Repo" No. 6603-TU Turkey: Adjusting Public Investment (In Two Volumes) Voiume I: Overview of Findings and Recommendations March 30, 1987 Europe, Middle East and North Africa Projects Department FOR OFFICIAL USE ONLY H Document of the World Bank This report has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. TURKEY ADJUSTING PUBLIC EMENT VOLUME I CURRENCY EQUIVALENTS Currency Unit Turkish Lira (TL) US$1 TL 652 TL 1 US$ 0.0015 Currency equivalents are those effective April 1986, unless otherwise indicated. ABBREVIATIONS BOAT - Build-Operate-and-Turnover IAF - Investment Acceleration Fund MHF - Mass Housing Fund PCF - Petroleum Consumption Fund PPF - Public Participation Fund SEE - State Economic Enterprize SPO - State Planning Organization FOR OMCIAL USE ONLY TURKEY ADJUSTG PBUC TABLE OF CONTENTS VOLUME I Page No. OVERVIEW OF FINDINGS AND RECOMMENDATIONS I. Scope of Report . * .* * . . . . * . . . . . . . a . * 1 II. Government Objectives in Structural Reform . . . . . . 1 III. Public Investment Strategy . . . . . . . . . . . . . . 2 IV. Public Investment Management . . . . . . .. . . 7 V. Suimmary of Action Program to Strengthen Public. . . . Investment Management..... .......... 14 VOLUME II MAIN REPORT AND STATISTICAL ANNEX CHAPTER I. Introduction.. .... ............. 1 The Agenda . . . . . . . . . . . 1 . . . . . o . . 1 CHAPTER II. The Public Investment Framework: Adjusting the Visions and Goals . . . . . . . . . . . . a . . . . . . . . . 3 CHAPTER III. Public Sector Investment Management: Adjusting the Means 20 CHAPTER IV. Institutional Reform: Adjusting the System . . . . . 30 CHAPTER V. Adjusting Public Investment: An Action Program . . . 43 ANNBES: o . o. . .. ........ This document has a restricted distribution and may be used by recipients only in the perfomancce of their official duties. Its contents may not otherwise be disclosed without World Dank authorization. This report is based on the findings of two main missions in February and November 1985 and on several sector studies carried out during 1985. The first mission comprised: Jayanta Roy (mission chief); Ian Johnson (deputy chief and energy); Branko Milanovic (macroeconomist); Ritu Anand (macroeconomist); Mabmud Tirmazi (irrigation); Robert Wildeman (housing/urban); Ajit Mosoomdar (public sector management); and William O'Neil (steel). The second mission comprised: Robert Liebenthal (mission chief); Friedrich Kahnert (deputy mission chief); Ritu Anand (macroeconomist); Shangshi Wu (general economist); Ian Johnson (energy); Joelle Manibog-Chassard (coal and lignite); P. T. Venugopal (pipelines); Kariyawasam Wijetilleke (refineries); Roy Knighton (transport); Linda Likar (forestry); David Gardner (forestry); Silvie Tillier (agriculture); William O'Neil (steel); Robert Wildeman (urban); Lars Rasmusson (water supply); David Davies (tourism); and Ajit Mozoomdar (public sector management). In addition, sector working papers were prepared by Bruno Laporte (education), Louis Vassiliou (health) and a number of other staff members. The report was discussed with the Government by Robert Picciotto and Robert Liebenthal in June 1986 and again in November 1986 by Robert Liebenthal, Friedrich Kahnert and Sven Kjellstrom. VOLUMEEI TURKEY: ADJUSTING PUBLIC INVESTMENT Overview of Findings and Recommendations I. Scope of Report 1. The recent transformation of Turkey's economic policies from an inward-looking to an export-led strategy has far reaching implications for the economy and society. Greater decentralization of economic decision-making, greater accountability for effective use of resources through realistic, market-based pricing, greater confidence in the enterprise and innovation of private economic agents add up to a new concept of the role of the State. Accordingly, public investment and the institutions that manage it are being reoriented. However, the vision of a rapidly growing, competitive economy will only be realized if continuously translated into specific agendas of reform backed up by effective management of public resources. Hence, centralized planning must give way to strategic, indicative, flexible planning, combined with strict programming and budgeting of public resources. In this new context, the broad aim of this report is to help the government of Turkey design the needed restructuring of its public investment. 2. Two sets of issues involved in this restructuring are covered. The first concerns public investment strategy: its size, the sectoral priorities, the relationship with private investment, the impact of decentralization; in short, the policies underlying public investment. The second concerns public investment management, issues critical to the realization of the strategic shifts now underway. Within this framework, several topics are treated in some detail: the need to change the coverage of public investment analysis; managing the sources of financing for public investment; avoiding overprogramming; strengthening the data base; and better provision for operation and maintainance. Changes are recommended in the institutions and procedures for public investment planning, budgeting and policy formulation to facilitate the effective implementation of the economic reform agenda. Detailed recommendations on the design, implementacion and assessment of the pudlic investment program are contained in Volume II of the report. These recommendations are derived in part from an in-depth review of sectoral investment programs. II. Government Objectives in Structural Reform 3. In response to the financial crisis of the late 1970s, the Government of Turkey embarked upon a reform program with two major strategic objectives: (a) resume growth, following financial stabilization, by switching the orientation of the economy outward, that is, by adjusting it increasingly to international market signals; -2- (b) change the role of the public sector from leading economic growth to supporting private sector development from both domestic and foreign sources. In addition to a major reorientation of macro-policies, the new economic strategy was implemented, starting in 1980, through measures to restrain the public sector's call on resources, to shift public investments and divest those state enterprises judged suitable for private involvement, and to improve the incentive framework for private sector activity. In particular, the Government has aimed at reducing the growth of public expenditures to avoid crowding out the private sector, and has given priority to infra- structure sectors (irrigation, energy, transport and communications) over manufacturing for public investment outlays. 