Document o f The World Bank FOR OFFICIAL USE ONLY Report No. 5 1062-TR INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED LOAN I THE AMOUNT OF EURO 93 1 MILLION N (USD 1.3 BILLION EQUIVALENT) TO THE REPUBLIC OF TURKEY FOR A RESTORING EQUITABLE GROWTH AND EMPLOYMENT PROGRAMMATIC DEVELOPMENT POLICY LOAN February 24, 201 0 Poverty Reduction and Economic Management Turkey Country Management Unit Europe and Central Asia This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization. TURKEY - GOVERNMENT FISCAL YEAR January 1 - December 3 1 CURRENCY EQUIVALENTS Exchange Rate Effective as of February 19,20 10 Currency Unit: Turkish Lira (TL) USD 1 .OO = TL 1.5 120 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities AKP Justice and Development Party ALMP Active Labor Market Policy BEEPS Business Environment and Enterprise Performance Survey BK - Bag-Kur Social Security institution for Self-Employed and Farmers in the Old System BRSA Banking Regulation and Supervision Agencq FOR OFFICIAL USE ONLY SDU Strategy Development Unit SOEs State Owned Enterprises SPA Special Provincial Administration SPO State Planning Organization SSI Social Security Institution SSK Social Security Institution for Workers in the Old System TCA Turkish Court o f Accounts TEPAV Economic Policy Research Institute TESK Merchants and Artisans Confederation o f Turkey This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not be otherwise disclosed without World Bank authorization. Vice President: Philippe H. Le Houerou Country Director: Ulrich Zachau Sector Director: Luca Barbone Sector Manager: Bernard Funck Task Team Leader: Mark Roland Thomas TURKEY RESTORING EQUITABLE GROWTH AND EMPLOYMENT PROGRAMMATIC DEVELOPMENT POLICY LOAN (REGE-DPL) TABLE OF CONTENTS I . INTRODUCTION................................................................................................................. 1 `I1. COUNTRY CONTEXT ........................................................................................................ 3 RECENT ECONOMIC DEVELOPMENTS I TURKEY .................................................... 3 N MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ................................ 12 1 11 . THE GOVERNMENT PROGRAM .................................................................................. 20 I V. BANK SUPPORT TO THE GOVERNMENT PROGRAM ........................................... 33 LINK TO CPS ...................................................................................................................... 33 COLLABORATION WITH THE IMF AND OTHER DEVELOPMENT PARTNERS.....33 RELATIONSHIP TO OTHER BANK OPERATIONS........................................................ 34 LESSONS LEARNED .......................................................................................................... 37 ANALYTICAL UNDERPINNINGS .................................................................................... 38 V . THE PROPOSED "RESTORING EQUITABLE GROWTH AND EMPLOYMENT" DEVELOPMENT POLICY LOAN (REGE-DPL) .......................... 40 OPERATION DESCRIPTION.............................................................................................. 40 POLICY AREAS ................................................................................................................... 43 VI . OPERATION IMPLEMENTATION ................................................................................ 47 POVERTY AND SOCIAL IMPACT.................................................................................... 47 ENVIRONMENTAL ASPECTS .......................................................................................... 50 IMPLEMENTATION, MONITORING AND EVALUATION (M&E) .............................. 51 FIDUCIARY ASPECTS ....................................................................................................... 52 DISBURSEMENT AND AUDITING .................................................................................. 54' RISKS AND RISK MITIGATION ....................................................................................... 55 ANNEXES ANNEX 1: LETTER OF DEVELOPMENT POLICY (LDP) ANNEX 2: OPERATION POLICY MATRIX ANNEX 3: COUNTRY AT A GLANCE ANNEX 4: RELATION TO EARLIER PPDPL AND CEDPL SERIES ANNEX 5: SOCIAL SECURITY ANNEX 6: THE ENHANCED CREDIT GUARANTEE FUND (CGF) MAP # IBRD 33501R2 The Restoring Equitable Growth and Employment Loan was prepared by an Internation,alBank for Reconstruction and Development (IBRD) team consisting o f Mediha Agar, Juan Diego Alonso, Diego Angel-Urdinola, Angela Armstrong, Seda Aroymak, Pinar Baydar, David Bernstein, Gordon Betcherman, Raif Can, Tunya Celasin, Sarbani Chakraborty, Adriana Damianova, Jesko Hentschel, Kamer Karakurum Ozdemir, Hannah Koilpillai, Muammer Komurcuoglu, Zeynep Lalik, Maureen McLaughlin, Rekha Menon, Carlos Pifierua, Margaret Png, Cristobal Ridao-Cano, Mark Roland Thomas, Sebastian Trenner, Arzu Uraz, Cihan Yalqin, and Asta Zviniene. Peer reviewers were Eduardo Ley and Hassan Zaman. LOAN AND PROGRAM SUMMARY TURKEY RESTORING EQUITABLE GROWTH AND EMPLOYMENT PROGRAMMATIC DEVELOPMENT POLICY LOAN (REGE-DPL) Borrower Republic o f Turkey Implementing Undersecretariat o f Treasury Agency IBRD Loan Terms: Euro denominated commitment-linked variable spread loan with final maturity o f 19.5 years including a grace period of 16 years, with level repayment o f principal. Amount: EURO 93 1 million (USD 1.3 billion equivalent) ~ Operation Type Public sector management, private sector development, labor M a i n Policy Areas markets, health. Public debt-to- Gross Domestic Product (GDP); Public Financial Management (PFM) performance indicators; internal financial control consistent with European U n i o n (EU) Acquis; Universal Key Outcome Health Insurance (UHI) coverage; declining combined health and Indicators social security deficit-to-GDP; unified pension administration; preschool coverage; employment; credit to small and medium enterprises (SMEs). The program supported by the REGE-DPL focuses on the transition from managing the impact o f the global crisis to fiscal adjustment and shared growth and aims to contribute to the Program following main objectives: (1) economic management; (2) public Development financial management; (3) affordable universal healthcare and Objective(s) and improved educational access; (4) employment; (5) improved Contribution to investment climate; (6) increased financial intermediation, Country Partnership especially to SMEs. The proposed program supports all three Strategy (CPS) pillars o f the Country Partnership Strategy, which are ( i ) improved competitiveness and employment, ( i i ) equitable human and social development, and ( i i i ) efficient provision o f high- quality public services. There are four main risks to the program's outcomes: Global economic riskfactors. High uncertainty over the pace of global recovery creates s t i l l substantial downside risks to global demand for Turkish exports (especially from the EU), to output Risks and Risk growth and fiscal performance, and to the availability of Mitigation international private capital flows to finance Turkish investments and the corporate sector's roll-over o f external loans. In addition, there remains some risk o f further systemic disruption in the global financial system, with potentially significant ripple effects on the Turkish economy. Realistically, there i s l i t t l e that Turkey can do to mitigate the most severe risks o f further global 1 economic disruption, beyond continued strong management o f its own economic span o f control (monetary and fiscal policy). Turkey also faces uncertainty stemming from international energy prices. Here mitigation measures include increasing energy efficiency and diversifying into non-oil sources such as wind and solar energy, policy areas where the Bank and the Government are collaborating closely. Economic management risks. The main risk comes from the challenge to macroeconomic, especially fiscal, management in the face o f the current slowdown. The 2010-12 Medium Term Program (MTP) has set a fiscal policy framework with measures and targets addressing the risk o f rising public debt ratios. Mitigating this risk i s the government's strong record o f fiscal management and high capacity in public debt management. A longer-term risk i s that fiscal balance i s achieved at the cost o f declining levels o f public investment i n growth-enhancing areas such as core infrastructure, reducing potential growth. The risk o f further delay o f some key reforms in the areas o f the labor market and worker protection and o f the investment climate i s reduced as the MTP and the Government's 2010 Annual Program contain these. Actions to mitigate these risks include continued close dialogue between the government, Bank teams, and those o f other institutions (e.g., IMF, European Commission (EC)), and the programmatic structure o f the Bank's DPL support to Turkey. Political risks. Turkey has had a stable government since 2002 under the Justice and Development Party (AKP), facilitating the implementation o f major reforms. Key risks relate to continuing domestic political differences and the possibility o f declining public support for reforms due to the impact o f the crisis. There i s also a risk that a focus o f legislative and policy activity on the political agenda could delay ambitious and controversial reforms during the remainder o f the CPS period. The EU accession anchor continues to mitigate political risks. Social risks. The severe recession over the last 18 months caused increases in poverty and unemployment, especially youth unemployment, and as the recovery will likely be moderate and gradual, there i s a high risk that unemployment and poverty w i l l stay at elevated levels for some years. High unemployment and increased poverty, especially among young people, in turn create risks o f social tensions and declining support for Turkey's reform agenda, including the outstanding second phase o f the labor market reform. Mitigating the risk i s the emphasis the Government's program places on labor market measures, including active labor market programs. ODeration ID P112495 .. 11 IBRD PROGRAM DOCUMENT FOR A PROPOSED RESTORING EQUITABLE GROWTH AND EMPLOYMENT PROGRAMMATIC DEVELOPMENT POLICY LOAN (REGE-DPL) TO THE REPUBLIC OF TURKEY . I INTRODUCTION 1. Turkey i s now passing through a transition from weathering the global financial crisis to re-establishing fiscal balance and sustainable, shared growth. The crisis has placed strains on Turkey's economy and public finances. Manufacturing has been hard hit, with effects on unemployment and economic hardships at the household level. At the same time, fundamental strengths have kept Turkey on course to benefit from the global recovery. The first step to returning to growth is to move from crisis-related fiscal expansion to balance and avoid crowding out the private-sector led recovery. The second step i s to reinvigorate the business climate reforms and human-capital investments that are central to Turkey's long-term goals. 2. The proposed operation supports both the Government's c r i s i s response and this transition back to sustainable growth under the new Medium Term Program (MTP). In late 2008 and 2009, the Government's crisis response packages went some way towards maintaining jobs and protecting families during the downturn. Now, fiscal adjustment will rely on further measures. Most important among these are cost containment in the health sector and continued implementation o f social security reform to limit the fiscal burden o f the combined health and social security deficit. Looking forward, the enactment o f legislation o f a fiscal rule and improving oversight o f public spending are the keys to greater certainty in economic policy and value for money in public finance. T o spur j o b creation, planned reforms will increase labor- market flexibility and worker protection and create an improved private-sector regulatory framework under the new Commercial Code and Capital Market Law. 3. The proposed Restoring Equitable Growth and Employment (REGE) DPL continues support to Turkey's public sector reform agenda under the Programmatic Public Sector Development Policy L o a n (PPDPL) series. The Government has pressed ahead with i t s public sector reform program, especially in the health and social security system and in PFM. This program has been supported by the PPDPL series.' The program to be supported b y the REGE-DPL continues this agenda with prior actions in the areas o f health, social security, and public financial management. Accordingly, the REGE-DPL i s defined as the third operation o f the PPDPL series.' 4. The REGE-DPL also supports the transition to recovery and job creation through business climate reforms supported under the earlier Competitiveness and Employment Development Policy L o a n (CEDPL) series. Since the onset o f the global financial crisis, the Government's private-sector development agenda has focused largely on immediate measures to mitigate the impact o f the crisis and there has been a pause in the pre-crisis business climate 'Programmatic Public Sector Development Policy Loan (PPDPL), Report No. 36274-TR, June 5,2006 and Second Programmatic Public Sector Development Policy Loan (PPDPL 2), Report No. 43473-TR, May 17.2008. See Table 8 in Section I V for details about the PPDPL and CEDPL series. reform program, which had been supported by the CEDPL ~ e r i e s Business climate reforms in .