat inconsistent design and implementation experience of IEDP related to the strengthening of the policy and institutional framework for industrial export finance. As a result, questions of sustainability of both, contributions of the IEDP investments financed and IEDP contributions to the longer-term enhancement of Turkey's capacity to develop export finance and industries to generate adequate and needed levels 21 of growth and foreign exchange, arise. Finally, the success of the t.a. components was even more modest, although their objectives remain as important as ever to the development of Turkish exports. Physical Results and Impact 1.26 At loan closing, total commitments under IEDP amounted to US$287 million, and covered a total of 112 projects (100 targeted). Based on questionnaires completed by the PCBs, it is estimated that ex post, incremental, annual export earnings would reach US$284 million (about 2 percent of total 1992 exports), with subprojects' incremental exports representing about 32 percent of average total production. The PFIs report that the project generated about 16,600 new jobs (20,000 targeted), while average total investment cost was about US$69,650 per job compared to US$30,000 estimated at appraisal. The lower than expected employment and higher than expected capital cost per job generated were due largely to investments in large capital intensive tourism projects, which were deemed eligible under IEDP on the basis that, like export-oriented investments, they are foreign exchange earning. Most of these additional costs were borne by the GOT, whereas the project's financing plan appears to have been based on initial expectations regarding elimination of the FERIS subsidy for projects financed under IEDP and eventually of other similar subsidies. Ex post, IEDP supported total investment costs estimated at US$1.15 billion or almost double the appraisal estimate of US$599 million. The subprojects' estimated ex ante ERR and IFRR averaged 36 percent and 35 percent, respectively."3/ However, indications of general portfolio issues faced by Turkish banks are that ex post returns could be significantly lower, especially for those sectors/activities where over-capacity developed (e.g., tourism) due to the extensive subsidies offered for such investments by the GOT, for which availability of funding is uncertain. Ex post debt/equity ratios were estimated by the PFIs to average 0.7:1 and debt service cover ratios at 3.6:1, within the prudent limits set under the project. In this regard, it must be borne in mind that to a large extent, equity was comprised of generous cash grants from the GOT, and own funds risked by entrepreneurs was limited. Nevertheless, an overall positive performance of the subprojects could be a likely outcome in light of the fact that existing and established firms were responsible for most (80 percent) of the investments and because of GOT actions to address the portfolio issues related to specific sectors/activities (e.g., treatment of tourism loans for purposes of loan loss provisioning). 1.27 The results of the t.a. component were also mixed and had little impact. Eximbank was able to build up a significant level of export credits and related product lines in support of exports. It also established a computerized trade information system. However, the export promotion role of IGEME evolved slowly and until now, remains weak. The credit delivery study produced useful insights regarding problems concerning investment credits and modalities for improving the existing allocation mechanism; however, its delayed completion diminished its value to the formulation of the follow-on project to IEDP and/or other subsequent GOT/Bank efforts. 3/ Since only about two years or so have elapsed after the completion of most of the subprojects, the PFIs have expressed reluctance and difficulty in updating the ex ante ERR and IFRR figures for the 112 subprojects. 22 Project Sustainability 1.28 As indicated above, it is likely that ex post, investments financed under IEDP will be found to have satisfied the rate of return requirements of IEDP, and will largely be viable operations due to: (a) the experience of the investors involved; (b) the special treatment accorded the main sectors financed in the provisioning regulations of banks; and (c) the assumed availability of GOT funds committed to these investments. More broadly, however, the financing of industrial export investments through an estimated 40 percent matching of investor/PFI/IEDP funds with GOT funds is clearly unsustainable from a budgetary perspective, and detracts from the achievement of IEDP's broader objective of strengthening the policy and institutional framework of industrial export finance. During IEDP, investors and PFIs continued to be exposed to macroeconomic imbalances, inflationary pressures, currency instability, and high interest rates. Without these factors in check, when FERIS rates eventually became market-based, demand for IEDP funds slowed. Under prolonged periods of uncertain macroeconomic conditions, the existence of GOT subsidies for investment becomes a disproportionately important factor in investment decisions. Thus, attaining sustainable investment and export levels in the longer-term required firm, unwavering commitment to addressing the macroeconomic and policy issues facing Turkey. Regrettably, during IEDP implementation the direction of macroeconomic management and sector policy in the context of which IEDP was prepared, began to shift. 