PREPARED BY THE WORLD BANK ACKNOWLEDGEMENT This report has been prepared by the Turkey Country Team under the overall direction of Ajay Chhibber. James Parks and Sally Zeijlon are the principal editors of the report. The principal authors of the policy notes are Hormoz Aghdaey, Gokhan Akinci, Ismail Arslan, Dilek Barlas, Betty Hanan, Tunya Celasin, John Innes, Ira Lieberman, Ranjit Lamech, Gareth Locksley, Mark Lundell, Anil Markandya, Maureen McLaughlin, James Parks, Mirtha Pokorny, Christoph Pusch, Lalit Raina, and Sudipto Sarkar. Important contributions were made by Mediha Agar, Marie-Renee Bakker, Enis Baris, Jeanine Braithwaite, Marjory-Anne Bromhead, Mukesh Chawla, Peter Dewees, Annette De Kleine, Nedret Durutan, Guiseppe Fantozzi, David Fretwell, Vinod Goel, Robin Horn, Zeynep Kudatgobilik, James Moose, Kamer Ozdemir, Arzu Ozturk, Elliot Riordan, Ferda Sahmali, Joop Stoutjesdijk, Mathew Verghis and Anders Zeijlon. Pinar Baydar has prepared this report for publication. TABLE OF CONTENTS OVERVIEW ..............................................................................................................................................................1 1. MACROECONOMIC POLICIES FOR SUSTAINABLE GROWTH.............................................................................9 2. PUBLIC SECTOR REFORM FOR EFFECTIVE GOVERNMENT ............................................................................14 3. ENHANCING TRANSPARENCY AND FIGHTING CORRUPTION FOR GOOD GOVERNANCE ................................19 4. IMPROVING SOCIAL PROTECTION THROUGH FISCAL SUSTAINABILITY, INSTITUTIONAL REFORM AND EFFECTIVE TARGETING................................................................................................................................22 5. EDUCATION AND TRAINING FOR INVESTMENT IN TURKEY'S FUTURE..........................................................27 6. REFORMING THE HEALTH SECTOR FOR IMPROVED ACCESS AND EFFICIENCY..............................................30 7. ISSUES FOR FINANCIAL SECTOR DEVELOPMENT AND GROWTH ...................................................................34 8. ASSISTING THE ENTERPRISE SECTOR IN TRANSITION FROM THE CRISIS.......................................................39 9. SME DEVELOPMENT AND TECHNOLOGY.....................................................................................................44 10. ACCELERATING PRIVATIZATION TO STRENGTHEN REFORM CREDIBILITY AND SUPPORT PRIVATE SECTOR DEVELOPMENT ............................................................................................................................................47 11. ATTRACTING FDI FOR COMPETITIVENESS AND GROWTH............................................................................50 12. MANAGING THE TRANSITION TO COMPETITIVE PRIVATE ENERGY MARKETS..............................................53 13. TELECOMMUNICATIONS REFORM FOR THE INFORMATION SOCIETY.............................................................58 14. EFFICIENT TRANSPORT FOR EQUITABLE GROWTH.......................................................................................63 15. RURAL REFORMS AND INVESTMENTS FOR GROWTH AND EQUITY ...............................................................66 16. IMPROVED ENVIRONMENTAL MANAGEMENT FOR SUSTAINABLE GROWTH AND CONTRIBUTING TO GLOBAL ENVIRONMENTAL GOALS ..............................................................................................................71 17. PROTECTING TURKEY THROUGH DISASTER PREPAREDNESS AND MITIGATION............................................74 18. IMPROVING MUNICIPAL SERVICES FOR TURKEY'S GROWING URBAN POPULATION ....................................77 19. LEGAL AND JUDICIAL REFORM ....................................................................................................................81 20. CIVIL SOCIETY.............................................................................................................................................85 OVERVIEW Turkey is a country with a huge potential. The vision that drives our proposals for the 58th Government is that of a country with greater prosperity, social justice and sustainability, that unleashes creative energy to realize fully this potential. Turkish society has come a long way from the 1960s, when a largely agrarian society began to modernize. In the 1980s, Turkey opened to the world economy and began a process of transformation into a competitive industrial economy with a vibrant private sector. The average family began to witness enormous improvements in its standards of living, Figure 1: Historical Growth & Inflation Rates opportunities, and hopes for parents and their children. But Growth Inflation 6 80 these gains were not 70 5 consolidated in the 1990s, and a 60 4 series of weak coalition 50 3 40 governments were unable to 2 30 build the institutional structures 20 to make these improvements 1 10 permanent. During the 1990s, - - 1980-90 1990-99 1980-90 1990-99 Turkey's economy recorded lower growth and higher inflation than in the 1980s (Figure 1). The 1990s was characterized by large "boom/bust" swings in the business cycle with average annual growth well below Turkey's potential, high inflation, increasing debt, and economic vulnerability. Corruption soared, and with slower income growth and limited improvements in basic services, social frustrations grew. If Turkey's untapped potential can be unleashed, the next decade can be much more productive than the 1990s. The coming decade need not be characterized by such volatility. Rather, it could be one of steady accomplishments, without the economic upheavals and unsteady reform progress of the past decade, with low inflation, and without the growing income disparity between sections of the population. This vision requires a substantial change in priorities and the way in which the state, market and citizenry interact. It requires: : a substantially greater effort on primary and secondary education, and on healthcare ­ where Turkey lags far behind even other middle income countries ­ and on improving the system of social protection to help reduce inequality; : faster growth through increased productivity and investment ­ especially foreign direct investment (FDI) ­ by fostering greater fiscal discipline, and cutting red tape; : increased focus on exports and competitiveness as Turkey tries to catch up to richer countries in Europe; TURKEY: POLICY NOTES OVERVIEW : a change in the relationship between the state and market from one of granting favors to an environment that fosters investment and competitiveness. Private sector productivity rather than public sector spending must become the engine of sustainable growth; : replacement of a top-down state led development approach by a bottom-up empowerment strategy, to ensure inclusiveness, social justice and enhanced productivity; and : a different role for the state, greater reliance on market and civil society does not mean a minimalist role for government, but requires government playing a central role in setting the guidelines, through participation with an active civil society. This vision can be translated into reality through urgent actions ­ especially in the early stages of the government's tenure. Some of the urgent actions are needed to maintain short-term credibility ­ fiscal balance, completion of banking reforms, accelerated privatization. Other actions are structural and of a more medium-term nature ­ reforms to public spending, taxation, health, local government, secondary education ­ but upfront actions to begin the process are needed to signal intentions quickly. The focus of the policy notes presented here is on structural, and longer-term reforms and programs, which are integral to achieving and sustaining the vision of a more prosperous, equitable and sustainable Turkey. The policy notes also highlight urgent upfront actions to establish credibility and maintain momentum. Of course, there are many needs and limited resources. The new government will need to prioritize carefully its policy actions and investments and place these within an appropriate medium-term budgetary framework consistent with its fiscal policy targets. : A More Prosperous Turkey will accelerate growth and create productive jobs for its citizens. Local and foreign investment will increase rapidly--as Turkey stabilizes its macro-economy, reduces public debt, lowers interest rates and inflation, further liberalizes its domestic markets (including energy and agriculture) and reduces red tape. Agricultural productivity--which has declined over the past decade despite large subsidies -- will be enhanced by focusing on titling and land improvement, provision of basic farmer services rather than wasteful crop and input subsidies, and with a safety-net provided by direct income support. Export and tourism development will play a key role in an outward-oriented strategy. Special emphasis will be placed on knowledge and technology built around public-private partnerships to ensure that Turkey does not fall behind rapid global technological changes. : A More Socially Just and Inclusive Turkey will ensure Figure 2: Inequality in Turkey andComparators improved education, health and 0.7 social protection for all its citizens, e 0.6 so that the opportunities are more m equally available. Turkey has high 0.5 inequalities with the incomes for conIfot 0.4 the rich 7 times higher than those of cienif 0.3 the poor. Inequality in Turkey is lower than in Latin America, but efoCini 0.2 G yet higher than several countries in 0.1 the region and other large middle 0 income countries (Figure 2). Turkey does not have large numbers of absolute poor (only 2% S.Africa Brazil Mexico Russia Turkey China Bulgaria Italy Indonesia below US$1 per day), but a Less Equal More Equal 2 TURKEY: POLICY NOTES OVERVIEW significant proportion of the population (above 15%) is classified as food poor or economically vulnerable. These problems can be addressed by: improved targeting of social assistance, wider access to education and basic health, reduced corruption, fairer legal and judicial systems, a more just and inclusive society would be created; transparent allocation of public services, public service employment and infrastructure to serve their objectives, the citizenry, rather than as favors to special interests. In the transport, banking, energy, telecommunications sectors, where special interests have typically exploited privatization and access, such problems must be avoided by creating strong and independent regulatory institutions; and increasing agricultural productivity and a more comprehensive rural development strategy for rural areas, where some 35% of Turkey's population resides will also improve equity. : A More Sustainable Turkey is needed to ensure that Turkey's current development does not come at a cost to future generations. Turkey's future generations must be able not only to sustain development but also enjoy a well preserved cultural and natural heritage. Effective land management and rehabilitation, care for Turkey's unique and valuable coastline, and water management must be given much greater importance. Clean air ­ by expanding gas networks and reducing transport pollution ­ is needed to reduce health problems. Turkey's rich bio-diversity must be protected. More effective use of civil society to address environmental concerns and a more decentralized decision-making structure would help as well. This vision is compatible with European Union (EU) accession and would be further strengthened by this process. As Turkey knocks on EU's door, in many respects the vision that drives Turkey toward Europe is similar to that of the other EU aspirants; and so are the challenges. In its overall level of economic development Turkey is similar to the average for the other EU aspirants (Table 1), and not too far behind levels of development in Greece, Portugal and Spain when they entered the EU (Table 2). Just as their entry into the EU was a ticket to a more prosperous, socially just, inclusive and sustainable society, an EU anchor could help accelerate Turkey's drive to achieve its vision. The World Bank would like to support Turkey in reaching its vision. To realize these intertwined aspects of Turkey's vision for the future, a development strategy should be outlined. Five themes which could frame such a strategy are: : Sound macroeconomics in a framework of transparent governance raising living standards in ways everyone can understand and track : Equitable human and social development addressing basic human needs, building human capital, including the economically vulnerable in both the social safety-net and the growth process : Attractive business climate and linkage to global knowledge well regulated competitive markets create opportunities for productive investment and sustainable employment linked into the global economy : Strong environmental management and disaster prevention 3 TURKEY: POLICY NOTES OVERVIEW preserving natural resources and avoiding preventable loss of life and capital, to ensure continued national wealth for future generations : Enhanced justice, decentralization and participation by civil society in development decisions to make more relevant choices, at local level where appropriate, including all stakeholders Linking the Vision to Development Themes and Sector Policies Vision Development Themes Policy Areas Income Equality Sustainability and Social Justice I. Sound Macro-Economics and 1. Macro Policies Governance 2. Effective Government 3. Corruption II. Equitable Human and Social 4. Social Protection Development 5. Education 6. Health III. Attractive Business Climate 7. Banking and Finance and Knowledge 8. Corporate Sector 9. SME Development 10. Privatization 11. FDI 12. Energy 13. Telecom 14. Transport 15. Agriculture/Rural Development IV. Strong Environmental Management and Disaster 16. Environment Prevention 17. Disaster Mitigation V. Enhanced Justice, 18. Municipal Services Decentralization and 19. Legal Reform Participation 20. Civil Society Primary impact Secondary impact The policy notes presented here are intended as background for initial discussions between the new Government and the World Bank about the development strategy for Turkey, and the possible support the World Bank could bring to implement that strategy. The policy notes present recent work on specific sectors where action by the government would be needed to deliver results in these strategic themes. The notes combine policy commitments made under existing projects with policy options and recommendations identified by analytical studies and preparatory work for possible future projects. The main points in each note are summarized below: 1. Turkey has already learned that macroeconomic stability is a precondition for sustainable and equitable growth. Success to date in implementing a stabilization program has brought inflation down to the 35% range and the economy is growing again. The debt burden nonetheless remains high, and the program's successes could be at risk if concerted reform implementation were to waver. Strict fiscal management is key to full realization of the twin objectives of low inflation and steady growth in a setting of a gradually diminishing public debt burden. 4 TURKEY: POLICY NOTES OVERVIEW 2. More effective government is the road to permanent macroeconomic stability and better delivery of public services under conditions of fiscal austerity. A comprehensive public sector reform program has been launched with three pillars: structural fiscal reforms to underpin fiscal adjustment, structural and institutional reforms to modernize public expenditure management, and institutional reforms to enhance public governance. However, implementation has lagged in the face of fragmented institutional responsibility for fiscal management and tepid political will. More impressive results will materialize when high level political support for the program is mobilized to reduce institutional fragmentation and move forward with urgent measures to protect social expenditures, pursue tax reform and public employment rationalization, upgrade expenditure management, fight against corruption and initiate civil service reform. 3. Fighting corruption is vital to ensuring that the government delivers effective services and regulatory system to help markets and improvements in citizens lives. The new vision for Turkey in which transparency and accountability are to replace the old approach of special interests is key to an inclusive society. 4. While extreme poverty (US$1 a day) remains very low in Turkey, both urban food poverty and economic vulnerability are significant and have grown recently. Turkey needs a strong social protection system to reduce these. The current system is unaffordable and does not effectively reach the most vulnerable. 5. Turkey has made unprecedented strides in the basic education program launched in 1997. Now the twin challenges are to increase gradually the share of GDP dedicated to education while still accepting that not all improvements in education can be afforded at once. The ambition to improve skills and knowledge from the early years through tertiary education is the right one, but tight management of resources will be needed to make that happen. 6. Turkey ranks far behind most middle income countries in terms of health status. To meet the objective of improving the health status of the population, fundamental and systemic changes will be required in the ways that health care is financed, organized, and managed. Extensive national consultation will be important for insuring that such a thorough change is agreed, accepted, and effectively implemented. 7. Revitalizing the economy and further improving competitiveness require continued attention to the financial sector. The lack of depth and breadth has made the financial services industry vulnerable to shocks, resulting in repeated crises and reducing the efficiency of intermediation, which constrains private sector growth. Completing the reform agenda will create a sound world-class banking sector. Development of well regulated non-bank financial intermediation will further contribute to private sector growth. 8. Business was badly affected by the 2001 crisis, and although now exhibiting signs of growth, requires selective assistance to recover fully with the ability to compete in the future. The Istanbul Approach is a voluntary workout scheme, where banks and other creditors cooperate in assisting troubled companies to reschedule their debts and restructure their businesses for new competitiveness. 9. Small and medium-sized enterprises (SMEs) should drive the creation of productive employment opportunities. Turkey's SMEs need fair opportunities to compete, including access to knowledge and technology, and to credit under market conditions. 5 TURKEY: POLICY NOTES OVERVIEW 10. Accelerating privatization is important for strengthening the credibility of the reform program and for supporting private sector development. Privatization results have been below expectations and more decisive political will is needed to achieve Turkey's objective of shifting to a private sector led development model. A well structured privatization program and a comprehensive strategy to promote SME development are complementary pillars in the development of the private sector. Inasmuch as privatization/restructuring/liquidation involves downsizing, a vibrant SME sector can function as part of an effective safety net. Conversely, high losses by unviable state enterprises and banks can lead to macro crises and high interest rates which damage SME development. 11. Attracting foreign direct investment will also play an important role in Turkey's recovery from crisis and private sector development. Turkey has begun to develop an FDI strategy, but this does not yet address the all of the potential obstacles. The key now is to move ahead with implementation of the actions identified so far, while broadening the approach to tackle deeper problems in the investment environment. Increased FDI will help Turkey to balance its external financing with less debt and more direct investment, in line with the much larger FDI inflows attracted by other middle income countries. 12. Energy prices in Turkey are now well above OECD averages, which imposes a cost on the whole economy. The centralized development model for the energy sector based on state owned monopolies and guaranteed take-or-pay contracts has not delivered affordable energy. The transformation of the electricity and gas sectors to competitive private energy markets aims to decrease costs and risks currently borne by the government by attracting private capital. 13. Telecommunications can be an important driver of technological change and economic growth for Turkey. Policymakers need to set their sights on the average level of telecommunications development for EU states. Credible restructuring and privatization of Turk Telekom and further regulatory improvements will make this possible. 14. Raising the efficiency of Turkey's transport sector will contribute to economic growth, environmental sustainability and poverty alleviation. The transport sector could shift to a culture focusing on users' needs and affordability. This would help Turkey's competitiveness by lowering logistics costs. It would also increase the access of rural and urban populations to basic services, markets and jobs, and reduce the high human and economic costs of traffic accidents. Mobilizing private investments and managerial know-how in this effort will help reduce the sector's current onerous deficits. 15. In recent decades, agriculture and other rural economic activities have failed to live up to their potential as contributors to growth, rural employment, and rural welfare. Falling growth rates of value added have been the result of a legacy of costly agriculture support policies that distorted markets. The comprehensive reform in agriculture now underway has reduced the fiscal subsidies but enabled direct income support to be paid to 75% of farmers. A broader strategic rural development challenge for the government would be to focus on improved support for market development and strengthened management of investment and services in irrigation, forestry, and rural cooperatives, while leaving other initiatives to the private sector. 16. Turkey has globally important biodiversity and a large natural resource base. With improved management, these riches can contribute more to Turkey's own sustainable development and to global environmental goals. 17. Turkey is highly vulnerable to natural disasters, especially earthquakes and floods. Effective mitigation and preparedness can significantly reduce the risk of large economic and social costs. In the past three years, Turkey has introduced disaster insurance, and institutional framework for 6 TURKEY: POLICY NOTES OVERVIEW emergency management, and improvements in land use planning and trauma treatment. But without making the national emergency management agency fully effective, the problems encountered in August 1999 could be repeated in future disasters. 18. Effective decentralization through greater empowerment of municipalities is key to improving services. Municipalities are facing difficulties in addressing operational and financial management issues, and this is impeding their ability to handle sustainable provision of good quality water, wastewater management, urban transport, road maintenance, and solid waste management. Investment needs are high, yet the role of the private sector has been minimal. Fiscal constraints mean that financial discipline and local accountability are essential in future. 19. Reform of the administration of justice will help ensure that justice is not denied by being delayed. Legal and judicial reforms are needed to complete the modernization of Turkey's economic legislation, streamline the justice system, reduce the backlog of court cases, and widen access to the system. In most surveys, citizens and businesses in Turkey rate problems with the legal system among their top concerns. 20. Bringing civil society into development decisions will lead to more effective implementation of programs and meaningful results. The development of civil society will be facilitated by more participatory approach by government and an improved legal framework for the establishment, operation and financing of civil society organizations in Turkey. Participation, transparency and a culture of measurement are important in achieving this vision. A greater emphasis on transparency and participation must be combined with more readily available and consistent information. In any development strategy, measuring and monitoring results creates a feedback loop for constant improvement and improves public understanding of and commitment to policies and investment programs. In Turkey, a free press helps improve transparency ­ but lack of easily accessible data and information and public communication remain as issues. The Millennium Development Goals (MDGs) provide an internationally applicable framework for measuring progress towards achieving Turkey's vision in an increasingly global world. The MDGs are a roadmap composed of monitorable targets for achieving the objectives set out in the Millennium Declaration adopted unanimously by the UN General Assembly in 2000. The MDGs cover core social development objectives ranging from poverty alleviation to improvements in health care and education to ensuring environmental sustainability. As such, the MDGs are very much in line with the vision for Turkey set out here. In cooperation with the UN agencies, the World Bank is assisting countries establish monitoring mechanism for tracking progress towards the MDGs. Of particular importance to Turkey are the MDG targets for health where the country lags badly behind its comparators. The MDGs in health are presented in detail in the health policy note. * * * * * The Bank would be happy to provide more detail on any matter in these notes and looks forward to working with the government. 7 TURKEY: POLICY NOTES OVERVIEW Table 1: Comparison between Turkey and other EU Accession Countries-2000 INDICATORS-2000 Turkey Bulgaria Cyprus Czech Slovak Republic Estonia Hungary Latvia Lithuania Malta Poland Romania Republic Slovenia Population (thousands) 65,293 8,167 757 10,273 1,369 10,022 2,372 3,695 390 38,650 22,435 5,401.8 1,988 Rural Population (% of total population) 35 30.4 43.2 25.3 31.4 36 31 31.6 9.5 34.4 43.7 42.6 49.6 Gross National Income (US$ billions) 202.1 12.4 9 53.9 4.9 47.2 6.9 10.8 3.6 161.8 37.4 20 20 Gross National Income per capita-2000 (US$) 3,100 1,520 12,370 5,250 3,580 4,710 2,920 2,930 9,120 4,190 1,670 3,700 10,050 Gross Capital Formation (% of GDP) 23.8 16.6 .. 29.7 25.8 30.6 27.1 20.7 27.9 26.5 19.4 30.1 27.8 Life Expectancy (years) 70 72 78 75 71 71 70 73 78 73 70 73 75 Fertility Rate (births per woman) 2.4 1.3 1.9 1.2 1.2 1.3 1.2 1.3 1.8 1.4 1.3 1.3 1.2 Infant Mortality Rate (per 1,000 live births) 34.5 13.3 6.1 4.1 8.4 9.2 9.9 8.6 6.1 8.6 18.7 8.3 4.6 Adult Illiteracy Rate (% of people 15 and over) 14.9 1.6 2.9 .. .. 0.7 0.2 0.4 8 0.3 1.9 .. 0.4 Telephone mainlines (per 1,000 people) 280 350 647 378 363 372 303 321 522 282 175 314 386 Electric Power Consumption (kwh per capita) 1999 1,396 2,899 3,671 4,682 3,435 2,874 1,851 1,769 3,763 2,388 1,511 4,216 5,218 Internet Hosts (per 10,000 people) 17 19 100 134 261 129 66 39 34 67 13 59 .. Paved Roads (%) 1995-2000 34 94 57.7 100 20.1 43.4 38.4 91.3 87.5 68.3 49.5 86.7 99.9 Source: World Development Indicators database Table 2: Comparison between Turkey and Greece, Portugal, and Spain at the time when they entered into European Union 2000 1981 1986 INDICATORS Turkey Greece Portugal Spain Population (thousands) 65,293 9,729 10,008 38,519 Rural Population (% of total population) 35 42.2 60.9 25.6 Gross National Income per capita (US$) 3,100 5,500 2,750 5,250 As percent of average EU GNI per capita 13% 47% 27% 52% Gross Capital Formation (% of GDP) 23.8 21.1 22.7 21.1 Life Expectancy (years) 70 74.4a 73.4b 75.9b Fertility Rate (births per woman) 2.4 2.1 1.6 1.6 Infant Mortality Rate (per 1,000 live births) 34.5 16.3 15.9 8.7 Adult Illiteracy Rate (% of people 15 and over ) 14.9 8.5 15.1 4.5 Telephone mainlines (per 1,000 people) 280 246.7 155.9 253 Electric Power Consumption (kwh per capita) 1999 1,396 2,047 1,854 2,727 Source: World Development Indicators database (a: Data for 1980 are available. b: Data for 1985 are available.) 8 1. MACROECONOMIC POLICIES FOR SUSTAINABLE GROWTH Macroeconomic Stability is a pre-condition for sustainable growth. Despite impressive achievements over Figure 1: Historical Growth & Inflation Rates the past two decades, Turkey's economy has operated under a cloud Growth Inflation 6 80 of vulnerability­plagued by persistent 70 fiscal imbalances, chronically high 5 60 inflation, and sharp swings in the 4 50 business cycle. Earlier attempts to 3 40 stabilize the economy fell short, and 2 30 20 high growth has never been sustained 1 10 for long. Inflation was higher and - - growth was lower, on average, in the 1980-90 1990-99 1980-90 1990-99 1990s than in the 1980s. Chronic instability... FigurFigure Turkey: an "outlier" am ong e 2.5: 2: Macroeconomic Instability com parators in volatility of Turkey has suffered from an exceptional R E ER and G D P grow th [1990-2000] degree of macroeconomic instability. 12 Many emerging market countries have 10 Turkey ) E U experienced large fluctuations in either %hC( 8 M alaysia growth or the real exchange rate, but R 6 Turkey has experienced instability in both REE K orea 4 dimensions. Income volatility doubled CV: M exico T hailand 2 between the 1980s and 1990s as the C hile A rgentina 0 standard deviation of GDP growth 0.5 0.75 1 1.25 1.5 increased from 2.7% to 5.5%. The CV: GDP (Ch% ) "boom/bust" cycle has continued into the Source: W orld B ank, JPM organ; volatility m easured by coefficient of variation applied to growth rates of the variables new decade with 6% growth in 2000 followed by a record contraction of over Figure 3: GNIper capita, Atlas method(current US$) 9% in 2001. 18,000 16,000 14,000 ...has prevented Turkey from 12,000 realizing its full growth potential. 10,000 8,000 Instability has caused Turkey's growth 6,000 4,000 performance to lag behind that of the 2,000 leading emerging markets and faster 0 growing countries of the EU such as Spain. 