~ the proposed series are therefore largely forward-looking. The REGE-DPL program includes one prior action (on customs procedures) that extends the CEDPL agenda. Reforms from the earlier planned CEDPL 3 operation become triggers for the expected follow-up operation (REGE- DPL2).4 5. The REGE-DPL also supports measures taken to maintain employment and household incomes in the face o f the global crisis. From late 2008 into 2009, the Government rolled out a series o f packages o f measures, first to protect financial stability, then io maintain employment and stimulate domestic demand. The REGE-DPL program includes prior actions related to these crisis-response measures. Figure 1 explains schematically how the proposed REGE-DPL series combines i t s three components: the public-sector agenda, the private-sector agenda, and the crisis response. Figure 1: Schematic Relation between the R E G E - D P L Series and Other Series 6. The proposed program supports the ambitious growth agenda now facing Turkey. Turkey's growth model will continue to be focused on integration with i t s neighbors, including the EU, with export growth expected to play an important role again as global economic growth resumes. The recent trend towards diversification o f its export destinations will reinforce Turkey's growth in the medium term. Success rests on reforms to the business climate and labor regulations to enhance competitiveness. At the same time, the fiscal challenge has intensified with the recent downturn. Fiscal sustainability crucial to confidence in the economy and to create the space for private sector finance. The ambition o f the reform program supported by the REGE series reflects the Government's own commitment and the consensus among Government, World Bank, and private-sector participants that these reforms are key to restoring strong, equitable growth and employment in Turkey. ' Competitiveness and Employment Development Policy Loan (CEDPL), Report No. 39826-TR, June I,2007; 2nd Programmatic Competitiveness and Employment DPL (CEDPL 2), Report No. 46436-TR, November 13,2008. See Table 8. The CEDPL series will be closed and evaluated in an Implementation Completion Report (ICR). 2 11. COUNTRY CONTEXT RECENT ECONOMIC DEVELOPMENTS IN TURKEY The Lead-Up to the Global Financial Crisis 2007 (Figure 6a). Part o f the Figure 2: Capital Inflows and Investment (Billion USD) ~- investment that drove this growth was ! 40- I Gross capital formation by the private financed by increasing capital inflows. sector more than tripled between 2002 , 20 I 30 r q 1 1 10 and 2007 (from less than IJSD 30 0 billion to 117 billion); during the same -10 t period capital inflows net o f reserves C o m accumulation rose from a small net ~ 7 ~ o 00 m c 0 N N mo - 0 gO0o N mN V g 0 g Dg h oc o 0 N N N 0 o 0 0 0 ~ outflow in 2002 to an inflow o f more .__._I Fixed Captd Formation , Gross Privae Sector , I than USD 30 billion in 2006 and 2007 - Captal Inflows Net d Reserve Accumulation ( I Q lag) i (Figure 2). I " I _ " Source: Turkish Statistical Institute (TURKSTAT) and Central Bank of Turkey (CBRT) 9. The Turkish economy had already begun to slow down from 2007 onwards. Growth in 2007 declined to 4.7 percent, from 6.9 percent in 2006. Quarterly year-on-year (y/y) growth was 7.2 percent and 2.8 percent in the first two quarters o f 2008, respectively, and had slowed fbrther by the third quarter to 1.0 percent (y/y, Figure 6a). This slowdown led to a build-up o f inventories by Turkish firms: inventory accumulation accounted for approximately 2 percent o f GDP between the first quarter o f 2007 and the third quarter o f 2008, before the crisis hit. 10. This slowdown had several causes. First, high oil (and more generally energy) prices were a driving factor i n Turkey's high CADS in 2006-08 (Figure 3). Second, at the same time (starting from 2006) inflation targeting increasingly struggled to combat persistence in Consumer Price Index (CPI) inflation (Figure 4), contributing both to higher real interest rates and to continued real appreciation (between end-2003 and August 2008 the exchange rate appreciated by 38 percent in real terms; Figure 6e). Fiscal expansion from 2005 onwards (measured by a 1.9 percent decline in the primary fiscal balance: Table 3) may also have contributed to uncertainty about the sustainability o f the growth o f 2004-06. 5 TURKSTAT definition using the national poverty line. 3 Figure 3: CAD and Energy Imports Figure 4: Inflation Targets and Reaiizations - _- - - - - __ 7 _ . " I I I 7 120 0 ' 6 l - 1 1 ' 8 8 $ 8 8 6 2 I 8 $ F Y I N 0 ~ ~ ~ N C V ~N N ~ N 0 I / 0 0 0 0 2002 2003 2004 2005 2006 2007 2008 2009 Energy Imports -Oil Price(RHS) ' I I Target Realization I I _ ~ _ - _ I _ _ I " _I_- I _. Source: CBRT, MTP, Reuters Source: CBRT 11. Slowing growth in 2007 was driven by slowing private investment and increased imports. The contribution o f private investment (gross fixed capital formation) to growth fell from 3.1 percent in 2006 to 0.6 percent in 2007 (Table 1). The contribution o f net exports caused a further 1.2 percent fall, driven entirely by imports. These two factors more than explain the slowdown in 2007, since at the same time the economy started to accumulate significant inventories (a phenomenon that accelerated i n mid-2008 as consumption stalled). I 2007 2008 2009 !003 2004 2005 2006 Q1 Q2 Q3 Q4 2007 Q1 Q2 Q3 Q4 2008 Q1 Q2 Q3 Cons umpt ion 6.5 8.3 5.8 4.1 4.3 2.9 5.2 5.1 4.4 4.7 0.5 -0.6 -3.3 0.2 -6.7 -1.0 -0.1 oiw Private 6.8 7.7 5.6 3.3 3.6 1.6 4.9 4.8 3.8 4.2 0.9 -0.8 -3.7 0.C -7.2 -1.0 -0.6 oiw Public -0.3 0.6 0.3 0.8 0.7 1.3 0.4 0.3 0.6 0.5 -0.4 0.2 0.4 0.2 0.5 0.1 0.5 Gross Fixed Capital F o m t i o r 2.5 5.4 3.9 3.2 0.6 0.4 0.5 1.6 0.8 2.2 -0.3 -1.7 -4.7 -1.3 -6.9 -6.2 -3.8 o/w Private 3.1 5.6 3.1 3.1 0.6 0.2 0.1 1.6 0.6 1.7 -0.7 -1.9 -5.3 -1.7 -7.5 -6.4 -3.5 oiw Public -0.6 -0.2 0.7 0.1 0.1 0.2 0.4 0.1 0.2 0.4 0.5 0.2 0.7 0.4 0.6 0.2 -0.4 Net Eqorts -3.3 -2.4 -1.4 -0.3 0.7 0.9 -2.4 -3.5 -1.2 -0.9 0.4 1.7 5.2 1.7 6.7 3.5 2.0 F%ports 1.6 2.7 1.9 1.6 3.1 2.3 1.1 0.9 1.8 3.1 0.9 0.7 -2.2 0.6 -2.9 -2.6 -1.2 Imports -4.9 -5.1 -3.3 -1.9 -2.4 -1.4 -3.5 -4.4 -3.0 -4.1 -0.5 1.0 7.4 1.1 9.6 6.1 3.2 Change in Inventories -0.4 -1.9 0.1 -0.1 2.5 -0.4 -0.1 1.0 0.6 1.3 2.2 1.7 -3.7 0.3 -7.8 -4.3 -1.3 GDP 5.3 9.4 8.4 6.9 8.1 3.8 3.2 4.2 4.7 7.2 2.8 1.0 -6.5 0.9 -14.7 -7.9 -3.31 Source: TURKST 12. Fiscal policy had already loosened in 2006-08. The public sector primary fiscal surplus declined from 5.0 percent in 2005 to 4.6 percent in 2006 and 3.1 percent in 2007. This change in fiscal stance was driven by lower growth and increased primary expenditures, which rose by 2.7 percent o f GDP over 2005-07. The main driver o f increased spending was current transfers, o f which the largest component i s transfers to the combined health and social security system. In 4 conclusion, this fiscal expansion was largely structural, made up o f rigid spending components that are hard to reverse in the short term. The Impact o the Global Financial Crisis f percent (Figure 6a) - a slight decline in Figure 5: Credits to Private Sector and M2 __- _ " II _ I _ _ _ _ (real) per capita income. In the final 500 300 ~ #-' quarter o f 2008 the TL depreciated by 450 e*` --I *.*mrH r e 280 25 percent against the U dollarS 4oo # 1 260 (Figure 6c). The Istanbul Stock 8P- ~ I I 350 , # 1 240 Exchange (ISE100) lost about half i t s M2 ( BiI lion TL) (LHS) I 14. Four factors have *___.- Credits to Private Sector (BillionTL) I I compounded the impact o f global Source: CBRT The Government's Response 15. T h e authorities' response to the impact o f the global crisis covered four areas: ( i ) monetary policy; ( i i ) banking liquidity measures; ( i i i ) fiscal stimulus; and (iv) employment and social measures. ~~ The CBRT Economic Tendency Survey includes a measure o f industrial inventory expectations, which peaked at a seven-year high o f +18 in September 2008. 7 December 2009 balance o f payments statistics report USD 33 million in M L T debt amortizations and USD 5 5 million in trade finance amortizations (CBRT). Gross short-term debt service adds to these amortizations. 8 As Table 1 shows, since mid-2008 net exports have contributed positively to growth, because imports have declined even faster than exports. 5 16. The inflation targeting regime allowed monetary policy to loosen in response to the slowdown. Between October 2008 and November 2009, the overnight interest rate was cut 13 times by a total o f 1,025 basis points, from 16.75 percent to 6.50 percent (Figure 6e). Inflation for 2009 was 6.5 percent, below the target rate o f 7.5 percent; the CBRT has kept rates unchanged in i t s last two monthly decisions. 17. The Government moved quickly to maintain confidence and liquidity in the banking sector. Following the failure o f Lehman Brothers in September 2008, there were high levels o f uncertainty about banks' access to foreign exchange (FX) and consequently concerns that financial intermediation might stall, in extreme scenarios potentially threatening some institutions' financial viability. Against this backdrop, the CBRT enacted several liquidity measures in the fourth quarter o f 2008: The CBRT preemptively addressed potential liquidity problems in currency markets through the re-introduction o f i t s "blind-broker" lending facility (see Section V), the re- start o f FX auctions, and a reduction in reserve requirements on FX deposits (providing USD 2.5 billion in liquidity). The CBRT also made the terms o f i t s lender-of-last resort facility more flexible, though i t has not had to be activated. Credit for pre-exporting activities was expanded through an increase o f the EximBank credit line at the CBRT by USD 500 million to lJSD 1 billion and then to USD 2.5 billion. 0 The Council o f Ministers was given power to adjust the terms o f the deposit guarantee scheme, though no adjustments have been needed. Credit subsidies and technical support programs to SMEs were increased. 0 The Capital Markets Board (CMB) took a number o f actions aimed at facilitating capital markets transactions, including the unification o f regulations on corporate debt issuance, the adoption o f regulation on asset covered bonds, a reduction in issuance fees, and the elimination o f maturity limits on corporate bonds and an increase in issuance limits. 18. The Government's measures proved successful. The banking sector maintained FX liquidity and Turkish banks have remained highly-capitalized and profitable. Figures tracking usage o f the CBRT blind broker facility shows that demand peaked in November 2008 at USD 1.1 billion and has since fallen away to an average o f less than USD 30 million per month since end-June 2009, as FX liquidity conditions have improved. 19: The Government later took steps to reactivate credit activity in the banking system. Chief among these actions i s the enhancement o f the existing Credit Guarantee Fund (CGF) scheme. Legislation was passed making an additional T L 1 billion available to leverage credit resources for SMEs (Annex 7). The fund follows international best practice in that it limits guarantees to 65 percent o f loan amounts and leaves credit risk assessment and recovery with the originating commercial banks. Burden-sharing has been introduced by requiring beneficiary banks to participate in a subscription o f fresh capital for the CGF. The Government also amended a decree (no. 32) to allow corporations to borrow in FX, for loans above USD 5 million with average maturity greater than one year, from local branches o f Turkish banks. 20. Later measures aimed to mitigate the credit effects on SMEs, which are the main source of employment in Turkey. SMEs are estimated to account for three-quarters o f 6 employment in Turkey. With the decline in lending to SMEs, the government increased funding to Turkey's Small and Medium Enterprises Development Organization (KOSGEB) by 48 percent to support existing credit subsidy and technical support programs. Credit availability through Eximbank was also expanded from USD 500 million to I J S D 2.5 billion. 21. Fiscal stimulus measures were limited in cost and targeted key industrial sectors. Automatic stabilizers have accounted for an estimated 2.6 percent o f the 3.8 percent o f GDP decline in the public sector primary fiscal balance between 2008 and 2009 (Table 3). O f this automatic adjustment, approximately 1.6 percent o f GDP i s explained by the increase in the combined deficit o f the health and social security system (Table 7, Section 111). In addition to these automatic stabilizers, in March 2009 the government introduced exemptions on Value Added Tax (VAT) applying to new cars and white goods. Initially these exemptions were to last for three months; a three-month extension was approved in June 2009, which expired in September 2009. The tax cuts appear to have had an impact, leading to a run-down o f inventories in these sectors. 