4: TURKEY COUNTRY ASSISTANCE STRATEGY FY04-07

Transcription

1 Page 1 of 59 Annex 4: TURKEY COUNTRY ASSISTANCE STRATEGY FY04-07 Completion Report Ankara, January 10, 2008

2 Page 2 of 59 ABBREVIATIONS AND ACRONYMS AAA ARIP BEEPS BRSA CAE CAS CASCR CCT CEDPL CEM CIR CIT CPS DIS DPL ECA EFIL EGDPL ERL ESS EU FDI FX FY GDP GEF GFS GNP HTP IAC ICA ICT IDF IEG IFC IMF IPA JPPR LI MEER MIGA MOH OECD PEM PFMC PFPSAL PIT PPDPL Analytical and Advisory Activities Agriculture Reform Implementation Project Business Environment and Enterprise Survey Banking Regulation and Supervision Agency Country Assistance Evaluation Country Assistance Strategy Country Assistance Strategy Completion Report Conditional Cash Transfer Competitiveness and Employment Development Policy Loan Country Economic Memorandum Country Impact Review Corporate Income Tax Country Partnership Strategy Direct Income Support Development Policy Loan Europe and Central Asia Export Finance Intermediary Loan Employment Generation Development Policy Loan Economic Reform Loan Education Sector Study European Union Foreign Direct Investment Foreign Exchange Fiscal Year Gross Domestic Product Global Environment Facility Government Financial Statistics Gross National Product Health Transition Project Investment Advisory Council Investment Climate Assessment Information and Communication Technology Institutional Development Fund Independent Evaluation Group International Finance Corporation International Monetary Fund Investment Promotion Agency Joint Portfolio Performance Review Local Initiatives Marmara Earthquake Emergency and Reconstruction Multilateral Investment Guarantee Agency Ministry of Health Organization for Economic Cooperation and Development Public Expenditure Management Public Financial Management and Control Programmatic Financial and Public Sector Adjustment Loan Personal Income Tax Programmatic Public Sector Development Policy Loan

3 R&D SDIF SEE SME SOE SPO TEMAD UN UNDP UNICEF WBI WHO Research and Development Savings Deposit Insurance Fund State Economic Enterprise Small and Medium Size Enterprise State Owned Enterprise State Planning Organization Turkish Emergency Management Agency United Nations United Nations Development Program United Nations Children s Fund World Bank Institute World Health Organization Annex 4 Page 3 of 59

4 Page 4 of 59 TABLE OF CONTENTS 1. Objectives and Methodology Turkey s Long-term Strategic Goals Progress and CAS Results Bank Performance during the CAS Period Key Considerations for the New CPS...29 Table 1: Turkey s Strategic Goals and CAS Framework...8 Table 2: Sound Macroeconomics and Governance Key Expected Outcomes and World Bank Benchmarks...9 Table 3: Equitable Human and Social Development Key Expected Outcomes and World Bank Benchmarks...15 Table 4: Attractive Business Climate and Knowledge Key Expected Outcomes and World Bank Benchmarks...18 Table 5: Environmental Management and Disaster Prevention Key Expected Outcomes and World Bank Benchmarks...22 Table 6: Turkey Portfolio Overview, FY Figure A: FY06 Turkey Portfolio Performance Indicators vs. World Bank and ECA...26 ANNEX 1: Key Outcomes and Bank Group Benchmarks...31 ANNEX 2: Turkey Country Assistance Strategy Matrix...35 ANNEX 3: Original, Revised and Actual CAS Lending Program...49 ANNEX 4: Original, Revised and Actual Non-lending Program...50 ANNEX 5: IFC in Turkey FY ANNEX 6: Developments in FY

5 Page 5 of Objectives and Methodology 1.1. The Country Assistance Strategy Completion Report (CASCR) assesses the effectiveness of the FY04-07 Country Assistance Strategy for Turkey. It measures the achievement of the expected results, and highlights key lessons learned. The assessment focuses on the FY04-06 period, even though the original CAS was extended to include FY07 in order to bring the Turkey CAS in line with the other CASs covering four years. This was driven by the need to utilize the CAS CR findings as inputs for the new Country Partnership Strategy (CPS), whose preparation began in early FY07. Key developments that occurred during the last year of the CAS are summarized in Annex While the CAS itself was not formally results-based, it was centered on two results matrices. One includes the key outcomes and World Bank benchmarks (see Annex 1), while the other, more detailed matrix, contains country performance indicators and more comprehensive Bank Group benchmarks (see Annex 2). Outcomes refer to broader achievements at the country level, while benchmarks refer to more specific areas of contribution from the World Bank. Overall, both outcomes and benchmarks have been relevant in capturing the key strategic objectives of the country and the ways in which the World Bank could contribute towards them The preparation of the CASCR benefited from a broad range of resources, including: Inputs from World Bank teams, including periodic updates of the CAS results matrices; Inputs from main counterparts, particularly the Undersecretariat of the Treasury and State Planning Organization (SPO), in addition to relevant line ministries; The annual Joint Portfolio Performance Review (JPPR), which in Turkey has taken on an increasingly strategic focus, moving into the assessment of CAS results in addition to the coverage of portfolio performance indicators. The JPPR itself is the result of a joint cooperation with the Treasury, the SPO, and all the line ministries and implementing agencies involved in Bank-financed projects and analytical work; and A Country Assistance Evaluation (CAE) 2 and a Country Impact Review (CIR) 3, prepared by the Independent Evaluation Group (IEG), assessing the effectiveness of the Bank and the International Finance Corporation (IFC) assistance programs, respectively, during the FY period. These reports, completed and made available to the Board in October 2005, provided useful insights on the initial implementation of the current CAS. 1 The results framework for this CAS was designed at a time when results-based CASs were in a pilot stage. Therefore, this results framework is not entirely consistent with the guidelines which currently govern results-based CASs. 2 The World Bank in Turkey, , Country Assistance Evaluation, Independent Evaluation Group, December 20, 2005, Report No Turkey: IFC Country Impact Review, IEG Findings No.4, Independent Evaluation Group, January 1, 2006, Report No