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Turkey Argentina Chile Mexico Korea, Rep. Spain 9 TURKEY: POLICY NOTES MACROECONOMICS Figure 4: GNP growth 10.0 The economy has begun to recover 5.0 from the 2001 crisis. 0.0 % The economy recovered strongly during the -5.0 first half of 2002 and indications are that -10.0 growth continued into the 3rd quarter. There -15.0 is a positive story on exports which 99 99 99 99 00 00 00 00 01 01 01 01 02 02 responded immediately to the devaluation Q1-19Q2-19Q3-19Q4-19Q1-20Q2-20Q3-20Q4-20Q1-20Q2-20Q3-20Q4-20Q1-20Q2-20 following the February 2001 crisis. Private Quarterly percentage change over the same quarter of the consumption has also started to recover and previous year. the drop in private investment has eased. Figure 5: CPI Inflation 80 Inflation has fallen. 75 70 65 Inflation spiked after the devaluation in 2001, 60 but has fallen sharply since early 2002, with % 55 50 annual CPI inflation easing to 33.4% and 45 WPI to 36.1% by October. Inflation 40 expectations are now fully consistent with 35 30 the end-year target of 35%. Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Annual Inflation Expected end-year inflation The shift to a floating exchange rate Figure 6: Real Effective Exchange Rate 1995=100 regime has played a key role in crisis 160 recovery. 150 140 Exports responded quickly to the devaluation 130 after February 2001 and the fall in inflation 120 110 has been helped by the significant real 100 exchange rate appreciation so far in 2002 as 90 the Lira has rebounded from initial 80 overshooting. Encouragingly, the depreciation of the Lira in mid-2002 on the heels of Jan-99Apr-99Jul-99Oct-99Jan-00Apr-00 Jul-00Oct-00Jan-01Apr-01 Jul-01Oct-01Jan-02Apr-02 Jul-02Oct-02 renewed political uncertainty did not lead to a jump in inflation. Figure 7: Real Interest Rate using Weighted Average of The recovery remains vulnerable to Compound Auction Rates * shifts in market confidence. 120 100 Auction Rate discounted by Improved market confidence is essential to 80 12 month historical inflation ensure the rollover of the government debt and 60 to lower real interest rates. After falling in early 2002, domestic interest rates on 40 government securities increased once more in 20 May as political uncertainty re-emerged. 0 Sustained high real interest rates would slow -20- Feb01 the recovery and add to the public debt Apr-01 Jun-01 Aug-01 Oct-01 Dec-01 Feb-02 Apr-02 Jun-02 Aug-02 Oct-02 burden. While the post-election decline in * Nov. 2002 is an estimate based on auction rates as of Nov 18th. 10 TURKEY: POLICY NOTES MACROECONOMICS interest rates is encouraging, credible policies by the new government will be needed to sustain this momentum and drive further improvements in investor confidence. The new Government must act quickly to establish its reform credentials to lower the large risk premium reflected in interest rates. Early, decisive actions can have a beneficial effect on credibility. Early Actions to Bolster Credibility: : Meeting the primary surplus target is important to stabilize the debt and is seen by the market as a litmus test. There was fiscal slippage in the run up to the elections. Early public announcement of the government's plans for meeting the primary surplus targets will be received very positively by the markets. : Privatization has been a weak point in the program. Announcement of an accelerated privatization program for 2003--including clear timetables for tenders of Petkim and Tupras, adoption of privatization plans for Tekel and Seker, a strategy for electricity privatization, and plans for liquidating non-performing companies including TZDAS--will help establish the government's reform credentials. : Announcement of an external financing plan for 2003 that reflects a realistic assessment of Turkey's external financing needs will be welcomed. : The government's positions on banking reform will be carefully evaluated by investors. A strong signal of support for BRSA's continuing independence and for quick action on pending issues in the banking reform program will be welcomed by the market. : The corporate sector remains burdened by debt accumulated during the crisis and credit to the economy has not yet begun to expand. A renewed push to accelerate implementation of the Istanbul approach combined with upfront action on bankruptcy reform will help ease the credit bottleneck and promote real sector recovery. Continuation of credible macroeconomic policies is needed over the medium term for sustained growth. Tough measures taken up-front will have a long-term payoff in terms of higher growth. Key Macro Policies for Sustained Growth: : Permanent Fiscal Adjustment Table 1. Fiscal Adjustment for Consolidated Public Sector, : Single Digit Inflation 1999-2001 (% of GNP) : Strong External Competitiveness Fiscal 1999 2000 2001 adj. Permanent fiscal adjustment is the key Total expenditures 40.5 41.0 48.7 to macroeconomic stability. Non-interest expenditures 18.5 19.1 21.7 3.2 Total revenues 26.2 28.6 32.3 6.1 Turkey will need to run large primary PSBR 14.3 12.4 16.4 surpluses over the medium term to lower its Quasi-fiscal deficit 10.4 7.2 4.8 -5.6 public debt level to manageable proportions. Adjusted PSBR 24.7 19.6 21.2 Tight fiscal policy is also required to meet Net interest payments 22.0 21.9 27.0 Turkey's disinflation objectives. Primary balance -2.7 2.3 5.8 8.5 International experience has shown that fiscal Real interest payments 11.7 9.2 10.9 adjustments are only sustained when they Operational balance -14.4 -6.9 -5.1 rely on measures to correct structural Source: SPO, WB problems such as weak expenditure 11 TURKEY: POLICY NOTES MACROECONOMICS management, excessive contingent liabilities, chronic public enterprise losses, and inefficient subsidy programs. The longer-term permanence of the fiscal adjustment is a major issue for Turkey. The impressive adjustment since 1999 has relied heavily on revenue increases and cuts in quasi-fiscal expenditures such as credit subsidies. Non-interest expenditures have actually increased significantly since 1999! Deeper structural reforms to the social security system, together with continued progress in public employment rationalization, stricter rules for government guarantees, agriculture subsidy reform, state enterprise restructuring/privatization, and energy reform are all needed to contain non-interest expenditures. Actions to Ensure Permanent Fiscal Adjustment: : Further structural reforms to the social security system including: early passage of pending legislation to underpin administrative and institutional reforms to improve collections and expenditure management, contain health expenditure, underpin the unemployment insurance fund, and implement the parametric reforms to the pension system enacted in 1999; extension of the full 1999 pension reform to Emekli Sandigi--the social insurance fund for civil servants; and further action to tackle re-emerging financial imbalances, notably in Emekli Sandigi. : Implementation of the public sector reform program including: improved tax structure and administration through continuation of the tax reform strategy; further rationalization of public employment; improved budget management through enactment of the Public Financial Management and Financial Control Law; better public procurement under the new Public Procurement Law; and new strict rules for government guarantees under the Public Debt Management Law. : Continuation of the banking reform program to the point where the blanket guarantee can be replaced with limited deposit insurance in line with EU norms. : Completion of agriculture subsidy reforms designed to replace inefficient indirect subsidies with direct income support for poorer farmers. : Privatization of state banks and SEEs which have been traditional mechanisms for delivering subsidies to favored groups and supporting over-employment in the public sector. : Deepening of reforms to introduce markets and contain the growth of quasi-fiscal liabilities in the energy sector. Low inflation is pro-growth over the longer term. Disinflation with growth can be achieved through credible policies and anchors. Turkey can meet the dual challenge of disinflation and growth in the medium term. The key is to avoid nominal rigidities (of wages, prices and interest rates) by ensuring the credibility of the stabilization program in reducing inflation. The lessons of Latin America and Central and Eastern Europe show that credible policies have a good chance of avoiding unpleasant trade-offs between recession and disinflation, at least in the medium term. Policies to Underpin Disinflation: : Fiscal adjustment underpinned by credible structural fiscal reforms : Structural reforms--with special emphasis on the financial and public sectors--to demonstrate that Turkey is serious about adopting a private sector led development model consistent with that found in other OECD and emerging market countries : Steady progress towards EU accession 12 TURKEY: POLICY NOTES MACROECONOMICS : Tight monetary policy underpinned by Central Bank independence Strong external competitiveness can drive export-led growth. The evolution of Turkey's trade openness has been exceptionally dynamic over the past two Figure 2.2: Trade to GDP has risen by Figure 8: External Openness decades. The change in share of trade to GDP more than 50 percentage points... since 1980 (about 53 percentage points) is close Speed of Integration GDP X+M Opennes [R scale] to the performance of Mexico and Korea. 25 70 Turkey has narrowed the path to convergence 20 60 in the level of openness with the European 15 50 Union. Turkey's openness ratio (66% in 2000) 10 40 is close to the 74% for the EU as a whole. 5 30 Turkey stands well above Latin America 0 20 (42%), but remains below East Asia (95% for -5 10 the region). 1980 1981-90 1991-95 1996-2000 2000 Source: World Bank data, EPPG calculations. Opennes: share in GDP of exports plus imports of goods and non-factor svcs. Speed of Integration: Trade growth less GDP growth. Further Steps to Strengthen External Competitiveness: : Consolidation of the floating exchange rate regime including establishment of an active forward market for foreign exchange. : Improvements in labor market legislation which is currently the most restrictive in the OECD and more effective social safety net : Competitive energy prices through market reforms : Active policies to attract FDI and promote competition : Higher public investment in human resources notably education, training and health The World Bank is actively supporting Turkey's economic program to reduce poverty and promote economic growth with policy-based loans, investment projects and technical advice under a high-case country assistance strategy (CAS). World Bank support is dependent on conditions being met that help ensure that this support has a meaningful impact. For the high case, these conditions include a credible macroeconomic framework that is also endorsed by the IMF. 13 2. PUBLIC SECTOR REFORM FOR EFFECTIVE GOVERNMENT Improved government effectiveness is the key to permanent macroeconomic stability and better public service delivery, especially under conditions of fiscal austerity. While the immediate trigger for the 2001 crisis was the fragility of the banking system, underlying this and previous crises is a deeper problem of governance which is manifested in serious, non-transparent and unsustainable imbalances in public finances. Correcting these structural weaknesses requires fundamental changes in the institutional arrangements for the management of public finances to ensure transparent public resource allocation and real accountability for results. Public sector management in Turkey scores badly in comparison to both OECD and emerging market norms. The impact of many years of weak fiscal discipline and poor expenditure 70 Central Government Expenditure in the OECD management is reflected in the 60 composition of public expenditure. The share of public spending on )gn 50 interest payments and wages and 40 salaries in Turkey is much higher than dinepSl ta in almost all of its OECD To 30 of counterparts. The large share of (% 20 interest payments reflects the legacy 10 of chronic deficit spending while the large salary payments reflect 0 . k da yl n . politically motivated public U.S naaC liaarts ar dnalnFi ecna Fr ynamr Ita sdnal yawr nia U.K Sp egare ece yekr Gre Tu Au miulgeB nmeD employment practices. Ge herteN No galutroP edewS dnalrezti Av Sw Countries (various years 1997-2000) Wage Expenditure Interest Expenditure Turkey's public sector management challenge has three dimensions: : Aggregate Fiscal Management is a major weakness The tax system suffers from a narrow tax base, excessive complexity and weak administration Public sector over-employment is endemic Significant resources are spent outside the formal budget framework and pose fiscal risks what is not measured cannot be managed. : Strategic Decision-Making is neglected and policies and plans de-linked from the budget the budget lacks strategic focus and credibility. : Excessive Control over budget implementation fails to prevent waste and inefficiency an abundance of formal ex ante controls provides little real management oversight and no focus on performance. 14 TURKEY: POLICY NOTES EFFECTIVE GOVERNMENT A key problem is the fragmented institutional responsibility for public expenditure management. : The Ministry of Finance manages the recurrent budget, the Treasury manages the transfer budget, and SPO is responsible for the investment budget. : The TCA is nominally Turkey's supreme audit institution, but it does not even audit all consolidated budget institutions, and there are numerous other bodies auditing general government agencies. : Until recently, there was no clear, unique borrowing authority for the central government with numerous extra-budgetary funds and autonomous agencies having the right to borrow. A comprehensive Public Sector Reform (PSR) program has now been launched, although implementation remains problematic. The program has three pillars: : Structural improvements to tax and public employment policy Tax reforms aim to improve equity, reduce distortions and broaden the tax base in order to lower marginal rates Public employment policies aim to correct over-employment and improve productivity : Policy and institutional reforms to improve the transparency and efficiency of public expenditure management (PEM) including action to: Improve budget preparation and execution, policy formulation, and the operational performance of public agencies Upgrade public accounting, procurement and audit standards to ensure financial accountability Ensure prudent public liability management : Broad based institutional reforms across the public administration to improve the quality of public sector governance. The strategy for Public Sector Reform is largely in place. : A three year strategy for improving the tax system was adopted by the government in January 2001. : The strategy for public expenditure management reform is laid out in the Strategic Framework for Public Expenditure Management Reform presented by government to the Bank in July 2001. : The National Anti-corruption Strategy was adopted by government in January 2002 under the slogan: A Transparent and Clean Turkey: Together Hand in Hand. Much of the legal framework to underpin the PSR program has been enacted. : A High Planning Council Decision on Rationalization of the Public Investment Program (PIP) was issued in June 2001. The 2002 PIP cuts the projected average completion time to 8.5 years, a 32 percent reduction. Overall, 353 individual projects and 649 subprojects have been dropped and the rationalization has reduced the total cost of the PIP by TL 36.9 quadrillion. The PIP rationalization has been one of the most concrete outcomes of the Public Sector Reform program to date. : A new Public Procurement Law was enacted in January 2002. The new law is based on the UNCITRAL model and moves Turkey towards compliance with EU requirements. The independent Public Procurement Agency established under the law is operational with staffing and funding in place. To ensure the credibility of the procurement reform, it is extremely important that the new law go into effect on January 1, 2003 as scheduled. : The Public Finance and Debt Management Law was enacted in March 2002. The law creates the foundation for a comprehensive risk management framework. The new law confirms the Treasury as the single borrowing authority for the central government. Under the law, stricter rules for the issuance of government guarantees have been adopted and Treasury has established a new office (the 15 TURKEY: POLICY NOTES EFFECTIVE GOVERNMENT "middle office") for debt and risk management. The new law also establishes a risk account in the budget, starting with the 2003 budget, to cover the expected fiscal cost of called guarantees. : Indirect taxes have been simplified under the strategy through introduction of the Special Consumption Tax (SCT) enacted in June 2002. The SCT consolidates the complex system of variable excises and the two highest rates of VAT into a single tax. However, implementation of the PSR program has lagged and a backlog of measures requires urgent attention. A major problem has been the lack of political coordination of the overall reform process exacerbated by the fragmentation of institutional responsibility for public expenditure management. None of the ministerial or high-level committees set up under the program has ever been operational. Urgent Priorities for Action include: Social Expenditure : Adequate social expenditure envelopes need to be established in the 2003 budget to ensure the social dimension. Social spending by the Social Solidarity Fund and the DIS program are likely to fall significantly short of agreed targets for 2002, although overall social spending is likely to be above the benchmark of 14.5% of GNP due to cost overruns in social security. Tax Policy : Publication of a government decree eliminating earmarking of SCT revenues, initially expected in August 2002. : Enactment of the direct tax reform package, initially scheduled for submission to Parliament in October 2002. The objectives are to: (i) harmonize taxes on investment income; (ii) rationalize ad hoc inflation adjustments in the tax system and lessen distortions associated with the taxation of nominal interest income; (iii) rationalize the system of investment incentives; and (iv) overhaul the system of credits against income tax. : Publication by MOF of a circular implementing the functional reorganization of the tax administration, originally scheduled for June 2002. The functional reorganization will reorient the General Department of Revenues from a structure based on administration of individual taxes to one based on the core functions of tax administration including taxpayer registration, taxpayer services, collections, audit, legal, information technology, and human resources. Concerns with the MOF's proposal for the functional reorganization including in the areas of internal audit, tax audit coordination and the tax policy unit should be resolved before publication of the circular. Looking further ahead, the government should consider creation of a separate revenues under- secretariat in line with OECD and EU norms. : Further steps to enhance tax administration include: (i) proceeding with implementation of the so- called "financial year zero" legislation passed several years ago but for which implementation has been repeatedly postponed, and (ii) avoiding a post-election tax amnesty which has become an unfortunate tradition in Turkey. Public Employment : Retrenchment of redundant employment in the SEEs is a core element of the reform program. Turkey is committed to eliminate by June 2003 all of the 46,000 redundancies already identified in the SEEs. The end-October timetable for reducing these redundancies by two-thirds has been missed. Work on identifying further redundancies should continue. 16 TURKEY: POLICY NOTES EFFECTIVE GOVERNMENT : Establishment of a comprehensive monitoring system for public employment (covering central government, SEEs and municipalities) with quarterly reports. This monitoring is required to ensure that the government's policies on public employment are in fact being implemented across the public sector. Public Expenditure Management : Upfront institutional reforms are needed to consolidate budget management under a single roof. A logical division of responsibility for public expenditure management would be: MOF­budget management, Treasury­public liability and cash management, SPO­policy formulation. TCA should become a true supreme audit institution. : Early enactment of the Public Financial Management and Financial Control (PFMFC) Law is urgently needed to set the foundation for improved budget management in Turkey. The PFMFC law was submitted to Parliament in August 2002. The law will harmonize and modernize budgetary practices across all of general government, reduce fragmentation and provide for a comprehensive presentation of the budget, allow for decentralization of financial control to spending agencies, and unify external audit under the auspices of the TCA. Remaining concerns with the law should be addressed before enactment to ensure effective implementation. These concerns regard: (i) the framework for internal audit, (ii) the respective roles of MOF, Treasury and SPO in budget preparation, (iii) recognition of Treasury as the sole borrowing authority, (iv) the need to phase expansion of TCA audits to all general government agencies with institutional reforms to TCA itself, and (v) creation of a government accounting standards board. The MOF visa authority provided in the PFMFC law should also be restricted to ensuring that funds for the commitment/contract in question are available in the budget in order to avoid overlaps with the responsibilities of the Public Procurement Agency. : The earmarked accounts ("special accounts") left over from the closed budgetary and extra-budgetary funds must be closed and the associated revenues treated as general non-tax revenues. The persistence of these earmarked accounts has prevented the closure of the funds from generating the intended improvement in budget transparency. More generally, the pervasive use of earmarking in budget management must be discontinued. : Finalization of strategic planning guidelines and their phased implementation across central government in order to link effectively planning, policy and budgets. : A multiyear action plan for further improvements in the Public Investment Program (PIP) has been adopted by SPO. The 2003 PIP should reflect further reductions in average project completion time. : Issue an MOF circular expanding new GFS budget classification to all of general government with fixed timetable. This action is critical to ensuring a more comprehensive budget. : Publish a government decree establishing the framework accounting standards and chart of accounts for general government in compliance with GFS requirements. The government should consider establishing a Government Accounting Standards Board which would be responsible for translating these framework documents into full-fledged accounting standards over time and in line with emerging international practice. This Board could be established by adding an article to the draft PFMFC law currently before Parliament. : Reissue Treasury circular on middle office to include strong emphasis on risk control function. Public Governance : The National Anti-corruption strategy should be put into operation. The strategy has remained on paper because of bureaucratic turf battles within the administration. : Preparations for the civil service reform strategy should get underway. Terms of reference for the functional review of government have been prepared but not yet approved. The capacity of the State Personnel Presidency to lead this effort remains in doubt. 17 TURKEY: POLICY NOTES EFFECTIVE GOVERNMENT World Bank support for the Public Sector Reform program hinges on strong government commitment. : Budgetary support for policy reform is provided under the US$1.35 billion Programmatic Financial and Public Sector Adjustment Loan (PFPSAL II). Disbursement of the second and third tranches of PFPSAL II is contingent on effective implementation of the program including the urgent priorities noted above. Advice on policy reforms is being provided for all core elements of the Public Sector Reform program. : Technical assistance is being provided to the Public Procurement Agency under a US$350,000 IDF Grant. This technical assistance is being used to help draft secondary legislation. : Technical assistance is being provided under the Public Financial Management Project (PFMP) for IT systems for budget management and debt management. This technical assistance includes support to the new middle office for debt and risk management in the Treasury. 18 3. ENHANCING TRANSPARENCY AND FIGHTING CORRUPTION FOR GOOD GOVERNANCE Good governance can help pay big development dividends. Corruption constitutes an Infant Mortality and Corruption Per Capita Income and arbitrary and often 90 12,000 Regulatory Burden 80 very high tax 10,000 70 which places a 60 8,000 50 disproportionate 6,000 40 burden on small 30 4,000 20 business and the 2,000 10 0 0 poor. Countless Weak Average Good Weak Average Good surveys and Development Development empirical x x Dividend Dividend investigations have Per Capita Income and Literacy and Rule of Law documented the Voice and Accountability corrosive effects of 10000 100 9000 corruption. Over 8000 7000 75 the past ten years, 6000 5000 50 the fight against 4000 3000 corruption has 25 2000 1000 grown into a global 0 0 movement whose Weak Average Good Weak Average Strong Development key weapons are x Development x Dividend Dividend reforms to improve governance and de- Transparency International Corruption Perceptions Index 2002 politicize economic management on the one 10 hand and public awareness campaigns on 8 the other. Recent analytical work by the 6 World Bank Institute xedInI highlights the strong CP 4 correlations between good governance and positive development 2 outcomes. 0 FinlanSwededKingHong d en dom ong SouthKoreaGreecezechSlovak Italy PolanRepubliRepublicMexicThailandTurUzbekistArgentinaRusPhilippinesUkrainedonesiaNigeria d c o an sia K USA GermanyJapanFrance key In Unit C 19 TURKEY: POLICY NOTES CORRUPTION Turkey faces a major governance challenge. Surveys consistently highlight the need to improve governance in Turkey. While it is far from the only country perceived to have a governance problem, Turkey does consistently rank below OECD comparators, as well as most emerging markets. Progress is being made to improve governance in Turkey. Governance Initiatives: : Structural reform to improve economic management has resulted in the establishment of independent regulatory bodies for banking, telecommunications, energy and public procurement, as well as full central bank independence. : Diagnostic surveys on corruption in Turkey covering the households and business community have been carried out by TESEV. A civil servants survey is ready pending government approval. : A National Strategy to Enhance Transparency and Good Governance in Turkey's Public Sector was adopted in January 2002. : The government has decided to prepare a civil service reform strategy under the PFPSAL program. The TESEV diagnostic surveys are helping to inform and empower. Household and Business Survey Highlights: : Corruption is one of the most important problems of Turkey. Households believe that bribery and corruption is the third most important problem after inflation and unemployment. Respondents from the business community rank bribery and corruption as the second most important problem after inflation. : Satisfaction with public services and trust in public institutions are very low. Only the primary/secondary education system and the armed forces score high levels of satisfaction with households. Businesses are satisfied only with the courts and the legal system, universities and the armed forces. : The extent of perceived corruption is quite widespread. Institutions with perceived problems include the customs, traffic police, and land registry. : Political connections are seen as an important factor for business. More than 65% of the business respondents believe that political connections are highly effective for doing business in their fields, indicating a high level of state capture in Turkey. A comprehensive national anti-corruption strategy has been prepared. The national strategy was prepared by a steering committee under the leadership of the Prime Minister's Inspection Board and including representatives from the Treasury, the Ministry of Finance's Financial Crimes Investigation Board (MASAK), the Ministry of Justice and the Ministry of Interior. The objective of the strategy is to provide a comprehensive framework for improving governance and reducing political influence over the economy which establishes clear priorities and benchmarks, and empowers and energizes public opinion to fight corruption. The strategy covers five core areas: public administration, the judicial system, the political system, civil society and the competitive private sector. Priorities under the Anti-corruption Strategy: : Accelerating the completion of ongoing work for institutional improvement and financial management within the framework of public administration reform. 