1.29 Reflecting general economic conditions, the basic financial health of key institutions within the credit delivery system was under strain. Of the ten PFIs participating in IEDP, seven met the nominal eligibility criteria, leaving at least three of the institutions with identified structural weaknesses that threatened their future viability. Moreover, eight of the PFIs showed negative real rates of return on equity, indicating an erosion of capital accounts in real terms. Systemic anomalies, particularly in the form of disguised credit arrears and inadequate loan loss provisions, had been draining the financial strength and capacities of PFIs to intermediate. While the GOT had enacted prudential regulations on provisioning, PFIs could avoid loan loss provisioning through reschedulings and other arrangements. Moreover, accommodating rules established by the GOT, allowed for cases which otherwise involved loss of creditworthiness to be declared as performing accounts by a simple declaration by PFIs' internal auditors or Board of Directors. The GOT also allowed the applicability of provisioning only to the arrears component of medium/long-term loans, rather than to the entire outstanding principal. Adequate provisioning and loss of creditworthiness also were avoided in instances where special rules were issued for the treatment of entire subsectors/activities where overcapacity had developed and portfolio performance of PFIs was being affected. Finally, the progress made under IEDP in enhancing competition between development and commercial banks was significant in terms of the gains of the restructuring and diversification programs implemented by TSKB and SYKB. However, sustaining and deepening this progress depends not only on the macro environment and the continued efforts of the DBs to diversify, but also and of equal importance, on the GOT's capacity, inter alia, to: (a) rationalize the structure, level, and institutional framework for the delivery of its financial incentives for investment; and (b) further level the playing field in the policies and regulations governing financial institutions (e.g., tax deductibility of loan loss provisions). 23 Bank Performance 1.30 The credit component of IEDP was successfully committed within the timeframe planned. While the project's preparation preappraisal and appraisal processes generally reflected an awareness of the importance of conceptual linkages between sector and project specific elements, the project was prepared at a time when the extent to which such linkages could/should be addressed under Bank credit lines, was under intense debate within the Bank. Pressures emerging during negotiations and political uncertainty in Turkey induced Bank management to abandon important sector policy measures under IEDP in the hopes that GOT commitment would be strong enough to continue implementation of its financial sector reform program (FSALs) and maintain the appropriate policy framework required to underpin IEDP. At the project design level, by the time of IEDP, Bank experience had already demonstrated that use of apex institutions in credit operations involves, inter alia, conceptual inconsistencies with sectoral strategies. In this sense, Bank acceptance of the compromise Al arrangement for IEDP was inconsistent with the Bank's objectives in opening up IEDP to PCBs, and in credit delivery. Also, the vagueness of the eligibility criteria ("sound financial condition") and the fact that TSKB and SYKB were to confirm PCB compliance, inter alia: (a) distorted the roles of these banks and emphasized segmentation in the banking system; and (b) contributed to PCB concerns over conflict of interest. Finally, it should be noted that by the time of IEDP preparation, separate loan/guarantee agreements with individual PFls had already become common in credit operations, even in countries where government/Bank dialogue in the financial sector had not yet progressed as far as in Turkey. 1.31 IEDP implementation experience also indicates that preparation of the t.a. component should have been more focussed. Key parameters of t.a. programs were not anticipated at the outset, namely: the legal aspects of a t.a. grant; unclear needs and resources for computer facilities; inherent weaknesses of the Eximbank; and ambiguous TORs and lead role responsibility for the credit delivery system study. These shortcomings in the t.a. preparation increased the need for close Bank supervision of this component. However, the first supervision mission (seven months after effectiveness), also served as the preparatory mission for a second IEDP. The second supervision mission, launched five months after the first one, also focussed on the follow up IEDP project. Thereafter, no formal supervision of the IEDP took place. Throughout IEDP implementation, the overall status of the project was rated as "1", the highest rating possible under the Bank's internal reporting system. It appears that the project earned this rating largely on the basis of rapid commitment of funds, without adequate consideration to the extent to which the totality of project objectives were being met. This early judgment of success based on a narrow assessment of implementation experience prematurely shifted Bank attention from supervision to preparation of a new credit operation. Borrower Performance 1.32 The GOT made substantial progress towards the introduction of some, but not the entire, package of policy measures needed to promote exports (para. 1.8). In spite of policy commitments under the FSAL program and related operations, continued negative interest rates in general, and FERIS rates in particular, during three of the five years of project implementation, resulted in budgetary demands which otherwise could have been avoided. The cost of maintaining fixed FERIS and other similar subsidies could not be sustained over time (para. 1.28). Unfortunately, policy decisions may have been too sensitive to political changes at a time when commitment and 24 consistency were required to effectively deal with the PSBR problems, liberalize the financial sector, and sustain export-led growth. 