22. As the employment effects o f the crisis became more apparent, the government added employment and social measures to its response. With unemployment rising rapidly, the Government introduced a number o f measures to encourage hiring, preserve existing jobs, and expand active labor market programs (Table 2). The measures are broadly in line with actions that other Organization for Economic Cooperation and Development (OECD) countries have taken in response to the crisis and their design has taken into account international experience as well as Turkey's legal and regulatory framework. The measures expected to have most crisis mitigation impact are the following: 0 Short-time employment compensation: paid to employees in companies that have had to substantially reduce weekly working hours temporarily or to temporarily suspend operation due to the effects o f the global crisis. This compensation i s paid from the unemployment insurance (UI) fund and "tops up" the reduced earnings paid to the worker. The Ministry o f Labor and Social Security (MOLSS) inspects f i r m s (at the f i r m s ' request) and determines eligibility. This measure already existed in the UI benefit system but, as part o f the crisis package, the government increased the amount o f the subsidy by 50 percent and extended the maximum length from 3 to 6 months, and then to 12 months. 0 Accelerated scale-up o f vocational training: prior to the May 2008 employment reform, the Turkish Employment Agency (ISKUR) training program operated at a smaller scale: in 2007, about 23,000 people were trained with a total expenditure o f T L 30 million and in 2008 this number was still about 30,000. The increases introduced in 2009 substantially extended the training program (to above 150,000), a positive measure given the slack labor market conditions that prevailed. The program also includes a training stipend (TL 15 per day) so it provides some income support as well as skills development. 0 Public works: these can be an effective instrument in a downturn for workers who cannot benefit from the formal social protection system. A key design feature i s to set employment features and the wage rate appropriately so that the program i s targeted towards these primarily informal sector workers. For legal reasons, under the Turkish program, participants are paid the minimum wage (pro-rata on an hourly hasis), which may in principle reduce the effectiveness o f the program's targeting. To ensure that the 7 poor are not crowded out, ISKUR uses other features o f the program, most notably the types of employment offered, to ensure self selection o f the poor workers. T ,le 2: Employment Measures In oduced in 200: o Respond to The Crisis Measure Description Duration Funding beneficiaries source Extension o f Existing subsidy program (social Until July 2010 49.9 17 T L 34m UI Fund subsidies for women security contributions) covering (July 2009) (July 2009) and youth hires previously unemployed new hires T L 8 1m (2009) extended one more year 'fL 137m Subsidy for hiring UI Social security contributions Not time bound UI Fund beneficiaries subsidized for remainder o f l J I benefit eligibility period Short-time Subsidy compensating for loss in Until end 2010 40,000 T L 162m UI Fund employment earnings due to reduced hours approx. (2009) compensation increased by 50 percent and (Dec. 2009) subsidy extensions maximum subsidy period extended from 3 to 6 months, then to 12 months Public works Resources increased from 10% o f Until end 2010 45,467 T L 156m UI Fund Active Labor Market Policy (Dec. 2009) (Dec. 2009) (ALMP) budget to 35% Expanded vocational Training to be provided by Not time bound 166,713 T L 238m UI Fund training ISKUR to 150.000 registered (end 2009) (2009) unemployed in 2009 Youth internships Stipend for graduates o f Not time bound 1.285 T L 2m for 2009 UI Fund vocational education (Dec. 2009) 1 Business start-ups Counseling. training, and grants 10,000 target 1 T L 5m UI Fund for new business start-ups j (estimate) 'Program i s to be applied retroactively and the beneficiary target population i s I I under identification. Source: MOLSS 23. The fiscal cost of the full package i s moderate. The 2009 employment measures are estimated to cost approximately TL 900 million (about USD 600 million) or about 0.1 percent o f 2009 GDP. Most o f the direct fiscal costs are being financed by the UI Fund, which has large reserves, amounting to about USD 28 billion in October 2009. Including all crisis-response measures (including those in taxation and the financial system), recent estimates put the 2009 cost o f discretionary measures at 1.2 percent o f GDP and the expected cost in 201 0 at about 0.5 percent o f GDP.9 9 IMF (November 2009), The State o Public Finances Cross-Country Fiscal Monitor, Staff Position Note 09125. f 8 Figure 6 (panels a-f): Macroeconomic Indicators, 2000-09 -, Figure 6a: Growth and Industrial Production (IP) Figure 6b: Seasonally Adjusted Unemployment (percent) 30 20 10 0 -10 GDPgrowth -- IP(Y/Y) -~ Unemployment Youth Source: TURKSTAT Source: TURKSTAT Figure 6c: Exchange Rates Figure 6d: Istanbul Stock Exchange ^^ ^^^ I 15 50,000 150 40,000 10 30,000 100 20,000 10,000 50 1 0.5 -ISE 100 - -- - - _I_ -REER index USDrfL Source: CBRT Source: Reuters Figure 6e: Nominal Interest Rates Figure 6f: Sovereign Spreads r j 1 200 I 80 ,400 150 60 200 1l 000 100 40 800 50 20 600 J 400 o 0 200 --+ I 1 -l _._ _ __ l, _ " PoIicyRate,simple% l_l_. I____, I.__ I__ .II .. 1 _*_.A $ 1 I. - I ..I-. ... I -I . - . I" EMBI+Turkey ..". EMBI+ Source: CBRT Source: JP Morgan 9 Outcomes 24. Turkey's economy continued to contract in the first three quarters o f 2009. As a consequence o f these factors and o f ongoing turmoil in world markets in early 2009, quarterly growth plunged further to -14.7 percent, -7.9 percent and -3.3 percent in Q1, Q2, and Q3 respectively (y/y, Figure 6a). Annual economic growth in 2009 i s now forecast by Bank staff to be in the region o f -6.5 percent. Unemployment has risen sharply (Figure 6b). After remaining stable at levels below 10 percent for several years, the three-month moving-average open unemployment rate peaked at 16.1 percent in January-March 2009 and stood at 13 .O percent in September-November 2009 (and 24.0 percent among workers aged 24 and under) although this recent decline i s in part seasonal. 25. Estimated poverty effects have been significant." Simulations carried out by Bank staff in early 2009 suggested that a slowdown o f the magnitude that Turkey i s experiencing could be expected to add approximately 5 percentage points to the poverty rate, raising the headcount rate (using the national poverty line) from 17.1 percent to about 22 percent (from 2008 to 2010). These simulations suggested that the most vulnerable groups are informal non- agricultural workers (who account for nearly half the estimated increase in poverty), children and young workers. 26. A crisis impact survey fielded by the World Bank in partnership with United Nations Children's Fund (UNICEF) and the Turkish think-tank Economic Policy Research Institute (TEPAV) has confirmed significant social impacts. The main findings o f these surveys have been ( i ) widespread impact on household income - 70 percent o f households report reductions in income - with the most important effects coming through self-employment income and wages; ( i i ) regressive distributional impact -the poorest 20 percent o f households before the crisis reported the highest share o f reduction in income; ( i i i ) coping strategies show reductions in food expenditures (including on children) as the main adjustment mechanism, with households reducing spending on education and health to a much lesser extent; (iv) , 7,000 1 300- formal safety-net coverage low - 6,000 1 C 5,000 * informal safety nets and borrowing E! t = 4,000 , having much more impact on the poor; ' 3,000 1 ( v ) informal safety nets and debt 2 2,000 , accumulations reaching their limits in 1,000 many cases (this finding coming from 0 - qualitative interviews); and ( v i ) a significant proportion of urban households in difficulty paying public 1 1 1 LT Bwrorving (LHS) 111 LT Repayment (LHS) Rollover Ratio utility bills, with disconnections rising. Source: CBRT 27. Private sector firms maintained access to international borrowing although rollover ratios declined. Corporate rollover o f foreign debt amortizations f e l l below 100 percent in December 2008 for the first time since January 2007. However, firms continued to cover most o f their debt service through new borrowing, with drawings tracking repayments quite closely loSee Section VI, Poverty and Social Impact, for further details. 10 month on month (Figure 7). Over the first nine months o f 2009 the rollover ratio o f the non- banking corporate sector's external debt was just over 70 percent. At the same time, net errors and omissions on the balance o f payments showed inflows o f nearly USD 14 billion in the last quarter o f 2008 and the first half o f 2009, reflecting repatriation o f Turkish FX. Since early 2009 the TL has traded in a narrow band around TL 1.50 to the U S dollar. 28. T h e banking sector has proven resilient but lending stalled in early 2009 and exposure to government securities increased. Banks remain highly-capitalized and profitable, despite deterioration in asset quality. The Turkish banking system relies on a strong and stable domestic deposit base and low loan-to-deposit ratios (80 percent in 2008 and 77 percent as o f November 2009). Wholesale funding (borrowing from banks abroad), including syndications and securitizations, i s only 15.8 percent o f non-equity liabilities (as reported by BRSA). Profitability has been helped in 2009 by widening net interest margins as the policy interest rate has been cut, enabling banks to reduce their deposit costs and compensate for higher provisioning charges. The capital adequacy ratio was 20.4 percent as o f end-November 2009. Since end-2008, commercial bank lending has increased only marginally (by 3.8 percent in nominal terms), while securities holdings have increased from 27 percent to 32 percent o f total assets. In nominal terms, lending to S M E s fell by 9 percent in the 12 months to November 2009. The performance o f corporate and commercial loans and mortgages has held up well, whereas non-performing loans (NPLs) for SMEs, credit cards and unsecured consumer loans have risen. The N P L ratio for the banking system as a whole was 5.4 percent at end-November 2009 compared with rates around 3 percent before the crisis. As o f end-2009, a gradual recovery i s reported in the loan portfolio, with slight reductions in N P L ratios. Table 3: Medium-Term Macroeconomic Projections Actual MTP 2004 2005 2006 2007 2008 1 2009 2010 2011 2012 Growth (%) 9.4 8.4 6.9 4.7 0.9 -6.0 3.5 4.0 5.0 GDP (billion USD) 390.4 481.5 526.4 648.8 741.8 608.0 641.0 669.0 723.0 Unemployment rate (YO) 10.8 10.6 10.2 10.3 11.0 14.8 14.6 14.2 13.3 CPI Inflation (%) 9.3 7.7 9.7 8.4 IO. I 5.9 5.3 4.9 4.8 General Govt. Rev./GDP, YO 31.5 32.9 34.8 33.6 32.8 33.5 35.6 35.3 35.1 General Govt. Exp./GDP, % 35.6 33.0 33.4 33.8 34.2 40.1 40.3 38.8 37.8 General Govt. Bal./GDP, % -4.1 -0.1 1.4 -0.2 -1.4 -6.6 -4.7 -3.5 -2.7 Public Sector Primary 5.5 5.0 4.6 3.1 1.7 -2.1 -0.3 0.4 1 .o Balance/GDP, % (a) Public DebtiGDP 59.2 52.3 46.1 39.4 39.5 47.3 49.0 48.8 47.8 (%, EU defined) Export Growth 33.7 16.3 16.4 25.4 23.1 -25.4 9.1 9.8 10.2 Import Growth 40.7 19.7 19.5 21.8 18.8 -33.7 14.2 9.8 11.3 CAD (billion USD) 14.4 22.1 32.1 38.2 41.9 11.0 18.0 22.0 28.0 CADIGDP (%) I 3.7 4.6 6.1 5.9 5.7 I 1.8 2.8 3.3 3.9 (a) O f 2009 balance, an estimated 1.2 percent o f GDP was due to discretionary anti-crisis measures. Source: MTP and Undersecretariat o f Treasury 29. External pressures have been alleviated in the short term by the economic slowdown combined w i t h lower oil prices. Although financing requirements remain from the external refinancing needs o f Turkish firms and banks, external sustainability concerns have diminished as the C A D has fallen, with lower growth and cheaper energy imports. The 2009 C A D i s 11 projected to be approximately 1.8 percent o f GDP (Table 3). For the medium term. the C A D i s forecast to remain in the range o f 2-4 percent o f GDP. Although the external accounts remain sensitive to oil prices, this i s not expected to create significant external vulnerability in the medium term (see "External Debt Sustainability and Financing Sources"). MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 30. The current account and inflation persistence have now diminished in immediate importance while the fiscal challenge has increased. Turkey's CADS are not expected to return to pre-crisis levels in the medium term, although higher oil prices could s t i l l pose a challenge. Inflation persistence appears to have receded, with inflation for 2009 below its .target. The monetary framework has not been altered and w i l l continue to pursue unchanged inflation targets (6.5 percent in 2010 and 5.5 percent in 201 l), line with the framework in place since in 2006. On the other hand, higher debts and deficits as a result o f the global crisis have sharpened the challenge to fiscal management and underlined the central importance o f the MTP and annual budgets. 