6 1.4. Criteria used to assess the progress and results of the CAS include: Annex 4 Page 6 of 59 Relevance of the CAS main development objectives in the context of Turkey s development agenda; Relevance of the CAS key outcomes and World Bank benchmarks; Extent to which the CAS key outcomes and World Bank benchmarks have been achieved; Impact of World Bank lending and analytical instruments on the achievement of key benchmarks; and Bank performance and other relevant factors contributing to, or influencing the achievement of key outcomes and benchmarks. 2. Turkey s Long-term Strategic Goals 2.1. Turkey s long-term agenda has been articulated in the 23-year National Development Plan ( ). In addition, priorities of the Government, which took office following the 2002 elections, have been spelled out in its program presented to Parliament and in the Urgent Action Plan. 4 The long-term development goals, as defined in these documents, include: Transforming the country s economic and social structure in order to become an influential regional power; Raising the level of health and education in the society; Improving the income distribution; Strengthening scientific and technological capacity; Enhancing effectiveness in infrastructure services; Protecting the environment The vision that Turkey has for itself is of a modern and secular participatory democracy, fully integrated in the European community, playing a critical role in its region, with an export-oriented, technology-intensive production structure. Turkey sees the EU accession process as an important opportunity for harmonization with international norms and standards. Also, Turkey s geo-strategic position offers a unique opportunity to reach its true economic growth potential Consistent with its long term goals, Turkey s development agenda has been centered around four major themes: (a) sound macroeconomics and governance; (b) equitable human and social development; (c) attractive business climate and knowledge; and (d) strong environmental management and disaster prevention. These themes, albeit to varying degrees depending on the Bank s comparative advantage and the role of other development partners, have also been the areas of focus for the CAS (see Table 1) The long-term goals, described above, have not changed during the CAS period and the four clusters of development themes have remained relevant. Changes in emphasis, however, have occurred. First, the EU s decision to open accession negotiations with Turkey has increased the priority of reforms necessary for EU accession. This resulted in an 4 A new strategic document, the 7-year 9 th Development Plan was approved by Parliament in June 2006, and the priorities defined in this plan will be reflected in the new CPS.

7 Page 7 of 59 adjustment of the Bank Group program, in the context of the CAS Progress Report of late 2005, to align it with Turkey s EU accession agenda. Second, employment creation has become a higher priority during the course of the CAS period. Despite sustainable strong economic growth, low labor participation and high levels of unemployment, in part due to labor shedding in agriculture, continue to constitute a key economic and social issue. The Bank has responded to this emerging priority by producing some critical analytical work, including the investment climate assessment, the labor market report and the education sector study, as well as by designing with the authorities a set of development policy loans (DPLs) which have been added to the program under the CAS Progress Report.

8 A. Transform economic and social structure a. Sound Macroeconomics and Governance Table 1: Turkey s Strategic Goals and CAS Framework Turkey s Long-term Strategic Goals B. Raise level of health and education, improve income distribution b. Equitable Human and Social Development C. Strengthen scientific and technological capacity, enhance infrastructure CAS Development Themes c. Attractive Business Climate and Knowledge Annex 4 Page 8 of 59 D. Protect the environment d. Strong Environmental Management and Disaster Prevention Stabilization of public creditworthiness indicators at sustainable levels Less volatile economic growth in the range of 5% Single digit inflation Low extreme poverty (1.8%) maintained and vulnerability reduced from 15% in 2001 to 12% in 2006 Net enrollment rate in basic education maintained at not less than 99%; girls enrollment increased, especially in secondary education: male/female ratio improved from 1.20 to 1.15 by 2006 Child mortality reduced and maternal health improved Expected CAS Key Outcomes Exports growth rate exceeds GNP growth rate Foreign Direct Investment reaches US$1.5 billion on average during the CAS period Stability of financial markets improved Significant convergence with EU environmental standards Disaster prevention and management system improved Achieved Largely Achieved Achieved Partially Achieved Satisfactory macroeconomic and fiscal framework consistent with the key outcomes Implementation of public sector reforms Expected World Bank Key Benchmarks Public expenditure on health, education and social protection sustained at pre-crisis levels Implementation of (i) the Conditional Cash Transfer (CCT) program to benefit over 1 million children, and (ii) at least 1,500 local initiative (LI) projects to support vulnerable people Renovation and modernization of schools Improvements in access and quality of basic health provision Increase in export capacity of enterprises Improvements in the overall investment climate, implementation of the new FDI law, establishment of an Investment Promotion Agency (IPA) Continued independence of financial markets regulatory agencies Completion of privatization of state banks; passage of new Bankruptcy Law and Commercial Code; implementation of nonbank financial institutions reform Environmental sector priorities updated in the EU context Introduction of mandatory insurance cover of private housing units; creation of a strict and enforced construction code enforcement system, and strengthening of emergency preparedness Achieved Achieved Largely Achieved Partially Achieved