1.33 Stronger GOT and institutional commitment was evident in activities relating to the restructuring of TSKB and SYKB. Both TSKB and SYKB were responsive to the project objectives related to their restructuring and diversification. In the case of TSKB, infusion of substantial quasi- equity helped avert the potentially serious erosion in the DB's real capital accounts. However, while quasi-equity of this sort improved the capital structure from the point of view of creditors, the interest burden constituted a drain at a time when consolidation of resources should have been maintained. The performance of the PCBs was mixed, at best. Excluding the qualification posed by the non- application of IAS 29, less than two-thirds of the PCBS nominally met the eligibility criteria under IEDP. 1.34 With respect to t.a., the GOT decision to forego the restructuring of Eximbank considerably weakened the effectiveness of the t.a. program in supporting enhancements to export finance. Its decision to reallocate funds away from IGEME left that institution to weaken even further while experiencing a series of ad hoc organizational and managerial changes over the period. Lessons and Recommendations 1.35 Many of the lessons learned from IEDP are common to financial intermediation experience more broadly. The main lessons of IEDP can be summarized as follows: (a) The impact of the macroeconomic environment on the financial sector and on financial intermediation must be recognized, and appropriate macro and sectoral policies must be pursued. Financial intermediation, in the context of weak sectors and an unstable economic environment, leads to distortions and inefficiencies in credit delivery, and places excessive demands on the budget. (b) Al and Apex experience prior to IEDP had indicated that while AIs are initially useful in familiarizing PCBs with Bank procedures, the structure can be problematic as it dilutes the effectiveness of supervision and the resolution of systemic issues. The arrangement also burdens the DBs which are themselves coping with serious institutional problems affecting credit delivery in the country. Moreover, it inherently presents a conflict of interest issue which is inconsistent with the context of reforms aimed at enhancing competition in the banking system. (c) The success of a project should not be judged so quickly, nor based just on commitments. More time should be given and other factors considered in order to best define follow-on activities, if any. (d) Technical Assistance should not be considered marginal in project design and implementation. If t.a. programs are to be included, they must be substantive, well- targeted and defined. They should enjoy the full support of government to bring about the desired results. (e) The legal framework underpinning all arrangements (PCBs and t.a.) must be clear and should support the continuity of dialogue and attention, both with beneficiary agencies 25 and between them and the Bank. The relative success of the TSKB/SYKB restructuring as compared with other components of the project exemplifies the benefits of clear contractual relationships. On the other hand, direct PCB/Bank relationships require that Bank supervision resources be supplemented to support more clients. (f) Substitutes for market mechanisms at various levels (exchange risk coverage, competition among banks, performance of PFIs, allocation of investment finance, etc.) may support short-term objectives, but undermine the attainment of broader, longer-term shared objectives of sound and sustainable economic management, growth and development. There must be clarity in Bank interventions. Either Bank support is for a discrete operation with short-term objectives, or Bank support should contribute positively over the longer term. Assuming the latter, then proper and solid commitment of government on a broader front needs to be assured, and the design of operations, such as IEDP, should be consistent within that framework. Given that changes in the Turkish Cabinet had created some uncertainty as to the GOT's continued broader commitment to its financial sector reform program (FSAL), Bank compromise and sensitivity to such factors may have been appropriate only with respect to those policy conditionalities which did not impact directly on IEDP design, implementation and sustainability. Although the earlier adoption of floating FERIS could have slowed commitments under IEDP, maintaining it as a condition of IEDP could have secured continuity in moving policies in the right direction despite uncertainty in political/economic management; it would have reduced the budgetary strain related to FERIS in IEDP implementation; and would have made IEDP's implementation more credible. Instead, the prolonged uncertainty of the GOT commitment in this area, combined with the uncertainty of Bank policies in transition resulted in inconsistencies between IEDP objectives and design, and the policy framework. Although FSAL II was eventually approved, it was not fully implemented, and the dialogue on the expected program of reform for industry and trade was also abandoned. At the same time, IEDP's follow-on project was prepared and approved, and its implementation continues to suffer from yet unresolved systemic issues which IEDP, combined with other Bank assistance of its period, aimed to address. Credibility of Bank assistance, at the project and policy levels, can be achieved only if both, Bank and Borrower, maintain commitment to shared objectives. (g) If tourism investments are to be considered eligible for financing under such credit operations on the basis of their foreign exchange earning character, the loan documents should then define eligible investments as "foreign exchange earning", or distinguish otherwise between "export-oriented" and "foreign exchange earning" activities. In addition, consideration should be given to whether or not sectoral concentration limits for certain sectors (such as tourism) which may be inherently more vulnerable to exogenous factors (i.e., impact of Gulf war on tourism), should be established. This would, inter alia, limit PFI exposure to special risks of such sectors. 