20 TURKEY: POLICY NOTES CORRUPTION : Implementing amendments to the Law on the Contents of a Declaration of Wealth, Bribery and Anti- Corruption (No. 3628) in order to make these declarations public and to require mandatory audits and public access to the declarations for all elected officials. : Enacting regulations to ensure that inspections of campaign financing, income and the expenses of political parties and election candidates are made available to the public. Amending the existing Law on Political Parties to require that political parties and candidates make a public declaration of contributions from individuals and legal persons above a fixed amount. The High Elections Board will be responsible for publishing and auditing this information. : Implementing amendments to the Law on the Prevention of Money Laundering Law (No. 4208) to expand the list of criminal activities giving rise to illegitimate profits and to restructure MASAK in order to provide investigative powers to MASAK experts in specific areas. : Creation of an Inspection and Audit Services Class and passage of an Inspection Law to put into effect inspection standards, to allow for a complete restructuring of all inspection and auditing units, and to implement changes to appointment procedures to allow for fixed-term appointment of presidents. Amending the Civil Service Law (No. 657) to include a specific employment category for inspection and auditing services. : Establishing specialised courts to facilitate quick resolution of corruption cases. : Founding specialised units within the security forces and under the supervision and inspection of the Chief State Prosecutor to investigate corruption cases. : Implementing ethic agreements in Turkey. Implementation of the national anti-corruption strategy has lagged and requires urgent attention. A high-level committee has been set up to coordinate implementation of the strategy but has never met. Urgent Priorities for Action: : Structural Reform for Economic Management - Strengthen the independence of the new regulatory agencies. : Civil Servants Diagnostic Survey ­ Grant permission to TESEV to carry out the civil servants survey. : Anti-corruption Strategy ­ Put the strategy into operation by activating Steering Committee to oversee implementation. The strategy has remained on paper because of bureaucratic problems within the administration. The Anti-corruption Steering Committee must be closely integrated with the ministerial and bureaucratic level structures charged with coordination of the overall Public Sector Reform program. Deadlines under the strategy are fast approaching, including preparation of legislation to establish a code of ethical conduct for civil servants and drafting of a Freedom of Information Act, both scheduled for end-2002. : Civil Service Reform - Launch active preparation of the civil service reform strategy. Terms of reference for a functional review of government have been prepared but approval has been pending since July. World Bank is strongly supporting Turkey's efforts to improve governance. : Policy support for structural reform, the national anti-corruption strategy and civil service reform is provided under the US$760 million Economic Reform Loan (ERL) and US$1.35 billion Second Programmatic Financial and Public Sector Adjustment Loan (PFPSAL II). Implementation of the anti-corruption strategy is a condition for disbursement of the second US$450 million tranche of PFPSAL II and progress in preparation of the civil service reform strategy is a condition for disbursement of the third tranche. : Grant-based technical assistance is being provided to TESEV for the anti-corruption surveys, including implementation and assessment of the results of the civil servants survey. 21 4. IMPROVING SOCIAL PROTECTION THROUGH FISCAL SUSTAINABILITY, INSTITUTIONAL REFORM AND EFFECTIVE TARGETING Turkey needs a strong social protection system to alleviate poverty and economic vulnerability. Extreme poverty (US$1 per day) at just under 2% of the population remains quite low in Urban Vulnerability & Food Poverty (2001) 1/ Turkey by international standards. However, both urban food poverty (based on a food 100 consumption basket) and economic 90 80 vulnerability (defined as consumption less than 70 twice the food basket) are significant. 60 50 Economic vulnerability is probably even greater households) 40 of in rural areas. Vulnerability and food poverty 30 (% 20 increase sharply with household size 10 highlighting the importance of effective 0 1 2 3 4 5 6 7 8 9+ targeting towards the poorest families and Number of Persons in Household children. Vulnerability Food Poverty 1/ Indicative results from an interim household survey conducted by researchers at Middle East Technical University Turkey has the basic elements of a modern social protection system, but it needs to become more administratively efficient, affordable, and effective in reducing poverty. Key Issues to be Addressed: : Weak institutional structure and inadequate financing of the social safety-net : Fiscally unsustainable social security system and increasing numbers of people lacking coverage : Limited effectiveness of the new unemployment insurance scheme : Fragmented health financing system : Unclear institutional responsibility for poverty reduction policy formulation : Inadequate monitoring of poverty, social inclusion and economic vulnerability The social assistance system and social safety net structures are not adequately institutionalized and are subject to abrupt shifts in operations or even possible abuse. Weaknesses in the Social Safety Net: : Currently, the social assistance and social safety-net is managed by the Social Solidarity Fund (SYDTF) through 931 Provincial (Il) and District (Ilce) Social Solidarity Foundations (SYDVs), which are not formal budgetary agencies. While there are some advantages to flexibility in organizational structure, there is a stronger risk of inconsistency due to the fluidity of staff 22 TURKEY: POLICY NOTES SOCIAL PROTECTION assignments. All the staff of the SYDTF are seconded and could be withdrawn at any time, while the staff of the SYDVs can be diverted to other duties frequently. : Financing through SYDTF and the SYDVs has been unreliable and inadequate, with a pro-cyclical tendency, thus impairing effectiveness in reaching the neediest at the right times. The SYDTF is financed mainly by its own extra-budgetary fund (EBF), but these funds are cyclically linked to economic growth. It is necessary to spend more on social safety nets during downturns. : Expenditures of the SYDTF have fluctuated between 0.19% and 0.30% of GNP over the last 5 years. Expenditures in 2002 are expected to fall well short of the target of 0.3% of GNP. This is very low by comparison to Western Europe where such expenditures reach 1% or more of GNP, or even neighbors in Eastern Europe such as Bulgaria and Romania at around 0.7% of GNP. : A number of SYDTF programs are not well targeted to the poorest. Until recently, inadequate criteria have existed for determining who are the most vulnerable, resulting in a mixture of inclusion errors (including the non-poor in programs) and exclusion errors (omitting the poor from programs). With tight budgets, it is very important to maximize the impact from any program to reduce vulnerability and poverty. The authorities have begun to close the holes in Turkey social safety but more decisive action is needed, most importantly institutional reform of the Social Solidarity Fund. : Legislation is needed to reform the institutional foundation of the social safety net including: Transforming SYDTF into a general directorate--but with special provisions to keep its financial flexibility to handle crises and client-friendly social safety-net. Rationalize the structure of the SYDVs giving professional recognition and status to their staff and ensuring proper financial accountability. Ensure adequate and secure funding by shifting financing for the SYDTF fully on budget. Budget funding at least equal 0.35% of GNP should be provided. Legislation to partially reform SYDTF was submitted to Parliament in 2001 but never adopted. An entirely new, more comprehensive law should be drafted. : The recently introduced Conditional Cash Transfers (CCT) system has created a robust, but simple scoring formula for the SYDVs to rank people from the poorest to the richest in order to make payments to the families with lowest incomes who continue to send their school-age children to school and maintain basic health clinic visits by younger children. The same Budget Transfers to Social Security (% of GNP) 4% formula is being used to target beneficiaries of the Local Initiatives 3% program which aims to help the poor grow out of poverty permanently. 2% This improved targeting mechanism could be used for other benefits such 1% as food and winter heating support. 0% : The new Direct Income Support (DIS) 1995 1996 1997 1998 1999 2000 2001 2002Est. system is stabilizing farmer incomes. A clear commitment is needed to SSK BAGKUR EMEKLI SANDIGI maintain the DIS system over the medium term with adequate funding levels, and improve its targeting to poorer farmers. Reforms to Turkey's social insurance system remain incomplete. Issues requiring urgent attention include: fiscal sustainability, institutional fragmentation, and limited coverage. : Despite the parametric reforms introduced in 1999, the fiscal sustainability of the social security system remains in question. 23 TURKEY: POLICY NOTES SOCIAL PROTECTION Reforms introduced in 1999 including an increase in premium from 24% to 30% of the contribution base, increases in the contribution base, and introduction of a 3-month minimum premium payment period before eligibility for health insurance resulted in a fiscal saving equivalent to 1.2% of GNP in 2000 compared to 1999. Nevertheless, the fiscal position of the social security system worsened in 2001, with the deficit rising to over 3% of GNP, a level likely to be maintained in 2002. : The social security system is fragmented in Turkey as separate funds have developed over the years to meet the needs of different sections of the labor market. The three separate social security systems badly need rationalization and integration. Each fund focuses on its own sector, and none accept responsibility for individuals outside formal employment. Employers and individuals exploit the gaps between the three systems which results in falling revenues and an increasing number of individuals with no long-term pension provision. The three funds are: Emekli Sandigi (ES) civil servants, falling under the Ministry of Finance Bag Kur (BK) covering self employed, falling under the Ministry of Labor & Social Security (CSGB) Sosyal Sigortalar Kurumu (SSK) covering private and state-owned enterprise employees under the CSGB. : The most pressing issue regarding institutional reform of the social security system is the lack of a legal basis. Legislation to underpin the institutional reform has stalled in Parliament following expiration of the deadlines given by the Constitutional Court, which cancelled the Government's earlier attempt to enact the same legislation by decree-law. Passage of the legislation--covering SSK, Bag Kur, ISKUR, and the Social Security Institutions Directorate in the CSGB--has become an urgent priority for maintaining the credibility and momentum of the administrative reform. : Coverage is constrained by the limited ability of the funds to collect contribution revenues from known participants and the inability to identify and collect revenues from non-payers. Strengthening the administration involves changing the working practices and upgrading information technology to improve the funds' capacity to correctly identify individuals who should be contributing to the funds and to ensure that the full and correct level of contribution is paid on time. This would provide an improved revenue base for pensions and unemployment benefit and services, and ensure that pension provision is extended to the maximum share of the population. : A major effort is needed to tackle the serious problems facing the social security system. Social Security Reform Priorities: : Action to tackle re-emerging financial imbalances, notably in Emekli Sandigi, and full extension of the 1999 pension reform to Emekli Sandigi, e.g., revision of benefit formula and indexation of Emekli Sandigi pensions to CPI inflation. : Early passage of the pending legislation to underpin the institutional and administrative reforms. : Action by SSK and BK to identify all contributors who have failed to contribute for more than one year and either (a) track them down and enforce payment or (b) establish that they are no-longer legitimate contributors and exclude them from future arrears build up. : Development of a cost-effective approach to implementation of the administrative reform including management information systems. 24 TURKEY: POLICY NOTES SOCIAL PROTECTION The unemployment fund created under the 1999 reform has got off to a good start, but has been hampered by an incomplete legal framework, high severance payment requirements and the prevalence of informal labor practices. : ISKUR began paying out unemployment benefits in March 2002, but still faces administrative problems. Because of legislative delays, ISKUR currently has no legal status and therefore is constrained in its activities including recruitment of new staff needed to handle the influx of unemployment benefit claims. Total claims have fallen short of expectations in part because employers prefer to hire informal labor and to send workers on informal leave rather than make the high severance payments mandated by law (one month per year of employment). Where workers are formally laid off, the combination of extended severance and unemployment benefits may discourage job search. In addition to passing the ISKUR law, the severance payment system should be fundamentally restructured in order for the unemployment insurance scheme to become the key support system for labor redeployment. Health coverage is extremely fragmented and divided among different agencies. Health financing should be disentangled from the social security and safety-net systems. : The fragmented system duplicates costs, inhibits overall control, and results in uneven coverage with large numbers of people outside of the formal system and having to rely on the Green Card. : Managing health services and health financing diverts SSK, Bag Kur and ES from more effective management of pensions, and diverts SYDTF funds from higher priority safety-net programs. One possibility would be to combine all SSK, Bag Kur, ES and SYDTF health financing systems into one compulsory comprehensive professionally managed health insurance fund. Responsibility for poverty reduction and social inclusion is scattered among many agencies which results in inadequate policy formulation for addressing vulnerability. : Monitorable poverty reduction and social inclusion strategies are required to be prepared by all EU accession countries. An institutional focal point for these issues is needed taking into account current capabilities and responsibilities. A regular and robust poverty monitoring system is being introduced, and it is important to maintain this system and make its results publicly available. : Starting in 2002, the SIS will carry out Household Income and Expenditure Surveys annually for at least the next 4 years. Also needed are: strong data analysis, poverty mapping (through interrelation with the census data), and panel data to track vulnerability over time. The World Bank has made a strong commitment to support strengthening of Turkey's social protection system. : Support for the SYDTF, including the CCT and Local Initiative programs, is being provided under the US$500 million Social Risk Mitigation Project (SRMP). Early enactment of reform legislation for the SYDTF is needed to continue disbursements under the SRMP. : Support for the DIS program is being provided under the US$600 million Agriculture Reform Implementation Project (ARIP). 25 TURKEY: POLICY NOTES SOCIAL PROTECTION : Support for funding of severance payments and retraining/reinsertion programs for workers laid off or retired under the privatization program is being provided under the US$250 million Privatization Social Support Project. : Policy support for the social security reform is being provided under the US$760 million Economic Reform Loan (ERL). Passage of the legislation to underpin the institutional reform of the social security system is a condition for release of the second US$375 million ERL tranche. : Support for implementation of the institutional and administrative reforms to the social security system could be provided if the government makes a clear commitment to a least-cost approach. 26 5. EDUCATION AND TRAINING FOR INVESTMENT IN TURKEY'S FUTURE Raising the educational qualifications of the Turkish population is crucial to making the country more competitive in the global economy and to meet the goal of EU accession. Improving the population's skills and knowledge will increase labor productivity, promote employment growth, and assist all citizens to participate in the expanding economy. : The nature of the demand for labor is shifting in Turkey as the country moves toward fuller integration into the global knowledge economy. : Employment in key sectors shifted between 1990 and 2001. The share of agriculture in total employment fell from 47% to 35%, while services increased from 33% to 41% and industry from 15% to 18%. : The result has been higher unemployment for individuals without the necessary skills. In 2001, workers with only a primary school education accounted for 45% of total unemployment; corresponding percentages were: 13% for junior high, 17% for high school, 11% for higher vocational training, and 8% for higher education. Turkey is in the midst of a nationwide mobilization to improve the skills and knowledge of its population--starting in the early years and extending to tertiary education and training. : This mobilization requires increasingly efficient use of existing resources, and potentially increasing public expenditure on education from 4% of GDP currently closer to the OECD average of 5%. : Even with a funding increase, government will face tough choices about priorities and phasing, as not all needed improvements in education can be afforded at once. Basic and Preschool Education: Turkey has made great progress under the basic education reform launched in 1997... : Primary education is nearly universal with a net enrollment rate of 95% in 2001. Law 4306 of 1997 extended compulsory basic education from five to eight years and raised new revenues to finance a major expansion of education infrastructure. This initiative had a dramatic impact on primary school enrollments. ...But faces three continuing challenges: (a) improving school quality and effectiveness, (b) raising primary school enrollments for rural and poor children, and (c) expanding enrollments in preschools. : Improve education quality and effectiveness. Turkey's children perform poorly on international tests and high repetition rates persist in parts of the country. Improving overall quality is a long-term challenge that will continue to involve teacher support, better educational materials, alternative educational methods, including the use of ICT, and incentives to provincial education departments to promote effective schooling practices. Supporting the expansion of education in a manner that maintains and enhances quality while not creating disparities among schools presents challenges. The 27 TURKEY: POLICY NOTES EDUCATION Government could define a set of quality standards for schools, using these standards as a yardstick to evaluate and improve equity across schools, and to target additional capital expenditures and professional training to schools below the standard. : Raise primary school enrollments for rural and poor children. While primary school enrollments have increased substantially, about half-a-million children in the age range (about 5%) are still not enrolled in basic education. Most of these children are from rural, poor families of the East and Southeast, or in gecekondu areas of the largest cities. In addition, the gender gap remains a problem, with significantly fewer girls in primary school than boys. The Government needs to develop mechanisms to collaborate with local communities and parents to identify barriers. Many village primary schools require investments to raise the standard of facilities, provide better educational materials, and better train teachers. Some urban schools and rural schools are overcrowded, and investments in expanded capacity are needed. : Expand preschool education. The Turkish government recognizes the social and economic benefits of early child development. The 8th Five Year Development Plan aims to increase preschool enrollment from about 10% now to 25% by 2005. More investments are needed, however, especially for children in poor families. Research in middle-income countries has found that early intervention in schooling for four- to six-year-olds can reduce repetition rates, improve chances of attaining higher levels of education, mitigate the risk of social exclusion, and promote higher incomes. Economic returns to investments are estimated at 12-15%. The World Bank Indicators report preschool enrollment rates of 25% in developed countries. Secondary Education: There is recognition in Turkey that the role of secondary schools in a modern knowledge economy is changing to preparing youth for a variety of transitions including further specialized education and lifelong learning. The shortage of skills at secondary and tertiary education is increasing. These developments resulted in the recent passage of Law 4702, which provides incentives for youth to complete secondary school and reduces barriers for students to move from secondary to postsecondary education and training (including two-year higher vocational training institutions). The 8th Five Year Development Plan aims to increase compulsory education from eight to twelve years by 2005. Turkey faces three main challenges in developing secondary education: (a) changing the content of secondary education programs, (b) improving quality and assessment, and (c) expanding resources. : Change the content of secondary education programs. Major curricula revisions are needed to reflect the increasing demand for technical skills and knowledge. OECD research on key competencies for the knowledge economy indicates that individuals must be able to evaluate information, make independent decisions, and function in socially heterogeneous groups. There is a particular need to redefine secondary vocational education, which continues to teach some 100 specialties, instead of the needed broad knowledge and skills. In addition, youth need career guidance and counseling to help them make informed career choices. : Improve quality and assessment. Quality enhancements must parallel increases in quantity. Turkey needs to improve existing internal assessments, as well as participate in a broader range of international benchmarking assessments--Program of International Student Assessment (PISA) and the Adult Life Skills and Literacy Study (ALL)---in addition to the Mathematics and Science Study (TIMSS). In vocational training, there is a need to continue development of occupational standards and assessments to identify cross-cutting skills for secondary programs, facilitate articulation between 28 TURKEY: POLICY NOTES EDUCATION broad secondary and specialized tertiary and non-formal training, and ensure quality programs in all areas. : Expand resources. More investment and recurrent funds are needed. The cost of moving from gross enrollments of 60% to 100% by 2005 has major resource implications. Changes in secondary programs will require parallel investments in teacher training. The estimated 3 million new secondary school places will require estimated investments of US$12 billion, and annual recurrent costs of about US$2 billion. Possible efficiency gains (i.e., the student teacher ratio in vocational schools is low at 12/1) could reduce these costs somewhat. Tertiary Education: Higher education is taking on increasing importance as Turkey progresses with the transition to a knowledge economy. : Only 18% of the 25-64 year-old workforce in Turkey has completed a secondary education and only 8% has completed higher education, in contrast to modern knowledge economies where two-thirds of citizens have some postsecondary education. The average education level of the Turkish adult workforce is just over 5 years compared with 10 years in high-income OECD countries. Key challenges for tertiary education include: (a) expanding access, and (b) diversifying programs to meet the needs of the knowledge economy. : Expand access. The gross enrollment rate in tertiary education in Turkey in 2001-02 was 29%, including distance learning students, compared to 64% in the OECD. Alternatives to expand access include, but are not limited to: (a) expanding the use of distance learning; (b) increasing the role of the private sector in tertiary education, and (c) diversifying tertiary funding while ensuring that qualified low income citizens still have access. : Diversify programs. There is a need to diversify the content and delivery of tertiary education to respond to the changing labor market. Currently the tertiary education system is a single "unified" system controlled by universities and comprising mostly fixed term two-year associate degrees, as well as undergraduate and graduate programs. There is recognition of the need for more flexible and shorter labor market programs and to create mechanisms to recognize prior learning, including secondary education as envisioned under Law 4702, as well as non-formal training. There is also a need to expand graduate programs and investments in research as there is only one Ph.D. graduate per year per 34,000 inhabitants in Turkey, as compared to one per 5,000 in the OECD. Support for development of education and training is a cornerstone of the World Bank's assistance program to Turkey. : The World Bank is supporting Turkey's basic education reform under the US$600 Basic Education Adaptable Program Loan for which the second US$300 million loan tranche was approved in mid- 2002. : Preparation is underway for a Secondary Education Project. : The Bank is open to discussions on analytic work in tertiary education and training. 29 6. REFORMING THE HEALTH SECTOR FOR IMPROVED ACCESS AND EFFICIENCY Turkey has made considerable progress in expanding healthcare coverage and improving on key health indicators, but continues to rank far behind most middle-income countries in terms of health status. Figure 1: Maternal Mortality Ratios for Selected European and Central Asian Countries 60 Whereas Turkey is the world's 17th most industrialized nation, it ranks only 85th out 50 of 180 countries in the 2002 UNDP human development index. Life expectancy is births) 40 nearly ten years below the OECD average, live and infant and maternal mortality rates are 30 among the highest of middle-income 100,00 countries. By most accounts, the health (per 20 sector in Turkey is under-performing in achieving health outcomes. MMR 10 0 Finland any a ia ia jan an (H) Germ Sloveni lgar bai Bu Armen Georgia rgyzstan Azer Kazakhst Ky Turkey Note: The estimate of 52 deaths per 100,000 live births in 1999 is based on hospital-reported deaths. Higher MMR rates have also been estimated Substantial and sustained efforts will have to be made in the coming years if the country is to meet the objective of improving the health status of its people, including meeting the health targets of the Millennium Development Goals (MDGs) by the year 2015. Turkey's Challenge: Millennium Development Goals for Reproductive and Child Health Goal: Reduce Child Mortality Target: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate Indicators: (i) Under-five mortality rate (from 67/1000 in 1990 down to 22/1000 in 2015) (ii) Infant Mortality Rate (from 58/1000 in 1990 down to 19/1000 in 2015) (iii) Proportion of 1 year olds immunized against measles (iv) Proportion of children immunized against DPT3 and OPV3 Goal: Improve Maternal Health Target: Reduce maternal mortality ratio by three quarters between 1990-2015 Indicators: (i) Maternal Mortality Ratio; (from 55/100K in 1995 down to 14/100K in 2015) (ii) Proportion of births attended by skilled health personnel 30 TURKEY: POLICY NOTES HEALTH Detailed background studies were carried out by the Bank and local experts in the past year to examine the trends in health status of Turkey's population and to evaluate the structure of production, finance, delivery, and organization of the country's health systems. The findings were summarized in the recent Bank Health Reform Study. Key Issues in Health: : The health status of Turkey's population is poor, both in absolute terms as well as in comparison with other countries at same income level; in particular, maternal and child mortality and morbidity rates are very high. : There are wide gaps between urban and rural populations and regional disparities in outcomes across almost all health indicators. : Not all those who are ill are able to get treatment for their illness; in particular, the poor are much more likely to not get treatment when ill than the non-poor. : Very little is spent on preventive care and on maternal and child health; in fact, allocations to preventive activities on a per capita basis have fallen in real terms over the last five years. : The primary health care system is underfunded and ineffective; most people avoid public primary health care facilities and either directly seek care at outpatient facilities of hospitals or, if they can afford it, from the private sector. : A large number of health centers are understaffed and many do not have even one physician; the situation is particularly grim in rural areas in general and in the Eastern and South Eastern Anatolia regions of the country in particular where a great number of health posts are not operating for lack of personnel (mid-wives). : The majority of general hospitals are operated inefficiently, wasting resources. : There are wide gaps in the distribution of health personnel across the provinces and regions; in particular, there is a concentration of physicians in the big cities and towns while rural areas are significantly understaffed. : There is little coordination between the Ministry of Health (MoH) and the Ministry of Labor and Social Security (MLSS) which, between them, are responsible for most financing and provision of health care in Turkey; in particular, even though their activities overlap across most services and they have facilities in the same towns and cities, there is little sharing of resources and complementarity between them and almost no planning or collaboration at any level. : Large segments of the population do not have adequate health insurance or any other form of financial protection; in particular, over 50 provinces have 10 percent or more of their population not covered under