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 DivisionCountry Department IEurope and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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ACRONYMS AND ABBREVIATIONS

Als Administrating InstitutionsCBs Commercial BanksCBT Central Bank of TurkeyDBs Development BanksERR Economic Rate of ReturnEximbank Export-Credit Bank of TurkeyFERIS Foreign Exchange Risk Insurance SchemePSAL Financial Sector Adjustment LoanGDP Gross Domestic ProductGOT Government of TurkeyIAS International Accounting StandardsIEDP Industrial Export Development ProjectIFRR Internal Financial Rate of ReturnIGEME Export Promotion Research CenterL/Cs Letters of CreditPCBs Participating Commercial BanksPCR Project Completion ReportPFIs Participating Financial InstitutionsPICP Private Investment Credit ProjectSAR Staff Appraisal ReportSLA Subsidiary Loan AgreementSYKB Sinai Yatirim ve Kredi Bankasit.a. Technical AssistanceTORs Terms of ReferenceTSKB Turkiye Sinai Kalkinma BankasiTU TurkeyWPI Wholesale Price Index

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D.C. 20433U.S.A.

Office of Director-GeneralOperations Evaluation

June 26;, 1995

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on Turkey - Industrial ExportDevelopment Project (Loans 2901-0-TU, 2901-1-TU and 2901-2-TUI

Attached is the Project Completion Report (PCR) for the Turkey Industrial ExportDevelopment project (Loans 2901-0-TU, 2901-1-TU and 2901-2-TU, approved FY89). prepared bythe 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& Theproject 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 exportsby providing credit to private, export-oriented projects in strategic industrial sectors withinternational comparative advantage; and (ii) to strengthen the policy and institutionai frameworkfor industrial and export finance and to simplify export finance procedures.

The project failed to deliver credit efficiently because: (a) contrary to tie loans' exp,icitintention, subloans took place at highly negative real interest rates, (b) many of thc participatingfinancial intermediaries had low creditworthiness and continue to show negative real rates of returnon equity, (c) continued macroeconomic instability provided an inhospitable environment forenterprise growth and loan repayment, and (d) technical assistance programs appeared to be poorlydesigned. The project, however, helped improve the effectiveness of some of the Financialintermediaries and financed 112 subprojects all of which had high ex ante rates of return. No expost rates are available.

Because of the above shortcomings, project outcome is rated as marginally unsatisfactoryand the institutional development impact is rated as modest. Because of the ongoing unstablemacroeconomic 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:inancialsector reforms as well as incentives for improved export performance succeed best in anenvironment of credible macroeconomic policies; and (u) it is difficult to accurately judge projecteffectiveness in an environment of direct and indirect subsidies.

The PCR is comprehensive in its coverage of the performance of the project and principalissues, and its overall quality is good, although it provides little information on actual pertormanceof 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 contentsmay 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 ContentsPage Nos.

Preface . ........................................................ 3Evaluation Summary ........................................................ 5

PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE ..... ........... 10

Project Identity ..................................................... 11Project Background . ................................................. 11Project Objectives and Description ........................................ 12Project Design and Organization ........................................ 13Project Implementation . ............................................... 17Project Results ...................................................... 20Project Sustainability .................................................. 22Bank Performance .................................................... 23Borrower Performance . ............................................... 23Lessons and Recommendations ......................................... 24

PART II. PROJECT REVIEW FROM BORROWER'S PERSPECTIVE .... ......... 27

Views of the Undersecretariat of Treasury and Foreign Trade .................. 27Views of Turkish Industrial Development Bank (TSKB) ....................... 28Views of Turkish Industrial Investment and Credit Bank (SYKB) ................ 29Views of Turkish Eximbank . ............................................. 30Views of Export Promotion Center ...................................... 31Views of Project Implementation and Design as a Whole ...................... 32Experience gained under the Project ...................................... 32Views on IGEME'S Performance in the Project ............................. 33

Part III. STATISTICAL INFORMATION ...................................... 35

Related Loans and Credits . ............................................. 35Project Timetable . ................................................... 36Loan Disbursements . ................................................. 36Project Implementation: Selected Indicators ............................... 37Project Costs and Financing (US$ million) ................................. 38Project Results ...................................................... 38Status of Covenants . ................................................. 40Use of Bank Resources . ............................................... 40

This document has a restricted distribution and may be used by recipients only in the performance of theiroff icial duties. Its contcnts may not otherwise bc disclosed without World Bank authorization.

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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), totallingUS$300 million equivalent, was approved on Dccember 19, 1988. The loans were extended to Lwodevelopment banic (DBs) - Turkiye Sinai Kalkinma Bankasi (TSKB) and Slnal Yatirim ve KrediBankasl (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 theCBs, on behalf of the GOT. The project closed on schedule on June 30, 1993, with disbursementsof 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 CountryOperations Division, Country Department I, Europe and Central Asia Region.

Preparation for the PCR began during the May 12-29, 1993 Supervision Mission for thePrivate Investment Credit Project (PICP, Loan 3346-TU), the follow-on project for the IEDP. ThisPCR was based, among others, on: the President's Report and Recommendations, and StaffAppraisail Report (SAR) of the IEDP and related projects (and/or their PCRs); Loan, Guarantee andSubsidiary Loan Agrcemcnts (SLA); Progrcss and Supervision Reports; Project Correspondence files;internal Bank memoranda and related papers; Financial Statements and Audit Reports ofparticipating linaincial institutions (PFIs); data supplilcd by the GOT and PFIP as part of the PCRpreparation process; nnd interviews with Turkith olTiicinls and batnkers, and Bnnk starf who dealt withthe project iat varitous Ntics.

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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. Theproject 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 commercialbanks (PCBs) which satisfied the eligibility criteria. TSKB and SYKB served as the AdministratingInstitutions (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 determinedunder the Foreign Exchange Risk Insurance Scheme (FERIS) administered by the Central Bank ofTurkey (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 numberof key modifications made that would color both the project implementation experience and thedevelopment impact of the project. Shortly before appraisal (and consistent with new directions inBank policies evolving at that time), the Bank suggested that, in addition to the DBs, commercialbanks be included as intermediaries of the Bank funds in support of improving the credit deliverysystem for long-term finance in Turkey. While the GOT agreed to broaden the channels for retailingBank 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 theseinstitutions would be inappropriate in an environment of financial sector liberalization and given theindependent 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 throughEximbank. As late as loan negotiations, two major concessions were made by the Bank which dilutedthe contribution of the project to the strengthening of the policy framewoiK for industrial and exportfinance: (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 assumptionthat 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, Boardapproval, signing and effectiveness of the loan. As a result, PFI pipelines of investment proposals

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built up awaiting loan effectiveness. Moreover, the investment demand for export modernization andexpansion was to some extent artificially high during the period of the loan, aided by extensive GOTsubsidies, grants, and other incentives (including FERIS rates, negative in real terms). In the financialsector, ongoing liberalization policies of the GOT were conducive to the development of a morepositive environment for the active involvement of PCBs as intermediaries in trade finance. Thecombined effect of these factors on the IEDP experience was that commitments in the earlier stageof the loan were very rapid, prompting the Bank to initiate preparation of a follow-on operation veryearly 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 foreignexchange fluctuations, but notably as a result of the transformation of FERIS into a market-basedfacility (at higher rates) and the introduction of other sector reforms such as the phase-out of GOT'spreferential credits. Nevertheless, the loan funds were almost fully committed by the originalcommitment date and the original loan closing date was met.