27 PART II. PROJECT REVIEW FROM BORROWER'S PERSPECTIVE Views of the Undersecretariat of Treasury and Foreign Trade 2.1 The most essential characteristic of the Industrial Export Development Project Loan (IEDP) is that IEDP is the first World Bank facility permitting commercial banks (PCB) to be intermediates of Banks funds for medium-long term productive investment finance in Turkey.a/ Through this way, intermediary commercial banks had a chance to improve their capacity to extent medium-long term lending and project appraise skill. Nevertheless, the efficiency of the administrative mechanism is open to discussion. Due to administrative role of investment banks, both the World Bank and Treasury had limited coordination chance and ability to monitor and supervise activities of participating commercial banks with respect to their compliance with IEDP requirements and dialogue on general issues. In this respect, we are sharing the Bank's opinion that direct PCB/Bank contractual relationship would be more effective. Besides, the World Bank supervision remained limited during the life of project. There were only two IEDP supervision missions which took place within about one year from loan effectiveness. Small number of supervision missions caused inadequate follow up of particularly participating commercial banks by also creating difficulties for Treasury in monitoring their activities within the framework of the Project. 2.2 On the other hand, it is apparent that much more than expected project as of both number and amount were financed through the Loan. These achievements were mainly resulted from the negative rated Foreign Exchange Risk Insurance Scheme (FERIS) and good economic conjuncture in those years. In this respect, it is certain that FERIS made positive effects on the acceleration of the disbursement of funds. But high volatility of currency risk incurred by Bank's pooling system required such a insurance system for especially small-medium scale investors. 2.3 In the beginning of the FERIS Implementation, FERIS rate was determined by the Central Bank's rediscount rate applied to preferred investment. If the Central Bank rate was not selected as a reference rate, there was no chance to attract investors to use the Loan proceeds. Actually, as a consequence of elimination of Central Banks rediscount facilities, FERIS interest scheme passed to floating interest rate adjusted on a monthly basis according to last three month arithmetic average of auctioned interest rate of three-month Treasury Bill. Due to increase in the level of Treasury Bills' rate in recent years; during the last period of Loan disbursement, FERIS interest rate reached to quite high real level and caused to Loan proceeds much more expensive than all preferential credits. a/ Bank comment: In fact, the First Small and Medium Scale Industry Project (Ln. 2647-TU) marked the first time that a commercial bank (Halk Bank) was included in Bank-supported medium to long-term industrial lending in Turkey. IEDP, however, broadened this practice, allowing commercial banks more generally, access to Bank funds. 28 2.4 On the other hand, project failed at some degree to achieve the employment and cost per job targets. The main reason for this that lending dominated at capital intensive projects whose higher costs were partly financed under Government subsidy scheme. Lack of any incentive to finance small scale investment in the terms of Loan agreements may be counted as another reason on the failness to achieve cost per investment ratio. 2.5 However, satisfactory results were attained in terms of economic rate of return in the most of the financed sub-projects. 2.6 Also significant progress was made in re-structuring and diversifying the finances and operations of the participating banks. Particularly, the participating development banks were substantially rehabilitated and operationally restructured under the IEDP. 2.7 Furthermore, some problems have been observed on some subprojects particularly in tourism sector which suffered cash generating difficulties in turn lead to problems in the repayment of borrowed funds. Those problems mainly emerged due to extra ordinary external factors like negative effects of Gulf Crisis. For this reason, in order to be able to get rid of such kind of problem, specific constraints like upper financing limit on sector basis should be brought to the legal documents. 2.8 Unfortunately, Technical Assistance Component of Project did not proceed smoothly as it had been expected. Since the government redefined the roll of Eximbank in export policy. Eximbank has focused on mainly short-term export-finance and insurance. Thus, the scope of Eximbank's activities under the Project was becoming vague in the course of restructured role of Eximbank in export policy. 2.9 IGEME fell into situation of requesting cancellation of the most of their technical assistance portion due to managerial problems on that time. On the other hand, through the end of Project closing date, IGEME requested the extension of closing date for the purpose of using its remaining allocation for completing software and hardware needs of their information system which actually initiated under IEDP was refused by the World Bank without giving any reasonable justification.b/ 2.10 The comments of the implementing agencies on the Project Completion Report are follows: Views of Turkish Industrial Development Bank (TSKB) 2.11 The evaluations related to the activities of TSKB under the Project are founded to be very objective on general. 2.12 TSKB's views on the Project's design, implementation and development are given below: b/ Bank comment: The aide-memoire of the World Bank PICP/LEDP supervision mission of May/June, 1993, and subsequent communications to the GOT, requested GOT advice as to whether or not it wished to extend the loan closing date and reallocate funds to accommodate IGEME's request. The GOT confirmed instead only that the loan should close, and the balance be cancelled. 