31. Global conditions are now more favorable. Since early 2009, the global environment for emerging markets has improved considerably. The Emerging Markets Bond Index (EMBI-t), one measure o f risk aversion towards this asset class, fell from a post-crisis high o f 865 basis points on October 24, 2008, to 274 basis points at end-December 2009 (Figure 60. Turkey's own EMBI+ spread has slightly outperformed the aggregate index, falling from its own post-crisis high o f 889 basis points (October Figure 8: Confidence Indices and Capacity Utilization Rate (CUR) 27, 2008) to 197 basis points at 1 I --- 140 end-December 2009, essentially back to pre-crisis levels." : 100 4 I d - - - - - - - # - - 1 i 60 80 I- -\ I - - h- 32. Manufacturing has now entered a phase of gradual recovery. Leading indicators 3 1 ` 1 T ~ X Y I * such as industrial capacity utilization and purchasedmanager indices o f business confidence Consumer Conf Index - - - - - Real Sector Conf Index point to the recession bottoming out in Turkey in the second Source: CBRT quarter o f 2009 (Figure 8). Capacity utilization has risen from a low o f 61.4 percenr in January 2009 to 67.6 percent in December. International Finance Corporation (IFC) clients confirm this picture: investment and business development plans remain in place even if delayed, access to finance, both domestic and external, i s not generally viewed as the binding constraint, and order books are fuller relative to the trough experienced in early 2009. " Improved prospects were reflected by a two notch upgrade by Fitch Ratings on December 3,2009 (to BB+ from BB-), citing "Turkey's relative resilience to the severe stress test o f the global financial crisis and some easing in prior acute constraints related to inflation, external finances and political risk." Moody's (to Ba2 from Ba3, January 8,2010) and JCR (to BB from BB-, February 1, 2010) also upgraded Turkish sovereign debt subsequently. Most recently, on February 19, 2010, Standard and Poor's upgraded Turkey's long-term credit rating from BB- to BB, maintaining a positive outlook. 12 33. Consumption i s expected to lead the recovery in GDP growth; exports will take longer. Fixed capital formation fell by 18.0 percent in the third quarter o f 2009 (y/y) whereas private consumption has already leveled o f f (-0.9 percent in the third quarter versus -1.5 in the second and -10.0 percent in the first). Weak demand for Turkish exports i s expected to improve only slowly. Exports have so far showed little sign o f recovery, falling by 4.6 percent in the third quarter (y/y). This puts limits on the pace o f expansion that can be hoped for in the recovery phase. Even with a resumption o f growth, unemployment i s likely to remain high as job creation will be likely to lag behind the recovery. 34. Public debt and deficits have risen as a result of the downturn. The overall public sector deficit i s expected to be 6.5 percent o f GDP in 2009. The primary balance i s projected at a 2.1 percent deficit in 2009 (the first primary deficit this decade), down from a 1.7 percent surplus in 2008. Public debt (EU definition) i s forecast at about 47 percent o f GDP at end-2009, from below 40 percent at end-2007. 35. This deterioration embodies rising expenditures and falling revenues and GDP. Expenditures rose 10.9 percent in real terms in 2009 (y/y) while revenues fell by 3.4 percent in real terms (y/y). General government expenditure as a share o f GDP w i l l increase neady 6 points to 40.1 percent in 2009. The largest item has been current transfers to the social security institution (SSI, including for health expenditures), budgeted to rise by about 2.0 percent o f GDP in 2009. Personnel costs (to rise by about 0.9 percent o f GDP in 2009) and interest payments (to ' rise by about 0.5 percent o f GDP) are also significant contributors. General government revenues are expected to rise by 0.7 percent o f GDP to 33.5 percent. 36. Crowding out the recovery i s now a risk. Turkey's access to foreign borrowing i s likely to remain lower than before the crisis in the medium term, given global financial conditions. Quarterly growth i s expected to turn positive (y/y) in the fourth quarter o f 2009 and Bank staff forecast growth in 2010 to be 3.5 percent, through gradual recovery and base year effects. High government financing needs in 20 10 could therefore crowd out private borrowers from domestic credit markets and stifle this recovery. The risk o f such crowding out underlines the importance o f fiscal adjustment. The Medium Term Program (MTP) 37. The M T P i s central to the transition from crisis management to renewed growth. On September 16, 2009, the Government announced the MTP, followed on September 18 by the more detailed Medium-Term Fiscal Plan. The MTP gives aggregate targets for the period 20 10- 12 and the 2010 budget must be consistent with it. The 2010 Budget passed by pliiliament on December 25,2009, i s consistent with the MTP. 38. The 2010-12 M T P uses realistic macroeconomic assumptions based on a gradual recovery. Growth i s projected to recover to 3.5 percent in 2010, 4.0 percent in 201 1, and 5.0 percent in 2012. These growth assumptions are i n line with forecast projections constructed by bank staff and discussed with the Turkish authorities. The growth process assumed in the MTP and underpinned by the reform program relies on a combination o f slowly recovering exports and private-sector led domestic demand and i s predicated on lower capital inflows. Growth in the range o f 3-4 percent in 201 1 i s below most estimates o f growth potential for Turkey, implying 13 that the MTP conservatively assumes a return to levels close to potential growth as o f 2012. Projected export growth i s modest throughout the period, in the range o f 10 percent, less than half its growth rate in 2004-08. Over 2004-09 the real effective exchange rate (REER, Figure 6c) has appreciated by only about 3 percent per year on average and with the continuation o f the inflation targeting regime and declining expected inflation (to 4.8 percent in 2012) the program assumes an approximately stable path for the REER. The return o f private sector investment ' growth to 8 percent in 2010 and 10 percent in 201 1 will be - to an even greater extent than recently - domestically financed. Private-sector external rollover (Table 6) i s assumed by World Bank to remain below 100 percent in 20 10 and to return to only slightly positive net borrowing in2011. 39. The MTP assumes only a gradual improvement in public sector balances. The MTP projects a shift from a 2.1 percent primary deficit i n 2009 to a 1.0 percent surplus in 2012. Half the adjustment occurs in 2010, with a reduction o f the deficit to 0.3 percent. More ambitious fiscal adjustment may not have been credible given the role o f automatic stabilizers and fiscal pressure from social security and health expenditures. The underlying policy measures are not discussed in detail in the MTP documents themselves but have been discussed with executing agencies as well as with bank staff, with the critical areas being health, social security, and revenue mobilization (including measures at central and local levels). The introduction o f a fiscal rule in 201 1 should provide an anchor for this adjustment process. 40. Improvement in the primary balance in 2010 i s driven by the revenue side. General government revenues increase by 2.1 percent o f GDP in 20 10 while expenditures remain roughly constant as a share o f GDP. The Government attributes about 8 percentage points o f the rise in tax revenue to nominal GDP growth and the remaining 10 points to policy changes.12 The latter include the removal o f special consumption tax (SCT) and V A T cuts in September 2009 (TL 3.0 billion) and petroleum and tobacco VATISCT increases (TL 6.4 billion). Other measures include a V A T hike on luxury restaurants; the introduction o f fees for imported mobile phones; increased fees for driving license, identity card, and passports; and increased highway toll^.'^ 41. Expenditure measures account for nearly all the planned adjustment in 2011 and 2012. Over the MTP period (2010-12) the MTP plans a total (cumulative) adjustment to central government primary spending o f 1.3 percentage points o f GDP (Table 4). The main sources o f this adjustment are health expenditures (0.4 percent), current transfers to the S S I (0.3 percent), and public investments (0.3 percent). An important assumption i s also that personnel expenditures fall slightly over the period, which will require moderate pay increases for public sector workers. Key reforms to underpin this adjustment are global budgets in health and measures to increase the contribution o f beneficiaries to health services. The MTP i s conservative about assumptions regarding the effect o f the health system copayments, assuming only the estimated revenue effects and making no assumptions about the demand shift effect on l 2 World Bank analysis suggests the elasticity o f tax income to GDP i s almost unity, leading to conclusions very similar to those o f the government reported here. l 3 Most measures are already enacted; the lump-sum taxes on petroleum, cigarettes, and alcohol require approval by the Council o f Ministers. 14 expenditures. General government interest payments as a share o f GDP are projected to decline from 6.5 percent in 2009 to 4.8 percent in 2012.14 Table 4: Sources o f Fiscal Adjustment (2009-2012) (Percent of GDP) 2009 2010 2011 2012 Public Sector Primary Balance -2.1 -0.3 0.4 1.o OIW Central Government (IMF Defined) -2.2 -0.8 -0.2 0.4 2009/08 2010/09 2011/10 2012/11 2012/09 Change in Central Govt Primary Balance -4.0 1.4 0.6 0.5 2.6 olw Change in Primary Revenues -0.3 1.3 0.0 -0.1 1.3 Interest Payment 0.5 -0.3 -0.6 -0.4 -1.3 Change in Primary Expenditures 3.7 ' 0.0 -0.6 -0.6 -1.3 olw Personnel Expendituresia 0.9 0.2 -0.2 -0.2 -0.1 Health Expendituresiaib 0. I -0.3 0.0 0.0 -0.4 Social Security Combined Deficit Transfers 1.6 -0.1 -0. I -0.1 -0.3 Investment Expenditures 0.0 -0.1 -0.2 0.0 -0.3 /a: Some expenditure categories shifted from central government health expenditures to personnel in 20 I O . /b: Including green card and active civil servants costs only. Source: Ministry o f Finance (MOF), State Planning Organization (SPO) and World Bank Analysis 42. The Program assumes increasing some own-revenue mobilization by local government. The M T P projects a 0.55 percent o f GDP adjustment in local administration' balances over 2008-12, moving to a fiscal deficit o f 0.3 percent o f GDP in 2012 from 0.6 percent o f GDP in 2008. This adjustment comes mainly from the revenue side (0.3 percent o f GDP). A new municipal revenue law i s expected to increase municipal own revenues. A slight improvement in local administration utilities' revenues i s also projected. In addition, the Program estimates a 0.1 percent o f GDP reduction on the expenditure side. 43. The Program assumes a slow but steady flow o f privatization revenues. These are projected to be TL 10.4 billion in 2010, TL 9.4 billion in 201 1, and TL 8.9 billion in 2012. Foreign investor interest in Turkey, particularly in i t s energy sector, remains high. The M T P assumes half o f these privatization proceeds in i t s projections for public debt. 44. The Government has announced its intention to apply a fiscal rule to set overall deficit targets from the 2011 budget onwards. The rule will improve medium term planning and will also serve as a legal signaling device to markets about the rationale for the targets set and the robustness o f the forecast trajectory for public debt, spending, and taxation. The Government has engaged in broad consultations, has undertaken a thorough review o f international experience, and i s considering the details o f design options. The parametric and institutional details o f the rule are expected to be determined before the 2011 budget process. The rule i s likely to set the EU-defined deficit (including local government but excluding public enterprises) and to allow for adjustment over the cycle to promote counter-cyclical fiscal policy. l4 The Government i s conducting an ongoing sector review o f public expenditures with technical inputs from the World Bank within the framework o f the Programmatic Public Expenditure Review (PPER). 15 45. Overall, the government's economic framework for 2010-12 represents an appropriate balance between ambition and realism. The measures underpinning fiscal performance will present challenges, against a backdrop o f high unemployment and political factors. More ambitious targets could thus have been perceived as less credible. The proposed DPL series supports key fiscal measures that underpin the achievement o f the MTP. Most important among these are reforms to the health and social security system to limit the burden o f the combined deficit and the planned implementation o f the fiscal rule from 201 1. 