9 Page 9 of Progress and CAS Results 3.1. Important progress towards achieving Turkey s long-term goals has been made during the CAS period. This CAS was designed at the beginning of Turkey s recovery from the 2001 crisis. This was no longer a crisis-management program but one which focused on consolidating the results of crisis management and on laying the foundation for sustainable high economic growth to help Turkey meet its long-term goals. Turkey s economy has produced a spectacular turn-around during the CAS period. Macroeconomic stability has improved greatly since 2001, while per capita GNP increased from about US$2,900 in 2000 to about US$5,500 by There has also been progress in social development, although somewhat less than expected. On the positive side, extreme poverty remained almost negligible and poverty, more broadly defined, has declined considerably. However, still about one out of five Turkish citizens would be considered poor. In health and education, access has improved. However, limited access to higher education remains a problem, and the quality and cost-effectiveness of education and health services require further improvements Following is a summary of Turkey s progress and Bank actions. Key outcomes and World Bank benchmarks, derived from the program results matrices (see Annex 1, 2) are grouped into the four development themes of the CAS. a. Sound Macroeconomics and Governance Table 2: Sound Macroeconomics and Governance Key Expected Outcomes and World Bank Benchmarks Expected Key Outcomes Outcome Expected Key Bank Group Benchmark Stabilization of public creditworthiness indicators at sustainable levels Less volatile economic growth in the range of 5% Single digit inflation Status Achieved Achieved Achieved Benchmarks Satisfactory macroeconomic and fiscal framework consistent with the key outcomes Implementation of public sector reforms, focusing on: (i) the tax system; (ii) public expenditure management; (iii) the social security system; (iv) the civil service; (v) local government; and (vi) anticorruption. Status Achieved Achieved

10 Page 10 of 59 Outcomes 3.3. The consequences of Turkey s economic crisis of 2001 were devastating: depreciation of the currency by some 50%, a jump in nominal interest rates to 100%, the virtual collapse of the banking system and the bankruptcy of scores of enterprises. At the end of 2001, Turkey registered a 10% decline in GNP, inflation was on the order of 70%, and the net public debt to GNP ratio exceeded 90%. Five years later, following a remarkable economic recovery, the picture looks quite different. Economic growth has been strong, with average GNP growth close to 8% between , and inflation was brought down to single digits by 2004, the first time for more than thirty years. In 2006, economic growth, while decelerated, continued to be robust at 6 percent. While high oil prices and the consequences of fluctuations in emerging markets in the summer of 2006 have reversed the declining trend of inflation, the Central Bank and the Government were able to keep it to single digit this year. Turkey s debt situation has improved substantially over time, as the net public debt to GNP ratio was reduced from over 90% in 2001 to 45% in Nevertheless, and despite growing exports, the current account deficit reached 6.4% of GNP in 2005 and 8.2% in External factors, such as the regional political context and potential political difficulties in the EU accession process, add uncertainty as to Turkey s ability to continue such a generally strong economic performance. Status of Key Benchmarks 3.4. Satisfactory macroeconomic and fiscal framework consistent with key outcomes: Turkey s remarkable macroeconomic performance has been due to several factors, including a solid agenda of structural reforms and strong fiscal discipline. The fiscal policy targeted the achievement of large primary surpluses of the public sector on the order of 6.6% to enable a reduction of the public debt burden. The Government s macroeconomic and fiscal framework has been supported by the International Monetary Fund (IMF) through consecutive stand-by arrangements and significant Bank adjustment lending Strong fiscal performance has been the cornerstone of Turkey s economic program, with an overarching aim of achieving sustainable fiscal balances, while improving stability, transparency and equity of the tax system. The Government s focus on fiscal adjustment, however, has been more on revenue-increasing rather than expenditure-controlling measures. Social spending has been kept well above the agreed benchmark of 14.5% of GNP. However, concerns remain over the social security deficit, which is to be capped at 4.5% of GDP in 2006 and A major positive step has been the approval, in May 2006, of a landmark social security and universal health insurance legislation, which aimed at the creation of an institutionally unified, fiscally more sustainable system with a universal coverage of health insurance. 5 In addition, an agriculture framework law 6 was approved in April 2006, and the follow-up regulation institutionalized the non-distortionary Direct Income Support (DIS) for farmers The US$1 billion Programmatic Financial and Public Sector Adjustment Loan (PFPSAL) III, the third in a series of programmatic loans, supported the Government's comprehensive reform of the financial and public sectors. The Health Transition Project 5 However, in December 2006, the Constitutional Court invalidated several provisions of the Law and the Government decided to postpone its implementation while it is trying to address the Court s concerns. 6 Agriculture Law No. 5488