4. The reforms were on the whole remarkably successful in improving the financial position of the country and in promoting structural adjustment. The process, however, is far from c,omplete. A number of macroeconomic problems persist. In particular, private investment has been sluggish due to inflation and high real interest rates. Crowding out has remained an issue because public investment expenditure grew faster than expected in 1985-86. Many of the institutional and procedural changes needed to anchor and support the reform program have yet to be implemented. The decentralization of public sector resource management that has occurred since 1984, by increasing the resources of municipalities and the rapidly growing number of extra-budgetary funds, has increased the need for institutional and procedural changes by highlighting the importance of coordination and planning. Economic decision-making, especially investment planning and budgeting and their linkage with private sector promotion policy requires strengthening. The responsibilities of the State Planning Organization (SPO) should over the next few years shift increasingly towards strategic indicative planning, and the design of policies to promote agriculture, industry, trade, communications, human resource development, urbanization, and environmental protection. There is also a need to develop short-term forecasting to reinforce the ability to manage public sector cash flows throughout the year and speedily make necessary adjustments. III. Public Investment Strategy (a) Size of the Public Investment Program 5. Macro-economic performance improved in 1985 but was m±xed in 1986. Growth in GNP is officially estimated to have reached 7.8 percent in real terms in 1986, which even if the final outcome is slightly lower, is nevertheless an exceptionally high rate of growth. The rapid growth was propelled by a sharp increase in domestic demand largely emanating from the public sector. With growth in demand outstripping the expansion in output, the balance of payments came under pressure. The current account deficit widened in 1986 and foreign borrowing rose. Public finances deteriorated, as the budget deficit widened. Recourse to domestic borrowing kept money supply -3- expanding at a rapid rate and prevented real interest from falling, although nominal rates declined. Inflation decelerated to the 25-30 percent range from 40-45 percent in 1985, but this favorable development was in part due to the unforeseen fall in oil prices and the dollar exchange rate (with respect to other major currencies). Medium-term economic prospects need to be evaluated carefully since developments in 1986 are not sustainable. The Government is adjusting its economic policies for 1987 by slowing the growth in public expenditure to reduce the public sector deficit and bring the rate of inflation down to the 20-25 percent range. The GNP growth target is set at 5 percent in real terms. Slower expansion in domestic demand is expected to permit a significant reduction in the current deficit on the external side. 6. Non inflationary growth requires an acceleration of productive private investment. High interest rates are inhibiting such revival, and they are due in part to the funding requirements of the public sector. Public investment growth should therefore be restrained. A growth rate of about 4 percent aniually through the remainder of the decade would be compatible with sustainable macro-balances, lowering of the inflation rate and revival of private investment. This should be the target until Government revenue is more buoyant, State Economic Enterprises (SEE) finances are under better control, and private investment is well launched in the key sectors. Concern arises, therefore, that the Government, while planning to reduce the rate of growth in public investment significantly from 1986 to 1987, is still aiming for a growth rate of 6.4 percent in 1987 (versus 10.2 percent in 1986 and 13.3 percent in 1985). iven the lower rate projected for 1987 is on the high side and might have to be revised downward during the course of the year. (b) Composition of Public Investment 7. Sectoral imbalances in the investment program have emerged, partly because of recent changes in Government policy and partly because of persistent sectoral differences in the implementation of investment plans. First, further reductions in public power investments pose high risks. The current program is predicated on the success of the innovative Build-Operate-and-Turnover (BOAT) schemes for private involvement in power and mining and on a demand estimate that assumes the dampening effects of further real price increases at an early date. While they deserve to be promoted aggressively, the BOAT schemes may not materialize at the rate required to meet estimated demand. Also, demand may rise faster than expected if a lasting oil price reduction leads to accelerated growth. The long lead times required for power generation projects reinforce the case for a fail-safe arrangement for financing a least-cost generation program of fully prepared power generation projects large enough to prevent debilitating power shortages. Consequently a list of reserve projects, fully prepared and ready to be implemented, is required in the power sector as a fall-back position in case the BOAT schemes are delayed or fail to materialize. 