Issues

4. The IEDP implementation experience points to a number of issues: (a) the rapidcommitment of credits was heavily supported by negative real interest rates and subsidies; (b) therewere observed project design weaknesses affecting the credit delivery system; and (c) implementationof the t.a. programs tended to be fragmented and drawn out. During the period when more than 90percent 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 othersubsidized incentive programs of the GOT, including generous cash grants which enhanced theattractiveness of undertaking investment by substantially reducing own funds risked by entrepreneurs.The subsidies/ incentives also resulted in: (i) IEDP investments being heavily skewed towards thosesubsectors and activities benefitting most from budgetary support; and (ii) budgetary costs inimplementing 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 bedisproportionate to activities regarded as the traditional role of PCBs. The creditworthiness of someof the PFIs themselves had fundamental weaknesses. In addition, the financial condition of the PCBswas 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 thequalifications, none of the PFIs were declared ineligible to continue to participate in the IEDP duringproject implementation. Moreover, the supervision effort weighed heavily towards the preparationof the follow-on operation. There were only two IEDP supervision missions, both of which tookplace within about one year from loan effectiveness. This said, the quality of the supervision effortand relationship with the DBs appeared to have been strong. Bank support to PCBs, theircompliance with IEDP requirements, and dialogue/resolution of systemic issues (e.g., LAS) could havebeen more effective if direct PCB/Bank contractual relations existed.

6. Implementation of the technical assistance (t.a.) programs supported under IEDP was highlyproblematic, and their effectiveness in supporting policy and institutional goals was weak. An initialprocedural legal issue in passing on borrowed t.a. funds as a grant, frequent managerial changes anda discovery that its computer needs could be met by an affiliated government center impeded thestrengthening of Export Promotion Research Center (IGEME). Portfolio problems at Eximbankinherited from its predecessor and the GOT's midstream decision against Eximbank's restructuring

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adversely affected the bank's managerial focus and capacity to effectively promote and financeexports. Completion of a credit delivery system study supported by the project was considerablydelayed 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. UnderIEDP, 112 subprojects (100 projected) were financed involving a total investment of US$1.15 billioncompared with the appraisal estimate of US$599 million. Based on questionnaires completed by thePFIs, it is estimated that IEDP led to an increase in exports of about US$284 million per annum andcreated 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-expectedcosts resulted from the large share of capital intensive projects financed (e.g., tourism), whose highercosts were largely financed by GOT subsidies/incentives. The subprojects' estimated ex ante ERR andIFRR 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 lowerthan the ex ante estimates. In addition, significant progress was made in restructuring and diversifyingthe finances and operations of the participating development banks. The IEDP record ofaccomplishment 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 inherentin project design. For example, the fact that FERIS rates only became positive in 1991, after IEDPwas 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. Totalbudgetary costs to the GOT of the IEDP investments are estimated to have amounted to US$387million, of which about US$214 million is attributable to the FERIS subsidy. However, no GOTfinancing of IEDP investments was indicated in the SAR. Similarly, with respect to t.a., confusionand delays related to assigning lead responsibility for the credit delivery study, diluted the utility ofits findings to support the policy dialogue/framework.

Sustainability

8. Continued term financing for export-oriented enterprises could not be sustained underconditions prevailing during IEDP. IEDP's subborrowers and PFIs continued to be exposed tomacroeconomic imbalances, inflationary pressures, currency fluctuations, and high interest rates.Notwithstanding the ongoing implementation (begun in the early eighties) of a program of structuraland financial sector adjustment (supported by the Bank) the vicious cycle of high public sectorborrowing requirements of the GOT continued to crowd out the private sector from the creditmarket. Prolongation of the FERIS and other similar subsidies contributed to this and to maintaininginvestment finance demand at a somewhat artificially elevated level through nearly 40 percentmatching of investor/PFI/IEDP funds with GOT funds. Maintaining high investment levels throughsuch budgetary dependence is clearly unsustainable in the longer-term. In addition, largely as a resultof the uncertain macro and sectoral framework, eligibility criteria at the PFH level were beingbreached, both nominally and substantively. Many PFIs exhibited structural weaknesses whichthreatened their future viability. Nevertheless, the participating development banks were substantiallyrehabilitated and operationally restructured under the IEDP, and their chances of future viabilitywere 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 theirportfolios remains in question.

8

Performance

9. The credit component of the project was nearly fully committed well within the timeframedefined under the staff appraisal report. The apparent strong credit demand implied by the rapidcommitment of the IEDP funds prematurely prompted a quick and significant shift of focus of Banksupervision resources towards the preparation of a follow-on project. The high costs to the GOTsbudget of the IEDP investments argues against the wisdom of the Bank's agreement, duringnegotiations, 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 accordedto their preparation and implementation. GOT actions, such as withholding Eximbank restructuringmoves, and shifting responsibilities for the credit delivery study, also adversely affected the outcomeof the t.a. component.

Conclusions and Lessons Leamed

10. Overall, IEDP could be considered to have been reasonably well-implemented, although underconditions which made sustainability of its achievements questionable. Many of the lessons learnedfrom IEDP are common to financial intermediation experience more broadly. The main lessons ofIEDP can be summarized as follows:

(a) It is not possible to insulate the financial sector from the impact of macroeconomicelements, nor to support longer-term growth through short-term measures andbudgetary dependence. IEDP demonstrates that financial intermediation artificiallystimulated under such conditions is inefficient, distorted and unsustainable in thelonger term.

(b) Project design and implementation arrangements should be consistent with projectobjectives and with objectives in the institutional and policy framework. Using DBsas AIs can be initially useful in familiarizing PCBs with Bank procedures, but such astructure is often problematic as it dilutes the effectiveness of Bank supervision andresolution of systemic issues, as well as efforts to enhance competition in the bankingsystem, including the institution-building of DBs. Similarly, if t.a. programs are to beincluded, they must be well-targeted and defined, and should enjoy the full supportof the government to bring about the desired results. Technical assistance should notbe 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 timeshould be allowed to lapse in a project's implementation period, and other factorsconsidered in order to best define follow-on Bank-supported activities.

(d) The legal framework underpinning all arrangements (e.g., related to IBRD/PCBrelationship and t.a. subcomponents) must be clear and should support the continuityof dialogue and attention, both within beneficiary agencies and between them and theBank.

(e) Substitutes for market mechanisms at various levels (fixed FERIS subsidies, specialtreatment of loan losses, etc.) may support short-term objectives, but undermine the

9

attainment of broader, longer-term Bank/Borrower objectives of sound and sustainableeconomic 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 onlyif both, Bank and Borrower maintain commitment to shared objectives.

(f) If tourism investments are to be considered eligible for financing under such creditoperations on the basis of their foreign exchange earning character, the loandocuments should then define eligible investments as "foreign exchange earning", ordistinguish otherwise between "export-oriented" and "foreign exchange earning"activities. In addition, consideration should be given to whether or not establishingsectoral concentration limits for certain sectors (such as tourism) which may beinherently 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 ofsuch sectors.

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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 ProjectLoan Numbers 2901-0-TU, 2901-1-TU and 2901-2-TURVP Unit Europe and Central Asia RegionCountry TurkeySectors Finance and Industry

Project Background

1.1 For most of the decade of the 1980s, the expansion of Turkey's exports resulted principallythrough higher utilization of existing production capacity. However, by 1988, the constraints of highcapacity utilization were reached and it was felt that additional capacity would be required to supportcontinued export growth. Extremely high interest rates and the shortage of long-term funds forinvestment, greatly influenced by the large government deficits and inflationary conditions (despitethe 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 measuresto stimulate investment in new capacity, diversify its export base and enhance product quality. Thecountry's ability to sustain its future growth was greatly dependent on its capacity to service itsexternal debt with higher export levels.