46. The projections in the M T P have so far been validated by recent economic developments and a recently announced ad-hoc increase in pensions will be fully financed within M T P targets. The central government overall deficit for 2009, assumed to be TL 62.8 billion in the MTP (6.6 percent o f GDP), was TL 52.2 billion (5.5 percent o f GDP). Similarly, the out-turn for the IMF-defined central government primary deficit was TL 6.5 billion better than expected in the MTP (1 - 5 percent o f GDP versus an expected 2.2 percent). The main reason was central government revenues, which outperformed the MTP target by TL 1 1.1 billion. In early 2010, legislation was passed to increase pensions (excluding civil service retirees) by a flat TL60 per month in all cases where this exceeds the CPI-linked increase mandated by law? The cost o f this measure will be about 0.3 percent o f GDP and this i s largely covered by compensating measures already taken, including higher than assumed increases to consum tion taxes and the social security revenue effects o f a higher than assumed minimum wage rise."The law leaves unaffected the provisions o f Law No. 55 10, the implementation o f which i s included in the REGE-DPL. Nonetheless, it introduces a discretionary element to decisions designed to be formula-driven and further compresses pension benefits, with potential adverse effects on incentives to contribute. 60 rFigure 9 : Public Debt Sustainability Analysis Public Debt-to-GDP Ratio (Percent) Pub1ic Debt Sustainabil ity ! 55 50 i 47. Stress testing undertaken by + Bank staff suggests that there are 45 , \*, moderate risks to Turkey's public __-_ -___ I , debt burden. Under the baseline 40 + I_ - __ _ _ _ _ . _ _ I __-. ".___ I___ --7 scenario, which reflects the , - -. 2008 2009 2010 2011 2012 2013 Baseline Real Interest rate shock government's MTP, total gross public - - _ - _Growth Shock _I Combined Shock I debt peaks at 51 percent o f GDP in - --- -- - _I -- I_~~- II_ _-..a I 2010 (49 percent, EU definition)." Source: World Bank Analysis l 5 The increase applies only to those retiring in 20 I O and earlier, This implies that from 20 I I,new retirees receiving the CPI-linked increases mandated by law may receive lower benefits than those retiring in 2010 and earlier. l6 The minimum wage effect i s estimated to be about T L 700 million. The main revenue measures are a I O percent increase in road tolls (estimated T L 480 million), a 9 kurus increase in SCT on beer (TL 450 million), an annual o eration fee on bank branches (TL 420 million) and a 10 percent increase in stamp duty (TL 400 million). "Turkey's public debt to the World Bank was USD 9.8 billion at end-September 2009, o f total public external debt o f USD 83.5 billion. 16 D an "interest rate" shock that applies a one S shock to the real interest rate in 20 10-11 interrupts the declining trend in debt-to-GDP, as public debt reaches 53 percent o f GDP in 2011 and gradually declines to 50 percent by 2013. Finally, a "combined shock" simulates an unchanged fiscal stance going forward by assuming that the 2009 primary balance remains the case in 20 10- 1 1, along with a permanent 15 percent nominal depreciation and one-half SD adverse shocks to the real interest rate and growth for 20 10-1 1. Under this combined-shock public debt peaks at 56 percent o f GDP in 20 1 1 before falling back below 52 percent by 20 13. The full description o f the stress tests i s given in Table 5. Source: World Bank Analysis 48. The rise in debt ratios underlines the importance o f the proposed measures underpinning Turkey's fiscal readjustment, as well as the return to growth. Turkey has a strong track record in public debt management, mitigating some o f the macroeconomic risk to debt sustainability. The measures in the MTP should allow Turkey to reproduce this track record during the recovery. I t should be underlined that the scenarios used for this debt sustainability analysis are fairly negative and that even under these scenarios the debt ratio remains at levels below, say, the EU Maastricht criterion o f 60 percent." Moreover, ,Turkey has a track record in 2002-08 o f bringing down its public debt through appropriate fiscal policy and strong debt management techniques when required. External Debt Sustainability and Financing Sources 49. The economic slowdown has removed the main source o f pressure on Turkey's external debt dynamics in recent years, the CAD. The gradual economic recovery assumed in the MTP and the associated external financing assumptions pose no threat o f a rapid escalation o f public or private external debt in the near future. 50. Public external debt i s low and i s expected to remain so. Since the 2001 crisis the Undersecretariat of Treasury has pursued a conservative strategy o f financing itself largely using domestic currency debt instruments, removing much o f the FX risk from the public debt portfolio. The Undersecretariat o f Treasury reports that in 2001 a 5 percent real depreciation would have added 2.2 points to the public debt-to-GDP ratio; in 2008 this sensitivity was only 0.8 points. Other market risk has likewise diminished. '* Note: The Maastricht ratio applies to EU-defined debt whereas the reported simulations use gross public debt 17 51. Only under a scenario o f continued low growth, weak Foreign Direct Investment (FDI), and real depreciation would private-sector external debt increase significantly. After declining in 2001-05, external debt-to-GDP increased by more than 4 percentage points in 2006, driven by corporate external borrowing. External debt-to-GDP stood at 37.5 percent at end-2008. Under the assumptions o f the MTP, simulations show that this ratio will increase to 45 percent in 2009, mainly due to the decline in GDP. Figure 10 illustrates two alternative scenarios with higher external debt outcomes. A n "accelerated recovery" scenario assumes a one percent increase in growth over the MTP, but with higher CADs only partly covered by FDI. Under this scenario, external debt peaks at 47.5 percent o f GDP in 201 1. A "headwind" scenario i s more adverse, with lower GDP growth (1 S lower over 2010-12), smaller CADs, USD 4 billion D lower FDI in 2010-12, and a one-off 15 percent nominal depreciation in 2010. Under this scenario, external debt climbs above 50 percent in 2010 and remains roughly flat thereafter. These s t i l l do not represent unsustainable levels o f external debt. Nonetheless, economic policy - Figure I O : External Debt Dynamics . - an investment climate conducive to I- F D I - has a role to play in minimizing 50 2 50 6 50.5 the danger o f another private external debt build-up. 47 1 I I -- 464 52. Concerns over external I 45 0 45 0 financing were prominent before I **.\r 447 433 and as the global crisis hit. However, the subsequent sharp contraction in economic activity has reduced the Baseline Accelerated recovery overall need for foreign financing in Headwind 2009, while at the same time most large corporations have either retained market access or been able to draw on their own FX holdings. 53. Turkey's foreign financing needs have fallen but will remain high in 2010-12. The C A D contracted from USD 41.9 billion in 2008 to USD 13.9 billion in 2009. A sharp contraction in investment has cut the demand for medium- and long-term (MLT) borrowing by the private sector, which has been reflected in lower rollover ratios. Repayments are also lower beyond 2010. CAD projections in the MTP rise from USD 1 1 billion i n 2009 to USD 28 billion by 20 12.19 54. On the financing side, Bank projections assume a moderate rise in capital inflows consistent with a slow global recovery. Turkey should be in a position to attract further F D I given privatization efforts and the potential for mergers and acquisitions: baseline net F D I inflows rise from USD 6 billion in 2009 to USD13 billion in 2012. Similarly, net portfolio flows are assumed to be positive, consistent with a storyline o f continued Eurobond issuance and the potential o f the domestic capital market to raise financing. l 9 IMF (World Economic Outlook) projections are similar, with a sharper rise in 2010 followed by a slower increase thereafter (USD 11.1 billion in 2009, USD 21.6 billion in 2010, USD 25.5 billion in 201 1, USD 26 billion in 2012). 18 55. Overall, there i s a high probability that external financing will be available to support the MTP. The base scenario below (Table 6), based on the M T P plus certain assumptions, assumes a gradual improvement in rollover ratios o f banks and corporations' MLT debt from 72 percent in 2009 to 130 percent in 2012 (compared with pre-crisis rollover ratios above 200 percent). Together with public external debt rollover, this assumption results in a small projected international reserve accumulation over the period. Lower rollover ratios o f the order o f 90 percent to 100 percent in 201 1 and 2012 would lead to only small declines in reserves. Higher o i l prices than assumed here also pose additional external financing risk.20 Table 6: External Financing Projections (Billion USD) 2007 2008 2009 2010 2011 2012 Gross financing requirement 72.1 79.0 55.8 54.7 53.6 65.7 CAD 38.2 41.9 13.9 18.0 22.0 28.0 Medium and Long-Term (MLT) amortization 33.8 37.1 44.1 36.7 31.6 37.7 General Government 8.5 5.4 3.9 5.3 5.4 4.6 Corporate (MLT) 22.3 24.7 33.0 27.8 19.4 24.3 Banks (MLT) 3.1 1.2 7.2 3.6 6.8 8.8 Capital Inflows 86.9 87.5 52.0 56.5 54.7 69.2 FDI (Net) 19.9 15.7 6.0 9.2 11.0 13.0 Portfolio (Net) 0.7 -5 .O 0.2 5.0 7.5 9.0 General Government (MLT) 4.6 8.9 4.8 11.9 7.1 6.9 Corporate (MLT) 48.0 47.4 23.8 25.0 23.3 31.6 Banks (MLT) 10.4 7.9 5.9 2.9 6.8 9.7 Short-Term Inflows (Net)' 1.8 6.9 2.9 2.5 -1.0 - 1 .O Net Errors and Omissions 1.6 5.7 8.4 0.0 0.0 0.0 Change in Reserves' -14.9 -8.5 6.0 -1.7 -1.1 -3.5 Reserves (Billion USD) 74.7 72.9 74.8 73.1 72.0 68.5 ReservesiST Debt 0.85 0.76 0.83 0.87 0.81 Rollover Ratio Assumptions Central Government 102 151 150 100 100 100 Corporate (MLT) 215 192 72 90 120 130 Banks (MLT) 335 I10 82 80 IO0 110 Source: CBRT, MTP and World Bank Projections (1) Net o f trade credits and other ST debt (2) Change in reserves i s a balancing item between capital inflows and financing requirement which includes change in official reserves and net foreign assets o f the banking sector. Minus implies a rise in reserves. The MTP assumes an oil price o f USD 75.20 per barrel in 2010, USD 78.00 in 201 1, and USD 80.90 in 2012 (based on IMF, World Economic Outlook). 19 111. THE GOVERNMENT PROGRAM The Ninth Development Plan 56. Turkey's Ninth Development Plan i s the keystone o f the CPS and o f the proposed loan series. Turkey's overall economic policy and reform program i s articulated in the Ninth Development Plan (2007-2013), published in the Official Gazette on July 1, 2006. The government follows implementation o f the Development Plans through its annual MTPs; the 2010-12 MTP was published on September 16, 2009, and forms the main basis o f the proposed operation. Turkey also produces annual E U Pre-Accession Economic Programs that detail short- and medium-term policy actions and structural reform priorities related to EU accession. Turkey has moved to medium-term budgeting since 2006, and the fifth Medium-Term Fiscal Plan covering the period o f 20 10-20 12 was issued i n the Official Gazette dated September 18,2009. 57. The proposed program supports four out of five o f the development axes of the Plan. The Ninth Development Plan`s vision i s "a Turkey which grows in stability, shares her income more equitably, i s competitive at a global scale, transforms into an information society and has completed the stage o f legal harmonization for EU membership". To pursue this vision, the Ninth Development Plan comprises five "development axes" or strategic areas o f action, namely: (a) Enhancing Competitiveness, (b) Fostering Employment, (c) Strengthening Human Development and Social Solidarity, (d) Ensuring Regional Development and (e) Increasing Quality and Efficiency in Public Services. The proposed program i s thus strongly aligned with the new strategic objectives o f the government; supporting selectively key elements o f (a), (b), (c) and (e). These program areas were chosen in view o f their importance, the quality o f the .' economic and sector work (ESW) on the subjects conducted jointly by government and the Bank, and their strong relationship to the CPS objectives. 58. The 2010-12 M T P mirrors these development axes. "Strengthening Human Development and Social Solidarity" includes reforms in health and social security that anchor fiscal stabilization, in addition to education and vocational training measures important for equitable growth. "Enhancing Competitiveness" includes the continuation o f business climate reforms. "Fostering Employment" includes labor reforms to increase employment flexibility. "Increasing Quality and Efficiency in Public Services" incorporates Turkey's agenda o f PFM reforms. The details o f the main areas supported by the proposed loan series are discussed below. Fiscal Adjustment, Growth and Employment under the Medium Term Program (MTP) 59. The M T P attempts to address Turkey's main growth constraints in the post-crisis global economy: limited financing (domestic and international) for investment; productivity and export competitiveness; and labor skills. The key to maximizing financing for private-sector led growth i s fiscal adjustment to free up domestic savings for private investment. As discussed earlier, Turkey's medium-term growth strategy will continue to focus on trade and financial integration with the EU and an increasingly diversified set o f other partners, for which the business climate reforms are central. Vocational training and labor- market reforms are steps on the path to making Turkey's labor market more competitive. Finally, universal health service provision, sustainable social security, and measures to broaden pre- school and basic education are the keys to making this growth process equitable in the long run. 20 Health and Social Security 60. Secondary legislation has been issued to continue the implementation o f the social security and UHI reform passed in 2008. The reform law had been enacted after being published in the Official Gazette on 16 June 2006 but the Constitutional Court then cancelled many provisions o f this law shortly before it took effect. Necessary modifications then having been made in M a y 2008, most provisions o f the law had taken effect by October 1 , 2008. A significant part o f the secondary legislation required for the enforcement o f this law (No. 5510) has since been issued. 