FILE COPY. Document of The World Bank FOR OFFICIAL USE ONLY. Public Disclosure Authorized. Report No. 2525b-TU. Public Disclosure Authorized TURKEY

Transcription

1 Document of The World Bank Public Disclosure Authorized FOR OFFICIAL USE ONLY FILE COPY Report No. 2525b-TU Public Disclosure Authorized TURKEY Public Disclosure Authorized STAFF APPRAISAL REPORT ON A PROPOSED PRIVATE SECTOR TEXTILE PROJECT Public Disclosure Authorized July 24, 1979 Industrial Development and Finance Division Projects Department Europe, Middle East and North Africa Regional Office This document has a restricted distribution and mav be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 TURKEY PRIVATE SECTOR TEXTILE PROJECT Exchange Rate between the Turkish Lira (TL)and US$ (Weighted Average) TL TL TL TL TL TL TL TL April - June TL June - TL ABBREVIATIONS DYB DPF KfW EIB LDR SPO SEE SMLI SYKB TSKB Devlet Yatirim Bankasi (State Investment Bank) Dyeing, Printing and Finishing Kreditanstalt fur Wiederaufbau European Investment Bank Less Developed Regions State Planning Organization State Economic Enterprises Small/Medium Scale Labor-Intensive Industries Sinai Yatirim ve Kredi Bankasi A.O. Turkiye Sinai Kalkinma Bankasi A.S.

3 FOR OFFICIAL USE ONLY TURKEY PRIVATE SECTOR TEXTILE PROJECT Table of Contents Page No. I. INTRODUCTION... I II. THE ENVIRONMENT A. The Industrial Sector B. The Financial Setting... 6 III. THE TEXTILE SECTOR... 8 A. Organization, Performance and Strategy... 8 B. Potential for Growth and Demand Projections Domestic Demand Exports C. Investment Requirements D. Issues and Problems Efficiency and Need for Modernization Technical Assistance Requirements E. Industrial Policy and Organizational Framework. 19 IV. THE PROJECT.. 21 A. Objectives and Justification..21 B. Design Financial Intermediaries..22 Equipment Component..24 Research and Training for the Financial Intermediaries..29 Technical Assistance. 30 Environmental Impact..33 C. Benefits and Risks.33 V. RECOMMENDATIONS AND AGREEMENTS REACHED This report is based on the findings of an appraisal mission which visited Turkey in October, 1978, and was composed of Messrs. Geoffrey Gowen, Abdul Haji, Jean-Francois Landeau, Cyril Halstead (consultant) and Jack Baranson (consultant). Mr. G. C. Maniatis headed the sector review/project identification mission and contributed to the report. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 Table of Contents (continued) ANNEXES Annex 1 Annex 2 Annex 3 Annex 4 Annex 5 Annex 6 Annex 7 Annex 8 Annex 9 Glossary of Technical Terms Projected Textile Demand Garment Export Expansion Basis for Investment Estimates Needs for Efficiency Improvement and Modernization SYKB: Review of Operations and Financial Outlook Summary of TSKB and SYKB Action Plans Training, Technical Assistance and Technology Project File MAP OF TURKEY

5 I. INTRODUCTION 1.01 Textiles 1/ is the single most important manufacturing industry in Turkey and its prospects appear bright. It will continue as one of the two or three major foreign exchange earners because of advantages which include local fiber resources (cotton), geographic proximity to European and Middle East markets, an experienced and energetic private sector (which operates about four-fifths of textile capacity), and significantly lower wage rates than Europe for skilled and unskilled labor The private sector textile industry must overcome a number of constraints in order to reach its full potential, however. In the course of rapid growth, some sub-sectors such as spinning have generated excess capacity while others such as garment/making-up are still undeveloped. Though equipment is generally modern reflecting the pace of recent expansion, some sub-sectors such as dyeing, printing, and finishing need modernization and replacement of obsolete equipment. Serving a protected domestic market to which nearly 95% of output is directed, textile firms have let efficiency remain well below European standards which undermines their comparative advantages in exports. Substantial improvement in both equipment and labor and material utilization is possible through technical assistance and training to upgrade skills, especially at management and supervisory levels, but practical local sources are not yet available and foreign sources are expensive. Expansion of exports is also dependent upon export incentives which must be closely monitored to ensure that they continue to offset the importsubstitution bias of Turkey's present industrial policy framework Since 1971 the textiles sector has been assisted by the Bank through DFC loans extended to DYB ($110 million) and to TSKB ($139 million) of which about 20% has been used for textiles. An additional $11.3 million has come from IFC. This is the first loan to approach textiles from a sectoral viewpoint, however, and is directed only to the private sector. A complementary Bank project (support to Sumerbank) now in final preparation will also seek to modernize the public sector's textile industry. The proposed project will help relieve the above mentioned constraints on efficient sector performance and improve the structural balance through 2 loans to two private sector financial intermediaries, TSKB (a long standing client of the Bank) and the Industrial Investment and Credit Bank (SYKB, an experienced intermediary to which a first Bank loan would be extended), providing $75 million for equipment and a US$5 million component for training and technical assistance to the sector, mostly to be administered by TSKB but including $0.1 million for SYKB training. 1/ The term "textiles" is used in this chapter and generally throughout this report to include making up into garments as well as spinning, weaving and finishing. Departures from this usage are indicated in the text. Annex 1 provides a glossary of frequently used textile terms.

6 The equipment component of the loans represents about 20% of the private sector's total foreign exchange needs for fixed investments during its three year commitment period. The pattern for its allocation has been derived from criteria of project selection which focus on improving sector balance; increasing production from existing facilities through improvement in productivity, modernization/integration and bottleneck removal; improvement of direct and indirect export capability; and increase of urban employment. Garments/making-up and dyeing/printing/finishing will receive relatively more emphasis than the other sectors: the former because it contributes to export and urban employment; the latter because of its relatively greater obsolescence which allows scope for significant modernization and bottleneck removal. Weaving will receive a large allocation because of its dominant size and shortage of capacity which constrains sector development as a whole In the light of findings that substantial increases in production and sector utilization could be achieved in Turkey simply by better technical and management practice, a main feature of the project is the component for technical assistance and training. The component will have two principal elements. One is a pilot program that seeks to establish an extension service in Turkey to identify and implement practical solutions to technical and production engineering-related problems and provide training. It will provide for 128 man-months of foreign expert assistance and the build-up of a trained cadre of Turkish experts over a five year period, and will directly benefit about 160 firms. The other element is a Technical Assistance Fund of US$3.3 million for which an estimated firms can borrow foreign exchange for technical assistance from abroad in production, management and marketing to complement the development of a local capability under the extension service. US$500,000 have been allocated for studies by, and technical assistance for, the intermediaries themselves Although trade barriers have hardened in recent years, total textile exports of $345 million by 1983 are possible--an increase of more than $100 million from present levels. The promotion of exports remains an important objective, not only for the foreign exchange to be earned, but for the upgrading in quality and efficiency of supplier industries as well as direct exporters, and for the expansion in urban employment resulting from the subsectors (garments/ knitting) with greatest export promise. The project requires that at least 30% of total sector investment and 80% of garment/ making-up/ knitting investment be directly export-oriented 0 It also recognizes the importance of having adequate quality inputs for use in exports by means of special foreign exchange allocations and the use of subproject criteria. The project includes provision for a dialogue on textile sector investment and export incentives In response to the growing Bank concern to raise the sensitivity of financial intermediaries to environmental problems, and to prevent Bank projects from contributing to environmental damage (important in textiles where certain types of effluent discharge can have highly detrimental impact), special conditions have been introduced into the proposed project that will

7 - 3 - require: (a) for new projects, that sub-borrowers comply with Bank guidelines, and (b) for modernization and expansion projects in the dyeing/ printing/finishing subsector, that they limit discharge to present levels and where necessary develop and carry out plans to deal with serious pollution problems. This is the first Bank project to require development banks and their sub-borrowers to take concrete steps to reduce environmental hazards and will provide operational experience on which to base policies in this area. II. THE ENVIRONMENT A. The Industrial Sector 2.01 Role in the Economy. The growth of manufacturing industries in Turkey has been rapid and relatively steady through the first three five-year plan periods ( ). Value added in manufacturing rose from about 15% of GDP in the early 1960s to about 18% currently, with an annual average growth rate of about 10%. The manufacturing sector absorbed some 30% of total fixed investment over the last decade up to 1975 but its share fell to 23% in 1978 largely as a result of its import-dependence and the growing scarcity of foreign exchange. With rising capital-output ratios, its share of total employment grew only slowly to reach 11% currently. During the past decade, the share of consumer goods in industrial output has declined to just under half, with that of intermediates steady and that of capital goods (but including consumer durables) rising from 12% to 16%, reflecting a gradual structural change The private sector has invested mainly in profitable consumer goods and durables, and only recently entered intermediate and capital goods production. It carried out 57% of industrial investment during the last decade and now accounts for about 50% of value added in manufacturing. However, as a result of the recent economic crisis, private manufacturing investment stagnated from 1974 to 1977 and fell 11% in real terms in The state has always been involved in basic industries where private capital has hesitated to enter because of long gestation periods, heavy capital requirements, or high risks. While the primary purpose of State Economic Enterprises (SEEs) is production, they have also been charged with social goals, such as the development of backward regions, provision of employment and maintenance of price stability, which have contributed to their generally poor financial performance. Low salaries, political pressures and otherwise limited autonomy, and featherbedding have affected the quality of their management and operating efficiency. Despite liberal legislation, foreign-owned enterprises contribute only 3% of total value added in manufacturing, as a result of a hitherto unwelcome political and bureaucratic climate Industrial Policy, Achievements and Problems. Industrialization has been viewed as instrumental for the achievement of high rates of economic growth, structural changes and greater self-sufficiency. In the pursuit of these objectives, industrial development policy has stressed import

8 substitution, the application of advanced technology and a shift of emphasis from consumer goods to intermediate and investment goods industries. The main instruments to support this policy have been large investment allocations with direct planning and control in the public sector, and the stimulation of private investment by generous incentives and high protection against imports. These past policies have produced some benefits. Private investment has been stimulated and public investment raised, with the result that the growth rates of industrial output and value added have been impressive. There has been considerable local production of basic commodities using newly introduced technologies and creating substantial labor skills. Dispersal of SEEs and incentives for private firms to invest in less-developed regions probably made a contribution to mitigating interregional disparities and slowing the pace of rural-urban migration, as have a widespread program of industrial estates and lending by TSKB There are, however, several problem areas. The immediate ones are low capacity utilization and the low level and rate of growth of manufactured exports. SEEs have been deliberately domestically-oriented. The private sector remained so because export incentives have not been sufficient to outweigh the advantages of effective industrial protection which, in a climate of growing domestic demand, made domestic sales more profitable than exports. As for longer term problems, although some industries are competitive, the domestic resource cost of other manufacturing or processing operations is high by international standards because of poor choices in investment allocations; small scale operations (often because too many producers were encouraged in the past); poor project implementation, under-utilization of installed equipment for lack of inputs, foreign exchange or incentive to increase shiftworking; compulsory use of lower quality domestic inputs, and absence of competition from imports. Other problem areas arise from Government policy and the design of incentives, which have over-encouraged capital-intensive activities and allowed a build up of the unemployment rate to over 13%. In recent years, the Government has also tried to start too many too large projects simultaneously, often without benefit of careful economic analysis Prospects. Turkey has a considerable natural resource base for further industrialization, a comparatively low-wage, skilled labor force, and a diversified, complex and interdependent industrial base, all of which are presently underutilized as well as a dynamic private sector responsive to market incentives. It also has an advantageous location near both Western and Eastern European and Middle Eastern markets. The immediate problems are to increase the currently low utilization of existing capacity and to achieve a rapid and sustained growth of manufactured exports (see following section). Over the longer term, substantial improvements in structure, efficiency and international competitiveness will be needed in many existing industries, and particularly in the SEEs, to enable them to use resources effectively and compete successfully at home, as well as provide some of the thrust for development of exports. The present variability of effective protection should be gradually reduced to mitigate distortion in resource allocation. More generally, efficiency would be spurred by a general move from reliance on quantitative restrictions to use of tariffs, accompanied by a gradual lowering

9 of the level of protection, in line with and as a stimulant to the build up of Turkey's competitive strength. Finally, a faster rate of job creation in manufacturing is needed, to prevent a further rise in the already high rate of unemployment. This could be achieved in part through shifts in project and technology choices, to better reflect the relative scarcities of capital and labor in Turkey, by changing the bias of present investment incentives so as to increase the relative cost of capital and intensify its utilization The Fourth Five-Year Plan ( ) provides for manufacturing production to grow by over 11% per annum, contributing a large share of GDP growth of over 8% per annum. Industry's share of GDP is to rise by 2% to 32% by Consumer goods are to grow by 8%, intermediates by 13%, and capital goods by 15% per annum; as a result, the share of investment goods (including consumer durables) is to reach 20% by This growth is to be based on total investments in manufacturing of TL 432 billion, 27% of the total in the economy. This will be an increase of 62% in constant prices over the actual figure in the Third Plan period. Private investment would grow relatively slowly, from TL 151 billion in the Third Plan period to TL 199 billion in the Fourth, with a significant decline in its share from 57% to 46%. Public investment is to be TL 233 billion, a doubling in real terms over Third Plan levels. The investment allocation is clearly along traditional lines with as much as 71% for large import substituting projects mainly for the production of intermediate goods. The Plan targets for manufacturing investment and output growth appear ambitious, in the light of the availability of both domestic and external financial resources Manufactured Exports. The share of manufactures in Turkey's merchandise exports increased from about 23% in the early 1960s to around 35% at present. The bulk of this gain, however, was achieved through a few industries: textiles, leather products and processed foods, which even today account for about 75% of all industrial exports. Nearly all exporting enterprises are in the private sector. Since 1973, domestic demand has continued to boom, the profitability of exporting has declined considerably due to rapid cost increases not offset by adjustments in the foreign exchange rate, and the world recession dampened demand abroad. As a result of these factors and the continuing import-substitution strategy, favoring sales to the highly protected and lucrative domestic market, exports accounted for only 7% of the gross output of the manufacturing sector in The Fourth Plan projects growth of manufactured exports from some $621 million in 1978 to $3.3 billion in 1983 at a rate of some 36% per annum in volume terms. The larger incremental contributions would come from textiles and clothing ($500 million) and food products ($358 million), with hides and leather and a variety of intermediate and even some capital goods exports growing rapidly. Preliminary Bank projections suggest that the share of unprocessed agricultural and mined products in total exports envisaged in the Plan, and that the overall export target, though ambitious is feasible, provided that the widespread commitment to export growth, evidenced most recently on June 11, 1979 by a devaluation of the TL from TL 26.5 to TL 47.1 = US$1 for most products, continues to be translated into appropriate policies.