1.2 Manufactured exports, which grew from 36 percent of total exports in 1980 to 71 percent in1986 and 83 percent in 1992, were the beneficiaries of a fundamental shift in trade policy towardexport-orientation. Increased participation in international markets made Turkey a leading exportearner among developing countries, while contributing to enhanced productivity in the manufacturingsector through scale economies and learning externalities, particularly for the private sector. Thepattern of export-led growth was prevalent across the entire manufacturing sector, as all subsectorsincreased their outward orientation. The main policy instruments were a significant depreciation ofthe real exchange rate until 1988, a dismantling of quantitative import restrictions, a lowering oftariffs 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 adecline 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 accountdeficit rose sharply.

Project Objectives and Description

Project Objectives

1.3 IEDP's main objectives were to: (a) support the country's expansion program for industrialexports; 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 financialrestructuring and operational diversification programs; (d) improve the credit delivery system forindustrial investment via the inclusion of commercial banks in the retailing of credit under the IEDPand the carrying out of a credit delivery study; (e) intensify export marketing and promotionalactivities by inducing greater private sector involvement in strengthening IGEME; and (f) establisha computerized trade and export credit information system at the Eximbank.

1.5 TSKB and SYKB borrowed and channeled two of the Bank loans amounting toUS$200 million to finance private export-oriented projects. The third loan of US$100 million to theGOT involved a credit component of US$98.5 million for relending through PCBs, with TSKB andSYKB 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 aportion allotted for a study on the credit delivery system in industrial finance. Participation criteriafor 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 financialcondition 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 selectingthe PCBs. While there were no pre-defined criteria for the selection process, the Bank expected todiscuss the selection basis with the GOT.'/ Each PCB had a maximum allocation of US$15 millionfor 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) exportat least 20 percent of incremental production within 3 to 5 years; (b) meet appraisal standards basedon Bank-approved guidelines; (c) demonstrate ex ante real economic rate of return (ERR) andinternal 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. Itwas agreed that the Treasury would assume responsibility for selecting the PCBs in accordance with agreedcriteria. The Bank expected to discuss with GOT the basis for the selection. The criteria required: (a) asound financial condition and performance; (b) unqualified audited financial statements; and (c) internalcapacity for project appraisal and supervision.

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guidelines. Subborrowers had the option of borrowing in foreign currency at the Bank's rate plus a4 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 loansby charging a spread between its lending rate and cost of funds. In so doing, FERIS providedinvestors access to foreign capital without the attendant foreign exchange risks, which hadrepresented a disincentive to investment. The FERIS rate was reviewed twice a year and adjustedas 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 ofgovernment borrowings (floating FERIS). As a result, FERIS rates were expected to become positivein real terms.

Project Design and Organization

Project Preparation

1.7 IEDP was prepared at a time when Bank policies regarding financial intermediation loanswere in transition to a more market-based, sectoral approach,3 / and in the context of the GOT'sfinancial 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 byenacting reform policies including: (a) the maintenance of real deposit rates and real lending rateson selective credits; (b) reductions in selective credits to decrease subsidies and improve creditallocation; 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 themobilization and allocation of funds and to foster financial deepening through: (i) appropriate interestrate policies, including the maintenance of positive rates on deposits and preferential credits;(ii) reduction of non-preferential lending rates through macroeconomic stabilization; (iii) curtailmentof preferential credit programs, with a view to abolishing them altogether; and (iv) policy-inducedlowering 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 FERISStudy, FSAL I). Bank efforts under the IEDP and other Bank operations were aimed at making FERIS moremarket-oriented. At the time of the IEDP appraisal, the Bank expected the FERIS rates to be positive in lightof the GOT's broader commitments under its macroeconomic program to bring down inflation, and underthe FSAL's to liberalize interest rates and eliminate subsidized credit. When FERIS was converted to amarket-based, floating rate facility in 1 989 (tied to T-bill rates), it was expected that the subsidy elementwould be eliminated. FERIS floating rates were based on the last three months' arithmetic average ofauctioned three-month Treasury bills.

3/ Although O.D. 8.3 was issued only in 1990, prior to its formal issues, internal Bank instructions requiredall financial intermediation operations to be consistent with the recommendations of a Bank-wide Task Forceon Financial Intermediation. Strong justification was required for exception.

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1.8 At appraisal, the project stipulated loan effectiveness conditions including, inter alia, theintroduction of floating FERIS rates (tied to the three-month Treasury bill rate) and theimplementation of policy changes related to export finance and incentives. These policy changesconcerned: (a) the availability of incentives to export-oriented investments (such as higher rediscountvalues for export finance papers); (b) the relaxation of eligibility criteria for access to preferentialshort-term export financing to accommodate new and smaller exporters; and (c) the establishmentof an export credit insurance agency. During negotiations, the GOT expressed reluctance to theintroduction of floating FERIS rates until market rates stabilized.4 / In order to allow the GOT moretime to deliberate this issue, the Bank agreed to a compromise formula: the minutes of IEDPnegotiations called for the GOT to consider a variable rate system within six months after Boardapproval. During negotiations, the GOT also proposed that other policy conditionalities related toexport 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 thatit was expected that a new Cabinet was likely to continue policy measures to promote exports, andthat 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 agreedto the GOT's proposal, and at the last minute, the draft loan documents were changed and sectoralpolicy matters were deleted.

1.9 The lack of long-term funds, combined with the high cost of finance, and the impact oninvestment activity were key Bank concerns during project preparation. To improve the creditdelivery system's efficiency and consistent with the Bank's newer policy directions regarding financialintermediation 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 Banksought to include commercial banks as relending outlets under IEDP. The GOT agreed to thisarrangement.'/ 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 toguarantee 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 987memorandum 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 rateby June 30, 1 988. Based on actual experience, rates tended to move higher and fluctuate in subsequentyears.

5 See the December 18, 1 987 memorandum from the Director, Country Department 1, to the Regional VicePresident, 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 ExportDevelopment Project", documents this possibility.

7/ The Appraisal Mission of April 1 4-30, 1987 developed the concept of retailing the sub-loans via a 100percent rediscounting facility made available by the CBT to the participating commercial banks. TSKB andSYKB 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.

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and instead suggested that the function be performed by Eximbank.5 / The GOT later withdrew thissuggestion in view of the priority it attached to having Eximbank focus on short-term export financeand insurance. In the absence of GOT agreement to allow for direct Bank lending to PCBs, as a lastresort (one month before negotiations) the Bank and the GOT agreed to an arrangement whichcalled for TSKB and SYKB to act on behalf of the GOT`/ for the administration of the PCB creditcomponent, 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 beforebeing onlent to PCBs.

1.10 The IEDP t.a. component was defined in broad terms at an early stage of project preparationand evolved into a tentative program that needed more tightly-knit elements. The TORs for theMarch 1987 appraisal mission called for a special write-up and action program on IGEME. Theappraisal mission aide-memoire listed action items to strengthen IGEME, but did not include theannex specified in the TORs, and discussed the general need for Eximbank t.a., but did not provideclearly for the specifications. A key item in IGEME's action agenda, calling for the reorganizationof its Board and management to make it more commercial in orientation, was deferred duringnegotiations. 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 satisfieduntil a much later stage.