61. T h e merger o f separate SSK (Social Security Institution for Workers in the Old System), B a g - K u r (BK) and E m e k l i Sandigi (ES) databases and the conversion o f remaining manual records into electronic form are key next steps o f SSI reform. Important progress has been made unifying SSK, BK and ES institutions under the single umbrella o f SSI, including the merger o f departments with parallel functions and the integration o f staff. All staff members now work under the same institutional structure, with unified human resource management. Given that around 25 percent o f active members have records spanning multiple databases and about 20 percent o f records are still in manual format, completion o f this project would increase efficiency significantly, allowing more in-depth analysis and one-point access at local S S I offices. All S S I departments are also developing strategic plans for further modernization, to be implemented in 2010. S S I monitoring and data analysis are also being upgraded. By end 2009, 80 percent o f the content o f the S S I Monthly Statistical Bulletin i s to have been revised. (Percent of GDP) 2008 2009 2010 201 1 2012 Budgetary Transfers 3.7 5.7 5.6 5.5 5.4 Combined Health and Social Security Deficit 1/ 2.9 4.5 4.4 4.3 4.2 Deficit Financing 2.7 3.3 3.1 3 .O 2.9 State Contribution (monthly deficit financing based on 0.2 1.2 1.3 1.3 1.3 previous month's deficit) 211 Other Subsidy or Social Assistance Type of Transfers 0.8 1.2 1.2 1.3 1.2 62. T h e depth o f the recession has posed a fiscal challenge to the social security system. Until the recession, S S I expenditures and revenues had grown roughly in line with the number o f beneficiaries and active contributors (Figure 1 1; Annex 6). The M T P estimates a 1.6 percent o f GDP deterioration in the social security and UHI combined deficit (total transfer from the budget plus state contribution) in 2009 from 2.9 percent in 2008 to 4.5 percent in 2009 (Table 7). This deterioration comes mainly from the expenditure side. A 1.4 percent o f GDP increase in expenditures is expected to be driven mainly by a 0.9 percent increase in pension payments (with the remainder coming from a 0.4 percent o f GDP increase in health expenditures). Revenues decline only slightly as a share o f GDP. The explanation for this pattern i s that nominal 21 percent in 2012. The imbalance in the - . 11: Social Security Institute Balances Figure - -__ -- 1 . " - I I system caused by the recession will 100 persist in the medium term. I 80 I J 60 i 63. With Turkey's health system performing well overall, its key challenge i s now fiscal sustainability. ; ;40 1 20 I I L i f e expectancy at birth in 2006 stood -20 ~ at 91 percent o f the OECD average, -40 I I compared with 7 1 percent in 1960. The 2000 2001 2002 2003 2004 2005 2006 2007 2008 infant mortality rate (IMR) has I "SSI Revenues OSSI Expenditures mSSl Deficit declined from 134 per 1,000 live births Source: ss, 64. Measures to date to contain health expenditures have had mixed results. In 2006, SSI introduced "bundled" pricing for outpatient visits to control excessive itemized billing in an open fee-for-service environment. However, this measure did not adequately control volume; i t therefore did not have major impact on health expenditures. In 2007, S S I implemented a fixed global budget for all Ministry o f Health (MOH) hospitals; to date the cap has been successful at containing further spending growth in these hospitals. Since 2007, S S I has unified the claims management system and all hospitals report through SSI's claims system Medical Messenger (MEDULA). The MEDULA system can verify claims and reduce fraud, increasing efficiency. Measures to control pharmaceutical expenditures are focusing on reducing prices. These have had an impact, with pharmaceutical expenditures declining as a percentage o f SSI health expenditures, although at 40 percent these remain high compared with other Middle Income Countries (MIC). The main cause o f high pharmaceutical expenditures i s the high volume o f prescriptions, with the consumption o f antibiotics a particular problem. 65. Expenditure measures applying to private healthcare have so far failed to rein in costs. In July 2008, S S I introduced several measures to contain expenditures on private health facilities: ( i ) private hospitals could charge a maximum o f 30 percent above the price charged by SSI, ( i i ) a co-payment o f TL 10 was introduced for outpatient visits to private health facilities, while the commensurate amounts for university and M O H facilities was set much lower (TL 6 and TL 3, respectively), and ( i i i ) the prices o f certain high volume procedures such as cataracts and cesarean sections were reduced. These interventions did not have much impact - expenditures on private hospitals continue to grow. S S I had saved TL 130 million through the co-payment measure in the first five months o f 2009, and TL 100 million through the reduction o f prices o f cataracts and cesarean sections in the first seven months o f 2009. 22 66. New measures to control health costs are therefore important for fiscal stabilization. From October 2009, increased co-payments for outpatient visits apply. Rates are T L 2 for family medicine, T L 8 for university and M O H hospitals and T L 15 for private hospitals. If no prescription i s given, no co-payment will be required for family medicine and a TL 3 discount w i l l apply to university, M O H and private hospitals, aiming to reduce over-prescription. Supplementary billing caps w i l l remain in place. The reform law has also introduced a legislative framework for global budgets, within which S S I has a right to buy health services from hospitals. S S I has been implementing a global budget with M O H hospitals since 2007. In 2010, the Government has also imposed spending limits for university and private hospitals. Complementing this, copayments and price caps are designed to control the costs o f private hospitals and pharmaceuticals. Ifspending approaches these cap, additional measures may be introduced. 67. A key fiscal challenge i s to strengthen health expenditure management policies. The Government has announced two future measures: (a) global budgets for university and private hospitals, (b) the expansion o f family medicine to all 81 provinces. The next step i s for S S I to negotiate global budgets with all hospitals based on a defined payment methodology. Expansion o f family medicine without further refinement o f the capitation system to emphasize cost- effectiveness would create fiscal concerns. 68. A further challenge i s the implementation of measures that will encourage microeconomic efficiency among providers. This can be best achieved through appropriate provider payment systems and applying controls to the benefits package. Measwes would include: ( i ) rational drug guidelines implemented for all primary health care physicians including family doctors; ( i i ) a quarterly monitoring and feedback system on prescribing practices for primary care doctors, linked to performance-based payments; ( i i i ) a Diagnosis Related Groups (DRG) system for acute care; ( i v ) performance monitoring and payments for university and private hospitals; and (v) a new Hospital Union Law and M O H Restructuring Law. Public Financial Management (PFM) 69. Improved PFM will support fiscal adjustment and increase effectiveness and value for money in public services. The government has a successful track record o f PFM reform but full implementation by line agencies will take several years. Progress so far has improved the comprehensiveness and transparency o f PFM. Turkey has transformed i t s legal, institutional and Information Technology (IT) frameworks. Budget and accounting systems now provide a sound infrastructure on which to base further PFM reform. The needed PFM reforms are large-scale, covering almost the entire public sector, and complex, requiring fundamental behavioral changes. These reforms are therefore expected to be implemented over several years and require on-going adjustments, based on outcomes. 70. PFM benchmarking revealed that achievements have been greater on upstream budgeting than on downstream implementation. The Government completed a Public Financial Management Performance (PFMP) benchmarking study (jointly with the Bank) in July 23 2009, using the Public Expenditure and Financial Accountability (PEFA) frameworkn2'Reforms such as upgrading the legal and institutional framework, the introduction o f medium-term planning and budgeting, new budget definitions and classification, the elimination o f off-budget activities, and setting standards and guidelines have so far been led by central institutions. These reforms are reflected in strong ratings. Weaknesses in downstream budget areas such as internal control and audit systems, a complementary external audit function, and commitment monitoring are now challenges. Ownership in the strategy development units (SDUs) o f the line agencies i s a further critical factor for the sustainable success o f the P F M reforms. 71. Reforms are ongoing in line with the Government's timetable. All central government institutions and municipalities and Special Provincial Administrations (SPAS) with populations above 50,000 - with the exception o f eleven institutions - have completed strategic plans.22 Likewise, 76 institutions completed performance programs in 2008 and 120 institutions prepared performance programs for the 20 10 budget cycle. The MOF. revised Performance Program (previously called Performance Budgeting) Guidelines in July 2009 and issued legislation on the performance program in the same month. To support institutions in the preparation o f performance programs in line with their strategic plans, the M O F has provided training events to representatives o f 172 public institutions. 72. Work on internal management and financial control has also progressed. The M O F issued standards in this area in December 2007. All general government institutions have prepared two-year internal control strategies and action plans. To develop the administrative capacities o f SDUs, 444 financial services experts and 148 financial services experts have been recruited. The M O F has been supporting capacity building through periodic training events focused on the SDUs. The M O F Central Harmonization Unit prepared a "gap" analysis on financial control supported by a twinning arrangement with the United Kingdom (UK) National Audit Office. Based on this analysis the M O F will prepare an action plan to address the issues identified by the analysis. 800 internal auditors have been trained, certified and appointed, with 128 new internal auditor candidates going through training. All secondary and tertiary legislation including internal audit standards have been issued. The Internal Audit Coordination Board has completed the Public Sector Internal Audit Strategy Paper for 2008-2010. The government has also announced that the structure and capacity o f the Board will be strengthened. The General Directorate o f Public Accounts (GDPA) o f the M O F has issued six public accounting standards in conformity with the International Public Sector Accounting Standards Board (IPSAS). Drafts o f two more standards have been shared with the public for comments. 73. The government has issued consolidated central government and local administrations financial statements on an accrual basis for 2006, 2007, and 2008. 21 PEFA i s a partnership between the World Bank, the EC, the U-K Department for International Development, the Swiss State Secretariat for Economic Affairs, the French Ministry o f Foreign Affairs, the Royal Norwegian Ministry of Foreign Affairs, and the IMF. PEFA aims to support integrated and harmonized approaches to assessment and reform in the field of public expenditure, procurement and financial accountability. Additional information on the PEFA methodology i s available in www.pefa.org. 22 Preparations for eleven central government institutions are s t i l l underway and expected to be finalized soon. These institutions are the Ministry o f Energy, Prime Ministry, Presidency, Constitutional Court, Court o f State, Turkish International Cooperation and Development Agency (TIKA), Higher Education Board, State Opera and Ballet, Bogazici University, Aksaray University, Student Selection and Placement Center (OSYM). 24 Consolidated general government financial statements are yet to be prepared because o f the lack o f consistent data from SSI. This owes to technical issues coming from the unification o f the three social security schemes. Once this accounting problem i s solved, the M O F will be able to produce the consolidated financial statements for general government. 