10 - 6 - B. The Financial Setting 2.08 The Financial Sector. Roughly 50% of total private fixed investment in industry is financed by intermediaries, 40% out of internally generated funds, about 8% from bond issues, and the remaining 4% through direct foreign financing. Turkiye Sinai Kalkinma Bankasi (TSKB), a long term client of the Bank, provided just 6% of the total investment requirements of private manufacturers during Another major source of long term industrial credit is the well-established smaller Industrial Investment and Credit Bank (SYKB). These two banks are the proposed intermediaries for this loan 1/. The new and rapidly growing State Industry and Labor Investment Bank (DESIYAB) is designed to mobilize inter alia the savings of migrant workers for investment in widely-owned companies mainly in the less developed regions, and the Halk Bank is a Government-owned financial institution financing small-scale industry, small tradesmen, and artisans Since 1972, commercial banks have increased medium-term lending to the private sector, in response to new regulations and incentives whereby they were required to earmark 10% (and, since 1976, 20%) of their deposits for loans of 2-5 year maturities. The volume of longer term loans granted by commercial banks accounts for less than 1% of their total operations. Between 1975 and 1978, private short-term capital inflows of $2 billion through convertible lira accounts (CLAs) with Turkish commercial banks were converted into local currency and lent to local borrowers, mainly for investment purposes. However, with the ending of the exchange guarantee by the Central Bank in 1978, the assumption and rescheduling of CLAs debt by the Government now being finalized, and the need for strict control of new short-term debt, CLAs are unlikely to play any significant role in future The capital market is presently thin and stagnant since, with the high inflation prevailing in Turkey, the returns on financial investments do not match those on real estate and other investments. Share issues by private corporations t-o outsiders are very limited. The Investment Finance Corporation was established in 1976 by a group of banks, including TSKB, to participate in the equity of industrial firms located in the LDRso By the end of 1978, it had invested TL 353 million in a wide variety of subsectors, including TL 205 million as co-financing of projects financed by TSKB The bond market is dominated by Government and State Investment Bank (DYB) issues, which enjoy a captive market. Bond issues by private corporations are a relatively recent development, and TSKB has played an important role by guaranteeing and placing such issues. Government bonds yield 21% net of tax and are redeemable on demand. Private bond issues reached TL 2.0 billion in still a relatively small amount, and declining in real terms. They yield 25% gross of tax. 1/ For discussion of institutional and financial aspects of these two institutions see paras

11 The role of foreign private investments in Turkey's industrial development has always been limited and foreign direct investments reached only $40 million in The official policy is to accept them when they lead to transfer of new technology and provision of training, contribute to export earnings, and entail no monopoly or special privilege. In practice the policy has been restrictive due to political opposition and administrative delays. However, the Government has now prepared a new, more liberal code for foreign investment to assist in mobilizing external capital during the Fourth Plan period Interest Rates and Foreign Exchange Risk. In February 1978, the Government increased the legal ceiling on term loans to industry from 14% to 16% per annum and in May 1979 further to 20%. In addition, borrowers pay a 25% transactions tax on interest and some small front-end fees. 1/ The effective cost to borrowers (before taking account of interest subsidies for priority activities) from TSKB is now around 26%. SYKB has historically charged 2% more to cover requirements of its shareholder banks which provide it with large sums for relending. Because the inflation rate, as measured by the wholesale price index, increased from 16% to 24% in 1977 and 51% in 1978, the real cost to borrowers of short term local currency loans is substantially negative. Inflation is currently projected to remain at 40% in 1979 and to decline to 30% in 1980, and 10% by 1982 following the Government's stern stabilization measures. The situation, however, is different in the case of medium and long term local currency loans, as the real cost of term loans should be measured over their maturity when the rate of inflation is expected to decline. A typical 7-year loan made by TSKB or SYKB at the end of 1979 with a 2-year grace period would have a zero cost in real terms over its entire life, if the borrower paid nominal financial charges of about 19% per annum. As a result, the prevailing interest rates result in a real cost to borrowers of about 7% before interest subsidies Borrowers of foreign exchange bear the exchange risk on both principal and interest. The Government has stated to the IMF and the Bank its intention to maintain a realistic exchange rate through adjustments as needed. These are expected to reflect the difference between domestic and international inflation. Under these circumstances, the effective cost (gross of interest subsidies) of foreign currency loans of 26% with the full exchange risk is substantially positive in real terms. This is appropriate considering the current scarcity value of foreign capital to the Turkish economy, and entrepreneurs are willing to pay it. The rate is currently appropriate for on-lending of the proposed loan by TSKB and SYKB. However, its possible impact on the international competitiveness of Turkish firms will be reviewed annually by TSKB, beginning in connection with a study of export potential being conducted by TSKB under the direction of SPO. 2/ 1/ The cost of funds to borrowers from commercial banks was raised further before May 1979 because they charged a 2% per annum commission on collateral held, and informally requested compensatory deposits of 10-15% of the amount of the loan (worth another 2-3% per annum). 2/ For details, see TSKB XIII SAR, Project File No. A9, para

12 III. THE TEXTILE SECTOR A. Organization, Performance and Strategy Organization 3.01 Textiles is predominantly in private hands. In 1976, the organized textile sector 1/ (including clothing) accounted for 20% of total manufacturing investment, 16% of production and value added, 45% of exports, and 24% of employment. The public sector comprises 28 large scale enterprises under Sumerbank's control and accounts for 19% of the investment in the textile sector, 14% of production, 17% of value added, and 20% of employment. In 1977, there were some 1,400 textile establishments up from 950 in 1970, in the private organized sector employing close to 200,000 workers. In addition, there were an estimated 8,000 establishment in the unorganized sector 2/ employing another 100,000 persons. The table below shows the distribution of establishments and employment by size of firm (measured in terms of workers employed) in the organized sector. As can be seen, enterprises employing 200 or more workers, representing 13% TEXTILES AND CLOTHING DISTRIBUTION OF ESTABLISHMENTS AND EMPLOYMENT 1977 Size of Establishment Number of Number of Workers (No. of workers) Establishments Employed , , , ,157 Total 1, ,932 1/ Defined as establishments employing 10 or more workers. 2/ Establishments employing less than 10 workers. Most of these establishments employ up to 4 workers.

13 -9- of the firms in number, account for 73% of employment in the organized sector, reflecting the concentration of production in relatively large units. In the organized cotton sector, probably 155,000 are employed in spinning, weaving, and finishing, and about 25,000 in the garments/making-up and knitting segments. The wool sector employs around 20,000 workers. The nature and degree of integration varies widely. The number of large, fully integrated units which account for an estimated 20-25% of sector employment are increasing. In * the unorganized sector, garments and knitting account for roughly 60% of the employment in this sector. The balance is mostly small weavers with obsolete equipment. About one-half of the textile enterprises in the organized sector are located in the Istanbul area. Marmara, Aegean and the Mediterranean regions account for the bulk of the industry, including two-thirds of the public sector textile mills The garments/making-up segment of industry is undeveloped. Production takes place largely in households and in the unorganized sector by units mostly of less than 4 employees. Large firms in the garment industry are very few, employment does not exceed 5,000, and their contribution to value added is only 5%--compared with 40% in developed countries. However the organized sector has been fast growing--from only 25 registered establishments in 1963 to about 600 at the present time. Further rapid growth is expected. Garment making is largely concentrated in Istanbul with more than 80% of the organized sector firms including most of the largest ones. Ankara and Izmir account for perhaps an additional 12-14% and the small remaining balance is found mostly in Bursa and Adana. The Government's policy to decentralize development has succeeded in promoting new garment firms in the cities of less-industrialized areas but the available labor is not efficient. The potential for further decentralization is limited principally to standardized, relatively low fashion items in which rapid communication and transport access are less important or where the volume of production can justify services, such as fashion designing, production engineering, and marketing, on an "in-house" basis. Performance 3.03 Investment in the private organized sector, fuelled by generous incentives and growing domestic and export markets, rose from TL 240 million in 1965 to TL 2,646 million in 1974 in 1965 prices when it accounted for 42% of total manufacturing investment. It has since tapered off because of excess capacity in spinning and the adverse economic developments in the country. The capital intensity of the textile industry also rose dramatically during this period. The capital/labor ratio tripled between 1965 and 1975 to TL 67,600, which is above the average for the manufacturing sector as a whole (TL 65,900), reflecting the heavy investment in modern equipment, particularly in the spinning sector. Labor productivity more than tripled between 1965 and The sector was profitable in the early seventies, then slumped because of over capacity and declining export prices, reaching a low in 1976 when return on equity of TSKB's portfolio, which is representative of the industry was only 7.2%. Profitability has since improved--because of foreign exchange

14 constraints on expansion, leading to better capacity utilization in some subsectors (spinning) and even excess demand in others (weaving). 1/ 3.04 The volume of cotton sector output has been growing to meet domestic demand for cotton and blended fabrics at a steady 6% per year on average (8%- 10% in value) for the past decade. Knitting has been evolving at an even faster rate, estimated at around 15% per year. Although the consumption of wool has been relatively stagnant, the wool sector has been growing at 6-7% a year, using an increasing percentage of man-made fibers to meet the highly income elastic demand for worsted fabrics. The domestic market accounts for about 92% of the value of production. Fabrics woven in firms using cotton system equipment account for about two thirds of the textile fibers consumed; wool fabric production is about an additional 13% and knitting about 14%. The consumption of cotton fiber is nearly 65% of the total which is much higher than the 40% characteristic of Western Europe and U.S. This reflects not only traditional buying patterns in Turkey but also prices of man-made and wool fibers that are nearly double that of world-priced cotton because of import tariffs and protected local industry Until recently the bulk of the sector has been organized to serve the domestic market. Since 1970, however, the Government has induced a tenfold expansion of the value of exports valued at $266 million in From 1970 to 1976 cotton yarn exports almost quadrupled in volume reaching 78,000 tons, valued at nearly $160 million but have since declined slightly. Cotton fabrics earn a steady $20-25 million. Garments and made-up articles represent a fast growing share of exports rising from nearly zero in 1970 to 5,500 tons or US$60 million in 1977, which is 26% of the sector's export value. About 80% of textile sector exports go to the EEC where Turkey's share of imports ranges from 22% in spinning to about 1% for fabrics and garments. In 1973, developed countries bought 93.5% of Turkey's clothing exports. But such exports represented (in 1975) only 1.5% of total OECD imports of clothing, and in the U.S. and Scandinavia only %. Turkey's share of Middle Eastern textile markets is small because of competitive local industry and Turkey's concentration on EEC. The capability to export in a number of garment lines, has been hampered however by inadequate quality accessories and a limited range and supply of local fabrics of acceptable price and quality, administrative difficulties in importing foreign fabrics for re-export, and high prices for fabrics using non-cotton fibers. Since 1977, exports have stagnated due to the growing domestic demand, the uncertainty about export opportunities following the import restraints in foreign markets, and pricing problems. Nevertheless, there is potential for further expansion of exports within existing market constraints, which this project will seek to foster (paras ). Sector Strategy 3.06 The Plan document emphasizes the modernization, reorganization and specialization of production in the public sector, which is long 1/ Project File B.2 provides additional details on recent financial performance of textile firms in TSKB's portfolio.

15 overdue. The Bank's Sumerbank rehabilitation project (in preparation) meets these very same objectives. Except for hand-woven carpets and some ready-towear clothing, no new textile mills will be established in the public sector. Investment in spinning both in public as well as the private sector aiming at expanding further existing capacities will be discouraged, until the sector approaches full capacity utilization. On the other hand, investment in intermediate goods and auxiliary materials used as inputs in garments and knitting in short supply will be encouraged. The local production of textile equipment (mostly spare parts) will also be promoted. Finally, exports of finished goods, such as made-up articles, woven and knitted goods, carpets, will be supported. Though the quantitative targets are high (para 3.08, 3.12) the Plan's objectives are reasonable and point in the right direction The industry's major objective should be to meet growing domestic demand and most sector investment is required for this purpose. In addition, sector performance can be improved through (a) modernization in selected subsectors (especially dyeing, printing and finishing where there is substantial obsolete equipment) and through (b) increased efficiency of the productive facilities which can be furthered by the extension of technical assistance and training. Reduction of sectoral imbalances, most pronounced in spinning, will occur with market expansion but can be hastened through careful selection of projects directed to reducing redundant capacity including through forward integration. Exports should continue to be expanded to the extent that market constraints will allow, because of the foreign exchange earned, the tonic effect in communicating export standards of price and quality to the rest of industry, and because the most promising exporting sector (garments) will expand urban employment. Development banks can play an important role in identifying and fostering priority projects in all areas and in helping to deliver technical assistance. Government's role should be directed primarily at improvement of the industrial policy framework, particularly for exports, but it can also help to ensure that the necessary training, technical assistance, and export promotion facilities are available. B. Potential for Growth and Demand Projections Domestic Demand 3.08 Domestic demand for textiles (in physical volume) is projected to increase by about 21% between 1978 and 1983, or at an annual average rate of about 4%. Per capita fiber consumption will grow to about 9 kg from its present 8-1/2 kg. Growth rate in value of production would be on the order of 5-6%, reflecting product upgrading and improvement in quality. This is less than recently experienced and considerably short of the 9.5% rate in value forecast by the Fourth Five-Year Plan because of the present economic slow-down. Since import substitution is long since complete, and export expansion has market constraints, meeting domestic demand remains the most important opportunity for expansion of the textile industry. See Annex 2 for details of projected textile requirements.