8. Second, the level of resources allocated to transport and communications now appears high. Telecommunications investments have high priority since they are addressing a recognized deficiency in service and must meet rapidly expanding requirements of trade and industry. However, the willingness of customers to pay fully for the cost of the service is well -4- established. Therefore, the sector should make a positive contribution to public resources, and could well offer opportunities for effective SEG reform, or even for privatization. On the other hand, the transport investment program involves few projects which can be funded on a commercial footing by the private sector. As now designed, it contains projects of doubtful priority, particularly in its motorway and rural roads components. They should be pruned, and greater attention paid to effective operation, maintenance and improved transport enterprise management, especially in the railways. Selectivity is called for in motorway construction to avoid premature investments. If the private sector however is willing to finance, build and operate motorways without Government guarantees, it should be free to do so. 9. Despite Government intentions to increase the share of agriculture in public investment, it has actually declined since 1982. While institutional improvements in the sector are essential to increase absorptive capacity, there are high returns to the improvement of rural infrastructure and the accelerated completion of priority irrigation and drainage schemes. Hence, allocations to agriculture should increase, particularly from the budget. 10. The share of education and training should also rise. The sector has been starved of funds to the point where quality has deteriorated. An above-average rise in public investment is needed simply to maintain present standards for the growing school-age population. Increased resources will be needed to reduce the structural mismatch evidenced by shortages of skilled manpower that co-exist with high rates of largely unskilled unemployment, and to lay the basis for sustained growth in labor productivity. Some of these resources could come from larger private funding, but international experience suggests that the creation of a highly skilled labor force and an innovative private sector cannot take place without a major commitment of public resources and State leadership in the field of human resources development. 11. Long-term productivity growth also justifies increasing the share of public investments in health. Some parts of health delivery, in particular in preventive care, will not attract private interest, and much progress can be achieved by redeploying existing resources. But the health sector has suffered disproportionately from past expenditure constraints and now has significant needs in equipment procurement as well as in staffing. 12. Tourism also requires extra funding, but rather than providing interest subsidies which distort resource allocation, public investment should be concentrated on the enhancement of municipal infrastructure to support private investments in the sector (both foreign and domestic). 13. Public manufacturing and mining investments have generally lower priority and should be reduced further and faster than planned. In two of the three subsectors that have been responsible for the excess of overprogrammed investments in the past, iron and steel and petrochemicals, ongoing investment programs are nearing completion. Identified public manufacturing investments fall well short of targeted levels. Moreover, these identified programs -5- contain projects, primarily in textiles and engineering, that should remain suspended pending the results of privatization efforts. S*,me plants may require publicly-funded rehabilitation investment, if they are to be saleable at an attractive price. Others may not be saleable at all. Under the Government's policy, t'he preferred economic solution would be to close them. If the plants cannot be made viable, then this is what must be done, with specific arrangements to redeploy the affected workers. Under highly specific and circumscribed conditions, it may be rational to invest in cost-reduction and general efficiency improvements in some plants, but only after critical review. (c) Stimulating More Private Involvement 14. The Government's objective of encouraging much larger private involvement in activities previously dominated by the public sector has given rise to a wide-ranging set of policies. They range from substantial investmesut incentives to the BOAT initiative, the intended divestiture of many State Economic Enterprises (SEE) and the removal of discrimination in favor of public enterprises in such areas as preferential credit, taxes and general operational subsidies. 15. Even the modified growth projections put forward in this report rely on a significant acceleration of private investment without which the vital recovery in exports, after the decline in 1986, would be jeopardized. It is of great concern that private investment is still not respording fully to the new policy environment, with the exception of construction under the impact of significant public support for housing through the Mass Housing Fund (MHF). Its estimated 13.02 overall growth in 1986 occurred predominantly in housing, with manufacturing investment growing by only 6X. This suggests that the privatization process should be accelerated, that means should be found to increase the impact of investment incentives and that real interest rates should be reduced. 16. The BOAT initiative is a promising model for mobilizing private involvement. However, it has been under discussion and negotiations for many months, at least in power generation, without any final agreement. The delays are probably inevitable given the novelty of the scheme and the time needed to develop a suitable environment for private sector involvement in power development. However, the delays could threaten power supply shortages in the medium and longer-term. 17. Stimulating private investments and larger private involvement in public investment is now critical for the eventual success of the Government's reform package. Action is needed along four lines: selected divestiture programs in textiles, cement, fertilizer, pulp and paper and engineering which have been adequately studied; gearing up future action programs for the privatization of other subsectors, including agro-industries; -6- ° development of sector-specific strategies to determine the respective roles of public and private investment, increasing public-private interaction in energy, transport and the delivery of urban services; o SPO sponsoring of long-term perspective policy studies, to guide these strategies. The capacity of SPO and of sector institutions to overr.e such work will need strengthening; and more comprehensive attention to cost-recovery issues, particularly in fields where private involvement is in prospect. The higher the degree of cost recovery, the easier it will be to transfer activities to the private sector, whether