74. There has been a significant improvement in local administrations' financial management and fiscal transparency. In line with the Public Finance and Debt Management Law, the PFMC Law, and the Municipality and Metropolitan Municipality Law, local administrations are now generating financial statistics consistent with general government standards and the Undersecretariat o f Treasury closely monitors their financial situation against domestic and foreign borrowing limits. Recent legislation (Law No. 5779) also introduced a mechanism to reduce municipalities' capacity to build up additional expenditure through arrears accumulation (tax, social security, electricity, etc.) although there remain some practical issues in implementing this automatic claw-back. 75. A stronger Turkish Court of Accounts (TCA) Law will be central to effective PFM and control. Effective financial accountability requires modernization o f public audit. Objectives are: (a) to clarify institutional responsibilities, promote audit improvements in line with international standards and support the shift from ex-ante controls to ex-post monitoring; and (b) to expand the scope o f TCA audits to cover the whole public sector. An updated draft T C A law was submitted to the Parliament on February 1,201 0. 76. The planned adoption o f a fiscal rule will be important to reduce economic uncertainty. The government's stated intention i s to target the overall public sector balance as a share o f GDP, which i s closely related to the trajectory o f public debt burden indicators. As described above, the global financial crisis has weakened Turkey's fiscal and public debt position. The M T P responds to these circumstances. As with any plan, implementation risks apply to the measures underpinning performance. International experience shows that a well designed and implemented fiscal rule can help reduce the uncertainty associated with implementation risks and increase investor confidence. Turkey's planned introduction o f a fiscal rule i s informed b y a review o f such international experience and o f relevant design options. 77. The M T P contains measures to improve weaknesses defined in the PFMP study. The M T P proposes the introduction o f the legal framework for a fiscal rule in 2010 and its implementation with the 201 1 budget. The external audit framework will be modernized through the new T C A Law, training activities to enhance audit capacity, and widening the mandate and activities o f the TCA. The number o f internal auditors i s being increased (through training and certification) while internal control systems will also be enhanced through capacity building. 78. Further reforms are expected to be programmed in line with the findings of the PFMP report. For example, the introduction o f a modernized public-sector commitment monitoring system i s critical for improved transparency, by providing more thorough information on the government's current liability and arrears. 25 Business Climate Reforms 79. Business regulatory reform can mitigate the effects of the global crisis and lay the foundations for sustainable growth and employment. Notable measures in recent years have included ( i ) tax simplification, accompanied by a reduction o f the corporate income tax (CIT) rate from 30 percent to 20 percent; ( i i ) streamlining o f procedures for firm start-up; ( i i i ) adoption of. a modern F D I promotion strategy coupled with the restoration o f legal certaipty for land ownership by foreigners; ( i v ) simplification o f customs procedures and e-transformation o f customs offices with the introduction o f a Computerized Customs Activity System (BILGE); (iv) strengthening the protection o f investors' and minority shareholders' rights; ( v ) reform o f research and development (R&D) legislation aimed at increasing the private sector share o f R&D; and (vi) first phase labor market reform geared toward lowering non-wage labor costs. Moreover, the government has continued its privatization program, despite a difficult global environment. In 2009, privatization revenues totaled USD 2.3 billion (compared to USD 6.3 billion in 2008), with the sale o f three regional electricity distribution companies accounting for the bulk o f these revenues (USD 2.07 billion). 80. The Coordination Council for the Improvement of the Investment Environment (YOIKK) plays a key role in stimulating and coordinating regulatory reforms. YOIKK's Steering Committee i s chaired by the Undersecretary o f the Treasury and comprises o f the Deputy Undersecretaries o f the Prime Ministry, SPO, MOF, Ministry o f Industry and Commerce, and Undersecretariat o f Foreign Trade, along with the Secretaries General o f the four main Turkish business associations. In 2007, YOIKK approved an action plan with reforms in 10 key policy areas: start-ups, labor market flexibility, licensing, land titling, taxation, customs simplification, intellectual property, investment promotion, SME support, and corporate governance. The plan was updated i n early 2008 and again 'in early 2009 and included FDI and R&D as key policy areas. Key reforms already implemented i n 2009 include an amendment o f the Customs Law to streamline and reduce the cost o f customs procedures; a simplification o f hiringhedundancy reporting requirements; increased SME financial support through the KOSGEB; the harmonization o f tax returns; a reduction in internet and wireless communication taxes; and a reduction in the Resource Utilization Support Fund Tax on bank consumer loans. The Government also introduced a new subsidy scheme for investment projects incorporating sector and regional development priorities. 81. An Investment Climate Assessment (ICA) i s being conducted jointly by YOIKK and the World Bank to identify constraints to productivity, innovation, trade and FDI. The ICA should be finalized in the first quarter o f 2010. The objective i s to benchmark progress in the business environment since the last I C A (2007) and examine issues critical for competitiveness. The I C A w i l l be complemented by the 2008-09 Business Environment and Enterprise Performance Survey (BEEPS). Roundtables with businesses were held in November 2009, to understand the implementation o f regulations and give a more accurate interpretation o f survey results. 82. Turkey's regulatory environment for business, despite improvements, i s still seen as a constraint for entrepreneurship. Doing Business indicators show challenges in reducing time and procedures to close a business, employ workers, and deal with construction permits. OECD Product Market Regulation (PMR) indicators also show that Turkey lags behind OECD 26 comparators in the conduciveness o f i t s regulatory framework to competitive outcomes: Turkey ranks only ahead o f Poland among OECD countries. Finally, BEEPS results indicate that the `time tax' - the time spent by entrepreneurs in dealing with the requirements o f regulation - increased three-fold in 2005-08, with senior management's time spent on dealing with regulations reaching 27 percent. Licenses and construction permits have been identified as two important areas for improvement. 83. Enactment of a modernized Commercial Code remains a critical future reform. The current Commercial Code was adopted in 1956 and has only sporadically been updated. The draft Code, which has been under preparation for about seven years, and i s in line with the EU Acquis, i s a major step towards better monitoring o f property rights and a simpler business climate. Consumer protection, investors` rights, minority shareholders' rights, corporate governance as well as electronic registry and transactions are among the topics covered b y the Code. Nevertheless, adoption o f the Code has proven to be a challenge, mostly on account o f i t s size (about 1,500 articles), given established parliamentary procedures. 84. Additional outstanding investment climate reforms include: ( i ) intellectual property rights (IPR) reform, including the Turkish Patent Authority Law, and the signing o f the Trademark L a w and the Patent L a w Treaties, to align the IPR regulatory framework with the EU Acquis; ( i i ) insolvency and corporate restructuring reform, including regulatory changes to restore the balance between preserving company value and protecting lenders' rights. 85. The Government's agenda to strengthen financial intermediation includes the Capital Market Law. The C M B i s planning to send a new Capital Market L a w to the Prime Ministry by end-2010 that i s expected to help promote the orderly growth o f capital markets. The L a w will reflect the results o f a twinning project with the German financial regulator, on harmonizing regulations with the EU Acquis on capital markets. Given delays in the adoption o f the Commercial Code, the C M B i s also exploring alternatives for a streamlined Capital Market Law, which would grant it regulatory powers not specifically linked to the Commercial Code. 86. A further law covering leasing, factoring and financing companies has been drafted. The draft law (prepared by the BRSA) i s currently before parliament. I t makes necessary amendments to existing regulation o f these institutions to meet new needs in the sector: strengthening the regulatory framework for the establishment, operation, and management o f institutions, enhancing financial reporting supervision and monitoring, and updating administrative fines and offences. I t i s envisaged that all these institutions will be subject to common regulation. Leasing, Factoring and Financing Company Associations are to be established o f which membership will be obligatory. A Central Invoice Registry System i s also to be established b y the Factoring Association to document factoring transactions. 87. The recently published Judicial Reform Strategy and Action Plan, as part o f their far-reaching scope, outline a further reform agenda important for the business climate. The judicial system provides a backdrop against which Turkish businesses and foreign f i r m s operating in Turkey must make investment decisions and enter contracts. According to the 2008 27 BEEPS, one-third o f all Turkish firms found the court system was a substantial "obstacle".23This was a slight worsening from 2005 BEEPS results. In addition, 75 percent o f firms found the courts to be These results correspond to a broader 2007 survey o f Turkish citizens which found that less than 50 percent were satisfied with Turkish courts, with the most negative views held about speed o f pro~essing.~' Judicial Reform Strategy, endorsed by the Council o f The Ministers, gives a thorough listing o f the issues facing the Turkish judiciary and judicial system. The Strategy gives a diagnostic consistent with the EC's 2009 Progress Report (and also with the Bank's own assessment in analytical work still underway). Development o f the Strategy responds to EC concerns and forms part o f Turkey's efforts on Chapter 23 o f the Acquis Communautaire (Judiciary and Fundamental Rights). 88. The Judicial Reform Strategy emphasizes the judiciary's independence, impartiality, efficiency and professionalism, in addition to raising access to justice and alternative dispute resolution. The strategy tackles some o f the most difficult issues facing judiciaries in emerging market countries, including ( i ) striking the right balance between judicial independence and accountability; ( i i ) judicial corruption; ( i i i ) making the best use o f automation for both efficiency and transparency; and (iv) identifying ways to improve public confidence in justice institutions. The Strategy makes proposals in several areas, in which the Action Plan then provides more detailed activities, including: 0 Creating permanent trainers to improve the Justice Academy; Improved evaluation, promotion and the disciplinary system for judges; A code o f ethics for judges and prosecutors; Online publication o f decisions o f the Cassation Court (Yargifay) and Council o f State (Danistay); Improved court management through professional administrative bodies and removing administrative responsibilities from judges; Legal Aid Centers to serve those that cannot afford court or attorney fees; and 0 Online filing and access to information by non-lawyers. 89. I n the judicial area, a revised Civil Procedure Law and a new Mediation Law applying to civil disputes remain on the agenda o f parliament. In addition, the implementation o f the Strategy and Action Plan will require the Ministry o f Justice to set priorities among (and establish the costs of) a broad set o f reforms. Labor Market Reform 90. Even before the current recession, Turkey's labor market performance had been disappointing. Despite six years o f sustained growth after the 2001 crisis, the employment rate never rose above 46 percent, about 20 percentage points below the EU average. Moreover, just under half o f those employed have been working in the informal sector. Employrncnt rates for women and young people have been particularly low by international standards. 23 This includes those firms responding that the court system was a moderate, major or severe obstacle to their business. The percentage increases when limited to only those firms that have used the courts. 