16 While the need for traditional natural fibers is expected to continue declining in relative terms, the market share for fabrics produced by the cotton sector will only decline marginally (from 58% to about 54%), because of the increasing use of fabrics in which cotton is blended with synthetic fibers. Wool sector output share would increase because of the high income elasticity of worsted materials used in suiting which utilize a high percentage of man-made fibers. Fastest growing sectors will be the factory production of garments, from both knit and woven fabrics because, with rising wages and continued urbanization, the organized sector will continue to erode the enormous share of the clothing market now held by less efficient home and artisan production It is expected that virtually all the increase in demand will be met by expansion of the organized private sector to which this project is directed. Sumberbank, though it accounts for from 14-30% of capacity in individual sectors, is planning mostly to modernize during this project period, which will only lift its cotton sector fabric production to its full potential capacity of 250 million m2 by an increase of 50 million m2 over present levels, or only about 4% of present total cotton sector fabric production. The small expansion in Sumerbank garment capacity involving three proposed new plants, 1wll add to present industry output by about 7%. Exports Textiles (Excluding garments/making up) 3.11 Turkey has a comparative advantage in textiles, which is one of the major sectors with a domestic resource cost substantially lower than the foreign exchange earned or saved at the recent 1/ official exchange rate. It is based upon energetic entrepreneurship, geographical proximity to Western, Eastern European and Middle Eastern markets, the local availability of an important textile raw material--cotton, the fact that the industry is already established and reasonably modern, and lower wage levels. Turkish wage levels remain twenty to forty percent of those that prevail in the EEC countries, and even if allowance is made for lower productivity levels, there still remains a positive competitive element For purely cotton products which involve a lower level of technology and skills (particularly in dyeing and finishing) the most efficient mills would be able to compete without effective subsidy or protection. For the industry as a whole, there is longer term promise that it can expand exports economically even in articles using non-cotton fibers as exposure to foreign markets increases, as productivity and efficiency improves, and as technical skills to produce needed qualities are upgraded. Exporters will also need to have adequate access to non-cotton fibers for which improvement in the I/ The rate of 25.5 = $1.00 which prevailed from March '78 to April '79.

17 operation of the temporary import scheme is needed. But the expectations for textiles embodied in the Fourth Five-Year Plan that exports can be nearly tripled by 1983 are unrealistic because they merely extrapolate recent ( ) growth rates and fail to reflect the constraints imposed as a result of restrictions in the principal market areas, especially the EEC. 1/ 3.13 Although the EEC quotas are based on industry association agreement rather than official protocols, they are accepted by Turkish industry as binding, and quotas for individual countries are monitored closely. Both cotton yarns and finished cotton fabrics are included in the list of "highly sensitive" textile items and have quotas for 1978 of 76,000 and 3,600 tons, roughly freezing exports at 1976 levels. The quota regime is to extend for 5 years with a review after two years--i.e. in Quota growth rates have not been established but are estimated at less than 1% per year. It is possible after 1980, if economic conditions have improved or if the impact of the quotas discourage quota fulfillment, that the EEC will ease its restrictions, and countries of Southern Europe seeking EC status such as Turkey could particularly benefit. A slight easing has been assumed in our projections for yarn exports, as well as some upgrading of the product. Their value is therefore projected to grow from an estimated $160 million in 1978 to nearly $190 million in It is not assured that the Turkish spinning industry will fill the available quotas since spinning firms are finding it more profitable to integrate forward into weaving to produce for the growing domestic market. Forward integration of this type should be encouraged when it increases efficiency and improves sectoral balance (para 3.07). At the same time spinners which have excess capacity should be encouraged to make the necessary effort, including improvements in quality and product standardization, to export. With regard to fabrics where Turkey is only a marginal supplier with less than 1% of cotton fabric imports, growth at a higher rate (6% in volume) than yarns is projected, involving upgrading of product lines which would raise the estimated 1978 level of exports of $26 million to nearly $40 million in Garments and Other Made-Up Articles 3.15 By contrast with textiles, there have been only modest changes in production technology for clothing. Labor productivity in developed countries grew only at 0.9%/year from less than in any other major group of industries. Turkey's lower wages, therefore, give it a clearer advantage over developed country industries than in textiles (provided also that productivity approaches European levels) except where frequent fashion and style changes require small units in immediate proximity to markets. Its overland accessibility to Europe allows transit times of two to three days at 1/ Turkey expects that, by virtue of its being an associate member of the EEC, it will be partly or totally exempted from market restraints in the EEC.

18 only 5-10% of total products costs--an important advantage with respect to many clothing exporting countries with far lower wages. Though exports of garments are still only about 5% of total production and knowledge about export requirements is generally sketchy, a nucleus of exporters has recently developed in response to Government export incentives and has established links to European marketing channels. Organized into a Government-sanctioned exporter's Union which is supported by a small tax on garment exports, the industry has a potentially effective institution to take actions needed to upgrade and expand exports such as: promotion of quality control, intensification of education and training and the monitoring of export quotas. Significant additional export expansion would be facilitated by greater availability and wider selection of fabrics (especially linings) and accessory inputs (zips, buttons, sewing thread, etc.) of satisfactory quality and price (para. 3.05); the availability of technical assistance in production, quality control and export marketing (see paras ), and an export policy framework that continues to encourage efficient producers (paras ) We estimate that the volume of exports of garments can grow at about 10% per year from 1977 actual levels (equivalent to 13% in value per year with product upgrading 1/) which reflects the following assumptions regarding market restrictions. a. Exports of items presently restricted by the EEC (which accounts for about four-fifths of Turkish exports by value though they are less than 3% of total EEC imports in the categories concerned) will be able to expand at a rate of 6% after 1980, from presently restricted rates of 1-1/2%- 4%. b. Non-restricted items (in which Turkey's share of the EEC market is 0.7% of the EEC market) can expand at an overall rate of 14% from 1977 levels to c. Non-EEC markets (the Middle East, North Africa and non- EEC European countries where Turkey's present share is small) can grow at 12% in volume (about 15% in value). (See Annex 3.) 3.17 On the basis of these projections, by the end of 1983 the Turkish exports of textiles and garments would reach nearly $345 million, an increase 1/ Faster growth of garment exports could come about if the industry had unhampered access to import fabrics when local fabrics are unavailable at a satisfactory price or quality. However, since garments quotas in importing countries do not discriminate on the basis of fabric origin and since expansion of fabric exports is constrained, there is at present no reason for Turkey to encourage large volume use of imported fabrics even when suitable local fabrics are not available.

19 of more than $100 million over the estimated 1978 level of $240 million. Garments would account for nearly two-thirds of yarn exports which has heretofore been the only significant source of export earnings in this sector. This is substantially less however than the export targets given in the Fourth Five Year plan of $745 million for the sector which appears optimistic even if restrictions in major markets were entirely lifted. C. Investment Requirements 3.18 Projected investments for the private sector (excluding Sumerbank) have been developed on the basis of the industry's requirements for modernization and for expansion to meet domestic and export demand (Annex 4) through As Table 1 below shows, they total an estimated $850 million, of which foreign exchange needs would amount to about $400 million. This represents most of the sector's requirements since early 1977 when foreign exchange constraints brought textile investment programs to a halt. This proposed loan will provide nearly 20% of projected sector foreign exchange requirements. The financing of the remaining foreign exchange costs, expected to come mostly from commercial banks and suppliers credits, is uncertain at the present time. This project, however, will be financing priority requirements and is not dependent on such other sources. Self-financing is expected to provide about 40% of total sector requirements, mostly for local costs. As can be seen in Table 2, about 78% is required for new investment and expansion and only 22% for replacement and modernization. The cotton sector, given its dominant position, will require far more than the wool sector. Garments and knitting, though relatively small, will require investment out of proportion to their present size. It is toward meeting a share of these foreign exchange requirements of the sector, that the major portion of the proposed loan is directed. Table 1: Estimated Private Textile Sector Investment Requirements and Financing, Investment Requirements Local Costs Fixed Working Foreign Sector Assets Capital Total Exchange Total Garments Knitting Cotton Sector Wool Sector Accessories Total

20 Table 2: Estimated Foreign Exchange Requirements in Textiles and Making-Up Sector for Private Sector Textile Project (US$ million) Share of New Estimated Investment Replacement Share of Organized and and Estimated Sector Expansion Modernization Total Investment Value Added Garments and Household Articles % 5 Knitting Knitting Finishing % 3 Cotton Sector Spinning Weaving Finishing _ % 82 Wool Sector Spinning Weaving Finishing % 10 Accessories % 1 TOTAL % 100% 78% 22% 100% D. Issues and Problems Efficiency and Need for Modernization Garments/Making Up 3.19 The garments/making up sector, has mostly modern equipment; but its labor productivity is only some 40 percent of European standards, except for a few firms with technical assistance from a foreign marketing partner. Partly this is due to short production runs as a result of lack of specialization. It is also the result of production in unsuitable and cramped premises,

21 poor plant layout, organization and work methods, and a lack of cost control. There is scope for considerable improvement in efficiency, primarily in areas related to industrial engineering and production management. Textiles (excluding garments/making up) 3.20 The rapid expansion of the private organized sector since 1970 has been accompanied by increases in productivity of about 14% per year which is higher than for manufacturing as a whole and reflects a heavy program of investment in modern equipment that has averaged $200 million/year until 1976 when exchange constraints and Government restriction caused it to fall off Individual sub-sectors differ greatly in structure and degree of modernity and efficiency. a. In cotton spinining utilization was only 68% in 1977 following a program of rapid expansion and modernization in response to uncoordinated program of incentives, in which its capacity doubled from more than 1.3 million to 3.0 million spindles. It is now the most modern subsector. There is a need for additional capacity only in combed yarns, doubled yarns and sewing thread. Relatively few plants require modernization 1/ but some require balancing investments with upgrading of product lines. A recent study estimates that productivity in spinning. despite its modernity, ranges from 42% to 64% of European standards. Two-thirds of this difference could be correctable through better maintenance, job scheduling, working methods, load assignments, etc. 2/ Though these changes would not be easy to bring about because of traditional management resistance to change and the lack of competitive pressure under domestic market conditions they could result in increased output estimated at 10-15% without additional investment. b. Cotton weaving sector capacity is concentrated in about thirty mills, mostly integrated and is now fully utilized to meet domestic demand. About half of the capacity is less than 6 years old. 2! New looms are required to replace worn out equipment estimated to be 12-18% of capacity and for expansion of demand. A productivity study, similar to that for spinning found that productivity in Turkish mills ranged from only 35% to 57% of their European counterparts of which about two-thirds would also be correctible and could eventually result in increased output without additional investment of the order of 20%. 1/ See Project File No. B.4 for details on estimated age distribution of equipment in the private organized sector. 2/ See Project File No. B.5 for additional information on productivity differences between European and Turkish mills.

22 c. Dyeing, Printing and Finishing (DPF) requires replacement of some 25-30% of its equipment and in printing the percentage could be as high as 70%. Though there is excess capacity for the subsector as a whole, there are regional shortages of capacity in certain lines, and a national shortage in drying machine capacity. d. The knitting sector has expanded so rapidly that there is little need for modernization. Additional capacity is needed for growth in demand and a shift in consumption from woven to knitted fabrics. Lack of yarn dyeing capacity is a constraint on further development of knitting. e. The wool sector has economic sized spinning plants but whereas worsted spinning has expanded rapidly in response to demand for suiting, woolen spinning has stagnated and needs modernization. Capacity utilization in worsted spinning has been hampered recently by shortages of merino wool which must be imported. Wool weaving occurs mostly in small firms of uneconomic size, and even the larger firms producers have a relatively high proportion of obsolete equipment so that the whole subsector requires modernization. Efficiency is well below European standards. Technical Assistance Requirements 3.22 While some firms have already reached satisfactory levels of productivity and consistency of product quality, a much greater number of enterprises should be involved and the training process speeded up. Indeed, the problems arise primarily because of the inadequate level of training of supervisors and middle managers. The several available sources of technical assistance cannot presently meet all the requirements Formal educational institutions serving the sector include the textile faculty of Ege University in Izmir; a school for textile technicians in Istanbul; and a recently established school for garment operatives. Sumerbank's Textile Training and Research Center has so far been of limited help to the private sector. TSKB provides practical advice to its clients. For garments, where most training is on-the-job, the best source is the foreign marketing affiliates of some exporting firms, but this is usually limited to what is needed to meet buyer specifications. In textiles, where firms are much larger, managers are more professional, equipment manufacturers provide important but limited services, while foreign consultants who could provide wide ranging services have been employed only to a limited extent because of high costs, foreign exchange shortage, and lack of incentive given market conditions There clearly remains a need for practical training and technical assistance at the middle management and supervisory level involving technical and industrial/production engineering fields. 1/ Specifically the training 1/ See Annex 5 which details problems for individual subsectors in these fields.

23 should include work methods, production planning, housekeeping, quality control, preventive maintenance, financial controls and improvement of relations with top management and workers which is increasingly important in the face of growing unionization in Turkey. The training and technical assistance component proposed for this loan will try to remedy this by fostering a local capability to meet some of the needs and by removing the foreign exchange constraint to greater use of foreign technical assistance sources. Appropriate training programs as well as delivery systems have been devised and are outlined below (see paras and Annex 8). E. Industrial Policy and Organizational Framework Investment Incentives 3.24 Turkey's strategy of import substitution and basic industry development includes high protective tariffs, averaging 50% of c.i.f. imported value on industry generally, and an elaborate quota system. 1/ Through its power to grant concessions, the Government has strong leverage on private industry to follow the Government's priorities as embodied in the five-year plans. Grant of a Certificate of Encouragement gives a firm (a) accelerated depreciation; (b) exemption or deferral of customs duties; (c) concessional interest rates on medium and long-term credit; and (d) reduction in corporate income taxes in relation to the amount of equity investment involved. During the ten year period ending in 1976, about a third of total investment was granted the certificate, but since 1972 the proportion has been significantly higher. For textile industries, though not for garments and knitting, it is regarded by investors as an essential condition of investment, and its grant is required by development banks before making a loan Virtually all textile sectors were eligible for certificates of encouragement through the end of 1978 and most could qualify for the maximum exemption on customs duties--even cotton spinning which is acknowledged to be over-extended. The system allowed considerable latitude to administrators in selecting and shaping projects according to a variety of criteria that took account of many often conflicting objectives, and was used in textiles mainly to mitigate regional disparities in development and to foster exports. The incentive's main weakness was that by eliminating import duties and providing concessionary interest rates, it created a capital-intensive bias of the investment incentive framework. In textiles it tended, therefore, to discriminate against garment manufacturing 2/. The new schedule of incentives for 1979 substantially reduces the number of subsectors that can qualify for waiver or deferment of duties on capital equipment; in textiles none are eligible for complete waiver and only two for deferment. While this will 1/ The adverse effects of the protectionist system, including suggestions to improve industrial efficiency and competitiveness, were discussed in paras / Only about 3% of sector projects granted incentives has gone to garments and knitting.