Project Design

1.11 Although IEDP's objectives were dual, focussed on support to industrial exports as well ason 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 immediateavailability of medium/long-term credit for export-oriented investments in Turkey, and thediversification and restructuring of TSKB and SYKB. The project consisted of a credit componenttotalling US$298.5 million and a t.a. component of US$1.5 million. With respect to TSKB, theproject design consisted of a financial restructuring of the bank whose financial position had beenadversely 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 forthese banks to meet the following eligibility criteria to participate in IEDP: (a) a maximumdebt/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 Embassyin Washington, D.C. conveyed the views of the GOT that: (a) the new CBT Governor wanted to limit its roleto traditional central banking functions of formulating and implementing monetary policies; and (b) theEximbank be designated as the apex organization. See: (a) the September 1 6, 1 987 memorandum from theChief, Industry, Trade and Finance Division, to the Director, Country Department I; and (b) theSeptember 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 providea 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 eliminatingthe PCBs and reallocating US$100 million to TSKB and SYKB. At that point, the Bank decided to have TSKBand 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 tothe Regional Vice President, EMENA.

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program of TSKB involved entry into working capital finance, money and capital market-typeoperations, lending to non-industrial subsectors, and leasing. SYKB's diversification plans were moremodest, with leasing activities being limited to an indirect portfolio investment in a joint-ventureleasing company.

1.12 As indicated above, the evolving and eventually divergent views that developed between theBank and the GOT before Board presentation prompted compromise agreements which affected theproject's ultimate design. The sectoral policy support provided by the project was significantlyweakened. Deferring the adoption of a market-based FERIS to a later date resulted in below marketpricing of subloans (negative rates of interest), clearly inconsistent with ongoing Bank/GOT effortsunder the FSAL program and fiscal objectives. With respect to administration/ implementationaspects of the project's design, an expedient mechanism (AIs and Eximbank) was agreed in order tofacilitate the inclusion of CBs under IEDP; this arrangement was also not entirely consistent with theGOT/Bank shared objectives to improve, in a sustainable manner, the efficiency of the credit deliverysystem, and enhance competition among Turkish banks. As the AIs in the IEDP, the role of TSKBand SYKB included the: (a) verification of the eligibility of PCBs; (b) reviewing PCB compliancewith eligibility criteria of sub-projects; (c) provision of advice to the PCBs on the Bank's disbursementprocedures and maintenance of the Bank's loan accounts; and (d) submission of implementationreports on the PCB subcomponent to the Bank. There was an inherent conflict of interest in therole of the AIs vis-a-vis the PCBs since: (i) all of the PFIs were retailers of funds; (ii) the AIs weresupposed to review the eligibility of PCBs and their subprojects; and (iii) all of the PFIs had internalcapability for opening L/Cs.10/

1.13 The t.a. program had three basic elements. First, IEDP would support export promotionactivities by carrying out an agenda to strengthen IGEME, its management structure and internalprocedures. IGEME would utilize US$500,000 to: (a) provide advisory services to small- andmedium-sized exporters; (b) train the staff so that they could service more effectively the exportsector; 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 proceduresfor the extension of post-shipment export finance; and (ii) a trade and export credit informationsystem. Third, US$100,000 of the IEDP t.a. funds were earmarked for a study of Turkey's industrialcredit delivery system, given the GOT's macro and sectoral objectives and its broader policy dialoguewith the Bank. Efficiency of the banking system was seen as key to meeting the financialrequirements of private industry.

Project Implementation

Implementation Schedule

1.14 Changes in the project design and related conditionalities delayed loan negotiations, Boardapproval, signing and effectiveness by about three months. Nevertheless, soon after effectivenesssubloan 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 commentsof 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.

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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 ofschedule. During the first supervision mission (about seven months after effectiveness) commitmentsstood at US$202 million or more than double appraisal expectations, and covered about 100subprojects. By that time, a total of six major commercial banks had qualified as PCBs. Ongoingliberalization policies of the GOT were conducive to the development of a positive environment forthe active participation of commercial banks as intermediaries in trade finance, funded significantlyout of foreign currency deposits and related sources. Moreover, IEDP effectiveness occurred at atime 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 subsidiesavailable to exporters under the GOT's investment incentive programs.

1.15 The second IEDP supervision mission (about one year after loan effectiveness), reportedcommitments of US$262 million or 88 percent of the total IEDP credit component. By then, eightPCBs 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 rateof IEDP commitments subsequently decelerated markedly as foreign exchange fluctuations impactednegatively on investment decisions, and certain financial sector reforms were introduced (includingthe shift to a market-based FERIS scheme, and the phase-out of specialized credit facilities of theCentral Bank). These measures dampened what now appears to have been a somewhat artificiallyelevated 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 almostfully committed by the original commitment date (December 31, 1990), and the original loan closingdate (June 30, 1993) was met.

1.16 The restructuring and diversification of TSKB were successfully launched, and substantialprogress 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 developmentsoccurred, 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 wellwithin 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 alsoattained satisfactory progress in its restructuring program, although its diversification oves tended tobe more conservative and modest. While the IEDP aims with respect to implementing restructuringand diversification programs for TSKB and SYKB were largely achieved, the real rates of return onequity 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, andto which the playing field between development and commercial banks has been levelled (and thecredit 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. Thiscovenant, together with others, were introduced in subsequent and follow-on projects in Turkey.

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1.17 The IEDP SAR had anticipated that the GOT would take steps to strengthen Turkey's exportpromotion agency (IGEME), in management and procedures within a year from the IEDP Boardapproval. After loan effectiveness, however, the GOT encountered a legal procedural technicalityin transferring borrowed t.a. funds to IGEME as a grant, an issue that the GOT eventually rectifiedthrough the budgetary process. (Prior to the conversion of IGEME to a more commercially-orientedagency, it was not expected to have the capacity to repay borrowed funds). Even then, the fundsallocated 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 anaffiliated GOT center. Consequently, only US$100,000 out of the original US$500,000 were retainedto fund training and consulting services for information systems to improve IGEME's operations, andUS$400,000 were reallocated to the IEDP's credit component for relending by banks. After thecompletion of limited consulting services, IGEME used US$370,000 of its own resources to purchasecomputer hardware for its information systems. However, at the time of IEDP closing, the computersystem 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 forsupportive equipment for hardware. Although the Bank indicated its willingness to consider thisproposal, the GOT did not follow-up with the required formal request to the Bank to reallocate theloan 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 resultingdifficulties in focussing on concrete t.a. specifications initially hampered implementation of theEximbank's t.a. program. The GOT itself decided against the restructuring of Eximbank 20 monthsafter the effectiveness of IEDP and notified the Bank accordingly. Managerial focus was alsohindered by portfolio problems that the Eximbank inherited from its predecessor, the StateInvestment Bank, which had provided project financing for state enterprises. These internal problemsdetracted attention from the principal task of the promotion and financing of exports. Eximbankused its allocation of t.a. funds mainly for purchasing personal computers and training since itsmanagement perceived these items as important for raising its volume of operations. Despite theindicated complications, by IEDP closing, Eximbank was able to build a significant portfolio of exportcredits and export credit insurance, owing largely to GOT intensified support for export incentivesduring 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 monthsfollowing effectiveness, suffered considerable delays. First, the original TORs for the study were sobroad that they tended to generate different interpretations from various quarters, and eventually hadto be revised. Second, there was a problem of sponsorship of the study. Responsibility for the studyinitially shifted from one unit to another within the Treasury. Recognizing the significance of thesubject 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 whichit raised, while providing useful insights, were marginal to the implementation of IEDP and topreparatory work of subsequent projects. Moreover, expectations that its findings would supportaspects of the GOT's broader financial sector reform program were dashed due to its delayedcompletion 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 andthe subsequent deceleration of commitments raises a number of issues. First, the rapid commitments

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occurred at a time when FERIS rates were fixed at levels that were significantly negative in realterms, suggesting that pricing to both the PFIs and the sub-borrowers was below market, despite thefact that: (a) FSAL I supported reforms that included, among others, the maintenance of positivelending rates on selective credits; and (b) IEDP and subsequent agreements with the Bank reinforcedthis position generally, and with respect to FERIS, specifically. The fixed FERIS rate was increasedfrom 32 percent in 1987 to 43 percent in 1988. Nonetheless, FERIS rates in real terms, based onthe 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 averageFERIS rate rose from 42 percent in 1990 to 64 percent in 1991 and 72 percent in 1992, with only thelatter two years yielding positive real interest rate levels of about 6 percent. By the time the GOTintroduced market-based floating FERIS rates in 1989 as agreed under IEDP, more than 90 percentof IEDP funds had already been committed.