by terminating public involvement, or by contracting with private enterprise for service delivery or management. (d) Supporting the Transfer of Increased Resources and Responsibilities to the Municipalities 18. Automatic transfer of rising shares of tax revenues to the municipalities (along with transfer of increased responsibilities) reflects a welcome trend towards decentralization of economic decision-making and greater local accountability. Municipalities account for approximately 9% of total public investment in 1986, but their investment expenditures are projected to rise by 8.9% per annum over the rest of the plan period not counting other sources of finance for municipal investments, and without allowance for several large potential investments under consideration, but for which the source of finance is still to be identified. Municipal expenditures in general, and urban investments in particular, have been underfunded for many years with the -result that large service deficiencies have accumulated. The need to catch up on these backlogs and to service an urban population growing at 4X per annum means that improvements in local resource generation (including better cost recovery) will remain critical for a long time. 19. Urban areas account for the bulk of economic activity in Turkey as elsewhere, and are employing a growing share of the labor force. this makes it important that urban areas provide adequate and efficient services to their population and their business sector. Increases in financial resources are necessary but not sufficient, because at least in non-metropolitan urban areas, these increases in resources and in municipal responsibility are way ahead of the needed improvement in management and general institutional capacity to use the resources and fulfill new tasks efficiently. It is, therefore, necessary to promote urgently the involvement of private agents in the delivery of selective urban services (solid waste, gas distribution, urban transport), as well as to put in place a support system for municipalities in such areas as finance, staff training, operation and management of municipal services, cost-recovery and resource-generation policies, municipal accounting, etc. In parallel, the functions of central agencies active in municipal investments have to be reviewed and adapted. Coordination between the central government, local authorities and the private sector must be -7- strengthened. The Government also needs more reliable information on regional development and municipal investments, especially in sectors of rapid growth. In some countries, such functions are entrusted to a ministry of local government. In others, regional planning bodies have been set up. In Turkey a regional planning system exists and could be developed further either as a complement to or substitute for enhanced devolution toward the municipalities. IV. Public Investment Management (a) Coverage of Public Investment Analysis 20. The coverage of the public investment program understates the total amount of public resources likely to flow into inveatments. It excludes companies owned in majority by the Government but operating under laws other than the one governing SEEs. The coverage also excludes public minority participations in business, but conversely includes the private portion of private minority participations in SEEs. Funds intended for investments through the Investment Acceleration Fund (IAF) are also not included ex-ante in the program, but are included in the data on realized public investment. Similarly, the public funds that are transferred to the MHF and onlent to individuals buying homes are recorded as private investment. 21. These practices understate the amount of public finance flowing into investment, especially in manufacturing and housing. it is, therefore, recommended that the official SPO investment program be accompanied by and analyzed together with a comprehensive list of such investment and investment- related expenditures. 22. Issues also arise from the growing practice of earmarking public revenues, especially taxes, for specific purposes and sheltering these resources from expenditure cuts as well as standard auditing procedures. Such earmarking is evident in the case of the extrabudgetary funds and the transfers to municipalities. Together, these earmarked transfers may now account for as much as one-third of government revenues. This weakens the use of the budget for macroeconomic management and resource allocation. (b) Managing the Composition of Public Investment 23. Changes in the sectoral mix of public investment have generally been in the intended direction, but not at the planned pace and degree. Some sectors, such as manufacturing, power and transport, have quite regularly exceeded their investment targets. Others, such as agriculture, health and education have just as regularly spent less than they were allocated. 24. The absorptive capacity of implementing institutions does not generally account for these divergences. Instead, the following factors appear to be responsible: (a) shortfalls of investment resources from the consolidated budget; (b) relatively free access of SEEs to resources, especially external borrowing; -8- (c) the impact of extra-budgetary funds. The "over-achieving" sectors are those using mostly foreign exchange, where SEEs account for an above-average share of total investments, where consolidated budget financing is less important, and where extra-budgetary funds have particular weight. The reverse is true of the "under-achieving" sectors. 25. Remedies lie in improved financial management of the program. First, efforts should continue to allocate adequate funds to priority projects, while low priority schemes are deleted or postponed. To help this, estimates of investable resources likely to be available from the consolidated budget should be conservative. More generous contingency provisions for priority projects would help protect their funding. Second, the SEEs' access to borrowing appears too easy and they appear to lack a strict dividend policy that would enable the shareholder (Government) to decide the disposition of earnings. Following the significant foreign borrowing by SEEs and municipalities in 1985-86, the Government decided to curtail sharply their foreign borrowing starting in mid-1986. More effective regulation of their foreign borrowing is needed, not only in order to manage the composition of investment effectively, but also to ensure that foreign borrowing does not overstrain the country's debt service capacity. 