24 reduce the profitability of much domestically oriented investment and could curtail total planned sector investment as a result, it provides a major corrective to the capital-intensity bias. The new incentives also explicitly encourage modernization; cotton textiles modernization is one of the two areas eligible for deferment of import duty payments. Finally the new schedule places explicit emphasis on exports and in most of the textile subsectors (knitting, and garments for example) projects are ineligible for any incentive unless export-oriented. The actual impact of these changes on guiding the sector's development cannot yet be evaluated but they appear to provide satisfactory improvement in this important element of the investment framework for textiles. An understanding was reached with the Government at negotiations on the annual provision of information on the prevailing incentives, and on a dialogue with the Bank at the request of either party regarding the adequacy of the level, and appropriateness of the structure, of the investment incentive structure for textiles. 1/ Export Policy Framework 3.26 Turkey has a complex set of export policy instruments needed to try to offset the import substitution bias of its industrial and trade policy framework which are evolving rapidly at the present time. These include provisions for temporary import of raw materials (which needs to be streamlined) and concessionary interest rates on working capital used in export The most important incentives (other than the exchange rate) in Turkey, however, are the system of export rebates, and the recently reorganized system of foreign exchange retention. The export rebate regime, first instituted in 1963, provides cash payments to successful exporters, calculated as a percentage of the selling price according to a published rebate schedule. The schedule changes from time to time, and for textiles it currently ranges from 5% for cotton yarns to 20% for garments. Large volume exporters (TL 3.5 million or more in a given year) are entitled to an additional 5 percentage points. On the basis of conditions at the time of appraisal there appeared to be adequate incentive for expansion of exports for efficient producers of garments, the subsector where export potential is the greatest, but the advantage was rapidly eroded thereafter by the high level of inflation. The Government recently revised its exchange retention scheme to provide a more liberal and more automatic basis for exporters to retain exchange earnings. This scheme and the large devaluation in June 1979 should have a substantial impact in inducing industrial exports and appears to have provided the necessary incentive to enable efficient textile and garment exporters to export. The dialogue with Government (para 3.25) will however also include discussion of the adequacy of the export policy framework mainly as it applies to garments. TSKB, as part of its regular reporting requirements, will prepare on a semi-annual basis for at least four garment products an evaluation of its impact on the export sector for use by supervision missions in the dialogue.2/ 1/ See Project File B.8 for additional details on operation and impact of the investment incentive framework. 2/ See Project File B.8 for additional details on the operation and impact of the export rebate and other elements of the export policy framework.

25 There is a substantial institutional framework to support and facilitate exports generally including special departments in the Ministries, an export promotion center, Chambers of Commerce and export unions of private producers. This framework has not been effective in the past because of lack of coordination between the Government and the private sector, ineffective administration, and lack of awareness of the requirements of export. The Government is now taking measures to strengthen its export center, streamline procedures within Ministries, and improve coordination within Government and with the private sector. With respect to the textile sector there is an increasing dialogue between the textile industry and the Government on indus- * try problems. Whereas only spinning export unions had been established the Government has now officially recognized the Garment Exporters' Union which can be a focus of export effort in this subsector (para. 3.15). IV. THE PROJECT A. Objectives and Justification 4.01 The proposed project's major objectives are: a. To improve the structural balance of the sector and to promote expansion and valued added, especially in less developed subsectors. b. To improve productivity, by upgrading technological proficiency, improving quality, and standardizing production in order to reduce costs and improve competitiveness in export markets. c. To induce modernization as required. d. To promote directly exporting projects, especially in the most promising subsectors (garments/making up and knitting) and to support projects that are capable of supplying inputs for exports of adequate and consistent quality. e. To improve the policy and institutional framework as it relates specifically to textiles. These objectives reinforce each other. Improvement in sectoral efficiency will improve the capability to export. Increased exposure to the requirements of exports will force the industry to upgrade quality and reduce costs. Technical assistance and training will help increase utilization of equipment, reduce costs of inputs, and develop a capability in Turkey to continue to provide such assistance. Up to 160 firms will benefit directly as a result of this assistance. The project will help channel sector production

26 capability to exports which will earn about US$25 million in foreign exchange. About 5,000 jobs would be directly created of which 3,000 would meet the Bank's urban poverty capital intensity criterion. The project will begin to sensitize financial intermediaries and their clients to the environmental impact of their operations and will include concrete steps to limit further environmental damage. B. Design 4.02 The proposed components of the project to meet these objectives are summarized as follows: ($ Million) (a) an equipment component to finance high priority sub-projects; 75.0 (b) a training and technical assistance component consisting of: 4.5 (i) a pilot program to develop a local capability to provide a training and technical assistance extension service to technical and middle management and export marketing staff; 1.2 (ii) a fund to enable firms to borrow foreign exchange for additional and more specialized training, technical assistance and technology transfer 3.3 (c) promotion, training and the financing of special studies by the financial intermediaries involved Financial Intermediaries The project will rely primarily on two private financial intermediaries for financing and administering the above components. TSKB, for which a thirteenth loan was recently approved, is well known to the Bank. 1/ SYKB is an experienced intermediary with new dynamic management where lending is 1/ See TSKB XIII Staff Appraisal Report, Project File No. A9.

27 envisaged for the first time. The Bank financing will be divided between TSKB and SYKB on approximately a 4:1 basis which is appropriate to the relative size of their overall and textile operations as well as the operations projected under their action plans. 1/ The two banks will be lending to different groups of firms with SYKB's expected on the average to be substantially smaller than those for TSKB. The objectives and structure of the individual components and their interdependence, reflecting that this is a sector loan and not a traditional DFC operation, will require the intermediaries to cooperate closely regarding their activities in the textile sector. They have agreed to sign a protocol to this effect satisfactory to both the Government and the Bank; an understanding was reached on the main elements to be included. Signature of the protocol is a condition of effectiveness of the proposed loans; and the DFCs have agreed to consult with the Bank and the Government before making any changes in it. TSKB 4.04 TSKB has been deeply involved with the textile sector, not only in its lending operations but through broad sectoral research which has established it as a leading authority on the sector. Its appraisal and engineering staff includes about 10 specialized in textiles who are among the best in the field in Turkey. It is well capable to undertake the specialized planning, appraisal and technical assistance roles which are assigned to it under this project (paras 4.33, 4.36, 4.56, 4.61). No general measures of an institutional nature are required under this loan in addition to those recently agreed in connection with the 13th TSKB loan. However, certain financial measures are required as a result of recent economic developments. The devaluations in 1978 and 1979 have caused large increases in TSKB's foreign debt when expressed in Turkish lira, which have carried its debt-equity ratio well beyond the 10:1 maximum agreed under TSKB XIII. TSKB has therefore decided to advance its ongoing capital increase from TL 425 million to TL 1,500 million. An understanding was reached that full subscription (which under Turkish law requires 25 percent to be paid in), which has already been invited, will be completed by September 15, IFC is seeking its Board's approval to participate. Agreement was further reached that the capital increase will be fully paid-in by December 31, 1979; and that the debt-equity ratio will be brought within the 10:1 limit by December 31, 1980 and remain within it thereafter. An understanding was reached that, if the demand for TSKB's loans is such that the ratio will not be restored by December 31, 1980, TSKB will take steps in consultation with the Bank to increase its equity base--preferably by increasing its share capital--as needed. Another issue was raised in the latest OED report on TSKB, the PPAR on TSKB IX and X (SecM77-92, dated February 11, 1977). This drew particular attention to the negative spread on TSKB's domestic borrowings, as a result of the prevailing interest rate structure, which constrained TSKB's domestic resource utilization. This problem has been resolved through agreement under TSKB XIII that 1/ See Project File B.9 for a comparison of indices of size on which this allocation ratio is based.

28 TSKB will review its local currency lending rate annually with the Bank, and adjust it as permitted by (a recent change in) prevailing legislation, so as to achieve a positive spread on average between the cost of borrowed local currency funds and local currency lending rates, to the satisfaction of the Bank. For a review of TSKB's operations and financial situation see also SAR for TSKB 13th Loan, Project File A.9. SYKB 4.05 SYKB has financed extensively in the textile sector (25% of total approvals through 1978) and with the recent addition of an experienced textile engineer to its technical staff has the capability for carrying out the planning and appraisal roles assigned to it (see paras 4.08, 4.11). A thorough financial and institutional appraisal was conducted for the purpose of this project, summarized in Annex 6, which concludes that SYKB would be a satisfactory and creditworthy borrower. It has agreed to submit a consolidated statement of policies for Bank approval by December 31, 1979 and adopt it promptly thereafter. Several financial measures will be required in view of the projected growth of its operations, however, and will need to be incorporated in the loan agreement: (a) that its present paid-in share capital be increased no later than January 1, 1980, by at least TL 300 million; (b) its debt/equity ratio be maintained at a level no greater than 7:1, based on a revised definition of the debt/equity ratio defined to include borrowings from its shareholders in long term debt (Annex 6, paras 8-10); and (c) that it allocate 5% of annual net income to build up provisions, hitherto unnecessary because of a very conservative lending policy, to 2% of loans and equity portfolio (see Annex 6, para 9). 2. Equipment Component Sectoral Allocation of Loans 4.06 The equipment component of $75 million will finance about 20% of the projected total sector requirements (para. 3.18) during its 3-year commitment period lasting up to December 31, 1982, and most of the textile projects that the intermediaries expect to finance during this time span. The allocation of this component will emphasize priority sub-sectors as explained below (para. 4.11). Additionally, selection criteria have been developed to identify projects within each sub-sector which merit highest priority (paras ). These criteria are described in connection with each sub-sectoral allocation and both criteria and allocations are spelled out in the Loan Agreements Since it is possible that the intermediaries may wish to undertake a small amount of textile financing outside of the loans, to ensure that the objectives of the loan are not frustrated, the intermediaries have agreed to make all commitments in textiles during the period consistent with the criteria developed for projects financed out of the loans. This is reflected in the Loan Agreements The intermediaries have developed action plans which feature a set of sub-projects proposed for consideration under the Loans (Annex 7). These

29 projects have been developed from the sector knowledge of technical personnel, from a review of each intermediary's file of applications for financial assistance, and on promotional visits to factories to identify modernization/ integration requirements. Though some sub-projects listed in the action plans are only in the formative stage, each project is briefly described, its investment requirements are estimated, and the rationale for its selection is given according to agreed upon criteria. The plans also describe work needed to develop individual sub-projects further, including studies where the strongest promotional effort is required -- mainly garments and knitting. The Bank has reviewed the action plans and promotional programs and considers that they will provide an adequate pipeline of projects to ensure smooth commitment of the equipment components of the loans. The intermediaries have agreed in supplemental letters to update the project pipeline in their action plans on a semi-annual basis for Bank review with a brief description of changes of the status of projects in the pipeline of each sub-sector, a summary description of new projects and the reasons for their inclusion, and a brief description of the promotional efforts planned Following are the proposed allocations targeted for each sub-sector. The proposed allocation pattern reflects subsectoral requirements and priorities, and is supported to a large extent by subprojects already identified by the financial intermediaries and included in their respective action plans. Proposed Minima TSKB SYKB Garments/Making up and Knitting Spinning Weaving Dyeing/Printing/Finishing Accessories and other Total Allocated Unallocated TOTAL The emphasis is on garments and knitting because they are relatively undeveloped and have employment and export potential, and weaving and dyeing/ printing/finishing because of their modernization and expansion requirements. The proposed allocation is also expected to help correct sectoral imbalances The estimated total value of foreign exchange requirements for the * sub-projects listed in the action plans exceed the amount of the proposed Bank loans as well as the sub-sectoral allocation suggested below, with the major exception for garments/making up and knitting. TSKB and SYKB will continue their efforts to identify additional eligible projects to fill existing gaps and to make up for possible slippages. Both intermediaries feel confident that enough projects will be identified and processed for financing within the three year commitment period of the loan. An amount of $13 million is recommended to remain unallocated in order to give TSKB and SYKB some flexibility in committing the loan, given the relatively small size of allocation categories in comparison with average project size in some sub-sectors, the

30 uncertainty about how quickly investors in individual sub-sectors will be willing to move ahead with specific projects some of which are still in the formative stage, or other delays in processing of projects. Projects from any subsector would be eligible for funding under the unallocated category provided that they meet the same sub-sectoral criteria and are included in the project pipeline of the updated action plan (para. 4.08). Criteria of Eligibility 4.11 General. Because considerable improvement in efficiency is possible by improving management practices and training (see paras ), there will be a general criterion of eligibility for all firms with existing textile facilities to be financed in , from either the loan or other resources. In particular, TSKB and SYKB have agreed to review the efficiency of existing operations in a given mill, whether or not directly related to the project for which financing is requested. Where significant efficiency improvements are judged by the intermediary to be possible, sub-loans will require an agreement between the firms and the intermediary to improve the efficiency of operations and to agree on a time table for reasonable improvements, and, if necessary, to obtain technical assistance. The technical assistance component (paras ) will be available, as appropriate, to facilitate this requirement. Mindful that sector projects as a whole may have been unnecessarily capital intensive, the DFCs also intend to pay particular attention in their appraisal reports to the technology choices available and the reasons for the one selected, including using shadow pricing of labor where appropriate. Additional criteria of eligibility (paras below) have been developed for each subsector to encourage projects that (1) address priority needs in each subsector for modernization, bottleneck removal, capacity expansion (summarized above, paras ) and (2) develop export capability because they either (a) upgrade existing export lines; (b) expand exports; or (c) supply inputs that are needed for garment exports (see paras ) Garments/Making Up and Knitting. Since these sub-sectors are undeveloped and have export and employment potential, any viable project in these sectors will be eligible. The main criterion for priority is a project's capability to make direct exports, which is in keeping with the sub-sector's comparative advantage and the potential influence on the sector as a whole in bringing about improved quality in supplier industries upstream. The definition of export-oriented is given below, para The agreed loan covenants require the intermediaries to allocate at least 80% of total garments making up and knitting foreign exchange financing during to directly exportoriented projects. The requirement to report semi-annually on progress has been recorded in a supplemental letter Spinning. Spinning projects will be required to qualify in at least one of the following: (1) modernization or bottleneck removal in the wool sector;