11 Page 11 of 59 (HTP) has supported broad reforms of the health system, including the introduction of a unified health insurance system. Finally, the Agricultural Reform Implementation Project (ARIP) assisted the Government in reducing agricultural subsidies which ultimately declined by 70% (excluding direct income support) between 2001 and On the non-lending front, the program was supported by two Country Economic Memoranda (CEM) on Macroeconomic Stability and EU Accession, delivered in FY03 and FY06, respectively. Fiscal reforms towards increased tax efficiency, expanded employment and higher labor productivity, expenditure rationalization, more favorable market environment, financial sector reform, industrial innovation, and promotion of social policies were some areas of focus. Additionally, the analytical work on policy and investment priorities for agricultural and rural development took stock of recent policies and investment patterns in the agricultural and wider rural sector in Turkey, helping to form the basis for the Agriculture Framework Law. Finally, a Public Expenditure Review (PER) focusing on quality of public expenditures was delivered in December Implementation of public sector reforms, focusing on: (i) the tax system; (ii) public expenditure management; (iii) the social security system; (iv) the civil service; (v) local government; and (vi) anti-corruption (i) Tax system: A medium-term strategy for improving the tax system in Turkey has been in place since 2000, based on a review carried out jointly with the World Bank. The overarching objective of the strategy is to improve the stability, transparency and equity of the tax system through measures to minimize tax distortions, broaden the tax base and improve the efficiency of tax administration. Implementation of the tax strategy has progressed reasonably well. In 2003, a legislative package was enacted under the direct tax reform designed to simplify and consolidate the direct tax regime, in line with the Organization for Economic Cooperation and Development (OECD) standards and international best practice. A second package was enacted in 2004 to minimize geographical, sectoral and other reinvestment incentives, including rationalizing the benefits in Free Trade Zones. The first stage of personal income tax (PIT) reform has been implemented by the enactment of the law reducing the number of brackets and unifying the wage schedules in March Turkey has also initiated reforms for simplifying the corporate income tax (CIT) as well as reducing its rates. The CIT rate was reduced from 33% to 30% for corporate income earned in 2005 and further to 20% in 2006 with a competitiveness consideration consistent with the developments and the trends in the European Union and OECD countries. In addition, the Revenue Administration Law, which established a semi-autonomous revenue administration within the Ministry of Finance, was enacted in A new unit responsible for determining the Government revenue policy under the Ministry of Finance was established in The PFPSAL III supported the design and implementation of the Government s tax strategy as part of the broad public sector reform program implemented in the context of this adjustment operation (ii) Public Expenditure Management (PEM): Improved PEM is a crucial element of Turkey s broader public sector reform strategy. It focuses, inter alia, on improved budget preparation and execution, the operational performance of public agencies, and upgrading public accounting, procurement, and audit standards. The PFPSAL III assessed the

12 Page 12 of 59 underlying problems of Turkey s PEM, pointing to a lack of modernization in the procedures and institutions governing decision-making and resource allocation. In this context, the passage of the Public Financial Management and Control (PFMC) Law, enacted by the Parliament in December 2003, represents an important step. The law constitutes the cornerstone of the legal framework for modern PEM in Turkey. It introduced modern public management principles by clarifying accountability of public officials, by delegating managerial responsibility, and by putting in place an internal control and audit framework that is compatible with EU and international practice. Budget transparency increased through the application of Government Financial Statistics (GFS)-consistent budget classifications, allowing a comprehensive and consistent presentation of the budget across all general Government agencies with a complete functional breakdown of expenditure. Through the 2006 budget, the PFMC law has been implemented in key areas including: (a) improving budget formulation processes to enable a medium-term fiscal strategy to guide fiscal aggregates and enable sector budgets to be linked to policy priorities; (b) expanding budget coverage to all central Government entities; (c) expanding the GFS-consistent economic and functional budget classification to the entire central budget entities and social security institutions; (d) delegating more responsibility (with related accountability) to spending agencies through reforming the internal control regime and abolishing central-level ex-ante control; and (e) improving accounting through implementation of accrual-based accounting for the entire general Government Under the PEM umbrella, the enactment of a new Public Procurement Law was a condition for continuous Bank support. A new Public Procurement Law, effective since 2003, has subsequently been amended for increased consistency with EU requirements. However, other laws have brought several other amendments to the Public Procurement Law, mainly to provide exemptions to various agencies and to exclude procurement of certain services from the scope of the law. Later, it was decided to hold all amendments to the law until after the Procurement Screening Process with the EU is complete The lending program, through the PFPSAL III, was complemented by an Institutional Development Fund (IDF) grant on public liability management. The grant assists the Government in adopting best international practices and technical tools in public liability management, including financial and fiscal risk management. Another IDF grant supported the introduction of the new Public Procurement Law (iii) Social Security system: Strong fiscal performance has been the cornerstone of the economic program since The public sector primary surplus exceeded 6% of GNP in the last three years. In addition, the overall budget deficit came down to below 1% of GNP by 2005 and is estimated to have stayed around 1% in The transfers from the budget to cover the deficit of the social security institutions (pensions and health services) were, however, equivalent to 4.8% of GDP in 2005 and such deficit would have increased rapidly in the absence of reform. Therefore, continued fiscal adjustment clearly requires action to address the structural imbalances in the social security system which currently originates largely from (a) deficits in the pay-as-you-go pension system, (b) deficits in the provision of publicly financed health services, and (c) unexploited efficiency gains in the operation of the social security institutions. In response, the Parliament passed a social security and universal health insurance law with the following components: (a) parametric reform for the pension system that will ensure the system s long term sustainability, (b) establishment of a universal health insurance system which will provide access to health insurance for all citizens. In