26. With appropriate policies, SEEs could increase Government revenue. SEEs account for more than half of total public investment, considerably more in a number of sectors. The Government's objective is that a first group of SEEs should be privatized, a second group should become fully viable enterprises operating in the same environment as private enterprises (enjoying considerable autonomy, with access to commercial funding while being held accountable to their shareholder for adequate profits), and a third group of unviable enterprises should be closed. The privatization and closure options should be pursued more aggressively. In addition, the Government should continue developing cohereut policies adapted to the different categories within the varied groups. These would include enforcing appropriate cost-recovery principles for all utilities, setting standards for dividend payments, for debt/equity ratios and for borrowing limits, defining the accountability of Boards and Chief Executive Officers and their degree of .onomy. Short-term financial management is another critical area where improvements are needed. Cash-flows stemming from both investment and current operations have to be integrated and anticipated, with a capacity to identify early, and adjust speedily to unforeseen developments. In addition, a central capability for policy-making on Government/SEE relations and SEE performance monitoring is needed. 27. Extra-budgetary funds accounted for about lef of public investment in 1986. Three extra-budgetary funds, the Public Participation Fund (PPF), the Mass Housing Fund (MHF), and the Petroleum Consumption Fund (PCF) are of particular importance in financing public investment. They are fed by earmarked taxes and other public resources and, in the case of the PPF, by revenue-sharing bonds issued to the public. A fourth fund, the Investment -9- Acceleration Fund (IAF), is a general budget line. The objectives of these funds are varied--to accelerate completion of priority projects (PPF, and, partly, IAF), to mitigate the effects of the structural reform package on real incomes (MHF) or to channel resources to projects of high priority (PCF). The IAF can also be used to meet physical contingencies, and to provide local resources for projects that attract foreign financing during the program period but were not part of the investment plan. It appears that not all the projects financed are of high priority. To this extent, the Government's ability to manage public expenditures in general and SPO's ability to manage public investments in particular are diluted and budget discipline is eroded. 28. The extra-budgetary funds have provided a quick solution to some problems, like under-funding of priority projects, at some risk to the effective management of public resources as a whole. Government should decide whether these funds are temporary expedients or permanent features of the financial system, in which case their financing, operations, audit and relations with Government and with other intermediaries need to be determined. A detailed program for improving the coordination and management of the funds is needed. There is some coordination at the summit but apparently not enough at lower levels. (c) Avoiding Overprogramming 29. The most serious general problem in Turkey's public investment management arises in the implementation phase and is duie to spreading available resources among too many projects--overprogramming. This problem had also been highlighted in the Bank's 1981 public investment review, but progress made has not gone nearly far enough and there may now be backsliding; for example, in the irrigation and transport sectors. 30. There are several causes. During the years leading up to the financial crisis of the late 1970s, SPO strongly encouraged the formulation of public investment projects. Despite the change in policy since 1980, agencies still propose new projects well in excess of available resources. In recent years, this has been coupled with target inflation rates that have been systematically lower than actual inflation, overstating the amount of real resources available for investment. Overprogramming also reflects shortcomings in project analysis, selection, financing and budgeting. Professional and technical analysis can clarify the costs of poor decisions -- and help to postpone them. 31. The Government has tried to tackle the problem by a combination of measures: a moratorium on new projects except for well-specified rehabilitation and modernization purposes; the priority ranking of the portfolio and-consequent suspension or deletion of low-priority projects; priority for projects that are nearing completion; and the creation of funding devi^es such as the PPF and the IAF$ designed to accelerate project completion rates. 32. These attempts met with only partial success. The moratorium was never really effective for "program-type" projects that consist of replicating -10- similar or identical operations. Some of these have multiplied rapidly, such as village electrification, rural road-building, low-dams projects, without the enforcement of adequate criteria to ensure productive use of public funds. Recently, the moratorium was extended to thermal power generation and lignite mining projects, but was prematurely relaxed in irrigation/flood control and motorway construction. Allocating full funding for projects to be completed within one year has not been fully effective, partly because there is no reliable data on how much it will cost to conplete the projects, and partly because implementing agencies are in some cases able to reallocate funds between projects. 33. The Government's approach to the problem should be extended to: (a) maintain and strengthen the "new project" moratorium; (b) formulate core programs of more sharply defined priority projects in all sectors to be protected from resource shortfalls; (c) integrate physical and financial programming and budgeting in a medium-term framework; (d) provide adequately for price contingencies in the core programs; (e) unify the revenue estimation, budgeting and expenditure control processes. 