31 (2) improvement of quality or upgrading of product lines for direct export in accordance with definition of export-oriented; (3) the production of thread or other product of export quality needed for garment exports Weaving. Weaving projects would not qualify simply because they relieve the existing capacity shortage but will have to involve one or more of the following: (1) modernization or removal of bottlenecks in all sectors; (2) the forward integration of a spinning mill with underutilized capacity which leads to overall improvement in efficiency; (3) production for direct export as a fabric in accordance with the definition of export-oriented; (4) the production of linings of exports standard and of other fabrics of export standard which are an input for garment exports Dyeing, Printing and Finishing (DPF). Projects for dyeing, printing and finishing are likely to be associated with weaving projects and in such cases equivalent criteria will apply to DPF projects as in para 4.14 above. In addition, commission finishing facilities serving knitting and commission facilities in regions with a shortage of capacity would also be eligible Accessories. Any projects which provide a needed input into garment manufacturing and making up, such as zippers or buttons, for which present local supply of adequate quality is unavailable will be eligible in this category Promotional Effort Required. The eligibility criteria which have been developed for this project reflect closely the priorities expressed by the Government in the revised schedule of industries eligible for investment incentives that has just come into effect for 1979 (see para 3.25). Though the schedule is more restrictive than before, there will be little impact upon the projects proposed for consideration under this project by TSKB and SYKB in their action plans since most qualify under this more restrictive schedule, and the majority of those that do not have already been issued Certificates of Encouragement and therefore can be financed by the intermediaries. A promotional effort will still be required from the intermediaries, especially for the garments/making-up sector for which there is a gap between the proposed allocation and the present pipeline, both overall and with regard to exports.

32 Export-Orientation 4.18 The benefits of textile and garment exports through generation of needed foreign exchange, from their tonic effect in improving sector performance as a whole, and the broader impact of the export learning experience justify a substantial export promotional effort under this project. Directly exporting projects can be promoted primarily in spinning where the sector's existing export orientation needs to be maintained in the face of growing domestic markets, and in garments/making up where significant export expansion is possible. Analysis of the intermediaries' Action Plans indicates that at least 30% of total project investment would be export-oriented including at least 80% in the garments/making up sector, where export development potential is the strongest. Under the project these percentages have been adopted by TSKB and SYKB in the Loan Agreements as minimum targets of their lending for textiles during the period , whether or not Bank-financed. The June 1979 devaluation should increase the supply of export-oriented projects and facilitate reaching these targets Projects will be considered export-oriented on the basis of the following percentages of their output to be exported by the time they are expected to reach full capacity: at least 40% for expansions or modernizations of an existing enterprise, and at least 30% for new projects. This definition is identical to that agreed under TSKB XIII. For garments the export levels implied by the above definition, given the additional target that 80% must be export-oriented, would account for more than half of the estimated growth in garment exports for the sector as a whole. Agreement has been reached that the DFC's subloan agreements for these projects will specify minimum export targets. Understandings have been reached that the DFC's appraisal reports on such projects will demonstrate their bona fide export potential using evidence of price competitiveness and an adequate marketing strategy; also that the DFCs will satisfy themselves that sponsors obtain available incentives in accordance with their export targets. The training of DFC staff which will be needed to accomplish the above export objectives is discussed below (paras ). Other Features of the Loan 4.20 Free Limits, Subproject Size, Amortization, ERR. The present policy limits on each intermediary's participation in a single project ($6 million for TSKB, $2 million for SYKB) will adequately serve to prevent pre-emption of this loan by a few large borrowers. A review of the preliminary project pipeline indicates, however, that the average commitment under this loan will be about $2 million, enabling about 35 to 45 projects to be assisted. The same free limit of $4,000,000 for TSKB is proposed as for TSKB XIII. For SYKB a lower limit of $750,000 is appropriate reflecting the smaller expected size of its projects and the need for closer supervision of its operations, this being the first time SYKB is associated with the Bank. For the purpose of monitoring subprojects below the free limit the intermediaries would agree to translate ex post the appraisal reports of a sample of up to one-third of such projects, selected by the Bank, from the list of approvals submitted.

33 While the selection criteria for individual categories should ensure that only high priority projects are identified, the intermediaries have also agreed to calculate an ERR, including using shadow pricing for labor where appropriate, on all projects with fixed assets (a) above $2,000,000 for TSKB in accordance with current practice; and (b) above the free limit for SYKB. The ERR should exceed 15% for projects submitted under these loans Relending Terms. The maturities and grace periods of the subloans will be commensurate to the economic life of the equipment and to the subborrowers' debt-servicing capacity which for the textile industry has typically required no more than eight to ten years. The amortization schedule for equipment would reflect the aggregate amortization schedules of the subloans and should not exceed 15 years. The intermediaries will charge on sub-loans the interest rate set by the Turkish monetary authorities for long-term foreign exchange loans currently 26%-28% per annum with taxes and fees and before taking account of interest subsidies (see para. 2.13). The foreign exchange risk will be borne entirely by the borrowers. As in the case of the current loans to TSKB, the intermediaries will retain as income 2.5% per annum, of the interest payment of subloans. TSKB would also retain an additional spread to help finance the technical assistance component to the sector, as described in para 4.31 below. The difference between the interest charged by the intermediaries and the interest due to the Bank will be paid by the intermediaries to the Government as a guarantee fee Procurement. TSKB and SYKB routinely ensure that procurement procedures appropriate to each project are followed to ensure competitive prices. Though the organized private sector in Turkey is in general well informed of the equipment available, the two DFCs have considerable experience in textile equipment selection in their field, and TSKB in particular routinely advises its clients on procurement. Procurement requirements for most contracts will therefore be in accordance with usual DFC procedures. In the case of contracts in excess of $2 million, however, an understanding was reached that the DFC's will normally require their sub-borrowers to use an appropriate form of international tendering which the Bank will review on an ex post basis. 3. Research and Training for the Financial Intermediaries The high level of TSKB's present textile sectoral knowledge derives from a substantial effort of foreign consultants, accounting for about 25% of its total research expenditures during the past four years, and over 50% of its foreign exchange budget for research. Textile sector research will continue to be required, focussing on: (a) follow up and expansion upon studies of sector productivity; (b) export market studies for specific products; (c) monitoring of the competitiveness of existing export firms in foreign markets under the incentive policy framework (para 3.27). An understanding has been reached that studies of the manufacture of textile dyes and textile machinery in Turkey will also be eligible. To conduct this research, TSKB will require continued use of foreign consultants specialized in textiles as well as foreign exchange to finance foreign trips of its own staff. The foreign exchange cost of this research is estimated at $300,000. TSKB's commitments

34 to continue its sector research program along the above lines, with individual studies proceeding according to an outline acceptable to the Bank has been recorded in its Loan Agreement The management of both intermediaries recognize that their staff's expertise in appraising the export prospects of projects, and in offering assistance to investors in this respect, is limited. Under the TSKB XIII loan TSKB is correcting this weakness by launching a comprehensive training program on the export aspects of projects for the technical and economic staff which will comprise: (i) hiring of a qualified expert for a period of 2 years, mainly for the purpose of providing on-the-job training to TSKB staff in the promotion of exports; (ii) seminars and training courses in Istanbul using foreign experts to lecture; (iii) sending selected members of the staff on trips abroad for practical experience, e.g. working with foreign and international export promotion organizations, participating in negotiations of export contracts of TSKB's clients with their foreign customers. This training program is being organized with assistance from the Geneva-based International Trade Center (ITC) and other qualified public and private technical assistance institutions. TSKB has already established contacts with ITC and several other institutins and preparation of a technical assistance agreement between ITC and TSKB is already fairly advanced. 1/ For the purposes of this project, additional emphasis on the textile sector (including problems of pollution control) will be needed and an additional $100,000 will be allocated. The program for SYKB, which is at a less advanced stage, would be entirely financed out of this project. It is being developed along the same lines and in close cooperation with TSKB and drawing upon the same institutions. SYKB's program would also require an allocation of $100, SYKB has made a commitment in its Loan Agreement to carry out a training program emphasizing textiles along the above lines acceptable to the Bank. TSKB will be required to demonstrate that its program takes adequate account of the textile sector's specific requirements. Both agreed to cooperate closely (this being recorded in the protocol, para. 4.03) and to combine the programs and facilities where feasible. Disbursement of the relevant portions ($300,000 for TSKB research, $200,000 for textile oriented training for both intermediaries) will be made conditional on the following elements which will be reviewed by, and must be acceptable to, the Bank: (a) technical assistance agreements with the training and technical assistance institutions; (b) qualifications and terms of reference of the technical assistance staff to be used by them; (c) detailed outlines of the first phase of the training programs and outline of the research studies proposed. 4. Technical Assistance 4.27 The technical assistance component will help significantly improve the industry's efficiency at low cost, through assistance in industrial/production engineering and financial control, and improve export marketing (see 1/ For details see TSKB XIII, SAR Project File A.9, para 6.06.

35 paras , 3.28). It comprises a local training and consultancy extension service, and a training, technical assistance and technology fund (see Annex 8). They are intended to be complementary and TSKB has agreed to avoid duplication. Firms which have used the extension service and have identified further needs will receive special priority under the technology fund, but firms which have used the fund will not be allowed to use the extension service unless TSKB judges no overlap in services will occur Extension service. This aims to institutionalize in Turkey a capacity for diagnosis, trouble shooting and in-plant training in production management and cost control. For textiles, it will involve a review of plant operations and in-plant courses. For garments/ making-up, the service will be more comprehensive; an export marketing assistance will also be provided. In the first two years, the service is expected to reach about 40 firms, 20 each in textiles and garments, and in five years, up to 160 firms. Most beneficiaries are expected to be clients of the DFCs, although all firms will be eligible. Assisted firms will receive priority for both equipment loans and use of the technology fund TSKB has agreed to administer the service for at least 3 years from the effectiveness date, which will cover the commitment period for equipment loans. This is appropriate in view of its management ability, large and experienced textile staff, and contacts with the industry. TSKB has agreed to consult SYKB and representatives of the industry with respect to the carrying out of the services, the understanding being that TSKB will seek policy guidance from, and strengthen contacts with, appropriate industrial organizations. A further understanding was reached that TSKB will, in consultation with SYKB and the consultants (next paragraph), develop procedures satisfactory to the Government and the Bank to ensure that the firms selected to participate will make effective use of the services and will provide a demonstration effect to the sector as a whole. Since the service is outside TSKB's main lending activities, there will be a review within 2 years of effectiveness by the DFCs, the Government, industry representatives and the Bank, to evaluate progress and propose successor institutional and financial arrangements satisfactory to the Bank and the Government. Institutional possibilities include continued DFC control, control by one or more industry associations or some combination of DFC and industry (see Annex 8, para 5). An understanding has been reached that TSKB will recommend successor arrangements to the review meeting, and that it will provide interim semi-annual reports on progress. It will also translate ex post up to one-third of reports on firms using the service selected by the Bank for monitoring TSKB has agreed to select resident and short-term consultants, including an initial short-term consultant to assist in start up, to provide an estimated 128 man-months of services over five years at an average foreign exchange cost based on per man-month salary and benefits of $6400. Additional amounts are allocated to allow for price escalation over a 5-year period, travel and administrative supplies and contingencies. The International Trade Center may help TSKB find export marketing consultants. These consultants will train fourteen Turkish counterparts, who will be offered attractive salaries to retain them. The appointment of (i) an experienced consultant

36 to assist TSKB in starting up the service; and (ii) consultants in weaving/ knitting, and for industrial engineering assistance to garments/making-up, will be conditions of effectiveness of the proposed loans. Agreement will be reached that (i) the detailed description of the program (financial and manpower budgets for the first year, and the mechanism for selecting beneficiary firms; and (ii) the qualifications, experience and terms of reference of the consultants, will be approved by the Bank prior to disbursements for this service. An understanding was also reached that TSKB would secure the Government's and the Bank's approval before changing the program TSKB will borrow the estimated foreign exchange cost of $1.2 million as part of the proposed Bank loan to it. The estimated local currency cost will be TL 100 million in mid-1978 prices. TSKB has agreed that the service will be free for no more than the first two years; and that thereafter, increasing fees will be charged with a view to enabling it to be self-supporting after five years. To meet the deficit of the first three years, TSKB will for 7 years retain 1 percent per annum of the gross spread on the proposed loan to it, plus amounts sufficient to service the loan portion borrowed. The successor arrangements will also provide for adequate financing of the service Training, Technical Assistance and Technology Fund. The extension service will cover only a portion of the sector's needs in five years. Also, its services will necessarily be limited by its staff's size and relative lack of specialization. The proposed project therefore includes a $3.3 million loan fund for additional and more specialized assistance in production/ industrial engineering, financial controls, research and development, pollution control, and export marketing. It will finance the foreign exchange costs of training abroad, hiring foreign consultants, and the purchase of equipment related to technological adjustment and quality upgrading such as laboratory and testing equipment TSKB has agreed to administer the fund. It has already identified demand sufficient to use 30 percent of it. It has agreed to undertake further promotion, in close cooperation with the extension service, according to a plan to be submitted to the Bank by March 31, 1980 for review; give priority to firms aiming to increase the productivity and efficiency of existing equipment, and to those entering, expanding, or upgrading exports; and give equal priority to SYKB's clients on a first-come-first-served basis. Appraisal will be simple and involve the creditworthiness of the firm, the eligibility of the expenditure, and its appropriateness to the firm's objectives. Loans from the technology fund are expected to average $100,000, but will be subject to an agreed maximum of $250,000; terms are expected to average 3 to 5 years including 2 years of grace, but will be subject to an agreed maximum of 6 years. A supplemental letter will record TSKB's requirement to provide semi-annual reports on commitments, approvals, status of projects in the pipeline and the provision ex post of up to one-third of the appraisals in English for the purpose of monitoring. If demand for this Fund proves strong it would be eligible for additional funds from the unallocated category of the equipment component with prior Bank approval. a

37 Environmental Impact 4.34 The existing environmental guidelines in Turkey are not fully suitable and the Government has not yet published revised guidelines nor a timetable for compliance for existing industry, though it proposes to do so in the near future. The intermediaries are familiar with environmental hazards of the textile sector and provide advice to clients concerning the nature and cost of investment needed to reduce their impact, but they have been reluctant to penalize individual clients by insisting that they undertake the additional investment in the absence of a national or regional effort that imposes the standards on all mills equally. They recognize that additional effort is needed, and in the absence of a suitable national or regional program the following measures have been agreed, which the intermediaries have sufficient capability to administer: 6. Disbursements (a) Sub-projects involving new plants or major expansion on separate physical premises will be required to meet the Bank environmental guidelines 1/ for textile plants as a condition of loan approval unless otherwise agreed. (b) Firms in the DPF sub-sector (which poses the most serious problems of pollutant discharge) seeking financing for expansion or modernization of existing facilities will be required to provide intermediaries with data on existing and proposed effluent discharge to enable a judgment by the intermediary of the steps, if any, that are necessary to make reasonable improvements. If these are possible, the sub-borrowers will have to agree to prepare and carry out a plan for achieving them. Any proposed sub-project which worsens the impact of pollutant discharge will be ineligible for financing unless the Bank and the financial intermediary otherwise agree Disbursements will be made against standard documentation in respect of (i) 100% of c.i.f. foreign exchange expenditures for equipment; (ii) foreign exchange expenditures for technical assistance and for DFC training and research. Disbursements are expected to be completed during 1984, so the closing date for both loans will be December 31, C. Benefits and Risks Benefits 4.36 This project will improve sectoral balance and promote expansion and value added especially in less developed sectors. It will improve performance by promoting modernization, integration and bottleneck removal 1/ See Project File A.10 for environmental guidelines for the textile sector prepared by World Bank Office of Environmental Affairs.