any insurance or Green Card scheme. : The distribution of public expenditures on health is not equitable; the richer regions spend more public money per person on health care compared to the poorer regions. To meet the ultimate objective of improving the health status of the population, fundamental and systemic changes will be required in the ways that health care is financed, delivered, organized and managed. Piecemeal changes at the margin are unlikely to reform the health system. A reform strategy aimed at addressing the problems of the health sector needs to be shaped around at least six areas: : separation of financing and provision functions : improvements in resource mobilization and allocation : enhanced access to health services : increased demand and utilization of health services commensurate with needs : improvements in efficiency in production and delivery of health services 31 TURKEY: POLICY NOTES HEALTH : improvements in clinical effectiveness of the health services. The recent Bank study outlined one health reform strategy that would address these challenges by encompassing the following measures: : Compulsory universal social health insurance, with optional supplemental private insurance The different health insurance schemes being offered through Sosyal Sigortalar Kurumu (SSK), Bagkur and Emekli Sandigi, and the coverage provided to civil servants and to welfare recipients under the Green Card scheme, could be combined into one compulsory national social health insurance system, a national independent and professionally managed Health Fund. This would rationalize current overlaps and gaps in coverage. : Developing a package of essential services and targeting public spending Several factors other than health services, genetics and lifestyles affect health at the personal level. Malnutrition, poor water supply, sanitation and personal hygiene, and tobacco use are among the major risk factors. In order to reduce maternal and child mortality and morbidity, health care should be delivered as part of a package of essential services available to the entire population, regardless of where they live and their health insurance affiliation. The package of services should include evidence-based and cost-effective medical interventions, including, inter alia, timely immunization, health education, pre- natal, delivery and post natal care, integrated management of childhood illness (IMCI), and a series of measures, that while outside the health sector, have high impact on health outcomes, including clean drinking water and basic household sanitation. Innovative organizational modalities of service delivery such as outreach services could be tested and scaled up to make the essential services available to the poor and the vulnerable in underserved areas. : Reorganizing public hospitals and providing greater autonomy To improve hospital efficiency and delivery of services, the MOH and SSK hospitals should gradually be granted administrative and financial autonomy, including human resources management and autonomy for procurement of necessary inputs. This would allow hospitals to define their own niche of service mix in the environment they operate, out source those medical and catering services which would be cheaper to purchase, and get into contractual arrangements with various purchasers and other providers for greater efficiency. : Consolidating and redefining institutional responsibilities Both MOH and MLSS have an important position to play in the country's health care system, given their existing investments and their respective influences in the health sector. The relationship between the two Ministries needs to be clarified and redefined so that they may function with common shared values and purpose, and within a common regulatory framework, but with a view to complementarity and collaboration in service delivery and patient referral. The division of labor should be based on health care functions instead of beneficiaries with MOH focusing more on policy formulation and regulatory oversight while MLSS on health insurance. : Strengthening delivery of primary care services Reform in the delivery of primary care should involve improvements in how primary health care professionals are perceived in both the medical as well as the patient community. These professionals should be given the necessary levers to steer patient treatment, either in a home-care setting or in a 32 TURKEY: POLICY NOTES HEALTH hospital setting, so as to ensure integration of the different health service delivery sectors. The practice of "family medicine", in which physicians provide comprehensive and continuous care for the whole family, and act as gate keeper through the provision of primary level clinical care should also be encouraged. Timing and sequencing of the reforms are critically important to enable the system to absorb the changes and not become overwhelmed. A recommended approach would be two-phase implementation: the first phase spread over three to five years and the second phase over a further three to five years upon completion of Phase I. The following steps during the first 100 days would lay a strong basis for defining and implementing a comprehensive reform: : Launch a consensus-building exercise on the reform agenda through a national conference designed to bring together key stakeholders in the health sector--government/non-government-- in order to help define, and ensure buy-in, for the reform agenda. : Set up a high-level, inter-ministerial committee (possibly under the Prime Minister) to be responsible for coordinating the implementation of the reform agenda. : Reach Government commitment and launch a pilot program in rural areas to reduce maternal and child mortality to the levels of other middle income countries. The Bank stands ready to support a health reform program for Turkey in a comprehensive manner, including both continued advisory services and possible new loans. : The Bank is currently supporting the Health II Project through an ongoing loan of US$150 million which is nearing closure. The project has included the implementation of important measures to help Turkey meet the MDGs related to maternal and infant mortality, as well as improvements in clinical effectiveness and increased demand for services. : The Bank has prepared a Health Reform Study to analyze the challenges facing the health care system in Turkey and outline the options for reform. 33 7. ISSUES FOR FINANCIAL SECTOR DEVELOPMENT AND GROWTH Turkey's financial services industry is in an early stage of development with credit markets dominated by banking (accounting for over 85% of financial system assets), and capital markets dominated by government securities (accounting for over 90% of trading). : Non-bank financial institutions (NBFIs) such as insurance companies, private pension funds, leasing, factoring and venture capital firms together account for less than 15% of financial system assets and less than 15% of GNP. The equity market has shrunk in recent years and market capitalization accounts for only around 30% of GNP. Corporate debt markets don't exist and organized derivative markets are still in their infancy. Lack of depth and breadth has made the financial services industry vulnerable to shocks resulting in repeated crises, and has reduced its intermediation efficiency to the detriment of private sector growth. Banking System The banking system has dominated the financial services industry over the last two decades, and weaknesses in the system have contributed to the overall turmoil in the economy in recent years. The main focus of reforms and development attention for the last three years has been on strengthening and stabilizing the banking system as the core foundation for a full fledged financial services industry. Much progress has been made in addressing key banking system issues. Key Banking Reform Milestones: : Upgrading of banking legislation, regulations and accounting standards to international best practice standards : Creation and operationalization of a new, independent Bank Regulation and Supervision Agency (BRSA) : Intervention by the Savings Deposit Insurance Fund (SDIF) in over 20 insolvent private banks and resolution of all but 4 of these banks : Implementation of a Recapitalization Program for private deposit taking banks, based on a 3 stage audit process finalized by the end of June 2002, which identified banks' true capital adequacy ratios based on a thorough analysis of their loan portfolios and IAS 29-based hyperinflation adjustments : Completion of the financial and operational restructuring of the state-owned banks Ziraat and Halk, and the closure of Emlak bank. 34 TURKEY: POLICY NOTES BANKING & FINANCE Despite these achievements, there is still a large unfinished banking system reform agenda ranging from institutional development of BRSA and SDIF to resolution of the remaining SDIF intervened banks to restructuring/privatization of the state banks. Banking Reform Issues to be Addressed: : Further strengthening the institutional capacity of the BRSA. Since its creation, the BRSA has made progress in upgrading its institutional capacity, but more still needs to be done to further bolster its effectiveness as an independent bank regulator. Specifically, there is a need to: substantially upgrade its offsite analysis capacity including through the development of a common data base for all BRSA departments and the timely receipt of comprehensive information from banks to further integrate the Sworn Bank Auditors into the overall BRSA staff to develop risk-based supervision to prepare a corrective action manual to be supplemented by a BRSA regulation specifying what enforcement actions the BRSA will take based on what types of prompt corrective action triggers to lift the current freeze on BRSA staff salaries as there is a need to ensure that the BRSA can pay market-based salaries to its staff and can avoid the departure of many of its most qualified staff. : Developing a long term strategic plan for the SDIF. The government needs to start thinking about broader SDIF institutional and Deposit insurance policy issues as the restructuring of the banking system nears completion. These include: Effective resolution of its portfolio (on a book value basis) of NPLs and real estate assets of almost US$10 billion equivalent Decision on lifting of the blanket guarantee and what level of limited coverage to provide thereafter Decision on the Location & Governance Structure of SDIF--thought should also be given to the question of whether the SDIF should be made independent from the BRSA to avoid possible conflicts of interest in future between the SDIF (as the owner of banks it intervenes in) and the BRSA (as the agency responsible for supervising banks owned by its own subsidiary). Also whether SDIF should be better located in Istanbul rather than Ankara. : Completing the resolution of existing banks under the SDIF. There are still some banks in various stages of resolution with the SDIF. These include Turk Ticaret (under liquidation), Taris (being sold to Deniz bank), Toprak (under liquidation following merger with Bayindir), Pamuk (in the market for sale with offers accepted till December 2002), and Bayindir (currently used as a transition asset resolution subsidiary of SDIF for good loans of failed banks and on a sunset path with these loans being repaid). All of these bank have to be ultimately resolved within the next three to six months. : Resolving the Ownership Question of Yapi Kredi. Through a complex interrelationship between Pamuk and Yapi Kredi, SDIF holds the majority ownership of Yapi Kredi previously held by Cukurova group companies declared unfit to be bank owners when Pamuk was intervened. Negotiations are currently underway between the SDIF and the Cukurova group to resolve the situation. Given the systemic importance of Yapi Kredi, it is critical that this issue is resolved as soon as possible, and that the bank is adequately capitalized. : Completing the package sales of NPLs under SDIF. The SDIF's collections department is also planning package sales of NPLs (other than NPLs outstanding to the owners of failed banks) to the market to accelerate their resolution over the next several months. Many of the above actions are ground breaking on the part of the BRSA/SDIF and will need the active support of the government. : Strengthening Execution and Bankruptcy Law and court infrastructure. Collateral and bankruptcy legislation in Turkey, as well as the supporting judiciary infrastructure, are in need of a 35 TURKEY: POLICY NOTES BANKING & FINANCE major overhaul to allow successful resolution of NPLs held by the banking system and the SDIF, including through the use of the `Istanbul Approach', and to encourage banks to resume lending. A first draft of amendments to the applicable legislation has been prepared. The government should ensure that the overhaul is completed as soon as possible in line with best practice standards as documented in the Report on Observance of Insolvency and Creditor Rights prepared by the Bank in cooperation with the Ministry of Justice. : Urgent restructuring and privatization of Vakif Bank. Vakif is a large bank (TL9 quadrillion as of end June 2002, representing 7% of banking system assets) and as such has the potential to destabilize the banking system if its financial condition deteriorates. The failed privatization shows that the bank cannot be sold as is for the following reasons: Very high NPLs Excessive proportion of non-banking assets on its balance sheet (e.g., real estate investments and equity participations) that have no synergy with its core banking business lack of a clearly defined ownership and corporate governance structure. Therefore, the government should urgently take a decision on what to do with Vakif. There clearly is buyer interest in the bank, but the bank cannot be sold until the three issues mentioned above are addressed through a combination of balance sheet and ownership restructuring. : Implementing a pre-privatization plan for Halk Bank. A clear and credible pre-privatization plan is needed to prepare Halk Bank for sale. Halk has a rather weak customer base as SMEs traditionally came to the bank for subsidized credit, but have generally brought their other banking business to large private banks given the poor quality of Halk's services. Halk will also face increased competition from Ziraat Bank, including for SME clients located in rural areas, as the latter expands into a full service bank in line with the recommendation of strategic advisors. The question whether Halk has a future as an independent bank needs to be resolved and the option of merging it with another bank considered. : Preparing Ziraat for privatization. Based on a strategic study of agricultural finance in Turkey undertaken by Ziraat with the assistance of RABO Bank of the Netherlands, it is clear that Ziraat cannot survive by financing primary agriculture alone, and will need to become a full service rural bank to be profitable in the long run. Further pre-privatization balance sheet restructuring may be needed for Ziraat, as its large balance sheet dominated by government securities may make it unattractive to private investors. Possible restructuring options require the government's urgent consideration given their complexity, magnitude and potential fiscal implications. : Reducing the banking system's exposure to government securities. Government securities account for a continuously increasing percentage of banks' assets, making the banking system vulnerable to any perceived or actual risk of sovereign default. The government should proactively seek other outlets for its debt securities to allow banks to gradually reduce their holdings of government paper and to move funds into real sector lending. Development of an institutional investor base that can absorb government securities is a key priority. The Bank's NBFI/Capital Markets study contains specific recommendations that can assist the government in designing a strategy for this purpose. Non-Bank Financial Institutions and Capital Markets Priorities Non-bank financial services such as leasing, factoring and venture capital, and capital markets (equity/corporate, debt/derivative markets) are likely to undergo rapid development in the near future. : Longstanding macro-economic instability and hyperinflation have discouraged investment in financial assets, and a persistently high PSBR has crowded out funding for the private sector. The 36 TURKEY: POLICY NOTES BANKING & FINANCE government's ongoing stabilization and structural reform efforts are improving the prospects for rapid development of the financial services industry from the current low base. While such rapid growth will be very beneficial for economic growth and private sector development, it can also create new vulnerabilities and actions should be taken to encourage and manage the growth effectively. To capitalize on this opportunity, and to ensure that rapid `catch-up' growth of selected parts of the financial system does not create such new vulnerabilities, a series of key policy issues should be addressed. NBFI Issues and Policy Recommendations: : Introduce tax and regulatory incentives to mobilize long term savings. Substantial savings currently held outside the formal financial system can be mobilized into the financial system to jump- start/help accelerate financial sector development. The key to doing so and to achieving rapid, yet balanced financial sector growth will be to develop a tax policy for financial products/services and institutions that removes existing distortions favoring one type of instrument or institution over another and introduces well thought-out incentives for savings to move into risk-based and longer maturity instruments such as equity/venture capital and pension/life insurance products. : Encourage development of an institutional investor base. To allow enhanced savings to be intermediated effectively, development of an institutional investor base (private pension funds/insurance companies/mutual funds) should be encouraged. For private pensions, this will require further reform of the state social security system, upgrading and centralization of regulation/supervision of existing and new private pension schemes, and harmonization of their tax treatment. For insurance, this will require upgrading applicable legislation/regulation and the quality and independence of insurance supervision. For mutual funds, this will require bringing regulations in line with the EU UCITS Directive, industry consolidation and putting in place a pass-through tax regime at the fund level. : Improve the efficiency of capital markets infrastructure. Existing inefficiencies should be addressed, i.e., privatization and demutualization of the ISE, addressing potential conflicts of interest in the nexus of market infrastructure companies with the ISE owning parts of Takas Bank, the new central registry, etc.; accelerating the dematerialization of securities, adoption of an electronic bond trading platform for Government securities. : Promote and facilitate development of leasing, factoring and venture funds. Leasing and factoring laws and regulations should be modernized; and a review undertaken of ways to stimulate venture capital development. : Strengthen minority shareholder rights and transparency of financial statements, and streamlining regulatory oversight of financial markets. Confidence in financial markets should be enhanced by strengthening corporate governance, developing a common IAS-based accounting standards platform and enforcement mechanism for all financial institutions and publicly held/traded entities, supplemented by special-purpose prudential reporting requirements for specific types of financial institutions as deemed necessary by their regulators, improving oversight of the audit profession, streamlining the various financial sector regulatory agencies, and developing consolidated supervision of financial, and financial-industrial conglomerates. 37 TURKEY: POLICY NOTES BANKING & FINANCE Financial Sector Activities of the World Bank The Bank has had a broad and deep pipeline of financial sector lending and non lending activities in Turkey spread over last four years. The current pipeline includes the following activities: : Export Finance and Intermediation Loan (EFIL, US$252 million). The Export Finance Intermediation Loan provided through Turk Exim Bank starting in September 1999 and continuing at present, has been very successful in providing export finance to diverse manufacturing sectors of economy including textiles, food processing, metal works, auto parts and furniture. It also strengthened financial intermediation in leading private banks by strengthening the credit and risk management functions through a bottom up dialogue directly with the market participants. : Programmatic Financial and Public Sector Adjustment Loan II (PFPSAL II, US$1.35 billion). The Programmatic Financial and Public Sector Adjustment Loan currently under implementation is the third in a series of adjustment loans in support of the policy and institutional reforms in the financial sector (the other two were the US$778 million Financial Sector Adjustment Loan in Dec 2000 and the US$1.1 billion PFPSAL I in July 2001). The focus of PFPSAL II is on enforcement of the regulations in the banking sector, institutional development of BRSA and SDIF, resolution of SDIF banks and their assets, reforms in the Execution and Bankruptcy Law and the court infrastructure, privatization of Vakif, and operational restructuring and strategic assessment of the future of Ziraat and Halk. : Non-Bank Financial Institutions (NBFI) Study. The Bank financial sector team in collaboration with the Turkish Capital Markets Board, General Directorate of Insurance and Department of Leasing/factoring in Undersecretariat of Treasury, BRSA, Istanbul Stock Exchange, Insurance and Securities Markets Associations, and a large number of pension funds has prepared a comprehensive study of the issues related to the growth of the Non-Bank Financial Institutions and capital markets in Turkey. The study also includes a detailed set of policy and institutional reforms that need to be undertaken to promote sustained growth in the NBFI sector. The study will be finalized in December 2002. The recommendations of the NBFI study will form the basis for discussion of future Bank support to the financial sector. 38 8. ASSISTING THE ENTERPRISE SECTOR IN TRANSITION FROM THE CRISIS Business was very adversely affected by the 2001 crisis. : The crisis hurt all sectors--industry, construction, trade and services. Export Orientation : Capacity utilization in the private sector averaged 65% in the first half of 40.0% 2001, increasing to 68% in the fourth 30.0% quarter. Capacity utilization was well below the break-even level for many 20.0% firms. 10.0% : Lower domestic demand adversely 0.0% affected many sectors focused on the 97q4 98q1 98q4 99q1 99q4 00q1 00q2 00q3 00q4 01q1 01q2 01q3 01q4 domestic market such as autos, construction, media and wholesale Large Medium Small distribution and retailing. Tourism remained strong with some 11 million foreign visitors in 2001. : The devaluation of the Turkish Lira Financial Expense Burden assisted many firms in exporting and somewhat mitigated the impact of the 40.0% crisis, but even exporting firms failed 30.0% to generate profits during 2001. 20.0% : Most firms were adversely affected by high financial charges stemming from 10.0% high real interest rates, the high cost of 0.0% servicing debt denominated in foreign 97q4 98q1 98q4 99q1 99q4 00q1 00q2 00q3 00q4 01q1 01q2 01q3 01q4 exchange and associated foreign exchange losses. Large Medium Small : Istanbul Stock Exchange (ISE) listed companies lost a total of US$1.0 billion dollars during the first quarter of 2001, compared to profits of Profitability by Size US$1.6 billion during the comparable 10.0% period of 2000. A hoped for 5.0% turnaround in profitability did not 0.0% occur in the last half of the year, with -5.0%97q4 98q1 98q4 99q1 99q4 00q1 00q2 00q3 00q4 01q1 01q2 01q3 01q4 net earnings of ISE companies down -10.0% 80% for all of 2001. -15.0% : Private investment declined by some 33% during 2001. -20.0% -25.0% : The downturn forced most firms to reduce their workforce throughout Large Medium Small 2001 by a variety of measures--direct 39 TURKEY: POLICY NOTES ENTERPRISE reductions in staff, reduction in working hours, extended plant Distressed Companies, 1998-2001 Q1 maintenance and extended leave. (ISE listed Companies) Workers and their families were badly hit by the crisis. At the end of 2001, 30 some 10.6% of the workforce was Sustainable unemployed and another 6% was under 59 73 70 6 employed. Operationally Distressed Many firms failed during 2001. 40 Financially Distressed 5 While the burden was particularly 4 5 22 acute for small and medium Technically Insolvent 11 13 enterprises, many mid-cap to larger 24 15 9 14 firms remain in distress as well. 1998 1999 2000 2001Q1 Growth has restarted in 2002, but the recovery could be fragile. Signs of Growth and Renewal: : GNP growth was 4.7% for the first half of 2002. : Exports held their own during the first six months, growing by some 3.3% compared to the comparable period in 2001. : Industrial production rose by 8% in the first half (9.3% in manufacturing), as opposed to a 7% decline in the same period of 2001. : Plant capacity utilization in the private sector averaged some 71% for the first half of the year, compared to 65% in 2001. : Unemployment continued to rise during the first quarter peaking at some 11.8% of the workforce, or some 2.5 million workers, but by the second quarter unemployment began to decline to 9.6% of the workforce or some 2.2 million workers. Also, the number of hours worked in the private sector rose during the first six months by some 5.3%. Potential Vulnerabilities: : It is not yet clear that the rise in production has been in response to robust demand; it appears that many firms were restoring depleted inventories. Moreover not all sectors have demonstrated recovery; output in the construction industry declined by 5% during the first six months of 2002. : Real interest rates remain high and firms are encountering difficulty attracting financing due to a reduction in post-crisis credit. To the extent financing is available its is almost always short-term, six months or less. : Firms continued to close during 2002 at an increasing rate. Some 11,377 small and medium firms closed through August, an increase of 15.5% over 2001. The rate of closure increased even for large corporations and cooperatives, increasing by 23.5% or some 2,025 companies. This reflects the continued fragility of firms, but also a likely lag in the process of legal closure. : The economy remains vulnerable to external conditions, in particular the economic slowdown in Europe and how that will affect export growth and the potential for conflict in the region and its impact on tourism, oil prices and Turkey's trade with its neighbors, specifically Iraq. 40 TURKEY: POLICY NOTES ENTERPRISE The Istanbul Approach (IA) has been developed to assist enterprises in their transition out of the crisis. : The World Bank provided advisory assistance to the Government, the banks and industry in the development of a corporate resolution strategy based upon the experience of other crisis countries in East Asia and in Mexico. This resulted in the adoption of the Istanbul Approach (IA) in June 2002, a voluntary approach to workouts where the banks and other creditors cooperate in assisting troubled companies in rescheduling their debts and in restructuring. Implementation of the Istanbul Approach is being accompanied by an overhaul of the bankruptcy framework which will strengthen incentives to participate in the IA and help improve medium-term resource allocation in Turkey. The Guiding Principles behind the Istanbul Approach are adapted to the Turkish context, drawing on the lessons of international experience with corporate workouts. Guiding Principles of the Istanbul Approach: Creditors have signaled that they are willing to pursue a non-judicial resolution of a company's financial difficulties rather than a formal process of seizing collateral or insolvency Istanbul Approach Process procedure such as liquidation. Inter-Creditor Selectionof Formationof Standstill/Due Agreement Companies Creditor Diligence Committee : The out-of-court program process is case-by-case that is each large Quality Workout Arbitration company entering the process is Review Agreement Panel 50-75% addressed by a separate Creditors' Creditors/Debtor Committee. An inter-creditor agreement has been signed by some Final 34 banks and non-bank financial Agreement >75% institutions, including the state banks and the SDIF, while other creditors such as trade creditors may join the Working Capital workout process through the Creditors Committee. : The IA is also time bound. The Creditors Committee has a maximum of 180 days to reach a resolution and agree to a workout with the debtor. : If 55% of creditors by value approve a plan, but less than 75% of creditors, the plan is brought to an arbitration panel which has the authority to approve it. If less than 55% of creditors approve a plan after 180 days, the case is dropped and each creditor is fee to pursue its own interests. : The commissioning by creditors of a due diligence review of each distressed company's long-term viability. : During the period of the review and negotiation the creditors have agreed to support a standstill. That is each of the creditors agrees to maintain its credit facilities and not to move against its collateral to the disadvantage of the other creditors. : New money could be provided on a pro rata basis by all existing lenders, by specific lenders with priority arrangements, or by release of asset disposal proceeds subject to priority considerations. Other principles underlying this potential financial support include recognizing seniority of existing claims and sharing losses on an equal basis among creditors in the same category. : If creditors agree that a company is viable over the long term, they should consider a formal rescheduling--such as an interest holiday, re-capitalization of interest in arrears, extension of loan maturities, lending of new money, or conversion of debt to equity. 