34. Stricter Project Selection. Improving the efficiency of public investments is a major strand in the Government's reform program. This implies that (a) the projects in the investment portfolio must be those that best promote the Government's economic and social objectives, (b) these projects must be implemented with the least cost in time and money, and (c) public assets must be operated and maintained efficiently. 35. The 1981 public investment review identified a significant number of projects of doubtful value in the portfolio. Many of these have since been suspended or eliminated. Sector analysis in this review has shown only a few such cases in the portfolio, but suggests several improvements in project selection, three of which deserve emphasis: (a) better consideration of possibly more appropriate or lower-cost alternatives of all types (investments versus better utilization of existing assets, alternative technologies, standards, locations, etc.), (b) more attention to project-specific linkage and phasing issues, and (c) greater weight of economic and financial criteria in project evaluation. 36. Strengthening the Moratorium on New Projects. The moratorium on new projects needs strengthening in several respects. First, it should apply to program-type repetitive projects as well as individual ones; ceilings on these program-type projects need to be imposed together with guidelines on minimum cost/benefit analysis and least-cost implementation standards and procedures. Second, projects in the "priority to be confirmed" category should only be admitted to the program if and when their priority is established and on -ll- condition that the resources for timely completion are available. This must apply also to projects that are justified as "exceptions" under SPO criteria. Third, reactivation of a previously suspended project should require specific approval by the Higher Planning Council, to prevent the re-entry into the portfolio of uneconomic projects, such as is now happening with the Sivas steel mill. These criteria would include important projects needed to complete or realize full value from existing investments, like the proposed gas pipeline. 37. Wider Use of Sectoral Core Programs. Sectoral core programs have previously been accepted by the Government in the transport and irrigation sectors, and SPO has been ranking projects by priority in other sectors with generally acceptable criteria. More stringent application of the core program concept is, however, required and procedures must be found to give full-funding priority to the projects in the core program. This review proposes a number of sector-specific criteria for definition of core programs. But intra- and inter-sectoral linkage and scheduling requirements should also be part and parcel of core project selection. This review has identified a number of cases where project-specific linkage and phasing needs were not taken into account with clearly negative impacts on project benefits. Finally, core program identification will also raise interagency coordination problems in such sectors as agriculture, transport and health, and between central agencies and municipalities, which are rapidly increasing their involvement in sectors such as transport, water supply/sewerage, housing, tourism, health and manufacturing. A number of specific proposals to improve coordination are included in Volume II. 38. Integrating Physical Scheduling and Financial Planning. Close integration between physical and financial scheduling is needed to avoid across-the-board cuts in project funding which leads inevitably to similarly general delays in project completion. This integration can only be effective if the investment programming and budgeting period is extended beyond the present annual horizon, because most of the investment program consists of projects that require several years for implementation. These all have discrete optimal disbursement profiles, which should be respected as much as possible in the interest of efficient implementation. Three-year (or five-year) forward planuing and budgeting makes it possible to anticipate bunching of financing requirements and take preventive action; it also provides the information necessary to decide on the start-up of new projects. Over the shorter term, there is a need to develop the capacity to make some adjustments in program execution during the current year as circumstances change. Occasional and limited reallocations for the current year should be possible, but would have to be promptly announced to all the concerned agencies to be effective. The existing quarterly review could be a useful starting point. 39. Price Contingencies in Core Programs. In the present inflationary environment in Turkey, the implementation of the core program should be protected from price escalation. The IAF could be used for this purpose. Price contingencies have been built into the 1987 public investment program, because an across-the-board inflation rate of 20% (the Government's target -12- rate) has been incorporated into all appropriations. Furthermore, where foreign exchange is involved, a TL/$ rate of 800 has consistently been applied (by comparison, the TL/$ rate was about 750 in December 1986). 40. Unifying Revenue Estimation, Budgeting and Expenditure Control. Finally, the present dispersal of revenue estimates (two departments involved), expenditure estimates (three departments) and post-budget expenditure control (two departments) creates problems of overlapping estimates and lack of coordination between investment budgets and provisions for operation and maintenance. It also makes it impossible to check how realistic expenditure estimates are. To make planning of revenues and expenditures more effective, it might be desirable to bring these functions under the purview of a single agency. If this were done, project budgeting and expenditure control could be done more effectively and scarce staff resources freed to improve project selection, appraisal and monitoring, to develop sector strategies and to promote private enterprise. (d) Operation and Maintenance 41. Compared to the overprogramming issues affecting project implementation, operation and maintenance programs are not pervasive. Nevertheless, sub-standard maintenance is a recurring weakness of sectoral programs. Inadequate cost recovery is only one