29 - The implementation of the Project had been taken place in years of 1986-1987; by the project the aim was set as the increasing of export oriented investment. - The transfer of the proceeds of the Loan to subusers and disbursements through them had been completed in a very short time. This quick disbursement indicates the success of the Project both from design and timely implementation part. 2.13 In conclusion, the Project, from the point of view of TSKB is a well-prepared, successfully implemented Project. Views of Turkish Industrial Investment and Credit Bank (SYKB) 2.14 In Article 3 of the PCR, the subsequent deceleration of commitments, among other factors, is attributed to the transforrnation of FERIS into a market based facility. However, according to our understanding this deceleration is not the result of application of market based FERIS rates.c/ We must point out that Loan 2901-TU was placed under FERIS on the basis of fixed interest scheme. The interest rate applied to the loans under 2901-TU were based on the rediscount rates applied by the Central Bank to fixed investment projects and inclusive of 3 percent spread it was 43 percent. Towards the end of 1989, Central Bank decided not to provide rediscount facility to new applications and starting February 13, 1990, the reference rate to be applied to loans eligible for fixed interest FERIS scheme was tied to the interest rate of Central Bank it charged to the advances. Only one case, in our experience fell into this category. In June when the Loan Agreement with this particular customer was signed the interest rate of Central Bank charged on advances was 54.5 percent. In our opinion, it is difficult to attribute deceleration of commitments to transformation of FERIS into a market based facility, which was not applied to Loan 2901-TU. 2.15 Loan 2901-2-TU was not the first case in involving the participation of commercial banks (PCBs) to use World Bank Loan through the intermediation of administrating institutions, and we think that it has been a successful implementations. SYKB has contributed to a great extend to PCBs in order to let them be familiar with IBRD procedures. Some of the commercial banks show interest to Loan 2901-TU, but a few years later, paradoxically the numbers of commercial banks which wanted to cooperate in Loan 3346-TU were fewer. 2.16 In Article 10(f), limit is suggested for sectors (such as tourism) which are more vulnerable to exogenous factors and it is pointed out that eligibility criteria should spell out the foreign exchange earnings. Tourism is eligible under Loan 2901-TU because it is considered as a foreign exchange generating activity by the Directorate of Incentive Implementation (TUB) and minimum amount of c/ Bank comment: The GOT's letter of May 31, 1994, referred to in Part II of this PCR, provides a clearer explanation of the determination of FERIS' rates which, in turn, served as the basis for lEDP pricing. In any case, IEDP rates during the Project's early stage were fixed at such low levels that they were negative in real terms, thereby inducing an extraordinarily inflated demand for IEDP funds. When IEDP pricing was later adjusted to reflect market-based rates, the demand for funds considerably slowed. 30 the foreign exchange to be earned is required under the Incentive Certificates of the companies engaged in tourism.d/ 2.17 It is known that, out of the total amount of US$100,000.00 allocated to commercial banks through the administration of SYKB and TSKB, balance of US$11,644,772 has been cancelled by IBRD out of the portion allocated to TSKB. We think that with a more proper communication between IBRD and SYKB new customers could be found and thus the eventual cancellation could be avoided partially or completely.o/ Views of Turkish Eximbank 2.18 As it was known, the objectives of the Industrial Export Development Project are the following: - Promotion of Turkish Industrial Export; - The establishment of institutional framework of industrial export financing. 2.19 The utilization of US$298.5 million out of US$300 million was envisaged for the investments oriented to exports. US $0.9 million out of 1.5 million was allocated Turkish Eximbank from the Technical Assistance Component of the Loan. 2.20 The objectives set by Turkish Eximbank under the Technical Assistance Component are determined: (i) to set up different programs for the purpose of promotion of exports; (ii) to establish a Management Information System for the financing of foreign trade. 2.21 As it may be recalled, the beginning of the implementation stage of the Project coincided with the establishment of the Turkish Eximbank. In this process, Turkish Eximbank on one hand was trying to adopt the programs of different countries with similar applications in export financing in order to meet the requirements of Turkish Export Sector; and on the other hand to conduct studies for the development of technological infrastructure to make aforementioned financing programs more effective. In conclusion, the studies of Turkish Eximbank carried on with the objective of export promotion for the development of a kind of export promotion system had been matched with the objectives of Industrial Export Development Project (Ln. 2901-TU). 2.22 In this period, Turkish Eximbank established System Development Department and completed the studies for an internal computer network and a system which are both considered to facilitate an d/ Bank comment: The reference to eligibility criteria in the PCR relates to investments deemed eligible by the IEDP loan documents, not the GOT incentive programs. e/ Bank comment: The reallocation of funds from TSKB to SYKB could not have been accomplished since TSKB requested and was granted a one year extension of the limit date for commitment of funds for subloans under its loan. Meanwhile, the SYKB commitment date had expired by the time it was recognized that TSKB would be unable to commit the balance of its allocation. 31 effective utilization of insurance, loan and guarantee programs; expedite the adaptation of probable changes that may arise in the said programs in the future. 2.23 Furthermore, Turkish Eximbank contacted 200 information companies located in 125 countries in order to increase the reliability of external buyer firms. For the purpose of receiving the necessary information about import and export firms, Turkish Eximbank set up the on-line system connection with the Undersecretariat of Treasury and Foreign Trade. 2.24 In addition to above, Turkish Eximbank had required the assistance of foreign consultants in its establishment process. As a result of this necessity, Turkish Eximbank approach a Dutch firm called NCM. For the purpose of augmenting the knowledge level of Turkish Eximbank staff in the export financing, various local and international training programs had been arranged. 2.25 The Technical Assistance component of World Bank Loan had been very helpful in the execution of above mentioned studies. 