13 Page 13 of 59 addition, a law aimed at reforming the administrative dimensions of social security by unifying the existing three social security schemes was enacted in May However, implementation of the social security reform has been delayed due to a Constitutional Court decision in December In addition to the PFPSAL III, which included important measures to support Turkey s fiscal adjustment, the Programmatic Public Sector Development Policy Loan (PPDPL) and the accompanying Health Transition Project have supported the reform of the social security system. One key objective of the HTP is the fiscal sustainability of the healthcare system, by supporting the implementation of systemic health reforms aimed at increasing efficiency in production and delivery of health services. These include the establishment of a single health insurance fund by consolidating the five existing health insurance schemes, including the Green Card system, the introduction of family medicine as an organizational model for the provision of outpatient or primary health care services, and the development of an effective patient referral system. In addition, with the support of the Bank-financed Privatization Social Support Projects, labor redeployment and job placement services are being provided to workers who have lost their jobs as a consequence of State-Owned Enterprises (SOE) privatizations (iv) Local government: Financial autonomy of Turkish municipalities is extremely limited. On average about 60% of municipal revenue is derived from intergovernmental fiscal transfers, while another 20% are derived from own-source taxes and fees. Profits of municipal commercial enterprises, rental income from municipally owned real estate, and various types of fines provide for the remaining 20% of revenue. Almost all tax rates are set by the Government and municipalities have little ability to improve their income or reduce their dependence on fiscal transfers as the main source of revenue. Capital investments represent on average about 30% of municipal expenditure. Improvements in the delivery of local services have begun but progress has been uneven. With 70% of the Turkish population living in urban areas, the need for core municipal services, such as water, wastewater, solid waste management and urban transport, is an increasing priority. One of the medium-term challenges will be the ability to meet the high costs of service provision in the context of high urbanization and EU environmental directives, especially as municipalities suffer from inadequate resources and financial management at the local level, and from an underdeveloped municipal debt market that does not allow them to access long-term credit. The approval of several laws on local government paved the way to more efficient resource and financial management at the local level, but many of these are not yet effective. The Government also committed to reform Iller Bank, a Government agency which operates as a conduit for inter-governmental fiscal transfers and a financier and an implementing agency for infrastructure investments, into a more effective and financially sound institution. This is relevant to Turkey s broader EU agenda, as Iller Bank is expected to be a key player in the implementation of upcoming EU projects. The World Bank Institute (WBI) provided extensive capacity-building support to Government officials on intergovernmental fiscal transfer designs as part of its multi-year Capacity-Building Program for responsive and accountable local governance The Municipal Services Project supports the Government s plans to provide technical assistance to municipalities on financial and institutional strengthening and to reach financial viability and target investments for water supply, sanitation and solid waste management. As the implementing agency of the project, Iller Bank s capacity to assess sub-projects is also