of its causes; it also occurs in sectors where inadequate funding is not an issue and in many revenue-earning activities. Nearly every sector has large backlogs in rehabilitation needs. More attention is needed to identify future expenditures required for the operation of investment projects, particularly if they are to be financed from the budget, to develop norms suitable for recurrent expenditure budgeting and to increase managerial incentives for effective performance of these important functions. (e) Data Base for Management 42. Investment data now collected by SP0 are often unreliable, analytically inappropriate and incomplete. Excepc for a limited number of large projects, SP0 cannot gauge how much it will cost to complete multi-year projects, how implementation is physically progressing, what the time schedule of disbursements is likely to be, how implementing agencies expect to finance remaining expenditures and what the call on budgetary resources for the operation of completed projects will be. This type of information is indispensable for improving project completion rates and for forward planning and budgeting. Starting with the 1988 investment program, implementing agencies should be required to supply for every significant multi-year project: (a) the degree of physical completion and the increase in completion percentage expected from the allocation requested; (b) an up-to-date estimate of remaining costs to completion; (c) an up-to-date disbursement profile year by year, showing foreign exchange and domestic currency expenditures separately; -13- (d) a detailed financing plan for the remaining costsOuntil completion; (e) future expenditures required for adequate operation and maintenance, particularly where they have to be financed from the budget, and the norms on which such estimates are based. 43. This system would also enable the Government, through the SPO, to monitor more comprehensively the efficiency with which the public investment program is implemented. SPO now monitors some 50 to 60 large projects, with 17 of the most crucial ones attracting particular attention. Wider monitoring was to be the job of the planning and coordination bureaus of sectoral agencies which, however, have not performed this function well. Until they are able to do so, such a data base would enable SPO to monitor progress on a much larger number of projects, and implementing institutions could be asked to account for any significant divergence between their plans and actual performance. Performance monitoring of this type, could eventually be built into a program-budgeting system. Recent Develooments Measures RecoMMended Issues Obiectives and Strateav ndLtasures For 1987 Beyond 1. Si2e and composition of Streamline and reallocate public Public investment increased 1) Aim for growth in 1) Retain public public investment need to investment to support Government's in real ternms by 13 and 10 public investment of investment growth be adjusted in line with objective of enhancing role of percent respectively in 4 percent in 1987. rate of 4 percent macroeconomic constraints private sector and increasing 1985 and 1986, target for through 1990. and sectoral growth reliance on market forces while 1987 set Pt 6 percent. 2) Examine means to 2) Pursue measures objeetives (despite major persisting with the outward sectoral allocation broadly realize savings in recommended under 2) progress realized in these orientation. aprropriate with the exception non-investment public for 1987. areas since 1980). of premature motorway expenditure including construction. costs of incentives. 3) Increase share of 3) Same as 3) for 1987. public investment c allocated to agri- culture. power and the social sectors. 4) Reduce share of public 4) Same as 4) for 1981 a m investment allocated to transport, manufacturing and mining. 0 0 "acro Issuec 5) In preparing for the 5) Ensure complete 1988 program. SPO should: funding and E a) develop core programs implementation of 3' in all sectors through core programs in the elaboration of more all sectors. cm0 stringent sector- pi'* specific criteria used to identify high- priority projects. 0 b) Review in detail on- b) Adjust ongoing going projects in projects according ei irrigation, water to outome of raview n supply. health and applying more education against stringent selection . these more stringent criteria in sample m selection criteria. sectors. Summarv of Action Proaram to Strenothen Public Investment Manaaement Recent Develooments M4easures Recommended Issues Obiectives and Strateay and Measur31 For 1987 tteyond 2. Public Investment: Reliable, comprehensive financing From mid-1986 tighter 1) Treasury should 1) Practice of Finance - Incomplete in a globally consistent frame- reins on fereign determine and monitor determining and erratic, high cost and work is required through better borrowing by SEEs and aggregate external monitoring uncoordinated financing programing, monitoring and municipalities while borrowing limits aggregate external have hampered implemen- readjustments. impoSing across-the- consistent with macro- borrowing limits to tation of public invest- board freeze of 8 economic constraints, be pursued. ment and even biased percent of 1986 budget project selection, allocations regardless 2) Only high-priority 2. Same as 2) for 1987. of project advancement projects approved by or priority. SPO should be eligible for external financing; project implementation and expenditure phasing should explicitly take account of repayment profile. 3) Process of preparing 3) SPO and Treasury 1988 program, sector should jointly agencies should be ensure full funding required to prepare of core programs in . action programs for all sectors. improving cost recovery in sectors. where this is a major issue. 