38 where required. Through technical assistance and training it will increase utilization of equipment and reduce costs of inputs. It aims to develop a capability in Turkey to continue to provide such assistance. In the process firms would be directly assist-d involving up to a third of total sector capacity. The project will help to channel sector production capability to exports which will earn about 25 million in foreign exchange, and will help to strengthen the capability of the financial intermediaries and the industry itself to promote further exports. The loan will provide loans to firms which will help to create about 5,000 jobs of which 3,000 would meet the Bank's urban poverty capital intensity criterion. The project will develop the capability of the financial intermediaries to engage in sector lending. It will begin to sensitize them and their clients to the environmental impact of industrial projects and the need to take concrete steps to limit further environmental damage. Risks 4.37 This is the first loan in the Bank to utilize strictly private financial intermediaries to foster the development of a specific manufacturing sub-sector, textiles, and is necessarily somewhat experimental. With regard to technical assistance it calls for TSKB, the principal intermediary involved, to undertake a major new type of activity, the launching of an extension service for which there are substantial risks that its ultimate objective of implanting a local capability in Turkey (due primarily to industry resistance and recruitment problems) would not be achieved. The great potential benefits in relation to costs justify the risks, however (see para 4.34), and TSKB, one of the Bank's most experienced clients, has a good record of innovation in pursuit of national objectives. For the closely related component of a technology fund for the sector, a sufficient pipeline has not yet been identified (para 4.38). TSKB, however, is capable and willing to undertake the promotional effort required. There is a risk that the targets for the garment/ making up sector which are presently well beyond the project pipeline that has been identified (para 4.08) will not be achieved because of the small industry characteristics of this sub-sector. The especially high employment and export benefits justify the promotional efforts which these targets (para. 4.19) will spur but continued stagnation in the major export market areas (especially the EEC) leading to extension of present constraints on Turkish garment quotas would seriously jeopardize attaining them. The present importance of exports to Turkey, however, warrants taking this risk and many of the benefits from exposure to export would be realized simply from the effort to export, regardless of the levels actually achieved. V. RECOMMENDATIONS AND AGREEMENTS REACHED 5.01 The Bank has reached agreement with the Government and the financial intermediaries, TSKB and SYKB, for a project with two loans totaling US$80,000,000 with the following components: (a) an equipment component of US$75 million (paras ) to be lent to TSKB ($60.1 million) and to SYKB ($14.9

39 million) for the financing of up to 100% of the foreign exchange requirements of high priority sub-projects in the textiles and garment/making up sector; (b) a training and technical assistance component for the sector (paras ) of US$4.5 million to be lent to TSKB to finance the foreign exchange requirements of: (i) the establishment of a local training and consultancy extension service (US$1,200,000) (paras ); and (ii) a Training, Technical Assistance and Technology Fund (US$3,300,000) for high priority subprojects for training, technical assistance, and technology transfer from foreign sources (paras ). (c) a component of US$500,000 for the financing of training and special studies by the financial intermediaries (paras ) with $400,000 for TSKB and $100,000 for SYKB Agreements and understandings regarding this loan detailed in paras below have been reached and recorded for the most part in: (a) a loan agreement with TSKB for a loan of US$65,000,000; (b) a loan agreement with SYKB for a loan of US$15,000,000; and (c) two guarantee agreements with Government The loan agreements with each intermediary have the following common elements on which agreement has been reached: 1. A closing date of December 31, 1984, and certain specified relending terms (para 4.22). 2. Three-year commitment period ending on December 31, 1982 (para 4.06). 3. Sub-sectoral definition, allocation, and project eligibility selection criteria (paras 4.09, , 4.20). 4. Export requirements and orientation (paras ). 5. Environmental impact measures (para 4.34). 6. Textile sector financing not provided from the loans to comply with sub-project criteria (paras and 4.11).

40 Other important features include:. 1. Free limits of $4 million for TSKB and $750,000 for SYKB (para 4.20). 2. Intermediaries to retain as income 2.5% of interest payment on sub-loans, plus additional amounts to TSKB to finance the extension service (para 4.22). Component for Training, Technical Assistance and Technology Transfer to the Sector: 1. Local training and consultancy extension service. TSKB's responsibility to launch and administer the service for at least a three year period (para 4.29). Bank review and acceptance of resident foreign consultants and initial short-term consultant for start-up. Recruitment of the latter and the initially required consultants (for weaving and for industrial engineering assistance to garments) as a condition of loan effectiveness (para 4.30). Provision for mid-term review (para 4.30). Financing (para 4.31). 2. Loan Fund for Training Technical Assistance and Technology Transfer for Textiles: a. eligibility, priority guidelines for project selection, single project limits, appraisal, commitment, reporting and review procedures (paras ); b. relending terms (para 4.33); c. promotional efforts required of TSKB (para 4.33); d. TSKB required to give equal priority to clients referred by SYKB (para 4.33) Agreement and understandings with TSKB on full subscription and subsequently full payment of its ongoing capital increase; and on restoration of its debt-equity ratio by end-1980, if necessary by further capital increase (para. 4.04) Agreement with SYKB (para 4.05, and Annex 6, paras 4, 8-10) regarding increase in its present share capital; revision of debt/equity ratio and observance of limits; build up of provisions; and consolidated statement of policies The following conditions of effectiveness have been agreed upon during negotiations: signing of protocol pledging close cooperation by intermediaries (para 4.03); recruitment of specified consultants (para 4.30). Since there are two proposed loans, TSKB could fulfill its effectiveness

41 conditions before SYKB and begin project operations alone. This is reasonable since it will handle about 80 percent of the Bank funds and will administer both the extension service and technology fund In addition, the following understandings have been reached: (a) Both intermediaries to provide progress reports regarding equipment component (paras 4.08, 4.17, 4.20), and export activities (para 4.19); (b) TSKB to monitor and report semi-annually on: the impact of export incentives on the garment sector for supervision mission discussions (para 3.27); progress of Extension Service (para 4.29); and the Technology Fund (para 4.33) The following understandings have been reached with the Government: (a) conduct of a textile policy dialogue with the Bank (paras 3.27, 3.28); (b) the intermediaries to pay the Government a fee equal to the amount by which payment of interest due on a sub-loan exceeds a positive spread of 2-1/2% plus, in the case of TSKB, additional amounts required to finance the Extension Service (paras 4.22, 4.31).

42 -38- Annex 1 Page 1 GLOSSARY OF TECHNICAL TERMS Carded Yarn: Yarns made from fibers that have been carded but not combed in the manufacturing process. Most spun yarns are of this type. Combed Yarn: Yarns in which shorter fibers have been combed in the early stages of processing which enables finer yarns to be spun from a given quality of cotton. Cotton Sector: DPF Fiber, Man-made: Fiber Natural: Integration, Vertical: Linear Meter: Making Up: Productivity: A term used broadly to designate the spinning, weaving, and DPF sub-sectors which process textile fibers with equipment developed to process cotton fibers even though a substantial proportion or even all the throughput at a given mill may be man-made fibers. Short for "Dyeing, Printing and Finishing" processes. A class name for various genera of fibers (including filaments produced from fiber forming substances which may be: (1) polymers synthesized by man from simple chemical compounds; (2) modified or transformed natural polymers. A class name for various genera of fibers, including filaments of: (1) animal; (2) mineral; or (3) vegetable origin. Examples: (1) silk and wool; (2) asbestos; (3) cotton, flax, jute, ramie. The process in which an industrial entity expands by adding a technically contiguous process. "Forward integration" adds a process which uses the output of the entity as an input. An example is the addition of weaving to a spinning mill. Backwards integration, by the same token, adds a process which supplies an input. One yard of textile fabric measured lengthwise. Thus, the dimensions of a linear meter of cloth with a finished width of 150 cm would be 100 cm by 150 cm. A "meter" of fabric means a linear meter, not a square meter. The conversion of fabrics into garments or household articles involving the processes of cutting and sewing. Output per manhour; in the textile industry productivity in spinning is usually expressed in kg of yarn and in weaving in thousand weft yarn inserted.

43 Annex 1 Page 2 Standard Time: Wool System: The time established, through methods time measurement (MTM) for completing a specific production task for a specific product, as the standard for an individual firm or for the industry in a given country. Actual operator times are compared with standard time to determine operator efficiency. A term used broadly to designate the spinning, weaving and DPF sub-sectors which utilize equipment developed to process wool fibers, even though a substantial proportion of the fiber throughput in a given mill may be cellulosic or synthetic fibers.

44 Projected Requirements for Textile Yarns in Turkey (Thousand Tons) DOMESTIC CONSUMPTION EXPORTS Woolen Cotton and Carpets Fabrics Woven Worsted and Cotton Made-Up Fabrics Knits Fabrics Misc. TOTAL Yarn Articles TOTAL Estimate Forecast Forecast Average annual growth rate / Historical trend 5.9 1/ n.a / 5.2 3/ / - Source: Bank estimates based upon data from Werner, Survey of the Turkish Textile Industry, (Project File, No. A _); TSKB, Wool, Wool Yarn and Wool Textiles (Project File, No. ), TSKB, Textile Sector (Project File, No. ) and Working Papers (Project File, No. ). 1/ Growth rate from / Growth rate from ] ( 4/ Quota is 76,000 but individual country quotas make it difficult to exactly fulfill total quota. Amount reached in 1978 is Practical maximum. 2%/year is reasonable expectation.

45 Annex 3 Present and Projected Garment and Made-Up Textile Exports from Turkey 1/ (tons) 1977 (Actual) Exports Grand Exports to EEC Countries Total EEC to Other Total CCT Category Restricted Non-restricted (3 = 1 + 2) C Countries (6 = 3 + 5) (1) (2) (4) 60. Knitted Garments 1, , , Woven Garments 317 1,745 2, , Household Articles ,638 TOTAL 2,115 1,983 4,098 1,393 5, (Projected) 60. Knitted Garments 1, , , Woven Garments 331 2,236 2, , Household Articles ,184 2,108 TOTAL 2,354 2,786 5,140 1,854 6, (Projected) 60. Knitted Garments 1, , , Woven Garments 372 3,349 3, , Household Articles ,362 1,597 2,959 TOTAL 2,781 4,349 7,130 2,747 9,878 Average Annual Growth Rate, % 14.0% 9.7% 12.0% 10.3% Historical Growth % 1/ EEC restricted forecast as follows: categories 60 and 62 at 4% per year through 1980, at 6% thereafter category 61 and 1 1/2% to 1980 and at 4% thereafter. 2, EEC non-restricted: assumed grow at average of 12% per year to 1980 and at _'6% per vear thereafter to / Tc non-eec countries assumed that can grow at 10% per year to 1980 and at 14% per year thereafter. 4/ 1977 is taken as base year from which growth is projected. Source: Bank Estimates based upon EEC import statistics and data from Turkish Garment Exporter's Union.