41 TURKEY: POLICY NOTES ENTERPRISE : These longer-term financial changes will need to be conditional on the implementation of an agreed business plan that may well require restructuring of the company over the term of the workout. Restructuring may include management changes, injections of fresh equity, sales of assets or divisions, mergers or even company takeovers by new owners. : Once a workout is agreed to, the creditors and the debtor (the company) will sign an agreement stipulating the terms and conditions of the workout, reporting requirements of the debtor and events which would trigger a review of the agreement. : The IA does not guarantee the survival of a company in distress. Regulatory authorities do not intervene and, because of its voluntary nature, the IA is only effective if it is mutually supported by the banking and corporate communities. A Coordination Secretariat under the direction of TSKB oversees the Istanbul Approach process to ensure that its logistics and timing function effectively. : A three person Arbitration Institutional Structure of Istanbul Approach Committee, appointed by the board of the Turkish Bankers Association, and under the direction of TSKB, Coordinating BRSA Committee will make decisions on a workout if between 55% to 75% of creditors by value approve the workout plan. TSKB Arbitration Coordination/Intermediation Panel Creditor Creditor Creditor Committee Committee Committee CaseI CaseII CaseIII As of October 2002, 189 firms representing US$2.7 billion in loans, had entered the Istanbul Approach. : These firms, of which 134 large firms and 55 SMEs, employ some 20,000 workers, have sales of US$1 billion and exports of US$419 million. This first phase of the IA is expected to be completed within the first quarter of 2003. Progress to date in implementing the Istanbul Approach has been reasonable, but a number of issues have emerged that might become stumbling blocks. : There is a need to activate the Advisory Council which was established with participation of Treasury, the Central Bank, BRSA, the banks, TOBB and TUSAID, but has not met since its inception. The Advisory Council should review the IA process and recommend modifications to the law and/or process as required. The World Bank has assisted the Turkey in several ways with respect to the crisis on the corporate sector and potential resolution strategies. : During 2001 Bank staff prepared various assessments of the crisis and its impact on enterprises. This took the form of several briefing notes and a Corporate Sector Impact Assessment report. A 42 TURKEY: POLICY NOTES ENTERPRISE workshop to discuss the report was sponsored by the Treasury with the participation of representatives of the central Bank, BDDK, the state banks, SDIF, the commercial banks and the corporate sector as represented by TOBB and TUSIAD. : Bank staff advised the government, the banking sector and industry on potential resolution strategies including voluntary workout programs based on the London Approach and on asset resolution strategies, based on experience in designing similar programs in East Asia, in particular Korea. This resulted in the design and implementation of the Istanbul Approach. Complementing the voluntary workout program, the Bank is also advising the government on a new insolvency law. : A Corporate Rehabilitation Loan is presently under preparation to provide medium-term financing to firms going through the Istanbul Approach, to mid-size firms that are restructuring and to SMEs. The loan, an Adaptable Program Loan in an amount of US$500 million, would be provided in two tranches: an initial tranche of US$150 million and a second tranche US$350 million, providing key policy conditions have been met. 43 9. SME DEVELOPMENT AND TECHNOLOGY Small and Medium Enterprises were hit earlier and harder than large firms by the 2001 economic crisis and subsequent re-organization of the Turkish banking sector. : SMEs were hit hard by the crisis. To assess corporate performance of SMEs in 2001 and expectations for the future, more than 10,000 firms were surveyed by the Union of Chambers of Commerce (TOBB), Ankara Chamber of Commerce (ATO), Ankara Chamber of Industry and Istanbul Chamber of Industry (ISO). The results of surveys and interviews conducted by TOBB, ATO, and ISO indicate that 70% of small and medium-size enterprises saw business decline in the first quarter of 2001, and more than 60% cut staff. Most of these firms did not expect conditions to improve or to have access to bank finance during the rest of that year. Enterprises in poorer regions such as the southeast and the Black Sea coast seem to have suffered the most, implying that poverty could increase in those regions. : SMEs suffered major job losses. Interviews and surveys suggest that job loss has been much higher among SMEs than among large manufacturers. Small companies lost an average of 19% of jobs in the first half of 2001, with much larger losses in transport, forestry products, and furniture manufacturing. In medium-size companies job losses ranged from 10-22%. : SMEs remain vulnerable, even though the latest 2002 3rd quarter results and the 4th quarter expectations of SMEs demonstrate some signs of growth and renewal. The latest TOBB and ISO surveys indicated that small enterprises saw production at their establishments continue to decline, and some 42% indicate domestic sales and new orders decreased. However compared to 2001, 57% of small firms indicated that investments remained the same and will continue to do so. Smaller Companies, Bigger Losses An analysis of the financial results of listed Istanbul Stock Exchange companies for the years 1998 to 2001 (fourth quarter) was prepared under the Turkey, Corporate Sector Impact Assessment Report. The segmented analysis by size of companies confirmed that smaller companies had bigger losses. Small ISE-listed companies (mid-cap companies) were hit harder by the crisis than were medium-size and large companies. In the first quarter of 2001 their profits dropped 20 percent (compared with 5 percent for medium-size and large companies). Their financial expense burden was a staggering 30 percent of sales (compared with 20 percent for large companies), and their interest coverage fell where they could not service their debt. Over the rest of 2001 the losses of small companies declined, averaging 5 percent of sales in the fourth quarter. Small companies were able to cut costs and probably stopped servicing their debt. SMEs are a cornerstone of the Turkish economy. : SMEs are estimated to account for over 95% all enterprises in Turkey. They employ more than 40% of the workforce, and account for half of the investment and 30­40% of total exports. Over the past ten years, the number of enterprises has continued to rise steadily. Growth in new business startups in the informal sector has accelerated, especially among women. But, SMEs lack capital and typically cannot achieve the productivity gains that would bring them higher profit margins. 44 TURKEY: POLICY NOTES SME : Providers of Credit to SMEs. Internal financing is the main source of funds for most SMEs. The private banks have so far been unwilling to lend to SMEs, even the larger ones, to any significant extent. However, in the aftermath of the crisis, some of the private banks realized that the SME sector represented a potentially lucrative new clientele. The primary providers in the formal banking sector are the special credit lines available through Halk, Ziraat and Vakiflar. The biggest provider by far is Halk Bank which has been operating a large micro-credit program through co-operatives (379 active co-operatives reaching some 160,000 active borrowers). But the effects of the financial and economic crisis of 2001 have profoundly shaken the cooperative lending scheme. Outside of the formal banking system, some credit guarantee funds exist that provide guarantees for SMEs which are unable to meet the collateral requirements of commercial banks. Also a small number of crafts and tradesman cooperatives allow members to access specialized credits. KOSGEB, the SME apex organization, provides advisory and technical support to those in the formal sector. There are very few NGOs and special interest groups that provide financial assistance. SMEs face serious constraints to growth. Key Constraints: : Lack of access to finance for both working capital and medium to long-term investment needs, especially for start ups. : Lack of ready sources for start-up finance and business development services for upgrading and expansion of SMEs. : Lack of adequate collateral to meet requirements of commercial banks: collateral must not be the deciding factor in credit decisions by banks especially for small and micro enterprises. : High rates of inflation and exchange rate instability constantly erode SMEs' capital. Small entrepreneurs have few alternatives open to them to counteract the effect of inflation on their businesses, because they are able neither to enlarge their fixed stock of real assets nor to borrow significant amounts from banks or other sources at negative real interest rates. Moreover, inflation undermines this internal financing which small entrepreneurs most depend on. : Excessive bureaucracy, opaque tax legislation and corruption which impose a heavy financial burden and force SMEs into the informal economy which is estimated in a recent SPO study to have been as big as 45% of the formal economy on average over the 1968-2001 period. Enhanced access to financial and non-financial services by SMEs would lead to employment generation and mitigation of regional imbalances of income and ultimately poverty reduction in Turkey. Key Recommendations: : Improve access to finance by encouraging banks to lend to SMEs through steps to: simplify lending procedures and collateral requirements; reduce bank transaction costs through providing technical assistance and training for application preparation and evaluation. However, the cost of funds to SMEs should be market determined. : Design mechanisms to facilitate Turkish Lira lending to SMEs as in most cases they are not able to carry (and hedge) FX risk. : Promote venture capital and equity funds through appropriate policy and regulatory framework such as strengthening minority shareholder rights, removing double taxation, etc. : Develop a collateral registry that will in time allow financing against accounts receivable and inventory. 45 TURKEY: POLICY NOTES SME : Promote establishment of leasing and factoring to help bypass the collateral constraint in the case of leasing and ease liquidity/working capital pressures in the case of factoring. : Improve business environment and non-financial services such as registration, inspection, taxation, business plan preparation, market identification and technology adoption assistance to increase the survival rate and efficiency in production. : Continue to promote the development of a systemic workout process to resolve the immediate liquidity problems of viable but illiquid small and medium-size enterprises. This process would require recapitalizing interest in arrears, providing a grace period for principal repayments, and extending loan maturities. This systemic approach would not only help small and medium-size enterprises but, to the extent that it lowers the bankruptcy rate, it would likely also lower bank losses. : Design a wider range of new financial products that would appeal to SMEs and could be marketed to them directly. The new products should be pilot-tested in one or two branches. State Banks should obtain technical assistance especially for adaptations to IT and MIS, reduced intermediation expenses; opportunities for cross-selling products; training and marketing loan officers in micro and small business lending. : Promote establishment of micro-finance institutions. : Develop a target-group oriented credit technology for micro and small enterprise lending where the specific problems and opportunities which the target group faces are analysed and understood in the context of the target group's country-specific and institutional environment. : Promote provision of non-financial business advisory services to the SMEs in order to help improve competitiveness, adopt better technologies, enhance use of IT and automation, and improve access to finance and markets. : Continue efforts to promote applied research and development and the linkages between research centers and Turkish industry. : Design new programs for specific sectors or on a pilot region basis, where economic activity could be directed to beneficiaries- special sections of society or regions. The implementation institution could be a NGO, credit union, state or commercial banks, or non-financial institution. The World Bank is actively supporting SME development in Turkey. : The World Bank financed Second Industrial Technology Development Project (US$155 million) is inter alia supporting: upgrading of business infrastructure such as modernization of intellectual property regime, upgrading of metallurgy services, harmonization of MSTQ with the EU, restructuring of R&D institutions, and R&D financing for SMEs, as well as, promotion of venture capital funds, technology parks, and innovation systems. : The proposed Adaptable Program Loan for the Corporate Rehabilitation Project presently under preparation will provide medium term financing to firms with workouts under the Istanbul Approach, to mid-size firms that are restructuring, and to SMEs. 46 10. ACCELERATING PRIVATIZATION TO STRENGTHEN REFORM CREDIBILITY AND SUPPORT PRIVATE SECTOR DEVELOPMENT Privatization in Turkey has proceeded much more slowly than in other emerging countries in Latin America, Asia and Eastern Europe. : The Privatization Administration (PA) is responsible for carrying out the privatization program under the authority of the High Privatization Council, a group of ministers chaired by the Prime Minister. : Privatization sales have consistently fallen short of expectations, regularly falling short of US$1 billion per year with the exception of 2000 when sale of a majority stake in POAS (petroleum distribution) and a third GSM license pushed sales above US$5 billion. : In most emerging market economies and many OECD countries, privatization has been a major driver of FDI. Disappointing privatization performance in Turkey may have been a factor in its failure to attract significant levels of FDI. Turkey: Privatization Under PA Portfolio and GSM License Sales (US$ million) 6,000 5,000 4,000 3,000 2,000 1,000 - 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Despite the competence and considerable experience of Privatization Administration managers, the program has suffered from many flaws. Delays in implementing privatization have hurt the credibility of the reform program. : A requirement that the Privatization High Council approve all transaction, regardless of size, has forced even small divestitures to be recycled several times--significantly lowering their value and reducing transparency. : The prevailing cross subsidy mechanism between profit making companies and loss makers in the PA's portfolio removes incentives for the managers of loss makers to restructure these companies and improve operational performance. As a result, many companies are transferred to and remain with the Privatization Administration for years. The PA has effectively become a large state holding group--a function it is not equipped to handle. 47 TURKEY: POLICY NOTES PRIVATIZATION : The most important privatization objective--making Turkish industry more efficient and competitive--has been subordinated to attempts to maximize revenue generation to overcome fiscal problems and to political concerns with public employment. : Privatization of large holdings--telecommunications, state banks--has remained the responsibility of line and state ministries. As in other countries this approach has led to delays, de-capitalization of state enterprises, and covert (if not overt) resistance to privatization. : Privatization delays have contributed to uncertainty about the irreversibility of structural reforms as the traditional vehicles of state intervention in the economy--public enterprises and state banks-- remain largely in place. Determined action to improve and de-politicize the privatization process will help strengthen the new Government's reform credentials. : As a first step, the PA's mandate should be broadened to include a "fast track" privatization process for non-strategic companies in its portfolio. In parallel, the cross subsidization mechanism should be terminated to improve transparency and operational performance. : The PA should be free to clear out its inventory of loss-making companies through mergers and liquidations. : The existing system of cross-subsidies should be eliminated and the transparency of the PA's finances improved. All privatization revenues and dividends from profitable companies in the PA's portfolio should be transferred to the Treasury and recorded in the budget. The costs of subsidizing loss- makers in the PA's portfolio and of severance payments and other payments to workers laid-off or retired as a result of privatization should be provided through the budget. : Finally, future privatizations should not be carried out by line ministries but by the Privatization Administration, so that the Government can take advantage of the authority's experience and technical abilities. : Of course, accelerated privatization will have social implications and the Government should ensure sufficient funds to cover all severance payments and other benefits due to workers laid off through privatization. Active labor market programs such as retraining and reinsertion can provide additional help to these workers. Savings from reductions in subsidies to loss-making enterprises can be redirected to help fund severance and retraining programs. A credible and strong privatization program for 2003 should be announced and implemented vigorously to deliver results as soon as possible. Privatization Priorities: : Adopt a privatization plan for Turk Telekom consistent with the new holding structure for the company following enactment of the required amendments to the telecommunications law. This was originally envisaged for November 2002. : Adopt privatization plans for TEKEL and SEKER which take full account of the complex financial and social realities of large state enterprises in the agriculture sector. These plans should incorporate measures to: (i) address the impact of termination of support purchases for tobacco and sugar on the companies' operations, (ii) resolve outstanding cross-arrears with the Treasury (particularly important for TEKEL), (iii) address large-scale over-employment in the companies, and (iv) secure future administrative arrangements for excise tax collection currently carried out by TEKEL. : Announce a clear strategy for electricity privatization and launch a pre-qualification tender for sale of electricity distribution companies transferred under the scope of privatization. : Announce clear timetables for tenders of majority shares in large companies in the PA's portfolio including TUPRAS, PETKIM and THY. The state's remaining stake in ERDEMIR should also be put up for sale. 48 TURKEY: POLICY NOTES PRIVATIZATION : Complete on-going tenders for medium-scale companies in the PA's portfolio including: TDI (ports concessions), TAKSAN (machinery), GERKONSAN (iron and steel), GSA (fertilizer), a plant of TZDAS (agricultural equipment), and SEKA (paper and pulp). Also to be completed is a series of mergers including: DETAS (maritime) with TUPRAS; and TURBAN tourism, TUMOSAN, TZDAS and ET BALIK with SUMER HOLDING. : Proceed with liquidation of non-performing companies in the PA's portfolio including assets of agriculture equipment maker TZDAS remaining after current tender is closed. These liquidations may be accomplished in part through the on-going mergers mentioned above. : Restructure and privatize Vakif Bank and complete sell off of banks under SDIF. The privatization program will need to take close account of market conditions and be synchronized with other structural reforms. : The recent rally in local capital markets represents an important opportunity for privatization, particularly for the medium and smaller scale companies in the PA's portfolio for which the potential investor base is almost entirely Turkish. : The approach and timing of privatization of the largest public companies where Turkey is aiming to attract both international and local investors will have to take into account developments in the international capital markets. Turkey unfortunately did not take advantage of the peak capital market conditions of the 1990s. Already, the approach to Turk Telekom is being adapted to the new realities of international markets and other components of the privatization program may be adjusted as well. Of particular importance are early and regular consultations with potential investors. : Privatization in sectors where companies enjoy a certain degree of market power, such as energy, must be carefully sequenced with structural reforms to ensure adequate competition and protection of consumers. Turkey has already made important progress by establishing independent regulators in sectors such as banking, energy and telecommunications where strong market regulation is needed for privatization to be successful. World Bank is supporting privatization in Turkey through a mix of policy based lending and investment projects to help address the social impact. : Policy support for privatization is provided under the US$1.35 billion Second Programmatic Financial and Public Sector Adjustment Loan (PFPSAL II) and US$760 million Economic Reform Loan (ERL). Completion of pre-privatization restructuring actions for Vakif Bank is an objective for the second US$450 million PFPSAL II tranche and completion of Vakif's privatization is a condition for the third US$450 million PFPSAL II tranche. A number of privatization actions are outstanding for release of the second US$375 million tranche of ERL as follows: Adoption of the new privatization plan for Turk Telekom Launch of pre-qualification tenders for privatization of the electricity distribution companies Complete privatization of one more large company in the PA's portfolio (TUPRAS, PETKIM or THY) Complete liquidation/privatization of all remaining assets of TZDAS and reassignment/separation of all employees. : Support for funding of severance payments and retraining/reinsertion programs for workers laid off or retired under the privatization program is being provided under the US$250 million Privatization Social Support Project. 49 11. ATTRACTING FDI FOR COMPETITIVENESS AND GROWTH International experience shows that foreign direct investment (FDI) plays a particularly important role in economic development, enhancing a country's competitiveness in a globalized market economy and stimulating economic growth. FDI can help a country recover from crisis. A review of recent crisis experience Ratio of FDI inflows: 1 and 2 years after internationally highlights the key role of crisis relative to 1 year prior to crisis FDI. With the exceptions of Chile, ratios of FDI shares to GDP, ratio over 1 indicates post-crisis FDI inflows were above pre-crisis inflows Indonesia, and Malaysia, net FDI flows in 6 the year subsequent to the onset of crisis 5 were higher relative to GDP than in the year Crisis + 1 year / pre-crisis year 4 immediately preceding it. One of the Crisis + 2 years / pre-crisis year 3 elements that appears to explain differences 2 in relative performance is the policy 1 environment. Countries that introduced economic reforms in general, and in 0 94 particular geared toward FDI inflows--such -1 -97 -82 -98 -97 -95 -98 - -97 97 as Argentina, Brazil, Mexico, Korea and Indon-2 esia Chile Russia Malaysia Argentina Brazil Mexico Thailand ea,Rep.- Thailand--witnessed sustained increases in Kor FDI inflows in the post-crisis period. FDI is a potentially extremely important source of non-debt creating capital inflow, but Turkey has a long way to catch up in attracting FDI. Turkey should be a FDI inflows ranked by EBRD Institutional Performance Indicator magnet for FDI given its from lowest to highest rating, rating with country name large market size, skilled Turkey - n.a. $204 Turkmenistan - 1.0 $67 cumulative net FDI inflows, per capita (1990-2000) domestic labor, and Tajikistan - 1.4 $21 competitive local firms as Belarus - 1.5 $124 Uzbekistan - 1.8 $38 suppliers to multinationals Armenia - 1.8 $154 However, Turkey has Russian Federation - 1.9 $141 Azerbaijan - 1.9 $467 never been able to attract Albania - 1.9 $167 Georgia - 2.0 $154 the substantial FDI Ukraine - 2.1 $69 inflows that would be Moldova - 2.1 $90 Kyrgyz Republic - 2.1 $87 expected from a nation Kazakhstan - 2.2 $528 with a strategic location Romania - 2.2 $292 Macedonia, FYR - 2.3 $191 between Europe, the Bulgaria - 2.4 $404 Latvia - 2.6 $1,047 Middle East and Central Croatia - 2.7 $1,079 Asia. Turkish FDI levels Lithuania - 2.8 $658 Slovenia - 2.8 $857 have stagnated during the Slovak Republic - 2.8 $777 Estonia - 3.1 $1,716 last 15 years while total Czech Republic - 3.2 $2,271 Poland - 3.3 $1,053 Hungary - 3.5 $2,105 $0 $500 $1,000 $1,500 $2,000 $2,500 50 TURKEY: POLICY NOTES FDI FDI worldwide increased by a factor of 12. Turkey has begun to assess the problem and develop an FDI strategy. Recent Progress: : Assessments of the FDI environment have been carried out in collaboration with the World Bank's Foreign Investment Advisory Service (FIAS) including: Diagnostic Review of the FDI Environment (2000), Administrative Barriers to Investment (2001), Legal Framework for FDI (2002), and Institutional Strategy for FDI Promotion (2002). These assessments were supported by the private sector--most importantly TOBB, YASED, TUSIAD and the ISE. : A structured agenda to improve the investment environment was adopted by government in December 2001. This program centers around a Coordination Committee (YOIKK) and 9 technical committees to review and advise the Government on such areas as FDI regulation, company establishment, sectoral licenses, investment promotion, and taxes and subsidies. YOIKK directly reports to the Council of Ministers and is responsible to implement and supervise the reform initiatives developed by the specialized technical committees consisting of representatives from relevant government agencies and the private sector. : A new FDI law was submitted to Parliament in June 2002. While the new law incorporates guidance provided by FIAS, it does not address deeper problems with the FDI environment embedded in Turkey's commercial laws. The key now is to move ahead quickly with implementation of the strategy prepared to date... Priorities for Immediate Action: : Reiterate Turkey's commitment to improving the investment environment and support for the YOIKK program. This effort would involve: Conducting the first overview meeting of the YOIKK at the cabinet level. Continuing the consultation process among stakeholders in the public and private sector. This will ensure the relevance and integrity of the process. It would also provide a continuous feedback mechanism to assess improvements and re-focus efforts. Providing the necessary support and resources for capacity building and implementation of the program. It is essential that reforming agencies receive adequate technical and financial support to carry out reforms. : Enact the new FDI law ensuring that it parallels international best practice as advised by FIAS. : Move ahead with the establishment of an Investment Promotion Agency (IPA). The following guidelines are proposed for consideration. Mandate: Solely investment promotion (no regulatory function). Financing: Public sector will be an important financing source together with financing from business associations and, if possible, private firms. Governance: Board of Directors with 11 seats: four seats reserved for government officials, three for business associations and four for private firms. Authority: The Board of Directors should govern the IPA. Its president should answer to the Board only. As the government would be the largest source of funds, the IPA should provide regular financial reports to the government and be subject to government audit of its accounts. Location: Headquarters in Istanbul, presence in Ankara. 51 TURKEY: POLICY NOTES FDI Legal status: IPA to be established by its own law (Constituting Document). : Activate the Investor Council consisting of high-level representatives of the international business community. The inaugural meeting of the Investor Council, originally scheduled for July 2002, is now scheduled for June 2003. ...While also broadening the strategy to tackle deeper obstacles to FDI. Recommendations for Tackling Deeper Obstacles to FDI: : Accelerate privatization in context of appropriate regulatory framework. : Initiate a full-scale review of commercial law and competition policy in Turkey to identify and address important obstacles to FDI. : Develop strategy to facilitate flow of "greenfield" FDI to SMEs. The World Bank is ready to continue its support for Turkey's efforts to attract more FDI through the work of FIAS, participation in the Investor Council and support for policy reforms to improve the investment climate. 