2.26 It can be concluded that Turkish Eximbank equipped with the tools of crediting of exports; external construction investments and services; providing the assistance for bringing insurance and guarantee operations with the international standards. The World Bank Loan provided assistance in the laying the foundation of Turkish Eximbank for the support of 30 percent of exports in a great extend. Views of Export Promotion Center 2.27 As it was known, Export Promotion Center is a public entity which had been founded with the law of dated October 27,1960 and numbered 118. Up to 1983, the Center continued its operations under the Ministry of Commerce. Afterwards the Center had been attached to the Undersecretariat of Treasury and Foreign Trade. 2.28 Although the World Bank, viewing IGEME's operations mainly forwarded to private sector, has appeared in a tendency in giving more weight to private sector participation in decision making process, private sector is being represented in executive board through Export Union and Chamber of Commerce (TOBB). 2.29 Under the new arrangements in the World Trade and GATT, the necessity of switching incentive system from subsidies to technical assistance requires strengthening of export promotion agencies/exporter firms and increasing of export promotion activities. The export promotion agencies, especial ly in Far East are continuing their operations under the financial aid of Governments. Moreover, there are Government subsidized agencies which are performing their functions independently. 2.30 IGEME's allocation totaling to US$500,000 in the beginning of the Project had been converted to Grant facility. However, in the face of the fact that dependence of increased amount of exports to the creation of additional capacity; bottlenecks in the provision of this additional capacity arising from the lack of investment inducements and the changes in Government and IGEM Management, the Grant facility of US$500,000 had bee reduced to US$100,000. As a result of said reasons, this amount could not have been utilized in consistent with Project objectives in the end. 32 At the same time, only half of the said amount had been spent for the training and consultant services within the framework of IGEME Trade Information System Project. 2.31 As it is stated in the Report, after the allocation of remaining US$400,000 to other parts of the Project, IGEME had spent US$370,000 for the purchase of hardware out of its own resources. On other hand, the application of IGEME for the reallocation of their remaining part of the Grant for the procurement of software had not been accepted by the Bank.f/ Views on the Project Implementation and Design as a Whole 2.32 In line with the objectives of the Project, IGEME's aim of strengthening of institutional structure through more effective private participation export promotion activities is very similar to that of many countries' export promotion agencies and it is generally observed that those agencies attain their aims; succeeded their activities. As a consequence of this, the World Bank's evaluation of IGEME's activities under the Industrial Export Development Project is very suitable from our side. 2.33 However, institutional building, bureaucracy, economic instability and frequent changes in governmental offices, like in other governmental organizations, place more negative impact than the internal ones. 2.34 In conclusion, there is no well-prepared Project component in conjunction with the Project objectives and a different aim was followed for the setting up of the Management Information System. Experience Gained Under the Project 2.35 In the process of Project Implementation the following facts and necessities were realized and determined: - We are of the opinion that the reallocation of US$400,000 of US$500,000 to other parts of the Project was not an appropriate decision for IGEME which suffers financial resource scarcity; - The basic problems are being faced mainly arise from the foundation law of IGEME dating back to 1960; - Taking into consideration other export promotion agencies' development levels and the role they are playing in export promotion, finding out of reasons weakening the institutional building of the Center is very important; - For the purpose of improvement of IGEME's organizational and administrative structure, sustainable and long-term solutions must be targeted rather than temporary ones; f/ Bank comment: See Bank Comment #2, page 19. 33 For the implementation of the Project, it is determined to be very important to employ a project implementation team. Views on IGEME's Performance in the Project 2.36 The performance of IGEME is expressed in the Report. However, the coordination among the Bank, the government and IGEME in following-up and supervision issues for the purpose of Project implementation was very weak. Supervision was taking place just on the financial issues, however, the views on the performance of implementing institutions and the Borrower were taken into account not in the Project implementation process but after implementation. The follow up of issues related to the Project implementation as well as the financial supervision would have been very helpful. In this conjunction, supervision and follow-up should be permanent and short term targets should be set; and coordination among relevant agencies should be bolstered. 2.37 In conclusion, in order to attain the Project objectives, it is very important to determine the problems, bottlenecks and obstacles encountered in Project implementation and to resolve them with long term measures. 