46 Annex Page 1 Investment Requirements for Private Organized Textile Sector The estimates of investment required by the sector during the commitment period of the loan have been developed for each of the items in Table 2 (para. 3.18) of the report taking into account as appropriate existing capacity, additional capacity in demand expansion, needs in modernization, targeted productivity increases and the plans of the private and public sector. Given the unevenness of existing data, the uncertainty regarding growth in demand under present economic conditions in Turkey, and lack of knowledge about how fast machine productivity of existing equipment can improve, the investment forecasts are necessarily imprecise. The basis for the forecast of cotton sector weaving, which is projected as the single most important requirement for the sector is given below. The basis for other investment estimates can be found by reference to notes and supporting tables in the Project File, B.3. Estimate of Foreign Exchange Required for Expansion and Replacement in Private Cotton Sector 1. Forecast Demand for Cotton Woven Fabrics, 1983 (million m ) 1,507 1/ 2. less Present Capacity (million m 2) -1, l.sa Industry Productivity Increase 2/ (million m 2) / 4. Gross Requirement for Additional Capacity, (million m 2) less Increase in Public Sector Capacity (million m 2) / 6. less Projects with Certificate expected to obtain financing commitments prior to 1980 (million m 2 ) / 7. Net Additional loom capacity required from private sector (million m 2) Looms Required for Increased Demand (loom equivalent) 5,000 5/ 9. Looms required for Replacement (loom equivalent) 1,500 6/ 10. Total Looms Required by Private Sector (loom equivalent) 6,500 7/ 11. Investment required ($ million) 136.5

47 Annex Page 2 Notes 1/ Based on yarn forecasts presented in Annex 3, page 2 for the sum of cotton woven for domestic consumption plus exports of fabrics and made-up articles, converted to square meters of fabric at kg/m 2. 2/ An increase of 1% per year in machine productivity is assumed for the organized sector whose capacity is estimated at roughly 700 million square meters. 3/ Assumed that rehabilitization and modernization program of Sumerbank,for which Bank project is being prepared will enable Sumerbank to increase production by 50 million m 2 in 1980 and 1983 to reach full capacity operation of 250 million m 2 4/ Certificates of encouragement for additional weaving capacity estimated at million m 2 have been authorized but in judgment of TSKB only 220 million m are serious projects as discussed in TSKB's Textile Sector Study (Project File, No. A 4), Vol 1, p. 26. Because of foreign exchange constraints in Turkey it is assumed that only (i.e. 25 million m 2) will receive commitments prior to the effective date of the project file essentially prior to / Assumes an average new loom will produce 35,000 running meters per annum with a mixture of narrow and wide looms which on the average will produce a fabric of 1.2 meters in width. To the extent that very wide looms are installed in place of either narrow or wise looms the total number of looms will be reduced. Total investment costs may or may not be reduced depending upon the brand of loom purchased. 6/ Based on estimate that 4,000 narrow loom (out of 6,359 narrow looms among larger firms) would be replaced over 6 year period with new looms of double productive capability. 7/ Based on an average of $21,000 per loom equivalent including associated weaving preparatory equipment, etc.

48 SBORT(OINIIGS PRODUCTIC7 ZNGINEERING AND TECENICAL ASSISTANCE? "luired IN PRIVATE ORGANIZED SECTOR Sector Work Layout Production Quality Product Preventative House Training of Financial Management Methods Planning Control Design Maintenance Keeping Supervisors Controls Functions Spinning Weaving Dyeing and finishing Printing Knitting and knitwear Garment Manufacture l _ - _ LEGEND: 0 Not Required; 1 Requirement slight; 2 Requirement moderate; 3 Requirement great Work Methods: Correct use of machines, sequence of Preventatiye Systematic maintenance of machines to machine operations. Maintenance: avoid unscheduled stoppages and breakdowns. Layout: Efficient space utilization, arrangement HouseKeeping: Clean and tidy workplace, clear passages of machines in processing sequence. and access to machines. Production Maximum use of machines and labor Training of Selection of personnel, on the job training, Planning: materials, work flow, job simplification, Supervisors: comunicating with workers and management, standard operation procedures, within human relations. the required delivery dates. Q ility Control: Qualitv Control: Inspection, testing asterials and Inspection, testing materials and Financial controls: Standard costing, pricing, budgeting. products to established standard Management Specialization of functions, areas of requirements, controlling consistency Functions: responsibility, evaluation of performance, of products, job specification, knowledge of labor, laews and social security regulations, Product Design: Modification of design to simpllfy the accidents preventing. assembly and reduce time In process. * CD 0 ~~~~~~~~~~ EMENA/lDF i

49 45 _ ANNEX 6 Page 1 SYKB: A REVIEW OF THE INSTITUTION, OPERATIONS, FINANCIAL SITUATION AND PROSPECTS 1. Establishment and Ownership. SYKB was established in 1963 by a group of five Turkish Commerical Banks. Is Bank controls 60% of SYKB's TL 400 million share-capital. Is Bank and three of the other banks are also shareholders of TSKB. In spite of this common ownership, TSKB and SYKB operate independently and often perceive themselves as competitors. 2. Management and Staff. SYKB is managed efficiently. Mr. Cahit Kocaomer, general manager of Is Bank and chairman of TSKB's board, has been the chairman of SYKB's six-member board since February In January 1979, Mr. Orhan Altan succeeded the retiring General Manager who had been in the position since the establishment of SYKB. Mr. Altan, has considerable experience in the banking field and has impressed the Bank staff as competent and able to turn SYKB into a more dynamic and growth oriented institution. 3. SYKB has a professional staff of 38 including 11 financial analysts, 6 economists and 5 engineers. Most of the departmental managers and staff have long experience to recruit 2 or 3 additional staff during 1979 to strengthen its technical staff and to meet the needs of its growing operations. To handle the projects under the proposed loan, SYKB has agreed to engage a textile engineer. 4. Policies and Procedures. SYKB has not consolidated its policies into a formal Policy Statement; but, in response to the Bank's request, it has agreed to do so within The principal operational criteria which have evolved over the past years include: (i) SYKB finances projects in which at least 51% of the ownership is in private hands; (ii) priority is given to projects consistent with the country's Development Plan and Annual Programs; (iii) in general, loans do not exceed TL 50 million and equity investments TL 5 million and are not less than TL 1 million; and (iv) SYKB requires 50% financing by project sponsors. 5. Appraisal and Supervision. SYKB's appraisal work is satisfactory. Projects are subjected to careful technical, economic and financial evaluation, including their contribution to the economy (e.g. favorable impact on the balance of payments, regional dispersion). SYKB generally requires an economic rate of return of at least 20% in the projects it finances. SYKB's loans are secured by mortgages and/or guarantees. The lending rate is 20% and the borrower bears the foreign exchange risk. The weighted effective cost of SYKB's funds is currently about 28% per annum as a result of taxes and fees. On the real cost of interest, see paras. 2.13, Operations. Total annual approvals in recent years have fluctuated between TL 400 and TL 500 million. Unlike TSKB, local currency loans account for about 83% of its total approvals; foreign currency loans and equity investments for 15% and 2% respectively. SYKB's only foreign exchange resources from AID and EIB were exhausted in 1977 and no foreign currency loans were

50 ANNEX 6 Page 2 made in 1978 in part on country grounds. SYKB had to turn down bankable projects due to shortage of foreign exchange during Working capital loans account for about 20% of its total approvals. Although SYKB has been financing industries in all sub-sectors, its major involvement has been in textiles (25% of total approvals), engineering industries (19.3%), and food and beverages (9.1%). About one-third of SYKB's loans during have been in the less developed regions. The average size of loan has fluctuated between TL 6 and TL 9 million, but increased to TL 13.5 million in 1978 primarily due to the devaluation. About 45% of SYKB's loans have been allocated for new projects. 7. Resources. In addition to its share capital (TL 400 million), SYKB has access to long-term loans from its shareholder commercial banks out of their deposits. The outstanding amount from this source was about TL 700 million at end of Other local resources mobilized by SYKB are: (i) a Government subordinated loan of TL 106 million in 1969 and funds from the Central Bank under a rediscounting facility amounting to TL million by December The foreign resources mobilized by SYKB to date are two AID loans ($14 million) in 1969 and 1973 and two EIB loans of US$6 million each in 1974 and All of these funds have been fully utilized. A new EIB loan of $19 million and a French line of credit of $13 million have just been agreed. 8. Financial Position. SYKB's financial position is sound. Administrative expenses, at 1.4% of total assets, are reasonable. SYKB's profit record has been satisfactory, with earnings before tax amounting to between 30 and 33% of average net worth since About 85% of SYKB's net income in 1977 and 1978 has been distributed to shareholders in proportion to their shareholding and outstanding loans to SYKB. SYKB increased its share capital from TL 40 million to TL 100 million in 1978, and as of December 1978 its long-term debt-equity ratio was 12.0:1. SYKB has agreed to increase its share capital further by TL 300 million by December 31, 1979; and that from the long-term debt (including borrowings from its shareholders) equity ratio would. This level of debt is considered reasonable given SYKB's sound management and quality of portfolio. 9. Quality of Portfolio. The quality of SYKB's loan portfolio is satisfactory. Losses on loans over the recent years have been negligible. At December 31, 1978, arrears of more than 3 months amounted to TL 23.4 million (1.2% of loans) affecting 3.8% of loans outstanding, which is well within acceptable limits. SYKB has assisted the four borrowers involved to overcome their financial marketing and management difficulties, and expects the situation is now under control. Because there have been no losses, specific provisions for bad debts has not been deemed necessary. However, in view of the projected growth of its operations, SYKB has agreed beginning 1979, to allocate 5% of its annual income to provisions for bad debts to build up provisions to 2% of Loans and Equity portfolio. Such provisions will be in addition to, and not treated as part of, SYKB's equity. SYKB's annual financial statements are satisfactorily audited by Touche Ross & Co., a firm of international reputation.

51 ANNEX 6 Page Outlook for Resource Mobilization. SYKB under its new management is anxious to accelerate its growth and increase its role in private industry financing. It plans over the next five years to increase the proportion of its foreign exchange lending (12% of its total loan commitments since 1976) to about half of its total annual commitments of 1.0 billion in 1979 increasing to TL 1.5 billion by To this end, it intends to give high priority to mobilization of fresh foreign resources which has been a major constraint on its growth in recent years. Resource expectations include the US$15.0 million of the proposed textile sector loan and another loan from the Bank in the same amount in 1981 for an urban employment project. SYKB hopes to obtain a further $12 million loan from EIB in SYKB also expects to obtain further French loans in 1980 and Finally, through the contacts of its shareholders banks with the international financial markets, SYKB in recent months has approached several European and American banks for loan funds. Although these attempts are unlikely to give immediate results given Turkey's economic situation, SYKB forecasts mobilizing resources from capital markets of about US$10.0 million by With regard to local currency, SYKB expects to continue to roll over existing local currency resources. An increasingly important source of fresh funds however is expected to be the Central Bank rediscounting facility, from which SYKB expects to mobilize a total of TL 1.0 billion over the next five years. For additional details on SYKB's organization, operations, and financial condition, see Project File B.ll.

52 Annex 6-48 Page 4 SINAI YATIRIMf KIEDI BANKASI A.0. Projected Approvals, Commitments and Disbursements (TL Million) Approvals Local Currency Loans Foreign Exchange Loans Total Investments 1, , , , ,430.3 Equity Investments Total Approvals 1, , , , , ==s==~~~~~~~~ == =; = === s == S= == Commitments Local Currency Loans Foreign Exchange Loans Total Loans , , , ,368.8 Equity Investments Total Commitments , , , ,389.5 Disbursements Local Currency Loans Foreign Exchange Loans Total Loans , , ,347.7 Equity Investments Total Disbursements , , ,366.3 min6-" =mm in a=m_o S Sa_t mw"=

53 Annex Page 5 SINAI YATIRIM VE KREDI BANKASI A.O. Projected Income Statements (TL Millions) (Actual) INCOME (Million TL) Income from loans: - TL Loans Foreign Currency Loans ) Dividends Other Income EXPENSES Total Income ,05.0 Expenses related to debt Personnel eicpenses ) Provision for termination 1 1 indemnity Administrative expenses Taxes, dues and fees Depreciation ) Provision for losses related 1.. to loans and equity investments Total Expenses Income before taxes Taxes Net Income APPLICATION OF INCOME - Statutory reserve (5%) Additional reserve (10%) ) * - Dividend Available for distribution Dividend bonus ) Total

54 Annex Page 6 SINAI YATIRIM VE KREDI BANKASI A.O. Balance Sheets (TL Millions) (Actual) ASSETS Cash Accrued Interest Other Receivables Current Investments Loans and Investment TL Loans 1, , , , , ,924.5 Foreign Currency Loans , , , , ,877.5 Financial Investments Equity Investments Total Loans and Investments 1, , , , , ,920.3 Less: Provision for losses Net Total Loans and Investments 1, , , , , ,877.0 Net Fixed Assets Total Assets 2, , , , , ,581.2 LIABILITIES Short-Term Debts Tax Payable on Previous Year's Profit Dividend Payable from Previous Year's Profit Bonuses for Management and Personnel from Current Profit Accrued Interest and Miscellaneous Debt Current Debt Medium-Long-Term Debts Shareholder Banks' Funds AID Loans Central Bank Total Turkish Currency Debts 1, , , , ,471.2 AID (Currency foreign currency) EIB (Current) EIB (Prospective) IBRD , ,276.4 French Export Credits US Eximbank Other Prospective foreign currency loans Sub-total , , , , ,877.5 Medium-Long Term Loans 1, , , , , ,348.7 Termination Indemnities Equity Paid in capital Legal Reserves Reserves for current yeas Dividend available for distribution Total Equity Total Liabilities 2, , , , , ,507.2 Long-Term Debt/Equity Ratio

55 Action Plan ProJect Pipeline Garments/Making Up Spinning Weaving DPF Accessories TOTAL Allocation TSKB SYKB TOTAL Allocation Note: Figures refer only to amount of project financing to be supplied by intermediaries. Source: Action Plans - Texts and Analysis, Project File No. B.12

56 ANNEX 8 Page 1 TRAINING, TECHNICAL ASSISTANCE AND TECHNOLOGY Transfer to the Sector 1. Much of the divergence in Turkey between present and potential efficiency of the textiles and garment industry is rooted in avoidable production problems in the technical and industrial engineering area (see main text, paras ). Better training at the supervision and middle management levels, and the greater availability of practical sources of technical assistance, both local and foreign, could significantly help to cure these deficiencies. There is also a widespread need for practical assistance in export marketing, especially for the garments/making up sub-sector (see main text, para 3.28). To help meet these needs a technical assistance, training and technology component is proposed for this project. This component has two elements: one, "Local Training and Consultancy Extension Service", seeks to begin developing a practical Turkish capability for diagnosis and on-the-job training in the above fields since no existing institutions provide such a service; the other, the "Training and Technical Assistance and Technology Fund," removes the foreign exchange constraint to technical assistance and training from foreign firms, now the principal supplier of these resources. The two elements are intended to complement and reinforce each other as discussed below. (a) Local Training and Consultancy Extension Service 2. Overview of the Program. This element, with an estimated foreign exchange cost of about $1,200,000, seeks to institutionalize within Turkey a practical capability in the fields broadly defined as production management and cost control for problem diagnosis, trouble shooting and in-plant training to improve machine, labor and other factor productivity involving primarily the application of technical, industrial engineering and related skills. There would also be provision for export marketing assistance in the case of garments/making-up and for textiles. The textile sector program would consist of two parts: (1) an in-plant consultancy, training, and follow-up service would involve sending a small team for several weeks to a participating factory to survey its operations, detect conditions which are reducing its efficiency, assist management in making changes in its operations and provide on-the-spot training of supervisors and foremen related to the proposed changes; (2) an industrial engineering training and follow-up service would run courses within individual factories with groups of participants from several factories to develop capabilities in techniques such as work study, production planning and control, preventative maintenance, etc. For the garment/making-up sub-sector there would be (1) a single industrial engineering consultancy, training and follow-up service, involving a more complete consultancy and training service than for textiles, because garment industry middle management is likely to be less specialized; and (2) an export marketing service, utilizing a resident marketing advisor supported by short-term specialists to help focus export promotional efforts and provide practical marketing assistance to individual firms.