52 12. MANAGING THE TRANSITION TO COMPETITIVE PRIVATE ENERGY MARKETS The centralized development model for the energy sector based on state owned monopolies and guaranteed take-or-pay contracts has not delivered for Turkey. Energy prices in Turkey are now well above OECD and other comparator Electricity Prices for Industry (US$ per Kwh) country averages. Despite high prices, the sector continues to suffer from 0.090 serious financial difficulties due to 0.080 expensive independent power producers 0.070 Turkey (IPP) contracts, excessive distribution 0.060 OECD 0.050 losses, and poor billing and collection. Mexico 0.040 Poland 0.030 High energy prices damage Turkey's 0.020 Slovak Republic competitiveness while the growing stock 0.010 of guaranteed take-or-pay contracts poses - a serious fiscal risk. 1995 1999 2000 2001 Turkey's electricity and gas sectors are undergoing reform of unprecedented scope in an effort to make the transition to competitive private energy markets. These reforms aim to decrease costs and risks currently borne by the government by attracting private capital into the sectors. At the same time they encourage competition in order to foster efficiency and lower costs. These reforms are expected to gradually decrease electricity and gas prices from current levels which in turn should lead to increased competitiveness and growth for those Turkish industries which consume substantial amounts of electricity or gas. Growth in these industries will in turn create more jobs. Households will also benefit from these reforms. Reform Milestones: : New electricity and gas market laws enacted in early 2001 which firmly orient the sectors to competitive markets with functionally separated, privately-owned, and independently regulated businesses. These laws also set the stage for privatization of state assets in the electricity and gas sectors. : Restructuring of state monopolies into separate entities has commenced and in the case of the electricity sector been substantially completed. : An energy regulatory institution, the Energy Market Regulatory Agency (EMRA), has been established. Implementing regulations are being issued and industry participants are reorganizing their businesses to conform with the new requirements. : Initial steps towards privatization have been taken. Two local gas distribution subsidiaries of BOTA were transferred to the Privatization Agency (PA) in September 2002, with a view to privatizing them in 2003. A first set of electricity assets to be transferred under the scope of privatization has been 53 TURKEY: POLICY NOTES ENERGY identified by Ministry of Energy and Natural Resources (MENR). Launch of pre-qualification tenders for privatization of the electricity distribution companies, repeatedly delayed and now currently scheduled for February 2003, is an urgent priority. Three categories of implementation issues must be addressed to manage the transition and achieve the reform objectives: : Critical impediments are factors constraining basic commercial and structural reforms which have emerged from past decisions and inaction. These impediments require immediate attention. : Gaps in the reform framework represent factors that are yet to be fully recognized or integrated into the reform implementation framework. These factors could easily become constraints or problems during the reform transition. : Program management issues refer to the need for strong, centralized direction and coordination of the reform program to direct multiple agencies to achieve common goals. Critical Impediments : Cash deficits in the electricity and gas sector Problem: Thirty percent of the electricity distributed by TEDAS is not paid for primarily due to power theft and poor billing and collection. This creates a cash-flow deficit and jeopardizes the financial sustainability of the sector. In addition, it will discourage any serious private sector interest in the distribution sector. Solution: Initiate a national campaign against electricity theft to raise the public profile of the problem underscore the government's commitment to address the issue and seek public support. Creation of trustworthy inspection teams in each of the districts Increasing the severity of legal penalties for electricity theft and enforce the penalties effectively. Upgrade distribution infrastructure with a particular focus on securing distribution lines and meters to minimize the scope for tampering and illegal tapping. Implement a credible plan to resolve past arrears including for government agencies and local governments that have failed to pay their bills. : Unresolved TOOR and BOT projects Problem: There are some 17 generation and distribution projects under the transfer-of- operating-right (TOOR) approach to private participation, and about 31 BOT projects, where there has been no final resolution. If these unresolved projects are implemented they would raise costs, increase the government's contingent liabilities, and seriously handicap the new market structure. Solution: The status of the TOORs and BOTs needs to be resolved in accordance with the roadmap agreed with the Bank, as follows: Sponsors of TOOR projects eligible for Treasury guarantees should be informed of those changes in their agreements needed to bring them into conformity with the Electricity Market Law. Eligible TOORs which accept these amendments may be given a provisional Treasury guarantee and six months to reach financial closure after which this provisional guarantee would expire. Transfer assets of those TOORs which are not eligible for Treasury guarantees or which are not modified to conform with the Electricity Market Law to be transferred to the PA for privatization. 54 TURKEY: POLICY NOTES ENERGY A similar approach should be used for the BOTs. : Stranded costs Problem: Turkey faces a classic "stranded cost" problem. Contracts with high off-take volumes and prices have been signed in anticipation of demand that is unlikely to be realized in the next 5-7 years. The revenues required to meet the costs of the contracted electricity may be difficult to recover in the competitive market with wholesale electricity prices at a reasonable economic price range of between 5.5 to 5.75 cents/kWh. Solution: A fair mechanism to cover and allocate stranded costs is required. The most feasible mechanism is low pricing (below its economic value) of hydropower. For this, hydropower sold to TETAS should be priced at a level that covers only operations and maintenance cost, and an allowance for depreciation. Additional measures such as a stranded cost levy may be required, or alternatively TETAS should be allowed to run a cash deficit for a few years and surpluses in later years. Gaps in the Reform Framework : Pre-privatization preparation and transition plan Problem: While the electricity and gas laws have defined the new market model, there is not yet a clear transition plan to prepare for privatization. Without an adequate pre-privatization preparation it is likely that investors would seek government guarantees and not bear adequate commercial risk ­ which has been at the root of past problems with the BOTs and TOORs. Solution: All government agencies involved in implementation need to subscribe to a commonly agreed pre-privatization process that is consistent and synchronized with the broader market reforms. Three elements of the pre-privatization preparation are critical: Restructuring generation and distribution companies to create operating businesses attractive to the private sector. Establishing vesting arrangements that mitigate initial revenue and market risk for investors and facilitate a smooth transition. Defining a privatization process that transfers management control to qualified private investors with the right commercial incentives. : Developing industrial and residential markets for natural gas Problem: Turkey's contracted gas import volumes were predicated on an industrial and residential demand accounting for over half of the gas volume contracted by 2005 and a growing volume out into the future. However, the prospective industrial and residential gas demand has not materialized as the city gas distribution systems have not been built. Solution: EMRA has initiated a tendering process for new gas distribution systems in 55 cities. This process should be accelerated by: Establishing a feasible distribution expansion strategy based on city-specific gas demand studies of potential industrial, commercial and residential demand. establishing a concession framework that has a viable allocation of risks between private and public sector and uniform tender evaluation criteria. possibly easing competition requirements temporarily ­ such as limiting the size of eligible consumers and allowing investors to tender for more than 2 cities. : Managing gas import contracts and the gas release program Problem: A fair and transparent auction of Turkey's gas import contracts (currently all held by BOTAS) is needed to facilitate the entry of new entrants in the upstream gas wholesale 55 TURKEY: POLICY NOTES ENERGY businesses, together with an appropriate vehicle to deal with possible stranded costs arising from over-contracting of gas. Solution: A two step strategy is suggested: Establishing a basis to adjust gas import volumes through a comprehensive study of BOTAS gas purchase contracts, the cost of gas by contract, and the operating cost of supplying gas down to the retail level in relation to expected demand. Carve out the gas import and contracting function of BOTAS and establish it as a separate company similar to TETTAS in the electricity sector. This agency would hold the Turkish gas import contracts with sovereign governments and would re-sell this gas as standard commodity contracts to new wholesalers to achieve a level playing field. This agency could also develop new re-export markets for gas in Western Europe. : Promoting renewable energy within the competitive market structure Problem: Energy sector reforms aimed at achieving the market-oriented structure envisaged in Turkey require policy interventions to ensure that the public-good benefits of renewable energy are not lost. Solution: The Bank and the government have been working together on a comprehensive policy and financing mechanism to insure that Turkey's renewable potential, especially small hydropower, is exploited. It is suggested that: A renewables directive be issued by MENR defining transparent procedures for identifying renewable energy projects and giving development rights to qualified investors. Regulations be modified to incorporate a clear definition of qualified renewable energy projects and the applicable market-based incentives. Program Management : Ensuring coordinated implementation Problem: The lack of alignment of the seven government agencies behind a single coordinated strategy, and the lack of accountability for delivering their work on schedule, is perhaps the biggest risk facing the reform program in Turkey. Solution: There is a need for strong centralized coordination. A government decree establishing such a unit should be considered based on three basic principles that would allow such a unit to play an effective reform management and coordination role: A clear mandate for reform implementation with necessary administrative authority. Strong full-time leadership with the ability to arbitrate and take decisions in the public interest. Adequate budget and infrastructure to perform the reform coordination role. World Bank support for the energy sector is assisting Turkey with implementation of the reform and financing needed investments. : Policy support for the energy reform program is being provided under the US$760 million Economic Reform Loan (ERL). Launch of pre-qualification tenders for privatization of the electricity distribution companies is a condition for release of the US$375 million ERL second tranche. : The US$270 million National Transmission Grid Project consists of two loans: A loan to TEIAS (US$250 million) finances transmission line construction, substations and the hardware and software for a balancing market for electricity. 56 TURKEY: POLICY NOTES ENERGY A US$20 million technical assistance loan to Treasury supports the implementation of the reform program including restructuring of the state monopolies (unbundling of TEAS into TEIAS, EUAS and TETTAS), institution building for EMRA, and technical support for the privatization process. : The Bank has provided technical assistance to help the authorities with preparing policies and drafting legislation. The Bank has prepared studies of various issues both in the electricity and gas sectors. : A proposed Renewable Energy Project is under preparation to assist with the new policy framework for promoting Turkey's renewable energy resources under the market model and establishment of an appropriate financing mechanism. 57 13. TELECOMMUNICATIONS REFORM FOR THE INFORMATION SOCIETY Development Objectives: A thriving telecommunications industry contributes to development of the Information Society and Knowledge Economy through: : Improving competitiveness by lowering cost, increasing production flexibility and widening opportunities (e-commerce) leading to job creation and retention : Promoting private investment through licensing, privatisation and the wider use of information technology : Enhancing human capital formation and innovation by facilitating the creation and sharing of knowledge, encouraging research and linking universities : Promoting social cohesion and inclusiveness by extending access to networks : Extending government/citizen relations through e-government The telecommunications sector is a key driver of economic growth and a significant source of investment. The fiscal contribution of the sector can be substantial. Sector Snapshot: Telecoms development in Turkey is in currently line with comparable countries in the Europe and Central Asia region. As a candidate for EU accession and signatory to the e- Europe+ initiative, Turkey should set its sights on the average level of telecoms development for EU member states. The attached charts (note the log scales) illustrate the relative position of Turkey within the Region with regard to: (i) the relationship between total tele-density (fixed plus mobile customers per 100 population) and US$ GDP per capita, (ii) the relationship between internet users (as % of population) and GDP per capita, and (iii) the urban-rural tele-density ratio (for fixed access) vs. GDP per capita. Tele-density is the ratio of the proportion of fixed telephones in the largest city to the proportion in the rest of the country. On these measures, the position of Turkey is: : close to that predicted by GDP per capita : in a similar position to Poland and Hungary : behind the performance of Slovenia and the Czech Republic Regulatory Reforms. Telecoms achieves its maximum potential where it is supported by a regulatory environment that is credible, ensures fair competition and promotes private investment. The appropriate regulatory model for Turkey is the EU's acquis communautaire. Private investors place a high value on a credible, predictable, effective and independent regulatory environment. Investments by government in building a credible and effective regulatory authority, 58 TURKEY: POLICY NOTES TELECOM provide benefits stretching over the long term. The Telecommunications Authority (TA) has established its credibility by the issuance of some 87 new licenses as of October 2002 (63 Internet Service Providers (ISP), 18 Satellite Telecommunications Service Providers (VSAT), 4 GMPCS Mobile Telephony Service Providers and 2 Satellite Platform). Regulatory Challenges: : Effectiveness of the TRA is restricted by the appeals procedure which allows the party to take action in any court. This situation could be remedied by establishing the Danistay as the appropriate court of appeal. : Adoption of the new acquis communautaire for telecoms published in May 2002 will require further amendments to Turkey's telecommunications law. The new acquis consists of a common framework directive on 'electronic communications' and a set of implementing directives on interconnection and access, authorization, universal service, etc. : TRA must finalize the secondary legislation required of the acquis communautaire. : TRA will need to gradually change the emphasis of its work from technical regulation to economic regulation as competition intensifies. The TRA will have to acquire the appropriate skills for these tasks. Of particular significance is the opening of fixed line services and infrastructure to competition at the end of 2003. : As with many other regulatory agencies in the Region, the TRA can benefit from technical assistance for capacity building and drafting of secondary legislation. Turk Telekom: The successful restructuring and privatization of Turk Telekom (TT) in preparation for the full liberalization of the sector at the end of 2003 will be a critical determinant of future development of telecoms in Turkey. In May 2002, TT's Board of Directors adopted a corporatization plan to commercialize its operations by restructuring TT into a holding company with 8 subsidiaries organized around lines of business (internet, mobile services, basic infrastructure). The restructuring plan is supported by international consultants. The new TT corporate structure will promote better regulation through separation of services from core infrastructure with transparent licensing and transfer prices, thereby lightening the regulatory burden on TRA. The new corporate structure will also provide for greater flexibility in privatizing TT. It will allow for privatization, separately or in combination, of TT's individual lines of business. Various privatization methods can be used such as IPO, block sales, and sales to strategic and financial investors (as well as sales to employees). In some circumstances, it may be appropriate to include a capital injection in the transaction. The new privatization strategy will provide the opportunity for greater participation by domestic investors. Urgent priorities for Turk Telekom restructuring and privatization: : A revaluation of TT is required by the Telecommunications Law. A new valuation committee has been established and international advisors hired (Rothschild and Ernst&Young). The same advisors are to help prepare the privatization plan. : Amendment to the telecommunications law to allow privatization of TT subsidiaries under the new holding company structure. This amendment was originally scheduled for October 2001. : Adoption by the Council of Ministers of the new privatization plan for TT in line with the new corporate structure. This was originally scheduled for November 2001. 59 TURKEY: POLICY NOTES TELECOM World Bank Support: Turkey's telecommunications reform program is supported by the Bank's Economic Reform Loan. : Adoption of the new privatization plan for Turk Telekom is a condition for release of the second US$375 million tranche of the Economic Reform Loan (ERL). 60 TURKEY: POLICY NOTES TELECOM Chart 1 ­ Total Tele-density 120 100 Slovenia 80 Czech Republic yti Estonia ns deeletla 60 Croatia Turkey Latvia Slovak R. Lithuania Tot Poland 40 Bulgaria Hungary Yugoslavia Macedonia Belarus Romania Ukraine Russia 20 Moldova Georgia AzerbaijanTurkmenistanKazakhstan Armenia Bosnia Kyrgyzstan Uzbekistan Tajikistan Albania 0 100 1000 10000 GDP per capita Chart 2 ­ Internet Usage 100 Estonia Slovenia SlovakCzech Hungary on)ita 10 R. Lithuania Poland Republic Yugoslavia Bulgaria Latvia Croatia Romania Turkey populfo Moldova ArmeniaBelarus RussiaMacedonia %(sresutenretnI 1 Kyrgyzstan Ukraine Kazakhstan Georgia UzbekistanBosnia Azerbaijan Turkmenistan 0.1 Albania Tajikistan 0.01 100 1000 10000 GDP per capita 61 TURKEY: POLICY NOTES TELECOM Chart 3 ­ Urban/Rural Tele-density Ratio 100 Albania oitaryitsnedleetlarur-nabrU Tajikistan Turkmenistan Bosnia 10 Uzbekistan Macedonia Georgia Kyrgyzstan Yugoslavia Azerbaijan Moldova Slovak R. Ukraine RussiaRomania Hungary Kazakhstan Latvia ArmeniaBelarus Lithuania Czech Republic Bulgaria Estonia Croatia Poland Turkey 1 Slovenia 100 1000 10000 GDP per capita 62 14. EFFICIENT TRANSPORT FOR EQUITABLE GROWTH Raising the efficiency of Turkey's transport sector will contribute to economic growth, environmental sustainability and poverty alleviation through: : Improving Turkey's competitiveness by lowering logistic costs. : Increasing access of the rural and urban poor to basic services, markets and jobs. : Lessening the environmental impact of moving people and goods by ensuring appropriate modal choices, policies and technologies. : Reducing the high human and economic cost of traffic accidents (seven thousand lives per year and an economic costs in terms of health services and forgone economic activity of about 1.5%-2% of GNP). : Contributing to fiscal stability by reducing the onerous deficits generated by transport agencies, and mobilizing private sector investments and managerial know-how for the provision of key transport services. The transport sector of Turkey is in need of major structural reforms to develop a culture focusing on user's needs, affordability and financial sustainability. : Past behavior emphasized expansion of infrastructure facilities and services with limited consideration for their economic merit. This has led to increasing deterioration of the sector assets and a decline in economic competitiveness. : The sector accounts for 30% of public investments and is the worst performer in terms of execution. The road agency (KGM) has annual budgets of about US$1.3 billion, 60% of which is for investment. This is thinly spread over numerous projects with an average completion time of 9 years. Investments are dominated by works on an over-designed motorway program. : The port and railway operator (TCDD) is the largest money loser among Turkey's public sector enterprises. Railway operating costs represent about 85% of TCDD's total costs; railway losses exceed TCDD's overall losses; and 20% of these losses are financed by monopolistic rents generated by ports, in effect imposing a heavy tax on foreign trade. : The government faces potential liabilities due to the neglect of existing infrastructure, as low priority expenditures divert funds from maintenance, and the sector is becoming increasing leveraged (50% of proposed 2002 KGM investment program is financed by suppliers and contractors credit). : There are substantial contingent liabilities associated with the uncertain costs of investments since both TCDD and KGM have a poor record of completing investments on time and within original cost estimates. There is an urgent need for action across a broad front ranging from institutional reforms to mobilization of private sector participation. Action Areas: : Institutional reforms to provide an adequate normative framework for the sector, providing for management of transport as a whole rather than one mode at a time, and clarifying accountability for outcomes. 63 TURKEY: POLICY NOTES TRANSPORT : Restructuring the two main sector agencies to improve their efficiency and reduce fiscal liabilities: (i) KGM should be transformed into an agency using modern managerial methods encouraging cost- effective performance; (ii) TCDD should be restructured following the directives of the EU Transport Commission to incorporate a commercial approach to railways and ports management. : Devolving the responsibility for decisions affecting the rural and urban populations to the local governments and communities. : Developing mechanisms to mobilize private sector resources to modernize an aging infrastructure in a framework of stringent budget constraints. : Endorsing and implementing the recently completed medium-term Road Traffic Safety Strategy A short-term strategy to address identified weaknesses would focus on a core set of measures. Short-term Measures: : De-leverage. Reduce the reliance of roads and railways on debt and gradually work-out the back-log of "on" and "off" balance sheet obligations that now exist. : Rationalize investments. Critically review the sector investment program within the broader context of the on-going rationalization of the Public Investment Program, and allocate existing resources to the maintenance and operation of the priority core rail and road network on a pay as you go basis. : Downsize. Reduce already identified excess labor in KGM, GDRS, and TCCD. : Un-bundle. Eliminate the cross-subsidization between ports and railways in order to measure and manage the financial performance of each. : Prepare for the future. Carry out studies and seminars to develop main sector policies regarding compliance with EU directives, institutional arrangements, sector financing, sector pricing, the role of the private sector, the distribution of responsibilities among the different levels of government, and other major decisions that are instrumental in shaping sector reform. Alignment of the transport sector to EU norms, and the strengthening of institutions to clarify and assign responsibilities will be needed in the medium term. : A system based on the division of responsibilities among different institutions/entities for (i) planning and supervision; (ii) regulation; and (iii) project execution and financial management would be a workable model. Medium-term Priorities: : Creating a single, higher level policy, planning and supervision institution that could focus on all transport modes under central responsibility within a client-oriented, rather than production-oriented, approach. The Ministry of Transport should be responsible for the consistency of transportation policies in different modes and jurisdictions (including roads), the preparation and assessment of sound sector plans, the control of the budgetary process, the management of information systems and the development of relevant benchmarking to monitor the performance of the sector, and the supervision and control of the fulfillment of the procedures and objectives established by any future transport regulatory agency. : Advancing in the implementation of EU accession requirements. Transport is normally one of the major issues in the EU ascension. Challenges include: physical integration, the harmonization of standards for infrastructure, vehicles, and environment, the development of logistic networks, the improvement of border crossings and trade facilitation policies, and 64 TURKEY: POLICY NOTES TRANSPORT the separation of social services from commercial services, a requirement that will have a special significance for TCDD (Ports and Railways). : Increasing transparency and accountability of outcomes. This would stem from development of a system that measures outcomes, costs, and how costs compare with internationally accepted benchmarks, where such information would be verified through credible auditing measures and disseminated widely to stakeholders. In the railway, this implies: (i) separation of infrastructure and operations; (ii) devolution of urban and suburban passenger services to the Municipality of Istanbul; and (iii) privatization of freight services. In KGM it would involve creating an independent agency with a mandate to manage the road network according to internationally accepted standards, on the basis of economic principles. In GDRS, efficiency improvements would come from decentralizing the responsibility of the rural network to local governments and creating community-based, income- generating systems for the development and maintenance of rural roads. : Ensuring the financial sustainability of the sector. The basis for financial sustainability would be defining sources and uses of funds in a way that links technical needs and service levels with the distribution of direct and indirect user charges among different modes and levels of government. A critically review of pricing policies in the tolled road network could lead to introducing pricing based on elasticity considerations to ensure an adequate balance between revenue maximization and the optimal level of utilization of a mostly underused network. It will be important to eliminate the creation of new government liabilities by ensuring genuine and permanent sources of funding for well targeted subsidies. : Mobilizing the private sector to attract additional resources and organizational and managerial efficiencies. The modernization of the sector will require substantial financial resources for large infrastructure works (e.g., Izmit Bay Bridge, Bosphorus Bridge, port development, etc). Turkey will have to set the stage to attract private sector financing through equity participation, securitization or other forms of financial engineering appropriate to a particular project. To ensure that the efficiencies brought about by the private sector are transferred to the users in the form of better services and equitable prices, Turkey will have to develop an independent regulatory system subjected to credible performance evaluations. The Bank has been supporting sector development through a Road Rehabilitation and Traffic Safety Project that has been instrumental in the preparation of a medium-term Road Traffic Safety Program, and through technical assistance and a study to advance restructuring plans for TCDD. : In the context of priorities to be agreed with the government for the new Country Assistance Strategy, the Bank would be willing to discuss future advisory services and possible lending for multi-modal transport sector modernization, traffic safety, and institutional restructuring for better transport management. 65 15. RURAL REFORMS AND INVESTMENTS FOR GROWTH AND EQUITY In recent decades, agriculture and other rural economic activities have failed to live up to their potential as contributors to growth and rural employment and welfare. : Turkey has more than 33,000 villages accounting for about 35% of the population; despite steady rural to urban migration, 25% of the population will still live in rural areas in 2015. : The rural population faces lower income generation opportunities. Agriculture accounts for 70% of the rural workforce, with industry and construction accounting for about 12%, and services for the remaining 18%. From 1960 to 1997, the share of agricultural labor in the total labor force declined from 55% to 44%, but the share of national value added generated by agriculture fell from 35% to 15%. Growth rate of agricultural value added fell to 0.4% per annum in the 1990s due in part to stagnant or even declining technical efficiency in Turkish agriculture. Over the same period, agriculture's share in exports fell from 60% to 10%. Land and labor productivity in agriculture had upward trends overall in 1960-2000, but growth rates declined steadily and turned negative in the mid-1990s. Currently, some 42% of Turkey's poor are employed in agriculture. : Owing to the lack of an integrated rural development strategy, access to public service is much lower compared to urban settings. Though 90% of the rural poor have access to primary education, only 42% have access to high school education compared with 69% in poor urban communities. About 12% of the rural population does not have access to piped water systems and sanitation facilities are in a poor state ­ health risks are therefore elevated. Infant and maternal mortality are 10 times worse in rural villages in the East than in urban centers in the West. Many rural health posts and centers are under-staffed and underutilized. Falling growth rates of valued added are largely a result of a legacy of costly agriculture support policies that distorted markets. During 1960-2000, large output, input and credit subsidies were allocated in an Agriculture Transfers and Growth effort to maintain rural incomes. 