1.21 Second, the GOT's various subsidies and investment incentive programs also heavilyinfluenced the application of IEDP funds across subsectors and activities. Twenty six percent ofproject costs financed under IEDP related to subprojects in capital-intensive tourism activities, and25 percent related to textile activities. With cash grants representing 25 percent to 40 percent ofequity capital or 13 percent to 20 percent of project costs based on an average debt/equity ratio of1:1, investment decisions had to have been heavily skewed towards those activities benefitting mostfrom such subsidies. Aside from questions which such a pattern raises with respect to efficiency incredit delivery and resource allocation, if IEDP was to support export-oriented activities in whichTurkey had a natural comparative advantage, then the rationale for such extensive budgetary supportcomes into question. Third, as a result of the FERIS and other financial subsidies, it is estimated thattotal budgetary costs of supporting US$1.15 billion of new investments under IEDP amounted toabout US$387 million, more than the total Bank loan. The IEDP financing plan specified no GOTcontribution to project financing in part because the FERIS subsidy was expected to be eliminatedunder the project. Thus, at a time when high public deficits were already creating inflationary interestrate and currency pressures, financial subsidies extended to investments financed under IEDPexacerbated already difficult macroeconomic conditions. Fourth, to the extent that budgetary fundsto support GOT commitments to investments financed under IEDP have been available, then theimpact of these on the investments may be limited to those described above. However, GOT fundsavailability has been tenuous, and for some activities/subsectors, completion of investments has beendifficult, giving rise to concerns over what the ex post results of the investments could be, and overpotential ramifications for the portfolios of concerned banks.

1.22 With respect to the structure of the World Bank loan, some PCBs had expressed a preferencefor a more direct relationship with the Bank, and took issue with the centralization of disbursementsthrough 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 percentcharged by TSKB and SYKB on letters of credit opened for a service that some PCBs felt they werebetter 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 beenconstructive 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 eligibilityto participate or continue to participate in IEDP was not the subject of supervision efforts, althoughall 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

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a number of them were frequently late in submitting reports. Moreover, the audits of all of the PCBswere explicitly qualified for non-compliance with the International Accounting Standards (LAS) 29which requires the adoption of inflation accounting. The GOT, however, has viewed the inflationcondition spelled out in LAS 29 to be inapplicable to Turkey, despite cumulative inflation ratesexceeding the LAS threshold of 100 percent for over three years. In addition, audit reports of someof 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: theexternal 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 alsocontained in the notes to all of the PFIs financial statements. Such qualifications concerned, forexample, questionable bookings such as increases in paid-up capital arising from the revaluation ofassets. Despite the qualifications, the Bank did not declare any of the PFIs ineligible to continue toparticipate in IEDP. IEDP was formally supervised only twice, and both missions took place duringthe first year of implementation. Moreover, a significant share of these missions' efforts was devotedto the preparation and identification of a follow-on project. The implementation experience indicatesthat the limited amount of supervision of IEDP aside, Bank support to PCBs and their compliancewith, e.g., reporting requirements, as well as dialogue/resolution of systemic issues (e.g., LAS, andaudit 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 thevalue of developing direct, ongoing relationships between the Bank and PFIs.

1.24 Finally, in contrast to the rapid rate of credit commitments, various issues impededimplementation and attainment of goals related to the technical assistance provisions of IEDP. Whilethe IEDP t.a. component was aimed at supporting improvements in the policy and institutionalframework related to export finance, the project included provision mainly for the development ofinformation systems of Eximbank and IGEME. No formal measures to improve the menu of exportfinance and other related support mechanisms were called for. GOT and Bank attention to thepreparation of this component appears to have been weak relative to the attention paid to preparingthe credit and bank restructuring component. The lack of specifications for t.a. componentsprevented a focussed approach during implementation, and caused delays in t.a. output whichdiminished their utility. There was evidently a need for more deliberate and coordinated monitoringof 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-orientedinvestments in Turkey during the IEDP time period. The project also contributed positively toenhancing competition in the banking system and improvement in the credit delivery system throughthe: (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 andimplementation experience of IEDP related to the strengthening of the policy and institutionalframework for industrial export finance. As a result, questions of sustainability of both, contributionsof the IEDP investments financed and IEDP contributions to the longer-term enhancement ofTurkey's capacity to develop export finance and industries to generate adequate and needed levels

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of growth and foreign exchange, arise. Finally, the success of the t.a. components was even moremodest, 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 covereda total of 112 projects (100 targeted). Based on questionnaires completed by the PCBs, it isestimated that ex post, incremental, annual export earnings would reach US$284 million (about 2percent of total 1992 exports), with subprojects' incremental exports representing about 32 percentof 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 toUS$30,000 estimated at appraisal. The lower than expected employment and higher than expectedcapital cost per job generated were due largely to investments in large capital intensive tourismprojects, 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, whereasthe project's financing plan appears to have been based on initial expectations regarding eliminationof 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 theappraisal estimate of US$599 million. The subprojects' estimated ex ante ERR and IFRR averaged36 percent and 35 percent, respectively."3 / However, indications of general portfolio issues facedby Turkish banks are that ex post returns could be significantly lower, especially for thosesectors/activities where over-capacity developed (e.g., tourism) due to the extensive subsidies offeredfor such investments by the GOT, for which availability of funding is uncertain. Ex post debt/equityratios were estimated by the PFIs to average 0.7:1 and debt service cover ratios at 3.6:1, within theprudent 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 entrepreneurswas limited. Nevertheless, an overall positive performance of the subprojects could be a likelyoutcome 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 specificsectors/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 ableto build up a significant level of export credits and related product lines in support of exports. It alsoestablished a computerized trade information system. However, the export promotion role ofIGEME evolved slowly and until now, remains weak. The credit delivery study produced usefulinsights regarding problems concerning investment credits and modalities for improving the existingallocation mechanism; however, its delayed completion diminished its value to the formulation of thefollow-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 PFIshave expressed reluctance and difficulty in updating the ex ante ERR and IFRR figures for the 112subprojects.

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Project Sustainability

1.28 As indicated above, it is likely that ex post, investments financed under IEDP will be foundto have satisfied the rate of return requirements of IEDP, and will largely be viable operations dueto: (a) the experience of the investors involved; (b) the special treatment accorded the main sectorsfinanced in the provisioning regulations of banks; and (c) the assumed availability of GOT fundscommitted to these investments. More broadly, however, the financing of industrial exportinvestments through an estimated 40 percent matching of investor/PFI/IEDP funds with GOT fundsis clearly unsustainable from a budgetary perspective, and detracts from the achievement of IEDP'sbroader objective of strengthening the policy and institutional framework of industrial export finance.During IEDP, investors and PFIs continued to be exposed to macroeconomic imbalances, inflationarypressures, currency instability, and high interest rates. Without these factors in check, when FERISrates eventually became market-based, demand for IEDP funds slowed. Under prolonged periodsof uncertain macroeconomic conditions, the existence of GOT subsidies for investment becomes adisproportionately important factor in investment decisions. Thus, attaining sustainable investmentand export levels in the longer-term required firm, unwavering commitment to addressing themacroeconomic and policy issues facing Turkey. Regrettably, during IEDP implementation thedirection of macroeconomic management and sector policy in the context of which IEDP wasprepared, began to shift.