57 ANNEX 8 Page 2 3. The capability to provide these services would be developed over a five year period utilizing a core staff of five experienced foreign consultants who would be resident for periods of one to two years. In the process of providing the above services they would eventually train approximately fourteen carefully selected Turkish counterparts, already technically trained and experienced, in the skills of consultancy, training, and technical assistance. 1/ Appendix 1 presents a chart of the services expected to be provided (see also Project File B.13). The program would be conducted in two phases: an initial pilot phase of two years during which about forty firms (twenty each in garments and textiles) could be assisted; and a three year maturing phase in which an additional 120 firms could be reached. To encourage participation in this project services would be provided free during the pilot period but an increasing scale of fees would be charged thereafter with the objective of making the service self-supporting after five years. 4. Criteria of Eligibility. Eligibility for the service would be based upon: (a) interest in participation and (b) a technical judgment that a factory would significantly benefit from the service. Firms which have previously borrowed from the Technology Fund (paras 9-12) would be ineligible unless TSKB judges that there is no overlap. The final selection of participating factories would be carefully made, after preliminary plant visits by the consultants, to ensure that the demonstration effect of the service would be maximized. Though the extension service in principle will be open to all firms in the sector, in practice it is expected that a large portion will be existing or prospective clients of the financial intermediaries. As a result of the service's diagnostic work, it is hoped that many factories would be motivated to follow-up this service either by undertaking programs of modernization and renewal requiring equipment, or by seeking additional or more specialized technical assistance. To facilitate such follow-up, the intermediaries will give priority to firms that have received assistance under the extension service which apply for loans either for equipment (see main text, paras ) or for further technical assistance under the Technology Fund. 5. Administration of the Program. The delivery agency for this program during the commitment period of the loan will be TSKB. Although a number of other possible local institutions were considered, TSKB's large and expe- rienced technical staff, its close touch with textile and garment sector needs, and its general management quality and proven capability to live up to its commitments, best qualify it to launch a program of this importance and magnitude and to supervise it during the initial pilot period. TSKB will consult with SYKB and industry representatives to obtain policy guidance and strengthen contact with industry. It will establish, in consultation with SYKB and the consultants a mechanism for selecting beneficiary firms. A detailed plan for the program will be submitted to the Bank for review and 1/ It is not expected that the functions of the export promotion advisor would be institutionalized due to the nature of the function.

58 ANNEX 8 Page 3 approval prior to disbursement. Since this type of activity is peripheral to its primary lending functions, TSKB has agreed to accept responsibility to launch the project and to administer it for three years. There will be a review of the program within 2 years, involving the Bank, the Government, TSKB, SYKB, and industry representatives to evaluate it, to decide whether it should be continued after the commitment period of the loans, and to propose subsequent institutional and financial arrangements satisfactory to the Bank. TSKB will prepare, in advance of this review, a report on the effectiveness of the services provided, on institutional and financial alternatives, and to recommend a plan for transition. Possible successor arrangements include the creation of a separate consulting agency owned by some combination of the development banks and the textile industry, or full control by one or more of the industry associations including the Garment Manufacturers Export Union, the Chambers of Commerce, and the Textile Employer's Union. The Governmentowned Sumerbank Textile, Training and Research Center is also a possibility if its organization and objectives are re-oriented to serve private as well as public sector needs. TSKB's agreement to provide semi-annual reports on progress in recruitment of consultants and in their provision of services is included in a supplementary letter. 6. Funding. Since the program will be offered free to participating firms during the initial period and at reduced rates thereafter, until adequate demand at full costs develops, funding will be needed for the Turkish lira costs (primarily the salaries of Turkish counterparts) estimated at TL 36 million during the three year commitment period of the loan and at TL 64 million for the following two years when it is targeted that the program would be able to become self-supporting. The Government has agreed in principle to provide financial support for the program for which utilization of a portion of the spread between the interest rate paid by the Government as a guarantee fee is envisaged. A portion of the spread of 1 percentage point per annum would be required for 7 years, plus amounts sufficient to service the foreign exchange portion of the cost of the extension service. The foreign exchange cost, estimated at US$1,200,000 would be financed as a sub-loan to TSKB for 7 years with 3 year grace period. 7. Selection of Consultants. To help ensure that the potential of this element for improving industry efficiency is realized, the following will be required: (a) Bank review and acceptance of resident consultants; they will be selected by and be responsible to TSKB, with appointment of the initial two consultants for weaving/knitting and for garments/making up as a condition of loan effectiveness to ensure that the program is promptly launched. (b) Employment by TSKB of a consultant acceptable to the Bank as a condition of effectiveness for an initial two to three month period, and for assignments thereafter when the program is reviewed; he should have

59 ANNEX 8 Page 4 practical experience in the proposed extension service and be able to develop a program outline, prepare detailed terms of reference, screen candidates, and provide general advisory assistance. 8. Risks. Given the experimental nature of this component, it must be recognized that there remains a risk that it might not meet all of its objectives. One risk is that a suitable permanent delivery agency cannot be identified until after the commitment period of the loan. The mid-term review procedure (para 5) is designed to prevent this. A second risk is that local counterparts might be hired away after their training by private industry, rather than remaining with the service. In anticipation of this, salaries budgeted for local counterparts have been set at attractive initial levels (TL 1 million/year in mid-1978 prices) and real annual average increases of 5% have been assumed. Furthermore, there is the long-term possibility that, though the organization proves its worth, it fails to become financially sufficient after a five year period as now projected. Continued allocation of a portion of the interest rate spread may have to be used to partially subsidize the service even after five years, if its establishment is slow but it continues to look promising. While these risks are substantial, the model is not new; similar extension services have been successfully established to serve segments of the textile sector in a number of other countries (U.K., Pakistan, India). The component can be justified simply on the basis of the training and technical assistance rendered for which net benefits in terms of foreign exchange saved could be substantial, regardless of whether this capability can be successfully institutionalized. (b) Training, Technical Assistance and Technology Fund 9. Scope. Since the local extension service described above would cover only a portion of the sector's needs even after a 5 year period, and since the scope of its services would necessarily be limited by the size of its staff and its lack of specialization, the textile industry will continue to require access to training, technical assistance and technology from foreign sources. To help remove the present foreign exchange constraint to such access, an amount of US$3.3 million would be allocated to a second element of this component called the "Training, Technical Assistance and Technology Fund" from which any creditworthy firm in the sector could borrow, provided there were no duplication of assistance from the Local Training and Extension Service, as discussed below, para 11. Eligible categories of assistance would relate broadly to the applied fields of production and industrial engineering, financial control, research and development, pollution control, as well as export marketing and would include: training of Turkish engineering or technical personnel abroad; hiring of foreign technicians, engineers and consultants; purchase of equipment related to technical adjustment and quality upgrading such as laboratory and testing equipment. Loan maturities would normally be for three to five years and TSKB has agreed to limit them to no more than six years. The loan agreement sets an upper limit of $250,000 to prevent pre-emption by large borrowers, but typical loans

60 ANNEX 8 Page 5 are expected to average about $100,000. There would be no lower limit, to allow worthwhile proposals for individual staff training or for high priority short-term consultants to be assisted. Priority will be given to applicant firms on the following basis: (a) firms seeking to increase productivity and efficiency of existing equipment; (b) firms which can show that the technical assistance will lead to entry into or expansion or upgrading of substantial export sales. Within the above categories, special priority will be given to firms with a plan for technical assistance developed as a result of prior assistance from the local extension service (para 7). 10. Administration of the Program. As with the Local Training and Extension Service, this element will be administered by TSKB and will utilize for its administration essentially the same experienced technical staff as for project promotion and appraisal in the textile sector. Appraisal and monitoring procedures would be kept simple, however, and would involve mainly an assurance of the appropriateness of the project to the company's objectives, its eligibility under the criteria of this component and the creditworthiness of the borrower. Bank supervision will be limited to ex post monitoring for which TSKB has agreed to furnish copies in English of every third appraisal, and semi-annual progress reports on commitments, approvals and status of projects in the pipeline. 11. Eligibility. Under the technical assistance set-up envisaged, a firm could be assisted under both elements. It could for example receive an initial diagnosis of problems and on-the-job training at a nominal fee under the local extension service, followed by more extensive and more specialized follow-up services from foreign consultants for which it would borrow under this element. TSKB intends to encourage the financing of such follow-up services by this Fund. Whenever a firm has been initially assisted by the extension service TSKB will make a judgment, recorded in its appraisal report, that no overlap in types of services received will occur. 12. Conditions for Utilization of the Fund. While the exact demand for this fund is difficult to ascertain, candidates for 30% of the total, have already been identified by TSKB in the course of promotional efforts it has already unidertaken. To further ensure that the fund will be utilized, agreement to the following conditions has been reached: (a) TSKB will undertake further promotional efforts to bring this facility to the attention of industry, in close cooperation with the Local Training and Consultancy Extension Service but utilizing its own staff as needed. This program will be based on a promotional plan submitted in advance to the Bank for review, and on which semi-annual progress reports would be made. (b) TSKB will cooperate closely with SYKB and give equal priority on a first come, first serve

61 ANNEX 8 Page 6 basis to clients referred by SYKB, provided that eligibility criteria are met. If this promotional effort succeeds in developing greater demand than supply, this element would be eligible for additional funds from the unallocated category of the equipment component, with prior Bank approval, upon documentation of the additional amounts needed..

62 Guidelines for Consultancy and Training Staff TSKB To be decided after review Institutional Responsibility PHASE 1 PHASE 2 Ycar 1 Year 2 Year 3 Year 4 Year 5 TEXTILES 1. In-Plant Management (a) Weaving/Knitting Foreign -- b - K (b) Dyeing/Printing/ Foreign Local Finishing Local Local [- - j (c) Spinning Foreign Local Local r - 2. Industrial Engineering Foreign - 1 Local I GARIMENT/MAKING-UP Local 1. Industrial Engineering Foreign Local Local _ Local Marketing Foreign Local ! Local _ l Foreign _ Foreign Foreign Foreign _ l AD HOC Consultant Foreign Number of staff during each 6 mo. period Deadline for program review Foreign consultants Local consultants (t +.,,r

63 Annex Page 1 Selected Documents and Data Available in the Project File A. Reports and Studies on the Sector 1. Cotton Textile Industries in Turkey and in the Common Market Countries TSKB, January Wool, Wool Yarn and Wool Textiles, TSKB, April The Turkish Textile Industry and its Export Prospects, Werner International, Inc (2 Volumes) 4. Export-Oriented Industries and Small-Scale Industries in Turkey, Industrial Sector Mission, August 1977 Bank Report No TU 5. Textile Exports - Project Identification Mission, December 30, Textile Sector, TSKB, April 1978 (3 Volumes) 7. Developing Countries' Exports of Textiles and Clothing: Perspective and Policy Choices, Donald B. Keesing (White Cover, report by Bank Staff, May 1978) 8. Fourth Five Year Plan, "The Textile and Clothing Industry" October 1978 State Planning Organization 9. Staff Appraisal Report on Proposed Thirteenth Loan to TSKB Bank Report No TU B. Selected Working Papers 1. Textile Sector Structure and Performance -- Selected Tables 2. The Financial Performance of Textile Firms in TSKB's Portfolio * (Working Memorandum) 3. Investment Estimates -- Notes and Supporting Tables 4. The Estimated Age Distribution of Spinning Equipment -- Selected Tables 5. Productivity of Turkish Mills 6. Technical Assistance Requirements of the Turkish Textile Industry and Review of Training Institutions (Working Memorandum)

64 Annex 9-60 Page 2 7. Technical Assistance Requirements of the Turkish Garment Industry and Review of Training Institutions 8. Impact of Incentive and Organizational/Administrative Framework for Exports of Textiles and Made-Up Articles 9. TSKB and SYKB: Comparative Indicators of Size and Volume of Operations 10. Environmental Guidelines applicable to textiles prepared by World Bank Office of Environmental Affairs 11. SYKB: Detailed tables of past operations, financial statements, and forecasts of operations, income statements, balance sheets, cash flow and resource requirements..

65 BULGARIA a c k Sea U.S.S.R. r'\o,,kirklareli- U J TEKI7DAK - KASTAMONU P 'IN ~~o'1'~~ ZONGULDA 0,* U R A S KARS OR-U o 1 NMI,,AKKALE L1/-\ / WB MUS x/ o t \ > ro K g GUMU,S *_IR 40 - Lu USAK AFYON~p EHLQ< KAYSEAA UF -N ERZURUM~~~~~~~ I RKEY L IK SHT.IMI,K,, <.N AL%Y N raa ri=j)t A / N ESKISEHIR ANKARA 0 0~~~~~~~~~~~~~~~~~PANAR NDISEDEU A.7A>M t ) REGIDNALBOUNDARIES Ml 1i4fS 1-0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~' ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~. 0 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~j \=eyogi Tg c/ a_ 7 DEVELOPED PROVINCES ANOMUNICIPALITIES IR EH_RASEMI DEVELOPED PROVINCES _~~~~~~~~~~JEIL I 0 I RAIlA Ale d i/erzr an ean Se a rl LEAST DEVELOPEDRFEGIONS S/ Y R I A ZM!R MTSAKIB REGIONALBRANCHOFFICES -5 SCYPRUS O ioo 200 3,00 < NILDMETERS O SO ioo IO 0-' TB KR ADMINISTRATIVE DISTRICTS - PROVINCIAL RDUNDARIES W 0J PROVINCIAL CAPITALS INTERNATIONALBOUNDARIES >_