35 PART III. STATISTICAL INFORMATION Related Loans and Credits Loans/Credits Purpose Date of Status/Comuments Approval Ln. 1754-TU, 1755-TU Assist financing of subprojects for dhe development, 09.04.79 Closed 12.31.85. Remaining Private Sector Textiles Project modernization, productivity improvement and export balances of US$1 .45 million capacity of the private textiles sector. cancelled. Ln 1952-TU Provide credit for development of labor intensive small 03.03.S1 Closed 06.30.86. US$0.46 Labor Intensive Industry Project and medium scale enterprises. million cancelled. Ln 2714-TU Improve the efficiency of the financial sector by 06.10.86 Closed 06.31.91. Fully Financial Sector developing a greater variety of financial instruments disbursed. Adjustment Loan I contributing to resurgence of private investment. Ln 2964-TU Support the development of a more efficient and deeper 06.21.88 Closed 12.31.92. US$100 Financial Sector financial sector that can mobilize and allocate funds more million cancelled. Adjustment Loan 11 effectively, thus generating higher investments and higher rates of return. Ln 2647-TU Provide credit for efficient small and medium scale 01.07.86 Closed 12.31.92. US$1.5 Small and Medium Scale enterprises. million cancelled. Industry Project 11 Ln 3067-TU Promote and support efficient SMI investment and 05.23.89 Closing date: 06.30.95. Small and Medium Scale operations; improve access by raising the number of Disbursements ahead of Industry Project 11 financial institutions that can function as efficient schedule. intermediaries for SMI finance and by providing credit at efficient market prices; improving SMI product quality and expanding their markets by providing technical and marketing assistance. Ln 3077-TU Provide funds through participating credit institutions to 06.15.89 Closing date: 12.31.95 Agroindustry Project U financially and economically viable private sector agroindustry projects for increasing agroindustry output. Ln 3346-TU Finance financially and economically viable private 06.13.91 Closing date: 12.31.96. Private Investment Credit Project investments, especially export-oriented activities; continue Disbursements being scheduled. assisting the private development banks in their business and resource diversification programs; support sustained implementation of the Government's banking reforms at the intermediary level. 36 Project Timetable Item Planned Date Revised Date Actual Date Preparation n.a. na. n.a. Appraisal Mission 05.01.87 04.06.87 04.10.87 Loan Negotiations 07.01.87 07.27.87 11.17.87 Board Approval 12.01.87 12.02.87 01.19.88 Loan Signing n.a. n.a. 01.25.88 Loan Effectiveness n.a. 04.30.88 04.15.88 Loan Closing 06.30.93 06.30.93 06.30.93 Loan Disbursements End June Actual Amount Profie Amount Ori*inal Amount Revised Amount Actual vs. Original Cumulative Cumulative Cumulative Cumulative (%) 1988 15.87 5.00 15.87 300 1989 152.37 30.00 106.00 152.37 144 1990 265.41 102.00 218.40 265.41 122 1991 285.62 210.00 279.60 285.62 102 1992 287.10 270.00 287.10 1993 287.49 288.00 1994 300.00 37 Project Implementation: Selected Indicators 1987 1988 1989 1990 1991 1992 TSKB Debt/equity ratio Appraisal estimate 6.1 5.7 5.9 7.1 8.2 9.9 Actual 5.7 5.9 5.9 6.1 5.6 5.7 Debt service cover ratio Appraisal over estimate 1.1 1.1 1.2 1.2 1.2 1.2 Actual Deducting refinancing' 1.0 1.2 1.4 1.5 I.5 1.6 Not deducting refinancing' n.a. n.s. n.a. n.a. n.a. n.a. SYKB' Debt/equity ratio Appraisal estimate 9.8 8.5 8.0 9.3 9.5 n.a. Actual n.a. n.a. 5.8 6.7 7.8 7.6 Debt service cover ratio Appraisal estimate 1.2 1.2 1.2 1.2 1.2 1.2 Actual n.a. n.a. 1.2 1.2 1.1 1.1 PCBs Comments on Audits Akbank Qualified for LAS 29; implicit qualifications Disbank Qualified for LAS 29; implicit qualifications Ekonomi Qualified for IAS 29; implicit qualifications Garanti Qualified for LAS 29; implicit qualifications Iktisat Qualified for IAS 29 and capital adequacy; imnplicit qualifications Is Bank Qualified for IAS 29 and adequacy of provisions; inmplicit qualifications Vakifbank Qualified for LAS 29 and adequacy of provisions; implicit qualifications Yapi Kredi Qualified for IAS 29; implicit qualifications * Under the IEDP covenants, both TSKB and SYKB are required to maintain a minimum debt service cover ratio of 1.1:1. Under a side agreement between the Bank and TSKB pursuant to another loan agreement, TSKB was allowed to deduct the refinancing of long-term debt from the computation of the DSCR. However, this anornaly was rectified during the negotiations on the Private Investment Credit Project which clarified that refinancing should not be deducted. This principle was clarified during the PICP Supervision Mission of May 1993. TSKB has yet to correct the computations on the DSCR. However, their auditors have been instructed to follow the clarification on this issue. ******* Of these banks, only Garanti, Yapi Kredi and Vakifbank either elected or were found eligible to participate in the IEDP follow-on project (PICP), in addition to TSKB, SYKB and several other private commercial banks. *+******* Implicit qualifications included the transfer of reappraisal surplus to paid-up capital and other questionable itenm in the notes to financial statements. 38 Project Costs and Financing (US$ million) A. Project Costs Item At Appraisal Revised Ex-Post Foreign Currency Goods & Services 298.5 298.9 n.a. Technical Assistance 1.5 1.1 n.a. Local Currency 298.5 298.5 n.a. Total 598.5 598.5 1,154 B. Proiect Financin Private Investors 248.5 577' Participating domestic banks 50.0 290 EBRD 300.0 287 Total 598.5 1,154 Of which an estimated amount of $173 million was in cash grants and an estimated amount of US$214 million in FERIS subsidy totalling US5387 million. The US$214 million estimated cost of FERIS subsidy was based on the average negative real rates for FERIS for 1988 and 1989 (-15 percent and -12 percent) and the weighted maturity for the IEDP subloans based on 3-year grace and 8-year maturity (i.e., 5.9 years). Project Results A. Direct Benefits Appraisal Estimate Actual Foreign exchange availability for export-oriented investment projects. Accomplished within the schedule envisioned at appraisal, with 40% of the loans disbursed within one year and 81 % within two years from effectiveness of the loans. Increased export-generating capacity (based on combined export capacity Annual increment in exports attributed to [EDP projects estimated at of subprojects). No estimated of total expected incremental exports. USS284 million. Creation of 20,000 new jobs with US$30,000 average cost per job. Creation of about 16,600 new jobs, with US$69,650 average cost per job. Adoption of appropriate policies and procedures for the enhanced No progress in