1.29 Reflecting general economic conditions, the basic financial health of key institutions withinthe credit delivery system was under strain. Of the ten PFIs participating in IEDP, seven met thenominal eligibility criteria, leaving at least three of the institutions with identified structuralweaknesses that threatened their future viability. Moreover, eight of the PFIs showed negative realrates 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 beendraining the financial strength and capacities of PFIs to intermediate. While the GOT had enactedprudential regulations on provisioning, PFIs could avoid loan loss provisioning through reschedulingsand other arrangements. Moreover, accommodating rules established by the GOT, allowed for caseswhich otherwise involved loss of creditworthiness to be declared as performing accounts by a simpledeclaration by PFIs' internal auditors or Board of Directors. The GOT also allowed the applicabilityof provisioning only to the arrears component of medium/long-term loans, rather than to the entireoutstanding principal. Adequate provisioning and loss of creditworthiness also were avoided ininstances where special rules were issued for the treatment of entire subsectors/activities whereovercapacity had developed and portfolio performance of PFIs was being affected. Finally, theprogress made under IEDP in enhancing competition between development and commercial bankswas significant in terms of the gains of the restructuring and diversification programs implementedby TSKB and SYKB. However, sustaining and deepening this progress depends not only on themacro environment and the continued efforts of the DBs to diversify, but also and of equalimportance, on the GOT's capacity, inter alia, to: (a) rationalize the structure, level, and institutionalframework for the delivery of its financial incentives for investment; and (b) further level the playingfield in the policies and regulations governing financial institutions (e.g., tax deductibility of loan lossprovisions).

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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 awarenessof the importance of conceptual linkages between sector and project specific elements, the projectwas prepared at a time when the extent to which such linkages could/should be addressed under Bankcredit lines, was under intense debate within the Bank. Pressures emerging during negotiations andpolitical uncertainty in Turkey induced Bank management to abandon important sector policymeasures under IEDP in the hopes that GOT commitment would be strong enough to continueimplementation of its financial sector reform program (FSALs) and maintain the appropriate policyframework required to underpin IEDP. At the project design level, by the time of IEDP, Bankexperience had already demonstrated that use of apex institutions in credit operations involves, interalia, conceptual inconsistencies with sectoral strategies. In this sense, Bank acceptance of thecompromise Al arrangement for IEDP was inconsistent with the Bank's objectives in opening upIEDP to PCBs, and in credit delivery. Also, the vagueness of the eligibility criteria ("sound financialcondition") 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 timeof IEDP preparation, separate loan/guarantee agreements with individual PFls had already becomecommon in credit operations, even in countries where government/Bank dialogue in the financialsector had not yet progressed as far as in Turkey.

1.31 IEDP implementation experience also indicates that preparation of the t.a. component shouldhave 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 creditdelivery system study. These shortcomings in the t.a. preparation increased the need for close Banksupervision of this component. However, the first supervision mission (seven months aftereffectiveness), also served as the preparatory mission for a second IEDP. The second supervisionmission, 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, theoverall status of the project was rated as "1", the highest rating possible under the Bank's internalreporting system. It appears that the project earned this rating largely on the basis of rapidcommitment of funds, without adequate consideration to the extent to which the totality of projectobjectives were being met. This early judgment of success based on a narrow assessment ofimplementation experience prematurely shifted Bank attention from supervision to preparation of anew 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 commitmentsunder the FSAL program and related operations, continued negative interest rates in general, andFERIS rates in particular, during three of the five years of project implementation, resulted inbudgetary demands which otherwise could have been avoided. The cost of maintaining fixed FERISand other similar subsidies could not be sustained over time (para. 1.28). Unfortunately, policydecisions may have been too sensitive to political changes at a time when commitment and

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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 therestructuring of TSKB and SYKB. Both TSKB and SYKB were responsive to the project objectivesrelated 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, whilequasi-equity of this sort improved the capital structure from the point of view of creditors, the interestburden 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 underIEDP.

1.34 With respect to t.a., the GOT decision to forego the restructuring of Eximbank considerablyweakened the effectiveness of the t.a. program in supporting enhancements to export finance. Itsdecision to reallocate funds away from IGEME left that institution to weaken even further whileexperiencing 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 experiencemore broadly. The main lessons of IEDP can be summarized as follows:

(a) The impact of the macroeconomic environment on the financial sector and on financialintermediation must be recognized, and appropriate macro and sectoral policies must bepursued. Financial intermediation, in the context of weak sectors and an unstableeconomic environment, leads to distortions and inefficiencies in credit delivery, and placesexcessive demands on the budget.

(b) Al and Apex experience prior to IEDP had indicated that while AIs are initially usefulin familiarizing PCBs with Bank procedures, the structure can be problematic as it dilutesthe effectiveness of supervision and the resolution of systemic issues. The arrangementalso burdens the DBs which are themselves coping with serious institutional problemsaffecting credit delivery in the country. Moreover, it inherently presents a conflict ofinterest issue which is inconsistent with the context of reforms aimed at enhancingcompetition 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-onactivities, if any.

(d) Technical Assistance should not be considered marginal in project design andimplementation. 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 aboutthe desired results.

(e) The legal framework underpinning all arrangements (PCBs and t.a.) must be clear andshould 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 restructuringas compared with other components of the project exemplifies the benefits of clearcontractual relationships. On the other hand, direct PCB/Bank relationships require thatBank supervision resources be supplemented to support more clients.

(f) Substitutes for market mechanisms at various levels (exchange risk coverage, competitionamong banks, performance of PFIs, allocation of investment finance, etc.) may supportshort-term objectives, but undermine the attainment of broader, longer-term sharedobjectives of sound and sustainable economic management, growth and development.There must be clarity in Bank interventions. Either Bank support is for a discreteoperation with short-term objectives, or Bank support should contribute positively overthe longer term. Assuming the latter, then proper and solid commitment of governmenton 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 Cabinethad created some uncertainty as to the GOT's continued broader commitment to itsfinancial sector reform program (FSAL), Bank compromise and sensitivity to such factorsmay have been appropriate only with respect to those policy conditionalities which didnot impact directly on IEDP design, implementation and sustainability. Although theearlier adoption of floating FERIS could have slowed commitments under IEDP,maintaining it as a condition of IEDP could have secured continuity in moving policiesin the right direction despite uncertainty in political/economic management; it would havereduced the budgetary strain related to FERIS in IEDP implementation; and would havemade IEDP's implementation more credible. Instead, the prolonged uncertainty of theGOT commitment in this area, combined with the uncertainty of Bank policies intransition resulted in inconsistencies between IEDP objectives and design, and the policyframework. 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 alsoabandoned. At the same time, IEDP's follow-on project was prepared and approved, andits implementation continues to suffer from yet unresolved systemic issues which IEDP,combined with other Bank assistance of its period, aimed to address. Credibility of Bankassistance, at the project and policy levels, can be achieved only if both, Bank andBorrower, maintain commitment to shared objectives.

(g) If tourism investments are to be considered eligible for financing under such creditoperations on the basis of their foreign exchange earning character, the loan documentsshould then define eligible investments as "foreign exchange earning", or distinguishotherwise between "export-oriented" and "foreign exchange earning" activities. Inaddition, consideration should be given to whether or not sectoral concentration limitsfor certain sectors (such as tourism) which may be inherently more vulnerable toexogenous factors (i.e., impact of Gulf war on tourism), should be established. Thiswould, inter alia, limit PFI exposure to special risks of such sectors.