14 Page 14 of 59 being strengthened. The Bank s contribution to improvements in local service delivery also came from a program of analytical work and capacity building activities, supported by the WBI. The Municipal Sector Report provided key suggestions for municipal sector improvements, which have been taken into account in the formulation of the draft Public Administration Law and amendments to the Iller Bank Law. The Water and Wastewater Report assisted the Government in improving governance at the municipal and central Government levels, improving the efficiency of water supply and wastewater investments, and increasing the operating efficiency of the water sector. Finally, the IDF grant on the Development of Performance Monitoring Systems supported the Government s efforts to strengthen the public oversight of the public funds allocated to Turkey's local government sector, improve the public accountability of the local authorities, and improve the sector's public expenditure management (v) Civil service and anti-corruption: Public sector governance has been improving. Among a comprehensive set of substantive actions was the enactment of the Law on Freedom of Information for Citizens in October 2003 and the issuance of the follow-up regulation on the implementation of the law in April The law provides an important basis for enabling citizens to monitor the performance of the public sector. In this context, public agencies have provided an opportunity to citizens to request information on-line, through their websites. A law on the establishment of an Ethics Board for civil servants was enacted in June Subsequently, in September 2004, the Ethics Board was established and in April 2005 the regulation on the Code of Conduct for civil servants was issued. Further, the new Penal Code contains provisions concerning bribery, trading in influence, abuse of power and embezzlement and punishes corruption-related crimes more seriously. 7 The Code also introduces the concept of liability of legal persons in cases of corruption and contains provisions concerning corruption in public procurement. The authorities have drafted a civil servants law, to replace the existing one. The draft law seeks to address several major objectives including: (i) improving efficiency; (ii) eliminating discrepancies in remuneration across similar positions within the public sector; (iii) making it easier to ensure a fiscally sound wage bill; and (iv) providing competitive opportunities for entry into the public administration. According to international indicators, Turkey s ranking has improved in terms of the level of corruption. The World Bank recently launched its new report, entitled Governance Matters VI: Governance Indicators for which contains an updated and expanded set of worldwide indicators for 212 countries on governance issues. The data related to Turkey in the report show that the country s performance over time has significantly improved in most indicators, including control of corruption. These improvements are indicated by higher percentile ranks for Turkey on most of the selected governance indicators. On government effectiveness, Turkey s estimated percentile rank has improved significantly since the mid and late nineties, and particularly since In terms of regulatory quality, Turkey s estimated percentile rank has slightly improved since 2002, although values for this indicator were stronger in the late nineties. Finally, after a noticeable decline in 2000/2002, Turkey s percentile rank for control of corruption has significantly improved, with the estimated percentile rank going from 40% in 2002 to 58.7% in Transparency International s Corruption Perception Index also ranks Turkey as 64th (out of a total of 180 countries) in the 2007 edition, compared to the rank of 77 th (out of a total of 145) in In addition, the Business Environment and Enterprise Survey (BEEPS) jointly conducted by the World Bank and the European Bank for Reconstruction and European Commission Progress Report on Turkey.

15 Page 15 of 59 Development 8, provide information about the views of entrepreneurs and business executives about taxes, macroeconomic and Government policies, corruption, anticompetitive practices and financing costs. Comparing the results with those of the 2002 survey, Turkey has significantly improved in many aspects, such as reducing red tape, improving its business environment and reducing corruption. However, the surveys also show that there is room for improvement in areas such as customs, business permits and taxes. b. Equitable Human and Social Development Table 3: Equitable Human and Social Development Key Expected Outcomes and World Bank Benchmarks Expected Key Outcomes Low extreme poverty (1.8%) maintained and vulnerability reduced from 15% in 2001 to 12% in 2006 Net enrollment rate in basic education maintained at not less than 99%; girls enrollment increased, especially in secondary education: male/female ratio improved from 1.20 to 1.15 by 2006 Child mortality reduced and maternal health improved to make progress towards the MDGs Outcome Status Partially achieved Largely achieved Largely achieved Outcomes Expected Key Bank Group Benchmarks Public expenditure on health, education and social protection are sustained at pre-crisis levels. The benchmarks as shares of GNP are: (i) education: 4.25%; (ii) health: 3.25%, and (iii) social protection: 7.00% Implementation of (i) the Conditional Cash Transfer (CCT) program to benefit over 1 million children, and (ii) at least 1,500 local initiative (LI) projects to support vulnerable people Renovation and modernization of schools, including in disadvantaged areas, and implementation of reforms in secondary education Improvements in access and quality of basic health provision The CAS period saw a reduction of extreme poverty to a negligible level of 0.01% in 2005, but one fifth of the population in Turkey remained poor by the end of 2005, when measured by the food and non-food poverty concept. 9 While regional disparities persist in terms of access to good quality education, there are encouraging signs of improvements in the reduction of gender inequalities: girls secondary net enrollment increased from 42% in 2001/02 to 51% in 2005/06, while the male to female enrollment ratio decreased from 1.33 to 1.27 from 2003/04 to 2005/06. Net enrollment rate in basic education remained at around Benchmark Status Achieved Achieved Partially achieved Partially achieved 8 The BEEPS covers all countries of Central and Eastern Europe, the former Soviet Union and Turkey. The objective of the survey is to evaluate the constraints on investment and private sector growth. 9 The availability of new, more reliable data as a result of the recent poverty assessment and the education sector work has necessitated the resetting of the baseline information in some instances. The Joint Poverty Assessment has redefined the poverty line and dropped the concept of vulnerability used in the CAS. Thus the vulnerability and poverty data are not comparable. In education, it appears that the situation at the time of the CAS was actually less favorable in terms of net enrollment in basic education and the female/male ratio in secondary education.