this area reported in past supervision missions. However, availability of export finance and the operation of export guarantee and the Eximbank has been able to build up a significant level of export credits insurance programs. and related product lines in support of export. Operation of a trade information system. Computerized trade information system established at Eximbank. Strengthening of IGEME's role in the promotion of exports. Weak evolution in the export promotion role of IGEME. TSKB financial restructuring and operational diversification. Substantially accomplished. However, the earnings performance in real terms remains weak. SYKB operational diversification. Limited results: Money and capital market operations and other non- traditional activities contributed a modest portion of profits. Diversification into leasing limited to portfolio rather than direct operations. Profitability in real terms needed to be strengthened. 39 B. Indirect Benefits Appraisal Estimate Actual Assistance to the Government in maintaining the private investment. Achieved in the short-term. However, underlying issues relating to the negative real interest rate pricing of IEDP for 90 percent of the subloans and to the availability of cash grants seriously limited sustainability and effectiveness. Enhanced efficiency of the industrial finance. Competition was enhanced in the credit delivery system with the inclusion of commercial banks and the restructuring of the DBs, although some of the PCBs limited their relending activities to providing parallel bank credits in collaboration with either SYKB or TSKB. C. Economic and Financial Parameters of Suboroiects Appraisal Estimate Actual Economic rate of return in real terms: at least 15 percent. Average of 36 percent, estimated by PF[s. Internal financial rate of return in real terms: at least 15 percent. Average of 35 percent, estimated by PFIs. Maximum debt/equity ratio for subprojects: none specified. Expost average of 0.7:1. Minimum debt service ratio for subprojects: none specified. Expost average of 3.6:t. D. Studies Appraisal Estimate Actual Study on credit delivery system: Analysis of past financing patterns and Completed 15 months after target date. Problems encountered due to efficiency of finance. Assessment of private industry in the late 80s and unclear terms of reference for the various channels for industrial study and 90s. absence of identified lead role responsibility for study coordination and completion. 40 Status of Covenants Covensnt Subject Status TSKB and SYKB Ln. 2901-0-TU & 2901-1-TU (TSKB & SYKB, respectively) Ln. Agr. Sec. 4.02 Submission of audited financial statements and Compliance for both TSKB & SYKB. related reports. Ln. Agr. Sec. 4.05 Maximum debt/equity ratio of 10:1. Compliance for both TSKB & SYKB. Ln. Agr. Sec. 4.06 Maximum debt service cover ratio of 1.1:1. Compliance for both TSKB & SYKB. Minutes of Nov. 17-20, 1987 loan negotiations TSKB program for diversification, satisfactory Compliance. portfolio management and unqualified audit. SYKB program for diversification and resource Compliance. mobilization. Participating Commercial Banks: Satisfactory financial performance and All PCBs continued their eligibility status condition. despite substantive qualifications in the audits of at least 3 PCBs. Unqualified audit reports. The audits of all PCBa (and DBs) were qualified for non-application of LAS 29. At least 3 PCBs had materially qualified audits. Submission of audited reports tended to be late. Use of Bank Resources A. Staff Innuts (Staff Weeks) Task FY 1987 FY 1988 FY 1989 FY 1990 FY 1991 FY 1992 FY 1993 FY94 Total Up to preparation 4.8 4.4 9.2 Appraisal 14.2 19.1 33.3 Negotiation 5.1 5.1 Preparation through approval 35.9 35.9 Subtotal: 54.9 28.6 83.5 Supervision 5.5 27.4 7.2 2.6 2.0 4.2 48.9 Project Completion Report 8.0 4.0* 8.0 Subtotal: 5.5 27.4 7.2 2.6 2.0 12.2 56.9 TOTAL 54.9 34.1 27.4 7.2 2.6 2.0 12.2 140.4 * Estimated B. MisLn 41 Activity Date of Report/ Comments & Types Dates Covered of Problems No. of Days in Project Persons Fied Rating Preparation and Preappraisal n.a. n.a. n.a. n.a. Supervision Mission 01.31.88/ 4 11 n.a. a. Credit component ahead of schedule, with 11.28.-12.09.88 62 percent committed. 5 major PCB's enlisted. TSKB behind diversification schedule and more capital needed. SYKB, while in sound financial condition, calls for more equity to cope with provisions. Role of TSKB & SYKB as Ala running smoothly. FERIS rate of 45 percent substantially negative due to 80 percent inflation. b. The GOT requests for a second IEDP on an accelerated basis. c. CBT introduces new facility for export finance, but accessible mostly to large exporters. d. TA not yet started. Credit delivery system study delayed by need to create task force. IGEME faced with legal issue of receiving grant and need for charter amendment to be effective. Eximbank preoccupied with other priorities. Supervision Mission 05.16.89/ n.a. 11 1 a. Credit component 2 years ahead of schedule, with 04.9.-20.89 88 percent committed. 100 percent commitments expected 08.89. 8 major PCBs equity eligible. Progress in TSKB's diversification and quasi-equity infused. SYKB initiates modest capital market division. PCBs object to hefty 3 percent L/C charged by TSKB/SYKB as Als and express preference for direct Bank relationship. Questions raised on the costs and viability of FERIS. Pricing shifted to variable basis. b. Bank prepares Initial Executive Project Summary on second [EDP. c. Progress reported on CBT action on export finance, especially domestic L/Cs. d. Credit delivery study further delayed by vague TORs and absence of lead role. IGEME beset with several managerial changes; discovery that affiliated GOT center can meet computing requirements leads to reduction of TA from US$500,000 to US$100,000, basically for training and consulting services and reallocation of cancelled amount to the credit component. Eximbank still preoccupied with other priorities and distractions caused by portfolio and management issues, thereby unable to effectively function in assisting export promotion and financing. a:\iedp .pcr IAt IN G Report No: 146778 Type; PCr