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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 intermediatesof 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 termlending and project appraise skill. Nevertheless, the efficiency of the administrative mechanism isopen to discussion. Due to administrative role of investment banks, both the World Bank andTreasury had limited coordination chance and ability to monitor and supervise activities ofparticipating commercial banks with respect to their compliance with IEDP requirements anddialogue on general issues. In this respect, we are sharing the Bank's opinion that direct PCB/Bankcontractual relationship would be more effective. Besides, the World Bank supervision remainedlimited during the life of project. There were only two IEDP supervision missions which took placewithin about one year from loan effectiveness. Small number of supervision missions causedinadequate follow up of particularly participating commercial banks by also creating difficulties forTreasury 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 numberand amount were financed through the Loan. These achievements were mainly resulted from thenegative rated Foreign Exchange Risk Insurance Scheme (FERIS) and good economic conjuncturein those years. In this respect, it is certain that FERIS made positive effects on the acceleration ofthe disbursement of funds. But high volatility of currency risk incurred by Bank's pooling systemrequired 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 CentralBank's rediscount rate applied to preferred investment. If the Central Bank rate was not selectedas a reference rate, there was no chance to attract investors to use the Loan proceeds. Actually, asa consequence of elimination of Central Banks rediscount facilities, FERIS interest scheme passedto floating interest rate adjusted on a monthly basis according to last three month arithmetic averageof auctioned interest rate of three-month Treasury Bill. Due to increase in the level of TreasuryBills' rate in recent years; during the last period of Loan disbursement, FERIS interest rate reachedto quite high real level and caused to Loan proceeds much more expensive than all preferentialcredits.

a/ Bank comment: In fact, the First Small and Medium Scale Industry Project (Ln. 2647-TU) marked the firsttime that a commercial bank (Halk Bank) was included in Bank-supported medium to long-term industriallending in Turkey. IEDP, however, broadened this practice, allowing commercial banks more generally, accessto Bank funds.

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2.4 On the other hand, project failed at some degree to achieve the employment and cost per jobtargets. The main reason for this that lending dominated at capital intensive projects whose highercosts were partly financed under Government subsidy scheme. Lack of any incentive to finance smallscale investment in the terms of Loan agreements may be counted as another reason on the failnessto achieve cost per investment ratio.

2.5 However, satisfactory results were attained in terms of economic rate of return in the mostof the financed sub-projects.

2.6 Also significant progress was made in re-structuring and diversifying the finances andoperations of the participating banks. Particularly, the participating development banks weresubstantially rehabilitated and operationally restructured under the IEDP.

2.7 Furthermore, some problems have been observed on some subprojects particularly in tourismsector which suffered cash generating difficulties in turn lead to problems in the repayment ofborrowed funds. Those problems mainly emerged due to extra ordinary external factors like negativeeffects of Gulf Crisis. For this reason, in order to be able to get rid of such kind of problem, specificconstraints 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 hadbeen expected. Since the government redefined the roll of Eximbank in export policy. Eximbankhas focused on mainly short-term export-finance and insurance. Thus, the scope of Eximbank'sactivities under the Project was becoming vague in the course of restructured role of Eximbank inexport policy.

2.9 IGEME fell into situation of requesting cancellation of the most of their technical assistanceportion due to managerial problems on that time. On the other hand, through the end of Projectclosing date, IGEME requested the extension of closing date for the purpose of using its remainingallocation for completing software and hardware needs of their information system which actuallyinitiated 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 veryobjective 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 extendthe loan closing date and reallocate funds to accommodate IGEME's request. The GOT confirmed instead onlythat 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 theproject the aim was set as the increasing of export oriented investment.

- The transfer of the proceeds of the Loan to subusers and disbursements through themhad been completed in a very short time. This quick disbursement indicates the successof 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, successfullyimplemented 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 ourunderstanding this deceleration is not the result of application of market based FERIS rates.c/ Wemust 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 bythe 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 applicationsand starting February 13, 1990, the reference rate to be applied to loans eligible for fixed interestFERIS scheme was tied to the interest rate of Central Bank it charged to the advances. Only onecase, in our experience fell into this category. In June when the Loan Agreement with this particularcustomer was signed the interest rate of Central Bank charged on advances was 54.5 percent. In ouropinion, it is difficult to attribute deceleration of commitments to transformation of FERIS into amarket 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 wethink that it has been a successful implementations. SYKB has contributed to a great extend to PCBsin order to let them be familiar with IBRD procedures. Some of the commercial banks show interestto Loan 2901-TU, but a few years later, paradoxically the numbers of commercial banks which wantedto 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 toexogenous factors and it is pointed out that eligibility criteria should spell out the foreign exchangeearnings. Tourism is eligible under Loan 2901-TU because it is considered as a foreign exchangegenerating 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 clearerexplanation of the determination of FERIS' rates which, in turn, served as the basis for lEDP pricing. In anycase, IEDP rates during the Project's early stage were fixed at such low levels that they were negative in realterms, thereby inducing an extraordinarily inflated demand for IEDP funds. When IEDP pricing was lateradjusted to reflect market-based rates, the demand for funds considerably slowed.

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the foreign exchange to be earned is required under the Incentive Certificates of the companiesengaged in tourism.d/

2.17 It is known that, out of the total amount of US$100,000.00 allocated to commercial banksthrough the administration of SYKB and TSKB, balance of US$11,644,772 has been cancelled byIBRD out of the portion allocated to TSKB. We think that with a more proper communicationbetween IBRD and SYKB new customers could be found and thus the eventual cancellation couldbe avoided partially or completely.o/

Views of Turkish Eximbank

2.18 As it was known, the objectives of the Industrial Export Development Project are thefollowing:

- 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 investmentsoriented to exports. US $0.9 million out of 1.5 million was allocated Turkish Eximbank from theTechnical Assistance Component of the Loan.

2.20 The objectives set by Turkish Eximbank under the Technical Assistance Component aredetermined: (i) to set up different programs for the purpose of promotion of exports; (ii) to establisha 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 withthe establishment of the Turkish Eximbank. In this process, Turkish Eximbank on one hand wastrying to adopt the programs of different countries with similar applications in export financing inorder to meet the requirements of Turkish Export Sector; and on the other hand to conduct studiesfor the development of technological infrastructure to make aforementioned financing programs moreeffective. In conclusion, the studies of Turkish Eximbank carried on with the objective of exportpromotion for the development of a kind of export promotion system had been matched with theobjectives of Industrial Export Development Project (Ln. 2901-TU).

2.22 In this period, Turkish Eximbank established System Development Department and completedthe 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 theIEDP loan documents, not the GOT incentive programs.

e/ Bank comment: The reallocation of funds from TSKB to SYKB could not have been accomplished since TSKBrequested and was granted a one year extension of the limit date for commitment of funds for subloans underits loan. Meanwhile, the SYKB commitment date had expired by the time it was recognized that TSKB wouldbe unable to commit the balance of its allocation.

31

effective utilization of insurance, loan and guarantee programs; expedite the adaptation of probablechanges that may arise in the said programs in the future.

2.23 Furthermore, Turkish Eximbank contacted 200 information companies located in 125countries in order to increase the reliability of external buyer firms. For the purpose of receiving thenecessary information about import and export firms, Turkish Eximbank set up the on-line systemconnection with the Undersecretariat of Treasury and Foreign Trade.