12 18 10 16 8 In 1999, total direct and indirect fiscal 14 ) 6 subsidies were US$7.16 billion or 3.2% %( 4 12 2 of GDP. Transfers from food consumers th 10 )lib$(s 0 er to producers exceeded US$4 billion. owrG -2 8 -4 6 -6 sfnarT Trade controls, government-dominated -8 4 procurement and marketing, and input -10 2 subsidization: 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 : reduced role of private marketers Agr. Support Agr. Grow th rate Trend (Grow th) which discouraged product quality and differentiation; 66 TURKEY: POLICY NOTES AGRICULTURE & RURAL : subsidized inefficient production technologies; and : limited output of products in which Turkey has a comparative advantage. A comprehensive agricultural reform program was initiated in 2000 with significant early successes. The reform targets: (i) reduced market intervention, (ii) direct income support payments to farmers, (iii) better regulation for more competitive markets. Agriculture Reform Results: : In 2002, estimated total fiscal subsidies have been reduced to US$2.33 billion or 1.06% of GDP. : About 75% of farmers are now registered to receive support through DIS, which has become main instrument of rural income support. The DIS is progressive as it is proportionally more beneficial to smaller farmers, and efficient as it does not distort production decisions. : State crop purchases has been reduced--TMO grain purchases have declined from 3.6 million tons in 2000 to less than 1 million in 2002. : Some Agricultural Sales Cooperative Unions (ASCUs) have begun restructuring programs and are beginning to be more responsive to their member farmers. : The legal framework for reform of the tobacco and sugar markets is in place. Near-term Reform Priorities: : Continued market rationalization (grain, sugar, tobacco, hazelnut, etc.) by eliminating the remaining state crop purchases and the price support function of parastatal enterprises. : Accelerated parastatal privatization (Tekel, Seker, Caykur). : Restructuring of the remaining ASCUs (notably Fiskobirlik) so that they serve farmer members, and do not burden the budget by having to buy or contract crop production at non-market prices : Completion of payments under the 2002 DIS program and early launch of registration under the 2003 program with improved targeting to the most needy farmers. The broader strategic rural development policy challenge for government is to focus on priorities where it can lead and leave other initiatives to the private sector. Key areas for government focus include improved support for market development and strengthened management of investment and services in irrigation, forestry and rural cooperatives. : Government can accelerate agricultural and rural growth through sound policy and investment programs in irrigation rationalization, improved commodity markets, and trade expansion through promulgation of product-related standards. : Improved water, forest, and landscape management will also increase efficiency and growth in the agricultural and tourism sectors without depleting future resource availability. : Government can promote equity and reduce rural income disparities through increased focus on better rural social service provision, extension for farmers in resource-poor areas, adequate natural disaster mitigation measures (especially flood management), introduction of insurance against catastrophic crop loss faced by agricultural producers. Enhanced state support for market development is important to promote growth and prepare for EU accession. Priorities include: : clear autonomy for cooperative organizations and organizational changes in state agricultural institutions : harmonization of legislation and regulations in veterinary, sanitary, phyto-sanitary standards 67 TURKEY: POLICY NOTES AGRICULTURE & RURAL : improvements in statistical systems (started under National Registry of Farmers but to be expanded for livestock) : additional investments in rural infrastructure (irrigation, transport, etc.) Appropriate public services and investments underpin rural development. Recommended areas for future action include: : Simultaneously improving community participation in institutional arrangements and decisions and increasing the level of cost recovery so that adequate maintenance can be funded (roads, drinking water and sanitation, irrigation). : Adjusting coverage of extension and veterinary services. Government needs to create an enabling environment for private extension enterprises to serve richer farmers, who are able to pay for high quality, tailor-made services. This would then allow public extension to concentrate its limited resources on the provision of services to under-served, poorer, and less developed regions; as well as on focal points such as natural resource conservation which have a public good dimension. : Provision of training to women producers in food production, processing and marketing, specially tailored extension, and technical services must be given focused attention if the many constraints rural and farming women face relative to their urban and male counterparts are to be overcome. : Bringing focus and accountability to irrigation sector investments. : Addressing institutional and policy problems in forestry which limit ability of sector to sustain income generation for forestry communities. : Improving risk mitigation for farmers through modern functioning commodity exchanges and crop insurance ­ and thereby reducing the aversion of commercial banks to rural lending. Turkey faces particular challenges in irrigation. There has been recent success in the pilot introduction of participatory privately operated and maintained irrigation schemes which can be built upon. Irrigation accounts for about 75% of Turkey's total water consumption of 40 billion m3, extracted from 26 river basins. The availability of water in many regions is stretched to the limit, and more efficient use and conservation of water is sorely needed, along with equitable sharing of water across users. Irrigation Challenges: : Without a Water Code, a transparent approach to river basin management which balances the requirements of different users and stakeholders is lacking. Thus, a key challenge is to devise a Water Code for regulation of the use and management of the country's water resources and of activities that may have negative impacts on the quality and quantity of such resources. : Rationalization of Investments ­ public works are not well prioritized or funded, so that at current rates of funding, it would take as long as two decades to get through the backlog of partially completed irrigation projects. To solve this problem, there needs to be a moratorium on starting new schemes, identification of highest return schemes and component investments, and reduction of completion periods. : A more focused irrigation investment strategy is needed, together with better coordination and adjustment of investment expenditures between DSI and GDRS. : Transfer of irrigation infrastructure to water users' organizations (WUOs) should be accelerated. : The WUOs should be provided a strong legal foundation. To this end, there is a need to enact a legislative framework for WUOs that would mandate: (i) independence from local government, DSI, and GDRS; (ii) transfer of irrigation infrastructure to WUOs in a way that reinforces this financial 68 TURKEY: POLICY NOTES AGRICULTURE & RURAL and managerial independence; and (iii) international standards for participatory irrigation management by WUOs. The challenge in forestry is to improve productivity to increase forestry income and thereby give better incentives for preservation in order for Turkish forests to play their vital role in watershed protection and the control of flooding and soil erosion. About 15% of Turkey's population lives in forest villages or forest-neighboring villages, which are far poorer than the national average. Owing to low income from forestry, these villages depend heavily on agriculture and livestock grazing which compete with forestry and can harm soil retention and flood prevention. A constrained legal and institutional framework is showing serious stress, as growing populations and market reforms call for the introduction of alternative management and protection regimes. This is particularly crucial as the lack of clear boundaries and well-defined tenure regimes has led to significant conflicts between the forestry administration and local communities. Opportunities for Forestry: : Separation of the regulatory from the production functions and reorientation of forest institutions toward demand-driven service delivery, with privatization of certain forest management functions, would improve both efficiency and sustainability. : Better management would improve the commercial efficiency of timber production in some of the more productive public forest areas (while maintaining tree replacement). : A reduced emphasis on timber production is needed in other areas where forest management agencies could be more cost effective by focusing on meeting the rising demand for non-timber forest values (recreation, tourism, protection, etc.). : Establishing community based forest management systems through introduction of long-term lease arrangements would improve sustainability. It is important to develop a strategy for consolidation and modernization of Turkey's rural cooperative sector including improving marketing, input supply, and credit extension. Turkey has a network of thousands of rural cooperatives but most are run by government rather than farmer members, which has made them less responsive to the service demands of the farmers. Development Challenges facing Cooperatives: : For the cooperatives to act more as private sector entities, they must restructure their organizations and operations to reduce costs and focus on the needs of farmer members. : Restructuring of agricultural sales cooperatives (ASCs) and their unions (ASCUs) should be accelerated. : An urgent effort to restructure the agricultural credit cooperatives (ACCs) and their unions is being planned to avoid the ACCs' becoming a serious fiscal burden. The World Bank is supporting Turkey's agriculture reform and rural development programs through lending operations under implementation or preparation. : The Agriculture Reform Implementation Project (US$600 million, of which US$200 million tied to reforms and US$400 million to specific activities) supports introduction of the DIS, the ASCU restructuring, and the transition of farmers from over-produced crops (particularly tobacco and 69 TURKEY: POLICY NOTES AGRICULTURE & RURAL hazelnuts) to crops demanded in the market. Acceleration of the ASCU and farmer transition components is key to the release of the second US$100 million reform-linked tranche. : The Participatory Privatization of Irrigation Management and Investment Project (US$20 million) supports the pilot management of irrigation maintenance and operation by WUOs. Strengthening the legal framework for WUOs is a key to expanding this success beyond the pilots. : The Commodity Market Development Project (US$4 million) has contributed to the development of several grain exchanges and study of the growing role of such markets in price determination. : The Biodiversity and Natural Resource Management (US$8.2 million Global Environment Fund grant) is contributing to the maintenance of global biodiversity by supporting participatory community involvement in management of four unique ecological zones in Turkey. : The Village-Township Project under preparation will aim at provision of roads and water, health and education services in clusters of villages with full community participation. The project will also target raising income levels by providing improved agricultural extension activities under the coordination of an integrated rural strategy : The Anatolia Watershed Rehabilitation Project, which is in an advanced stage of preparation, would support sustainable natural resource management and raise the income of communities in about 70 degraded watersheds in 13 provinces of Anatolia and the Black Sea Region. The participatory, community-based methodology for designing and implementing schemes for better conservation at the same time as raising incomes was successfully piloted in the earlier East Anatolia Watershed Project which is an example of good practices noted in other countries as well. Particular measures will be implemented to reduce the outflow of agricultural nutrient pollution to the Black Sea. 70 16. IMPROVED ENVIRONMENTAL MANAGEMENT FOR SUSTAINABLE GROWTH AND CONTRIBUTING TO GLOBAL ENVIRONMENTAL GOALS Turkey has rich natural resources and is home to globally important biodiversity, but risks damaging those assets through poor environmental management. Worse, weak environmental management could deepen poverty. The country has some serious environmental problems despite successful efforts in specific pilots. : Turkey has made some improvements in the management of "green" resources, including through gradually expanding use of community based microwatershed management, and definition of protected areas, but these efforts have not reached national coverage. : On the "brown" side, the improvements made through establishment of environmental impact assessments and private industry efforts to meet international standards (such as ISO) are helpful but fall well short of needs. In spite of sound energy pricing policies, air quality remains poor in many cities due to traffic and industry which contribute to high sulphur dioxide and particulate matter concentrations. Wastewater treatment in 1996 was not reaching 89% of the population. : When natural resources are used in an unsustainable way, degradation seriously affects the poor who depend on these resources for their livelihood. : The poor are exposed disproportionately to environmental shocks such as flood, landslide, earthquake and drought due to lack of disaster preparedness. The key to better environmental management will be a strong institutional and policy framework for implementing desired norms. : The Ministry of Environment does not have the capacity to monitor and enforce environmental compliance on a widespread basis, and needs strengthening to carry out its environmental policy-making role more effectively. Environmental concerns have not been incorporated into sectoral policies and have not been an important part of public expenditure and investment planning. Environmental measurement needs improved statistics and standards. : Although the government prepared a National Environmental Action Plan (NEAP) based in part on a participatory process involving NGOs in 1998, this resulted in little improvement, primarily because it did not secure the ownership of the agencies who needed to follow-up, nor did it lay out funding and implementation plans. The NEAP identified priority items amounting to around US$500 million, to be carried out over a ten-year period: in 2000 none of these received funding from SPO (due to the Marmara earthquake), and in 2001 only US$65 million were funded. : Sound cost-benefit analysis of environmental actions should be used more systematically to help justify them and implement them in cost-effective ways, as well as to focus selectively on investment projects that deserve funding and can be completed expeditiously. : Greater involvement by communities in decision-making about the local environment, managing resources and monitoring compliance has been shown to bring sustainability and improved livelihoods in Turkey. 71 TURKEY: POLICY NOTES ENVIRONMENT Turkey's environmental management will become strongly influenced by EU standards and Turkey's role as a signatory to important international agreements. : In recent years, Turkish society has grown increasingly aware of environmental issues. Turkey also faces the challenge of aligning environmental standards to those of the EU, and living up to international commitments including contributing to the reversal of Black Sea ecological degradation. Environment is a major component of any EU Accession Strategy; meeting the standards involves significant resources. : Other Accession countries have found that the costs of the environmental acquis communautaire are among the highest of all the acquis. Estimates for eight of the Accession candidate countries indicated a cost, over a period of some 15 years, of between 900 and 1700 per capita to comply with the environmental directives. Turkey has a poorer infrastructure than some other candidates did. The costs depend on how efficiently the country undertakes the investments-- there is a strong incentive to manage the process to minimizes costs. Even if Turkey is efficient in its accession strategy, however, the cost is likely to be between 60 billion and 110 billion, over a decade or so. : State spending is likely to start at around 750-1,400 million per year and go up to 1,700-3,100 after five years. This major increase in the budget for environmental spending should start around three years before joining the EU. : This expenditure will come from three sources: domestic public funds, domestic private funds, and external funds, most notably the EU. If the pattern experienced by other candidate countries applies to Turkey, external sources could 12-15% of the total cost, state sources would likely have to cover 28-32% percent and the private sector 53-60%. Turkey has signed international agreements and can play an important role in preserving globally important environmental values. : Turkey has important international obligations. With respect to the Kyoto Protocol on Climate Change, Turkey's status needs to be clarified and signature finalized. Once this is done it can benefit from a significant inflow of funds to increase energy efficiency. These are important economic mechanisms that could benefit Turkey. A prime example is a new international market in which it would be possible to `sell' reductions in greenhouse gas emissions. The potential for such reductions is substantial in Turkey and could be an important source for increasing energy efficiency in the industry and power sectors, thereby saving resources for investments. Once Turkey's status with respect to monitorable targets is clarified and Turkey signs the Protocol, the country will benefit from the international market for carbon, which would provide a major impetus to reduce carbon emissions. : Other international obligations in relation to biodiversity conservation and wetland protection, Black Sea nutrient reduction, and phase out of persistent organic pollutants mean that Turkey will need to improve its capacity to protect and regulate the environment, building on success so far in cases such as phase-out of certain ozone-depleting substances. : In addition, membership of the WTO requires that producers are compliant with domestic environmental regulations and the organization retains the right to audit enterprises to make sure this is the case. : Beyond the compulsory, there are voluntary schemes, such as ISO14000, which are desirable in opening up markets and allowing Turkey to expand its trade. 72 TURKEY: POLICY NOTES ENVIRONMENT The Bank has supported some successful environmental projects that demonstrated good principles and feasible implementation methods. Moving forward, the Bank stands ready to support sizing up these pilots and building the institutional framework. : The Bank is supporting the government of Turkey for the phase-out of ozone depleting substances and biodiversity preservation, under two grant programs. : The loan-financed East Anatolia Watershed Project, which recently closed, is now considered an example of best global practices in community based micro-watershed management. Building on that experience, the government is preparing with Bank support a broader Anatolia Watershed Management Project, for which a loan would be ready in the first half of 2003. : The new Anatolia Watershed Management Project is being combined with a grant-financed effort to reduce agricultural nutrient run-off into the Black Sea. 73 17. PROTECTING TURKEY THROUGH DISASTER PREPAREDNESS AND MITIGATION Turkey is highly vulnerable to natural disasters, especially earthquakes and floods. Effective mitigation and preparedness can significantly reduce the risk of large economic and social costs. This lesson was most recently demonstrated when the Marmara earthquake hit Turkey in August 1999 and resulted in a devastating loss of human lives and private and public assets. : Over 17,000 lives were lost. : 200,000 people were made homeless, over 200,000 housing units were damaged with US$1.3-3.3 billion damage to the housing stock. : More than US$200 million of infrastructure damage occurred. : About US$1.2-2.2 billion in other types of fiscal burden was imposed. One significant risk scenario would be if a seismic event of the same magnitude were to occur near Istanbul, the human suffering as well as the social, economic, and environmental impacts would be devastating. : Istanbul is the financial, cultural and industrial center of the country, and a metropolis of inter- continental importance. : Some sources estimate the economic impact of such a disaster in the range US$20-60 billion. : Casualties could easily reach a million. : According to recent expert assessments, the probability of a major earthquake affecting Istanbul in the next 30 years is 62% ± 12%, while the likelihood of such a devastation in the next decade is 32% ± 12%; that is, a risk roughly comparable to that in Los Angeles and San Francisco. Turkey has learned from past disasters and is improving mitigation efforts. Disaster insurance has been introduced, an institutional framework for emergency management has been established, and improvements in land use planning and trauma treatment have begun. The new national disaster insurance scheme, the Turkish Catastrophic Insurance Pool (TCIP), was successfully launched in September 2000. : In its first year of operation of the TCIP, about 2.4 million policies were sold which amounted to US$950 million in re-insurance placed at an attractive premium rate. The TCIP has been a remarkable example of a successful public-private partnership, now admired world-wide as a model in promoting better risk management and mitigation in the area of natural disasters. This scheme is: Providing readily available liquidity to the owners of homes damaged by future disasters; reducing the fiscal burden resulting from major catastrophic events; decreasing Turkey's dependence on foreign donors' assistance in the aftermath of disasters by shifting the financial burden to international re-insurers, capital markets and the TCIP. 74 TURKEY: POLICY NOTES DISASTER MANAGEMENT While the TCIP has had admirable initial success, recent fluctuation in the number of policies indicates a need for further measures for the successful growth and ultimate viability of the scheme. : By April 2002, the number of policies held dropped to 1.8 million (from the initial 2.4 million). Currently, the penetration increased again and stands at 2.5 million, but there is still a considerable room for improvement. Despite the enactment of the Decree Earthquake Insurance Law, the legal framework for the operations of TCIP remains weak and highly vulnerable to legal challenges. The worrisome volatility in the level of policies sold is mainly caused by a lack of the legislation introducing the effective compulsory measures and sanctions. The passage of the Earthquake Insurance Law by the Turkish Parliament remains the most important step towards the sustainable growth and viability of the Disaster Insurance Scheme in Turkey. A new emergency management structure, the Turkish Emergency Management Agency (TEMAD), was established at the end of 1999. : The agency has a mandate to coordinate at the national level, and initiate activities in the areas of disaster mitigation, preparedness and emergency response. However, the effectiveness of TEMAD has been thwarted by a lack of high level commitment to build the institution and strengthen its role. Two factors are key: : TEMAD's General Director must be given the authority to hire qualified staff who have the necessary skills to fulfill TEMAD's mission. TEMAD cannot be successful with the current staff. : The Government should indicate its strong support for empowering TEMAD, and achieving a more effective coordination between the Ministries and General Directorates that have emergency responsibilities. Without a strong coordinating function at the national level, and investment in enhancing Turkey's emergency management system, many of the problems encountered in August 1999 will likely be repeated in future major disasters. : TEMAD, with proper staffing and support, will enhance Turkey's ability to manage its risk from natural disasters and can help to save thousands of lives in case of a major earthquake. Making TEMAD fully effective is critical to improved disaster mitigation and preparedness in Turkey. The Bank has been very active in providing assistance to Turkey for reconstruction and recovery, as well as disaster preparedness and mitigation. : The US$369 million Turkey Emergency Flood and Earthquake Recovery (TEFER) project has been providing support for reconstruction and mitigation of flood and earthquake risk. : In response to the Marmara earthquake, the Bank provided, in close coordination and cooperation with the Turkish Government, the EIB, the European Social Fund, and other donors, a comprehensive US$3 billion assistance program consisting of: US$267 million in reallocation from on-going loans towards reconstruction work; a US$252 million Earthquake Emergency Recovery Loan (EERL) to support targeted cash assistance to needy survivors; the US$505 million Marmara Earthquake Emergency Reconstruction (MEER) project to support reconstruction, launching disaster insurance and other disaster risk mitigation efforts, and institution building to improve emergency preparedness. More than 11,000 apartment 75 TURKEY: POLICY NOTES DISASTER MANAGEMENT units and 800 rural houses have already been constructed. Components on land use planning, cadastre renovation, and a trauma program are progressing. The Government may wish to consider action to mitigate seismic risks in the municipality of Istanbul and to further strengthen capacity for emergency preparedness in order to reduce social, economic and financial impacts of future earthquakes. : Early thinking has identified important priorities including preparing and educating school children, hospital administrators and patients, the business community and government agencies including fire and police. Other measures could include planning for emergency response, including search and rescue, evacuation, and the establishment of temporary shelter and care facilities. Seismic strengthening of Istanbul's critical facilities and major lifelines would assure that the needed framework for the metropolis as a whole would continue to function even in the case of a major disaster. The World Bank is well positioned to support such an effort, in coordination with the Turkish Government, the Municipality of Istanbul, the European Union, UNDP and other donors. 76 18. IMPROVING MUNICIPAL SERVICES FOR TURKEY'S GROWING URBAN POPULATION Fast paced urbanization has strained Turkey's municipal services. Turkey has gone through a rapid urbanization and Urban Population Growth about 65% of the population currently lives in 50 70 urban areas. The urbanization rate is expected to 45 60 increase to between 75% and 85% before it 40 50 stabilizes. Demand for core municipal services-- 35 30 quality and sustainable provision of water, )snoilim( 40 25 etaRnoitaz wastewater, urban transport, road maintenance, onita 20 30 15 and solid waste management--has exploded. puloP 20 banirU 10 Municipalities are facing difficulties in addressing 10 5 operational and financial issues. 0 0 1927 1940 1960 1980 2000 Urban Population Urbanization Rate Partial measures have been put forward, but a more comprehensive municipal reform strategy is badly needed. Increased demand for municipal services has traditionally been met by increased financing from the central government. The draft Local Administration Law proposes sharp increases in central government funding for local authorities, but this is unrealistic given macroeconomic and fiscal constraints. It is increasingly difficult for the central government to oversee the 3,200 municipalities. A more broad-based reform approach centered on improvements in municipal governance and responsibility is needed. Diagnostic work underscores that business as usual is not sustainable. : Fiscal pressures rule out the past practice of meeting ever-growing service demands through increased allocations from the central budget. This is especially relevant for municipal investments which have been dependent on the central government through the Treasury guarantee scheme and heavily subsidized borrowing through Iller Bank. : Financial discipline is inadequate due to lack of incentives in the transfers and borrowing system. Although public expenditure management reforms have been mandated for all of general government, work in municipalities has not yet started. A major training and extension effort is needed to implement these reforms in the local authorities. : Local accountability is reduced due to large shares of central government funding for both operational and capital expenses at the local level. The transfers are not linked to actual service levels; extra transfers to the metropolitan municipalities foster preferential treatment and reduce the equalization effect. : The role of the private sector is minimal in the delivery and financing of urban services, excepting urban transport, due to the perceived high political risks and lack of a supporting regulatory framework. 