16 Page 16 of 59 90% during the CAS period 10, while the gross enrollment rate for secondary education increased from 68% in 2001/02 to 85% in 2005/06. Important achievements in the health sector include a significant reduction in infant mortality from 43 per 1000 live birth in 1998 to 24 per 1000 live birth in Nonetheless, Turkey ranks 105th on the World Health Organization (WHO) list of 192 countries with its current level of infant mortality, an unacceptable level for a middle income country aspiring for EU accession. Status of Key Benchmarks Public expenditure on health, education and social protection are sustained at precrisis levels. The benchmarks as shares of GNP are: (i) education: 4.25%; (ii) health: 3.25% and (iii) social protection: 7.00%: Since 2001, social expenditure targets have been broadly met, with a slight under-run in education in In 2006, however, education spending was 4.33% of GNP, health expenditures 5.31% of GNP and social protection expenditures 9.68% of GNP. On the one hand, this shows the Government s commitment to maintaining/expanding social programs targeted to the poor to keep the levels at least at the pre-crisis averages, while on the other it points to the increased amounts of social security expenditures that have led to continued social security deficits. Going forward, the Bank s program in this area could be improved by refining the coverage of social expenditures and disaggregating the broad categories with a view to look into the quality of the expenditures in addition to the amount Implementation of (i) the Conditional Cash Transfer (CCT) program to benefit over 1 million children, and (ii) at least 1,500 local initiative (LI) projects to support vulnerable people: The US$500 million Social Risk Mitigation Project aimed at alleviating the impact of the 2001 economic crisis on poor households, and at improving their capacity to withstand such risks in the future. The CCT component of this loan, which provides incentives for positive family behavioral change with respect to education and health, has benefited 2.6 million of Turkey s poorest children in poor households in Turkey, vs. a benchmark of 1 million. Under the same project, the Local Initiatives component has financed 7,500 sub-projects, vs. a benchmark of 1,500. These sub-projects are proposed by the provinces and local communities, to enhance employment opportunities aimed at poverty reduction. Key pieces of analytical work, including a labor market study and poverty-focused reports provided a broad assessment of poverty-related issues, and important policy indications, particularly in the area of labor market reform Renovation and modernization of schools, including in disadvantaged areas, and implementation of reforms in secondary education. Human capital is and will continue to be a key factor in allowing Turkey to meet its ambitions of becoming a modern economy, fully integrated in the EU. In this respect, access to high quality education is a critical issue A series of education projects have promoted improved access to quality education, with special focus on vulnerable groups such as girls and disadvantaged children. However, implementation of these operations has been slow due to lack of counterpart funds allocation in 2003, several personnel changes in the Ministry of National Education, and implementation capacity problems. Construction and renovation works are underway in more than 300 school sites and a significant increase in civil works is being undertaken. Reforms in secondary education have begun with an EU-financed project, while the Bank- 10 The assessment of the achievement of expected outcomes was based on reset baseline indicators.

17 Page 17 of 59 financed project to support secondary education became effective in the spring of 2006, but implementation has been limited. IFC has also provided financing for investments in the education sector for the establishment of a business school, including the distance learning for adult education through satellite learning centers across the country, as well as supporting the expansion of a pioneer vocational training school in the area of IT training and software systems The Education projects have been supported by an Education Sector Study (ESS), which contributed to the dialogue among policymakers, researchers, and other stakeholders regarding the development of a coherent, sector-wide strategy for improving Turkey s preuniversity education system. The studies commissioned under the ESS address a range of educational challenges, from access to pre-school to the equity implications of the existing high school entrance examination Improvements in access and quality of basic health provision: While Turkey has made considerable progress in improving key health indicators and in expanding access to health care services with the introduction of a universal health insurance, it continues to rank far behind most middle-income and EU accession countries in terms of health status and access to healthcare. Some of the issues still facing the Turkish healthcare system include inequalities in the access to health services, inefficiencies in resource allocation, and inadequate governance. There has been, however, some progress on building MOH s and relevant institutions' capacity in regulatory functions such as monitoring the quality of care in public hospitals and the collection and analysis of health sector data for evidence-based policy-making. New departments (Performance Assessment in the health sector and Monitoring and Evaluation) have also been established. Finally, high levels of health public spending remains an issue, and requires further and more comprehensive steps by the Government, focused, inter alia, on hospital reform (reorganization of hospital network, autonomy from the Ministry of Health), strengthening the referral system, pharmaceuticals cost containment, and expansion of the family medicine model Although with mixed results, the Health II and Health Transition Projects have supported the health sector in Turkey. While both the Bank-financed projects and the overall health system would benefit from strengthened capacity of the Ministry of Health (MOH), its institutional reform, particularly with regards to the reorganization and autonomization of public hospitals, has been limited. On a positive note, the important burden of disease study was completed, national health accounts were established to track expenditures, patientrecord keeping was established, and a comprehensive health reform effort is underway, to achieve increased efficiency and financial soundness. IFC s financing of private health care, and WBI s flagship program on health sector reform, have been an integral part of the Bank Group s assistance to the sector. Senior health systems managers and key public and private sector stakeholders benefited from a series of WBI-sponsored capacity building events on health systems organizations and decentralization intended for them to better assess the strengths and weaknesses of Turkey s health systems.