4) By end-1987. the Govern- ment should decide how to rationalize the use of extra-budgetary funds within a framework of efficient overall public sector resource management. Summarv of Action Proaram to Strenathen Public Investment Hanaaement Recent Devel oments Measures Recgmmended Issues Obiectives and Strateav an Measures For 1987 Beyond 3) Public Investment Achieve maximum return on Programming still pre- 1) In early 1987, SPO 1) Continue with three- Management: Programning. public investment within dominantly within one- should: year rolling public budgeting, monitoring - framework of optimal sectoral year perspective, although a) elaborate a three- investment programs short-comings in these allocations complementary to beginning to be extended year rolling public combined with areas have led to sub- the private sector. beyond such a limited investment program financing plan oPtimal allocation of horizon in a few sectors; consistent with a derived from macro public investaent and periodic monitoring financing plan derived framework. while returns thereon. during the year in process from macroeconomic examining jointly of being strengthened. projections, investment and recurrent expendi- ture requirements. b) elaborate list of investment related public expenditures and review Public investment and recurrent expenditure requirement jointly. c) In order to program invest- ments on a multi-year basis * from 1988 onward, sector agencies will need to: - update expenditure profiles for proposed project (showing foreign exchange separately), while presenting alternative phasing possibilities. - make sure Project plans and phasings have been coordinated within sectors. - indicate physical completion by year with financing plan until completion. - indicate prospective recurrent revenue requirements. Summary of Action Proaram to Strenathen Public Investment tanaaement Recent Develooments measures Recommended Issues Objectives and Strateav anid Measur For 1987 Bevond d) Strengthen the quarterly review of program implemen- tation and make sure the mid-year reallocation of funds respects overall spending limits and safeguards the core program. 2) Starting with the preparation 2) Continue with of the 1988 program. SPO should practice introduced establish price contingency under 2) for 1987. funds (using the Investment Acceleration Fund for this purpose) to handle divergences between targeted and actual rates of inflation. 3) Make arrangements to 3) Continue with ensure that multi-agency practice introduced linkage and phasing under 3) for 1987. issues are identified and reflected in project and program design. 4) Create a task force to study 4) have task force budgetary procedures. submit recommenda- tions within 18 months regarding: a) means to modernize budget procedures to ensure greater speed and flexi- bility in funding priority expendi- tures. b) reclassify the budget to achieve closer coordination between investment and recurrent expenditures. c) alternative arrangements for improving the coordination of budgetary functions. Summary of Action Proaram to Strenathen Pub! I Investment Management Recent Develoaments Measures Recrmmnended Issues Obiectives and Stratecy and Measures For 1987 Beyond 4. Strategic Planning - Achieve medium-term strategic Planning horizon gradually 1) SPO to begin strategic 1) Complete (and Absence of coherent planning that explores options being extended beyond one studies in cooperation with periodically update) development strategies and anticipates inter-sectoral year in key sectors like energy sector agencies according sector studies and in key sectors. lrikage and phasing requirements. and transport. to a specific action issue the resulting program. guidelines for planning and project selection including guidelines for project evalua- tion. 2) An action program should 2) Periodic consulta- be devised for the tations with the strengthening of sector private sector to be agencies to enable these maintained. to carry out budgeting and expenditure control functions currently handled by SP0. 3) Articulate long-term c strategies in energy. irrigation, regional development and urbanization. 4) Carry out studies of netroleum supply options, future iron and steel production and forestry. 5) SPO to organize periodic consultations with the private sector to discuss: a) public policy and investment prograaming; b) Incentive policies and priva- tization issues. Summarv of Action Program to Strengthen Public Investment Manacement Recent Developments Heasures Recommended Issues Objectives and Strateav and Measures For 1987 Beyond S. Decentralization - Rapid Strengthen the capacity of local Restraint imposed on borrowing 1) Government to establish 1) Step-wise execution decentralizaton of bodies to deal with their new, wider by municipalities, movement a program to support of decenttalization authority and resources tasks. toward increased revenue decentralization by: supPort program. to local bodies produced sharing slowed down. unsustainably large a) strengthening the increase in expenditure financial management of and impaired coordination, municipalities. including three-year investment programs. b) define resource generation policies. c) execution of local works should be assessed by the municipalities with support provided by central agencies. d) Iller Bank to be transformed from executing agency into financial institution supporting municipalities (to be done over t2-l8 months). 2) A single ministry or agency should be created to carry out the program listed under 1) above; in the meantime capacity of SPO to act in the matters should be strengthened. 3) SPO to institute annual survey of investment by municipalities. 4) SPO should promote better coordination of investment programing by central asencies and municipalities other than the largest metropolitan areas. Recent Oevelooments Measures Recommended Issues Obiectives and Strateay and easures For 1987 Beyond 6. Managsement of SEEs - Streamline SEEs to improve their Government moving from study 7) Clarifying role of SPO's 1) 1nplementation of Despite improvements in performance while exploring phase to execution phase Coordination Department as new policies and the financial performance privatization options whenever regarding privatization. oversight agency for SPOs. regulations for SEES of SEEs, they still potentially feasible. innovative BOAT scheme pursued. adopted in 1987. account for the pre- dominant share of the 2) Delegate authority to unsustainably large SEE Board of Directors to overall public sector approve most investments. deficit. 3) In parallel with increased SEE autonomy. determination of maxinum debt/equity ratios and foreign debt ceilings. 4) Profitable and financially - sound SEEs should be required to distribute dividends. 5) Financial institutions to be given a larger role in appraising and supervising SEE investments and should be strengthened in their capacity to do so.