77 TURKEY: POLICY NOTES MUNICIPAL : Investment needs are high. Significant investments (tentatively estimated at US$20 billion) are needed for Turkey to meet EU standards in the areas of water, wastewater and solid waste. A comprehensive municipal reform strategy should focus on a core set of policy objectives. : Increase credit-worthiness of municipalities: The poor credit record of municipalities remains a fundamental problem. Total outstanding municipal debt to the State is around US$5.1 billion and an estimated 85% of this debt is not being serviced. Almost 90% of the debt is related to State support for investments--Treasury guarantees or loans from Iller Bank. The remainder reflects outstanding payments to public institutions. : Upgrade institutional and financial management capacity: The current financial management system is not adequate to determine the effectiveness of the use of funds and ensure prudent use of funds. Institutional capacity at the local level is not adequate to effectively manage the funds. : Streamline central government oversight: The central government exercises considerable ex-ante controls over Turkey's municipalities. These controls has become increasingly ineffective as the urban economies have become large and complex. The oversight system is not outcome oriented and fails to provide information about municipal performance and actual service delivery. : Reduce dependence on the central transfer system: Central government transfers to municipalities amount to about 2% of GNP and represent 50% of municipal revenues. The large share of central transfers de-links taxation and spending, weakening taxpayer accountability. : Increase municipal raised revenues: Locally raised revenues correspond to 39% of total municipal revenues (about US$72 per urban citizen). While there are many taxes, the collection rates are low and the proliferation of local taxes and fees makes them costly to administer. Locally raised revenues are centrally controlled and to a large extent are generated by municipal commercial activities, not basic services. There are rigid controls imposed by the central government to adjust local revenues and often these taxes and duties do not keep pace with inflation. The absence of a tourist tax imposes an extra burden on residents of tourist areas who have to pay for the infrastructure designed for both residents and tourists. A two-pronged approach to municipal reform is offered for consideration which twins structural reforms to improve municipal governance and service delivery with measures to strengthen the system of municipal finance. Proper sequencing will be important. : Improving Municipal Governance and Service Delivery. Reforms would center around: (i) implementation of the public expenditure management reforms at the local level, and (ii) passage and implementation of an appropriately revised Local Administration Law. These reforms cover three broad areas: Central Government Oversight Functions: Training and advisory support. This support should be provided to improve financial and operational performance. A priority is training for implementation of the GFS budget classification and accounting reforms at the local level. Increase performance monitoring. To this end, the Government has started a pilot project that will benchmark operational and financial performance across many municipalities. Reduce administrative control. This would include increased local control over taxes and fees, modification of cumbersome administrative procedures that lead to delays, and eventual replacement of the existing system of central government authorization for staffing decisions with increased authority at the local level. Introduce a participatory budgeting process. International experience shows that the accountability of municipalities increases if citizens are involved in planning and budgeting processes. Increased accountability leads to better governance at the local 78 TURKEY: POLICY NOTES MUNICIPAL level. This type of budgeting process could be considered in the medium to long term. Central Government Transfers: Reduce dependence on transfers. Larger cities should be allowed to levy additional taxes, linked to centrally defined taxes, such as income tax. Link transfers to service. Central transfers could be linked to some degree to the level of service actually provided by the municipalities. Review of the equalization mechanism. In the longer term, amendments to the equalization program should be considered to establish clear objectives for the equalization scheme and to assist the smaller and the poorer municipalities. Locally Raised Revenues: Reform local taxation. A thorough review of the existing local taxes and fees should be conducted with the objective to consolidate taxes, introduce tourist tax, increase control for the local authorities to set rates, and convert the environmental tax into a fee based service. Improve financial management. As responsibilities of local authorities towards generating local revenues increase, it is important to strengthen local financial management systems in line with recent legislation and on-going reform efforts. Involve the private sector. Municipalities should disengage themselves from commercial activities that could crowd out the private sector. The municipalities should focus on the core services (transport, water, wastewater, solid waste management, and land use planning and development) where efforts to introduce the private sector should be made. : Strengthening Municipal Finance. Reforms would focus on establishing financial discipline at the local level and establishing a sustainable system of central government support for local investments. Increase automatic sanctions. Mechanisms to impose stiffer and automatic sanctions against municipalities that do not service their debt should be considered in line with the new stricter procedures for Treasury guarantees issued in early 2002. By making the sanctions automatic and not discretionary, greater incentives would be created for the municipalities to honor their debt obligations. Benchmark performance. The monitoring system that is being developed by the Ministry of Interior will be the basis for determining the performance of municipalities. The system will monitor both financial performance and quality of service. The results will be publicly available and will contribute to local authorities being more fiscally responsible. Promote development of a credit culture. As loan funds would be increasingly passed on to the municipalities without government subsidies or guarantees, changes would be necessary in the borrowing practices of the municipalities. Provide technical assistance. Assistance should be provided to the municipalities on investment planning, asset management, financial management, and project appraisal and implementation techniques. Technical assistance for financial management would cover budgeting, financial control, auditing and disclosure standards, and developing municipal credit records. Reform Iller Bank. Activities would entail setting clear objectives for the bank, establishing independent day-to-day operations, separating financial and transfer functions, separating financial and technical functions, achieving self-financing, being less reliant on direct government (or local government) support, and being transparent on the use of subsidies. At a later stage, after financial discipline is established, Iller Bank could play a role in financial intermediation. : Sequencing Reforms. A phased approach to reforms with measurable benchmarks may be appropriate. A suggested phasing could be as follows: 79 TURKEY: POLICY NOTES MUNICIPAL Phase 1 (1-2 years): Identify reforms, initiate monitoring of municipal operations in a comprehensive manner, adopt the Local Administration Law with appropriate provisions, and carry out an international audit/operational review of Iller Bank. Phase 2 (2-5 years): Implement the identified reforms, including the Local Administration Law. Key institutional reforms of Iller Bank would be implemented during this phase. Phase 3 (5-10 years): Focus on performance monitoring and enforcement of reforms. Review the equalization mechanism and options for expanding municipal functions to include social services. The World Bank is actively supporting municipal development in Turkey and could provide broader support for a comprehensive municipal reform strategy. : The Bank has traditionally supported municipal development in Turkey by financing a number of water and wastewater projects. The overlying objectives of these projects have been to increase service coverage and improve quality of service through the provision of safe drinking water and sanitation practices that minimizes health and environmental risks. : Future activities of the Bank in the sector would continue to ensure adequate service and quality and also focus in areas where the impact on meeting the Millennium Development Goals (MDGs) would be highest (in the East and Southeast) and in areas with significant environmental externalities that need to be addressed (large population; tourism area etc.). : Through an IDF grant, the Bank is currently assisting the authorities to develop a performance benchmarking system to track the operations in pilot municipalities. : The Bank is also providing support for on-going policy reforms to improve public expenditure management and restructure the financial sector under the Second Programmatic Financial and Public Sector Adjustment Loan (PFPSAL II). : The Bank could assist with the proposed comprehensive municipal reform in a number of ways including: advisory role including international perspective (a Local Government Sector Review has been prepared and presented to the authorities for discussion) further support for policy reforms to improve municipal governance and/or strengthen municipal finance possible use of the Bank's guarantee instrument to raise capital for the municipal sector or cover certain risks faced by private operators providing municipal services. 80 19. LEGAL AND JUDICIAL REFORM Legal Reform Turkey has a strong legal basis to address the requirements of increasingly complex economic and commercial relations, but upgrading the legal framework to international standards is necessary to face new economic and commercial challenges. : Since 1999, Turkey has developed the legal framework essential for economic reforms and private sector development, with legislation passed for social security, banking, telecommunications, agriculture, tax reform, fiscal management, public procurement, and public debt management. : Recently, attention has been focused on developing amendments to the Execution and Bankruptcy Law. : Preparations for revision of the Commercial Code are underway. This is an extremely important and timely effort especially for the development of a sound corporate governance environment. It should be noted that new methods evolved internationally during recent years in drafting of legislation have not been introduced in Turkey yet. : Assessing the costs and consequences of new laws and regulations should be an essential part of the law-making process. : Rules adopted without regard to questions such as the quality of the institutions that will enforce them, the burden imposed on the economy, or the opportunities they might provide for abuse and corrupt behavior often do more harm than good. : Over the past two decades members of the European Union have devised a variety of methods for evaluating the impact of proposed laws. Turkey should examine these methods and design strategies for their introduction into the Turkish system. Judicial Reform A more effective and better performing judiciary is an important prior condition for both investors' decisions and more equitable access to justice. : While the emphasis in Turkey has been on the legislation in recent years, the development of adequate institutions including the modernization of the judiciary will be key in further developing the rule of law. : Entrepreneurs are unlikely to invest without an adequate legal and institutional framework for the protection and enforcement of contractual and property rights. : Adequate enforcement mechanisms including strengthened judiciary are also needed to protect citizens from the overreach of the administrative branch. 81 TURKEY: POLICY NOTES LEGAL The key challenges of a comprehensive judicial reform program include: establishing an independent and accountable judiciary; establishing an effective judiciary; creating a sound and continuous legal education; and facilitating access to justice and public awareness. : Drawing on standards proposed by the United Nations, the Council of Europe, and other national and international bodies, a method has been developed for evaluating a nation's progress towards judicial reform. This method uses 30 different indicators divided into six categories: 1) quality, education, and diversity of judges; 2) jurisdiction and judicial powers; 3) financial resources; 4) structural safeguards; 5) accountability and transparency; and 6) issues affecting the efficiency of the judiciary. Turkey may want to use this methodology in order to assess its own judiciary. Establishing an independent and accountable judiciary: In Turkey, political influence, pressure and debate are challenging the work of judges and prosecutors and impairing the independence of judiciary. : The Global Competitiveness Report 2001-2002 of the World Economic Forum ranks Turkey considerably lower than Hungary and Poland in judicial independence. : On the most basic level, individual judges must be independent from the parties before them. Judges should decide matters according to the law and facts, and not according to undue influences (such as bribes or threats) placed upon them by the parties. : In addition to independence of individual judges, courts must enjoy structural independence. The judiciary must be independent from the other branches of power, as well as, at least in some sense, from public pressure. Establishing an effective and efficient judiciary: Adjudication of disputes and cases remain a very slow process in Turkey. Core Issues : The number of disputes is increasing, which causes a progressive increase in the number of pending cases carried over by courts from one year to the next. According to the statistics stated in the Statistical Yearbook of Turkey 1999, while the number of commercial judges basically stagnated in last five years, the number of cases increased by 40%. Case in Turkey take at least one year but often much longer. Court administration and case load management are not effective. : The survey done by Turkish Industrialists' and Businessman's Association which was published together with the report on "Quality in the Judicial System" in November 1998 identified slowness of judiciary as the major problem in the functioning of the judiciary. : There are deficiencies in the technical infrastructure serving the judiciary. Inadequate buildings and equipment constitute obstacles to the efficient functioning of the judiciary. : The salaries and working conditions of judicial staff are not adequate. Recommended Actions : The judiciary just like any other state institution can benefit from international experience in its organization, administration and most effective use of its resources. To that end, the current methods of resource allocation management systems and budget procedures should be reviewed in order to recommend adequate measures for better administrative efficiency. 82 TURKEY: POLICY NOTES LEGAL : The efficiency of the judiciary depends on adequate allocation of responsibilities amongst the judges, assistant judges, clerks, court administrators and other court personnel. International experience has demonstrated that efficiency gains do occur if judges obtain adequate assistance from court clerks and administrators. : Also, the introduction of case management procedures which adequately distinguished amongst different types of cases can play an important part in increasing the effectiveness of the judiciary. : Many legal systems have made important strides recently in developing institutions which are resolving and or mitigating conflict thereby decreasing the work load of the judiciary. : The effectiveness of the existing system of enforcement of judicial decisions should also be assessed in order to make recommendations for its improvement. Creating a sound and continuous legal education: The quality of the current system of legal education and its adequacy should be assessed. : Curricula changes and introduction of modern teaching techniques could improve the overall level of legal education, both at the university level as well as the continuous legal education for legal practitioners. Capacity building within the judiciary and i.e. training of judges and other court personnel is a key measure to enhance the effectiveness and performance of the judicial system. : Capacity building pertains to training of new judges and ongoing training of sitting judges. In the latter area, distance learning and e-learning facilities can be of great use for the reform of a decentralized system like the judiciary. Facilitating access to justice and public awareness: The poor continue to lack legal rights that empower them to take advantage of opportunities and provide them with security against inequitable treatment. Justice should be accessible for all Turkey's citizens. : Institutional reform, and in particular, reform of legal institutions, should be accompanied by adequate awareness and public education activities. The public--the ultimate beneficiary of such reforms--needs to be informed about the envisaged institutional changes, the standards to be introduced, and the expected outcomes of the reforms. Challenges: The challenges are complex and do not conform to any single simple model. Developing an effective strategy for judicial reform requires a careful and critical examination of the Turkish judiciary. : There are ongoing considerations and debates by the members of the judiciary, bar organizations and non-governmental organizations, over how to improve the judicial system in Turkey. In the meantime, there is an ongoing debate about the re-organization of the Supreme Council of Judges and Public Prosecutors to achieve full independence of judiciary and about the creation of intermediate appellate courts to deliver fair, rapid, effective and efficient judicial service. There are further plans to modify the procedural codes to introduce new arrangements to speed court proceedings and execution of judgments and improve court administration. 83 TURKEY: POLICY NOTES LEGAL : In order to be able to tailor an effective reform strategy to meet the needs of Turkey and achieve its intended objectives it is highly recommended that a comprehensive judicial sector assessment be carried out by the Turkish authorities drawing also on the international experience and expertise in this area. The World Bank has been instrumental in supporting many judicial reform initiatives of its member countries. The Bank's legal and judicial reform programs have expanded considerably since the Nineties. : Since beginning its activities in governance in 1991, the Bank has addressed judicial reform as countries began to recognize that enacting legislation alone could not yield the desired reforms without adequate infrastructure to implement, enforce, or modify the law. : Subsequently, the focus became building and reforming the institutions needed for dispute settlement as well as for access to dispute mechanisms and qualified and affordable representation. : Judicial sector assessments are highly desirable prerequisites to ensure that projects meet the needs of the country and achieve intended objectives. : Legal and judicial reform projects are continually evolving as the countries embrace a more holistic approach for longer-term legal and institutional reform. Key elements in legal and judicial reform now include promoting judicial independence through improved appointment, financing, and disciplinary procedures; modernizing judicial administration and case management; and training judges and court personnel. To date, there are 18 freestanding legal and judicial reform projects supported by the Bank in Latin America, Eastern Europe, Middle East, South and East Asia Regions, with another 10 projects under preparation. : Not only through lending, but the Bank also supports its member countries' judicial reform efforts through Institutional Development Fund (IDF) grants. IDF grants are implemented by the recipient governments and can support legal and judicial reforms. ARGENTINA Model Court Development Project A 1992 Judicial Sector Study was carried out under an Institutional Development Fund grant in 1992, and followed by a seminar with various stakeholders in 1995 helped the government define a National Judicial Reform program.. The improvement of judicial efficiency and quality, and access to justice were some of the main issues included in this program. As a first step in the program, a Model Court Development Project was developed to identify, establish, and evaluate conditions to support the realization of judicial administrative reform through three components: (a) court management; (b) judicial skills development; and (c) evaluation and dissemination. ECUADOR Judicial Reform Project In the early 1990s, judicial reform was included in the agenda for modernization of the State. In 1994, a judicial sector review assessed the legal and judicial system and provided recommendations for reform, thus creating the groundwork for the Judicial Reform Project. An overall judicial reform strategy involving the stakeholders was planned, laying out a long term reform agenda, priorities and donor coordination. The Judicial Reform Project for Ecuador has four components: (a) case administration and information support; (b) court-annexed mediation centers; (c) a program for law and justice, including a special fund for law and justice to support activities initiated by civil society and innovation by courts, a professional development program for law professors, a study on the state of legal education, research and evaluation of mediation pilot centers, and legal service pilots for poor women; and (d) infrastructure remodeling and development of court infrastructure standards. 84 20. CIVIL SOCIETY Engaging Civil Society for Turkey's Development Greater engagement of civil society in Turkey's development--for designing strategies and implementing programs--will raise the effectiveness and relevance of the government's efforts in the eyes of its citizens. : Internationally, the emergence of civil society involvement in development has been a significant trend over the past two decades. Partnerships amongst governments, private sector and civil society have proven to be effective in achieving sustainable economic and social benefits, particularly for the poor and vulnerable groups. Why Engage Civil Society? International experience has shown that engaging civil society groups in projects and policy dialogue improves development outcomes in several ways: Promoting public consensus and local ownership for reforms, national poverty reduction, and development strategies by building common ground for understanding and encouraging public-private cooperation; Giving voice to stakeholders, particularly poor and marginalized populations, and helping ensure that their views are factored into policy and program decisions; Strengthening and leveraging impact of development programs by providing local knowledge, targeting assistance, and generating social capital at the community level; Bringing innovative ideas and solutions as well as participatory approaches to solve local problems; Providing professional expertise and increasing capacity for effective service delivery, especially in environments with weak public sector capacity or post-conflict contexts; Promoting public sector transparency and accountability of development activities, as well as contributing to the enabling environment for good governance. Civil society in Turkey is becoming stronger. Turkey has made noteworthy strides towards greater civic engagement in the past four years, and could build on that experience. : Turkey's society has a strong tradition of community obligation. Citizens often set up charities or foundations, and there is a steady flow of funding to local groups in order to help those who are needier. : Strengthening of the market economy and democratic trends, together with the shocks that have shaken Turkey in recent years, have galvanized NGOs into action and advocacy. Important events have included the 1999 earthquakes, the 2001 economic crisis, the pull of the global information society, international forums on sustainable development, and the EU accession process. 85 TURKEY: POLICY NOTES CIVIL SOCIETY Despite encouraging progress, channels of effective communication and cooperation between the state and CSOs are limited in Turkey. : While there has been a considerable increase in the government's willingness to engage with CSOs on some development issues over the past few years, there remains hesitancy on certain fronts largely related to a desire to avoid fostering extremist movements. : Participatory decision-making and community driven development (CDD) Civil Society Organizations: Present Status in Turkey are relatively new concepts among Turkish non-governmental There are approximately 60,000 associations (dernek), more organizations (NGOs), perhaps due to than 2,000 foundations (vakif), 1,000 labor unions and nearly the traditional paternalistic nature of 500 career organizations in Turkey, giving a total of 65,000 Turkish society. organizations. However, 35-40,000 of these are local civil initiatives such as small associations for building mosques, : The regulatory system for NGOs is complex. There are various levels of beautifying a village, or cleaning up a street. Only 10-15,000 regulation and monitoring for voluntary are civil society organization (CSOs) with broader activities, a large number of members or supporters, and an established, organizations at the central level professional work program. When the branches or sub-units of ranging from the Council of Ministers each federation or organization are not counted separately, the to the Ministries of Finance and Interior number of CSOs comes down to 2-3,000. These CSOs and the line ministries. Additionally, represent a dynamic, functional and promising group. the General Directorate of Foundations and the Bank for Foundations (Vakifbank) carry substantial authority over the functioning of Foundations. The functioning of the system needs to be simplified. : Many NGOs either lack technical expertise in developing projects or face financial problems despite their innovative ideas. A number of measures can be taken to promote greater CSO involvement in Turkey's development process. : Proper legal framework is needed to facilitate establishment and funding of CSOs with appropriate transparency and accountability, including regular audits. In this context, the "Legislation of associations" should be revisited and amendments suggested by NGOs should be considered. : Forums in which CSOs can play a role in public dialogue on key issues can be established by the government. : CSOs can be provided with more opportunities to compete for contracts involving implementation and monitoring of development projects. : The government should avoid giving priority to "Government Organized Non Governmental Organizations" (GONGOs) which are often used by government agencies to create extra-budgetary income through the establishment of a revolving fund mechanism. This is frequently used to offset government budgetary controls imposed by providing direct access to derived incomes ranging from consultancy services at universities to the publications and sale of books, brochures and pamphlets by ministries. : The government should be careful not to go beyond the creation of opportunities and establishment of rules--by its nature it is important that civil society develop on its own. The Bank has good working relations with Turkish CSOs especially in the human development and environment sector. : The World Bank has been cooperating technically with TESEV (Turkey Economic and Social Studies Foundation) which is a prominent NGO think-tank on policy issues. Grant funding has 86 TURKEY: POLICY NOTES CIVIL SOCIETY assisted TESEV to carry out anti-corruption surveys as part of the Bank's overall support to Turkey on governance issues. : Within the framework of the Basic Education Project, the Mother and Child Education Foundation (ACEV) has provided training to mothers to help them prepare their children for school. : The SME Development Foundation (MEKSA) and White Point Foundation working for development of the quality of life have provided the Bank with inputs to strategic thinking about Turkey's development. : The Bank frequently consults environmental NGOs such as the Society for the Protection of Nature (DHKD) and the Environment Foundation of Turkey (TCV) for their expertise in small projects for planning, management and conservation of natural resources and biodiversity. : The Turkey Technology Development Foundation (TTGV) is the implementing agency for the Bank financed Industrial Technology Project. : The Local Initiatives component of the Social Risk Mitigation Project (SRMP) aims to strengthen and finance rigorously selected projects through the Social Solidarity Fund (SYDV), based on proposals by provinces, districts and local communities. An NGO Advisory Board has been set up within this framework. : The Small Grants Program (SmGP) is a World Bank grant mechanism that provides small-scale financing for local NGOs who have the capacity to implement projects to engage marginalized and vulnerable groups in expanded social dialogue, often related to social projects they are undertaking. So far, 11 NGOs have been awarded these grants in annual competitions, and gained opportunities to expand their skills and contribute to the building of social capital. The Bank is eager to contribute to efforts to create a more enabling environment for civil society development in Turkey. This contribution includes: : expanding the opportunities for community-based development within Bank-financed projects, : consulting CSOs more widely--in partnership with government--on program and project design, : supporting international forums involving participation of Turkish CSOs. 87