18 Page 18 of 59 c. Attractive Business Climate and Knowledge Table 4: Attractive Business Climate and Knowledge Key Expected Outcomes and World Bank Benchmarks Expected Key Outcomes Exports growth rate exceeds GNP growth rate Foreign Direct Investment reaches US$1.5 billion on average during the CAS period Stability of financial markets improved Outcome Status Achieved Achieved Achieved Expected Key Bank Group Benchmarks Increase in export capacity of enterprises financed through lines of credit provided by the World Bank Group Improvements in the overall investment climate, implementation of the new FDI law, and establishment of an Investment Promotion Agency (IPA) Continued independence of financial markets regulatory agencies Completion of privatization of state banks; passage of new Bankruptcy Law and Commercial Code, and implementation of non-bank financial institutions reform Outcomes Benchmark Status Achieved Achieved Achieved Partially Achieved The outcomes related to the overall improvement of Turkey s business climate have over-performed the CAS original targets. In 2003, 2004, 2005 and 2006 real GNP grew by 5.9, 9.9, 7.6% and 6%, respectively, while real export growth was as high as 16.0% in 2003, 12.5% in 2004, and 8.5% in both 2005 and Increased confidence level, mostly due to continued macroeconomic stability and the official start of membership negotiations with the EU in October 2005, improved the structure of capital flows towards more long-term financing, including Foreign Direct Investment (FDI). A fter remaining low at US$1.3 billion in 2003 and US$1.9 billion in 2004, net FDI inflows into Turkey increased to a historical high of US$19 billion in On a commitment basis, FDI is projected at US$22.5 billion in Finally, the stability of the financial sector has substantially improved. The open foreign exchange (FX) position of the Turkish banking system decreased after the volatility of May-June 2006, and the sector had a long FX position of US$184 million in end In addition, Turkish households had small FX-linked liabilities. All Turkish banks continued to 11 Data from Turkstat s National Accounts Database.

19 Page 19 of 59 protect themselves by proper provisioning against their problem loans, with the system in total having loan loss reserves equaling 91% of their non-performing loans. Capitalization of most banks has been sound, although it has declined as banks have grown their balance sheets. The capitalization as measured by the capital adequacy ratio fell to 22.4% in December 2006 from 24% in December 2005 for the banking system. Capital adequacy has been trending downwards for a few years as banks have shifted assets from non-risk weighted Government bonds to loans to the private sector and as the stabilizing economic conditions gave banks comfort to operate with greater leverage. On the policy front, reform of regulation and supervision of the banking sector has continued. Status of Key Benchmarks Increase in export capacity of enterprises financed through lines of credit provided by the World Bank Group. The second and third in a series of Export Finance Intermediary Loans (EFILs), worth around US$600 million, have provided medium and long-term working capital and investment finance to private exporters, and contributed to further facilitating export growth in Turkey. The Export Finance Intermediary Loan (EFIL) II reached over 230 exporters representing a wide spectrum of firm sizes, industrial sectors, and geographical regions. Their exports grew by an impressive 28% in US$ terms between 2004 and The repeater EFIL III became effective in FY06, but already disbursed almost one quarter of its funds by the end of the fiscal year, signaling a strong demand for continued export support. A recently approved project will focus on providing increased access to finance, specifically to small and medium size enterprises (SMEs) throughout the country, including regions with low access to credit (i.e., the East and South East) Improvements in the overall investment climate, implementation of the new FDI law, and establishment of an Investment Promotion Agency (IPA): Key investment climate reforms implemented during the CAS period include: a) reduction of administrative barriers to business entry and operation; b) improvement of market contestability; c) improvement of corporate governance; d) increased public investments in research and development (R&D) and ongoing review of Intellectual Property Rights legislation to ensure consistency with EU requirements; e) increased harmonization of quality standards and regulations with EU requirements; f) improvement in infrastructure; g) acceleration of privatization; and h) increased focus on SMEs. Additional reforms are needed in all of these areas to further increase investment and productivity levels. They should be complemented by microeconomic reforms aimed at reducing tax evasion and informality, improving labor market flexibility, increasing firms (particularly SMEs ) access to finance, increasing private investment in R&D and firms adoption of quality standards and technology (including Information and Communication Technology), and better aligning the skills of the labor force with the needs of the private sector The new FDI law, passed by the Government in 2003, established a more liberal FDI environment, although implementation in some areas is pending. Key features of the new law include: a) more flexibility for investors, by dropping all former FDI-related screening, approval, share transfer and minimum capital requirements; b) reassurance of existing guarantees to foreign investors of their rights in one transparent and stable document; c) upgrading, to accepted international standards, definitions of foreign investor (broadened to include Turkish national residents abroad and international organizations) and foreign direct investment (broadened to include all possible types of assets); and d) a policy shift from ex-