2.24 In addition to above, Turkish Eximbank had required the assistance of foreign consultants inits establishment process. As a result of this necessity, Turkish Eximbank approach a Dutch firmcalled NCM. For the purpose of augmenting the knowledge level of Turkish Eximbank staff in theexport 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 theexecution 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 andguarantee operations with the international standards. The World Bank Loan provided assistancein the laying the foundation of Turkish Eximbank for the support of 30 percent of exports in a greatextend.

Views of Export Promotion Center

2.27 As it was known, Export Promotion Center is a public entity which had been founded withthe law of dated October 27,1960 and numbered 118. Up to 1983, the Center continued itsoperations under the Ministry of Commerce. Afterwards the Center had been attached to theUndersecretariat 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 makingprocess, private sector is being represented in executive board through Export Union and Chamberof Commerce (TOBB).

2.29 Under the new arrangements in the World Trade and GATT, the necessity of switchingincentive system from subsidies to technical assistance requires strengthening of export promotionagencies/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 functionsindependently.

2.30 IGEME's allocation totaling to US$500,000 in the beginning of the Project had beenconverted to Grant facility. However, in the face of the fact that dependence of increased amountof exports to the creation of additional capacity; bottlenecks in the provision of this additionalcapacity arising from the lack of investment inducements and the changes in Government and IGEMManagement, the Grant facility of US$500,000 had bee reduced to US$100,000. As a result of saidreasons, 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 consultantservices 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 ofthe 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 Grantfor 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 institutionalstructure through more effective private participation export promotion activities is very similar tothat of many countries' export promotion agencies and it is generally observed that those agenciesattain their aims; succeeded their activities. As a consequence of this, the World Bank's evaluationof 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 ingovernmental offices, like in other governmental organizations, place more negative impact than theinternal ones.

2.34 In conclusion, there is no well-prepared Project component in conjunction with the Projectobjectives and a different aim was followed for the setting up of the Management InformationSystem.

Experience Gained Under the Project

2.35 In the process of Project Implementation the following facts and necessities were realized anddetermined:

- We are of the opinion that the reallocation of US$400,000 of US$500,000 to other partsof the Project was not an appropriate decision for IGEME which suffers financialresource scarcity;

- The basic problems are being faced mainly arise from the foundation law of IGEMEdating back to 1960;

- Taking into consideration other export promotion agencies' development levels and therole they are playing in export promotion, finding out of reasons weakening theinstitutional 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 employa 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 amongthe Bank, the government and IGEME in following-up and supervision issues for the purpose ofProject 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 takeninto account not in the Project implementation process but after implementation. The follow up ofissues related to the Project implementation as well as the financial supervision would have been veryhelpful. In this conjunction, supervision and follow-up should be permanent and short term targetsshould 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 theproblems, bottlenecks and obstacles encountered in Project implementation and to resolve them withlong term measures.

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PART III. STATISTICAL INFORMATION

Related Loans and Credits

Loans/Credits Purpose Date of Status/ComumentsApproval

Ln. 1754-TU, 1755-TU Assist financing of subprojects for dhe development, 09.04.79 Closed 12.31.85. RemainingPrivate 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$0.46Labor 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. FullyFinancial 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$100Financial 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$1.5Small 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 ofIndustry Project 11 financial institutions that can function as efficient schedule.

intermediaries for SMI finance and by providing credit atefficient market prices; improving SMI product qualityand expanding their markets by providing technical andmarketing assistance.

Ln 3077-TU Provide funds through participating credit institutions to 06.15.89 Closing date: 12.31.95Agroindustry 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 businessand resource diversification programs; support sustainedimplementation of the Government's banking reforms atthe intermediary level.

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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. OriginalCumulative 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

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Project Implementation: Selected Indicators

1987 1988 1989 1990 1991 1992

TSKB

Debt/equity ratioAppraisal estimate 6.1 5.7 5.9 7.1 8.2 9.9Actual 5.7 5.9 5.9 6.1 5.6 5.7

Debt service cover ratioAppraisal over estimate 1.1 1.1 1.2 1.2 1.2 1.2Actual

Deducting refinancing' 1.0 1.2 1.4 1.5 I.5 1.6Not deducting refinancing' n.a. n.s. n.a. n.a. n.a. n.a.

SYKB'

Debt/equity ratioAppraisal 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 agreementbetween the Bank and TSKB pursuant to another loan agreement, TSKB was allowed to deduct the refinancing of long-term debt from the computation ofthe DSCR. However, this anornaly was rectified during the negotiations on the Private Investment Credit Project which clarified that refinancing should notbe 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 financialstatements.

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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% ofthe loans disbursed within one year and 81 % within two years fromeffectiveness of the loans.

Increased export-generating capacity (based on combined export capacity Annual increment in exports attributed to [EDP projects estimated atof 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 creditsinsurance 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 realterms 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 directoperations. Profitability in real terms needed to be strengthened.

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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 thenegative real interest rate pricing of IEDP for 90 percent of the subloansand to the availability of cash grants seriously limited sustainability andeffectiveness.

Enhanced efficiency of the industrial finance. Competition was enhanced in the credit delivery system with the inclusionof commercial banks and the restructuring of the DBs, although some ofthe PCBs limited their relending activities to providing parallel bankcredits 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 toefficiency of finance. Assessment of private industry in the late 80s and unclear terms of reference for the various channels for industrial study and90s. absence of identified lead role responsibility for study coordination and

completion.

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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 statuscondition. despite substantive qualifications in the audits of

at least 3 PCBs.

Unqualified audit reports. The audits of all PCBa (and DBs) were qualifiedfor non-application of LAS 29. At least 3 PCBshad materially qualified audits. Submission ofaudited 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

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Activity Date of Report/ Comments & TypesDates Covered of Problems

No. of Days in ProjectPersons 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, with11.28.-12.09.88 62 percent committed. 5 major PCB's enlisted.

TSKB behind diversification schedule and more capitalneeded. SYKB, while in sound financial condition,calls for more equity to cope with provisions. Role ofTSKB & SYKB as Ala running smoothly. FERIS rateof 45 percent substantially negative due to 80 percentinflation.

b. The GOT requests for a second IEDP on anaccelerated basis.

c. CBT introduces new facility for export finance, butaccessible mostly to large exporters.

d. TA not yet started. Credit delivery system studydelayed by need to create task force. IGEME facedwith legal issue of receiving grant and need for charteramendment to be effective. Eximbank preoccupiedwith other priorities.

Supervision Mission 05.16.89/ n.a. 11 1 a. Credit component 2 years ahead of schedule, with04.9.-20.89 88 percent committed. 100 percent commitments

expected 08.89. 8 major PCBs equity eligible.Progress in TSKB's diversification and quasi-equityinfused. SYKB initiates modest capital marketdivision. PCBs object to hefty 3 percent L/C chargedby TSKB/SYKB as Als and express preference fordirect Bank relationship. Questions raised on the costsand viability of FERIS. Pricing shifted to variablebasis.

b. Bank prepares Initial Executive Project Summaryon second [EDP.

c. Progress reported on CBT action on exportfinance, especially domestic L/Cs.

d. Credit delivery study further delayed by vagueTORs and absence of lead role. IGEME beset withseveral managerial changes; discovery that affiliatedGOT center can meet computing requirements leads toreduction of TA from US$500,000 to US$100,000,basically for training and consulting services andreallocation of cancelled amount to the creditcomponent. Eximbank still preoccupied with otherpriorities and distractions caused by portfolio andmanagement issues, thereby unable to effectivelyfunction in assisting export promotion and financing.

a:\iedp .pcr

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Report No: 146778Type; PCr