24 These firms either tended to disagree or strongly disagreed with the statement that Turkish courts are "quick". 25 Justice Barometer: Public Opinion on Courts in Turkey, Justice Watch Project (project o f Istanbul Bilgi University Human Rights Law Research Center, 2008). 28 91. Not surprisingly, the labor market has deteriorated significantly over the past year. Non-agricultural unemployment peaked at 19.8 percent in February 2009, 5.6 percentage points higher than 12 months earlier. The number o f unemployed workers registered with ISKUR has doubled in the past year. The crisis has disproportionately affected youth and the less educated and job losses have been concentrated in industry and construction. The resumption o f job creation typically lags behind economic recoveries; it i s thus to be expected that the sluggish labor market w i l l persist even after the economy starts to expand. More recently, employment figures suggest a gradual recovery: in October 2009, non-agricultural employment was 1 56,000 more than a year earlier, while the unemployment rate was 1.8 percentage points higher. 92. First stage labor-market reform has focused on measures to reduce non-wage labor costs and raise skills. The Government's program focuses on three goals: reducing non-wage labor costs, raising skills, and making the labor market more flexible while improving worker protection. The third objective - labor market flexibility and worker protection - has been pushed back by the onset o f the crisis: understandably, the priority in 2009 has been mitigating the negative consequences o f the recession in the labor market. 93. Flexibility can be combined with worker protection. Key future actions w i l l involve reforming the regulatory framework to make the labor market more flexible (and thus more conducive to job creation) while continuing to strengthen the tools available to workers to adjust to change. The flexibility measures are important since Turkey currently has one o f the most rigid employment protection regimes in the OECD. 94. Priorities for reforming employment protection rules include increasing the scope for flexible contracting and changing the rules regarding severance pay. Flexible contracting includes fixed-term contracts, temporary work, and part-time work. Turkey's current regulations regarding the first two are out o f line with OECD norms. I n terms o f fixed-term contracts, removing the current restrictions on when these contracts are allowed and on the number o f possible renewals would make Turkey's rules more similar to those in other countries. Temporary work currently only occurs based on transfers to similar employment within the same holding company or group o f companies and with the written consent o f the worker. Concerns about easing these restrictions on fixed-term and temporary work center on the fact that they would encourage employment that was, by its very nature, non-permanent and potentially precarious. However, the existing restrictions on these work forms create incentives for even more precarious informal employment since there are no alternatives for flexible jobs in the formal sector. Women and youth would especially benefit from opportunities for flexible formal work. 95. Private employment agencies represent one step in this direction. In June 2009, the Government passed legislation to allow private employment agencies to facilitate temporary work beyond the narrow rules that currently exist. However, the bill was subject to Presidential Veto on the grounds that the version o f the law submitted did not ensure equality among different types o f employment contracts. The Government has indicated that i t will reintroduce legislation soon to permit private employment agencies addressing this concern. 96. The other major area for improved employment regulation i s severance pay. Turkey's generous severance pay rules are a disincentive to job creation and discourage 29 formalization. They are widely disregarded by employers so that, outside the public sector and large corporations, few workers actually appear to receive payments upon separation. Transitory Article 6 o f the 2003 Labor Code (Law No. 4857) provides for the creation o f a severance account. This would remove many o f the existing problems and be especially effective if severance funds were integrated with UI.26 97. The expansion o f vocational training helped the unemployed during the crisis; monitoring and evaluation (M&E) are now central to making further expansion a success. Vocational training in Turkey i s run by a government agency - ISKUR - reporting to the Ministry o f Labor and Social Security, which subcontracts courses through a tendering process to both public and private providers (in 2009 about half o f providers were private). The success o f these providers in placing trainees in employment i s one criterion used to determine provider selection. ISKUR programs, small scale until quite recently, are being enhanced to converge with the findings o f OECD experience in vocational training. ISKUR training programs have expanded rapidly, from about 33,000 in 2007 to about 210,000 in 2009 (for all ALMPs). The World Bank i s now partnering with ISKUR to help improve M&E and thereby, over time, adapt and further increase the impact o f i t s programs. 98. Turkey has begun to implement a competency-based qualification system. This l i n k s curricula and qualifications in technical and vocational fields with occupational needs. The objective i s not only to improve skills and encourage lifelong learning, but also to harmonize qualifications in Turkey with those overseas, encouraging labor mobility. The Vocational Qualification Authority (VQA), created in 2006, i s now accredited by the EU as the Turkey's qualifications coordination center and i t s certificates will be recognized by the EU. Secondary legislation and regulations are complete and staffing sufficient. Eleven "Sector Committees" have been established and increases to this number are being studied (four committees will be established in early 20 10). Twenty-one "Cooperation Protocols'' have been signed, developing 468 occupational standards in 13 sectors; 1 10 occupational standards were developed in 2009 alone (53 published so far in the Official Gazette) and this process continues in 2010. The National Qualification format has also now been determined. One National Qualification has been developed in the energy sector and certification has started with the accredited body. Qualification development protocols have been signed in three other sectors; construction, automotive and textile and 800 standards and qualifications for 400 occupations will be developed b y the end o f 2013. Turkey recently announced a Lifelong Learning Strategy, including V Q A in the associated action plan. Education 99. Increasing educational attainment while reducing disparities and providing quality are key challenges for Turkey. Turkey has almost universal primary school enrollment - with net enrollment o f 96.5 percent - but enrollment varies b y region and b y gender within certain regions. Despite increases in recent years, enrollment rates in preschool, secondary and tertiary education remain l o w b y international standards. Moreover, many learning outcomes are poor: almost half o f 15 year olds in Turkey score at or below the lowest proficiency level in mathematics, compared with about 20 percent for OECD countries. 26 This type o f integrated reform has been introduced most notably in Chile. 30 100. Improving educational outcomes in Turkey requires a comprehensive reform package. The education debate in Turkey has turned to the issue o f education quality: how to increase the number o f young children who enter school ready to learn, improve the quality o f learning outcomes, and link the education system with the demands o f the labor market. Curriculum reforms in primary, secondary Figure 12: Pre-Primary Gross Enrollment for 3-6 Year- I and vocational education are advancing, albeit substantial change i s still needed in B 0 France financing, teacher training and human resource policies to maximize the impact o f the new c ~ r r i c u l a . ~ ' 101. Early childhood development, including preschool education, provides the foundation to help young children develop the necessary cognitive, 0 10,000 20,000 30,000 40,000 50,000 physical, and socio-economic skills they GDP per capita (constant prices) need later in life. Preschool enrollment o f Source: World Development Indicators, 2008 young children i s l o w in Turkey given the country's income level and l o w comparc to most countries (Figure 12). In addition, the distribution o f preschool coverage i s highly inequitable, with fewer opportunities for preschool for the children who need i t most, including those whose parents have lower levels o f education and incomes as well as children living in less developed areas. 102. Investing in early childhood development is therefore an important part of reforms to improve the quality and equity of learning outcomes. Increasing preschool coverage, particularly for disadvantaged children and their families in Turkey, would help more children to enter school ready to learn, providing greater opportunity for the next generation to improve their educational attainment and earnings while reducing intergenerational transmissions o f inequities.28 In addition, expanded access to preschool would remove one o f the obstacles to female labor force participation and could result in increased female labor force participation in the short run with immediate growth and productivity effect^.^' 103. The Ministry o f National Education (MONE) i s working to increase preschool enrollment with the goal o f universal preschool education f o r 5 year-olds by 2014. M O N E has informed Governors and provincial education directorates about plans for making preschool education universal through a circular issued in June 2009; implementation began in September 2009 with 32 pilot provinces. These provinces were selected because universal coverage could be attained more quickly than in other provinces as they did not need any new facilities. M O N E has hired 15,500 new preschool teachers this school year, increasing the number o f preschool teachers b y more than 50 percent. Preschool enrollment in these provinces has increased from 804,000 at the end o f the 2008-09 school year to 900,000 in November 2009. The M O N E Projects Coordination Center i s also working on a "Strengthening Preschool Education Project" financed in cooperation with the EU under the Instrument for Pre-Accession Assistance (IPA) 27 MONE i s also working on an EU-funded project to improve the quality o f vocational and technical education. 2a World Bank, 2009, Turkey. Expanding Opportunitiesfor the Next Generation. 29 World Bank, 2009, Female Labor Force Participation in Turkey: Trends, Determinants, and Policy Framework. 31 and expected to start in 2010. The project aims to improve enrollment and attendance o f disadvantaged children at day care and preschool through capacity building in MONE, municipalities, other public institutions, and NGOs, and through the development o f community- based models and partnerships. Summary 104. The Government's program, supported by the proposed operation, includes measures to respond to the impact of the global crisis on jobs and incomes in addition to key reforms to help restore equitable growth and employment during the exit from the crisis. These reforms are focused on the areas o f health and social security, PFM, business climate reforms, labor-market regulation, and education. Participatory Processes 105. Turkey has its own participatory processes underpinning policy formulation. Government policy in employment, fiscal adjustment, social security, investment climate reforms, and other areas i s informed by regular consultation with stakeholders in varied forums. Groups involved in this process include unions, employer organizations, chambers o f commerce and industry, civil society organizations, academics, and private sector representatives. Important consultation processes revolved around the social security reforms, to ensure full feedback from beneficiaries. More recently, the World Bank and the Government jointly prepared Female Labor Force Participation and Welfare Survey Studies which in addition to quantitative data included numerous consultative meetings among stakeholders. 106. Strong working relations with civil society are an important part o f the World Bank's partnership with Turkey. The Turkish authorities and the World Bank have engaged intensively with civil society in the preparation and implementation o f projects such as the Health Transition Project (HTP) and the Istanbul Municipal Services Project. Academia, think tanks, private sector associations and businesses, as well as a wide range o f Non-Governmental Organizations (NGO), are engaged in the analytical and policy work the Bank undertakes with the authorities, e.g., the Middle East Technical University (METU) in joint human development policy dialogues (including United Nations Development Program (UNDP)), in which international experts assess social policy reforms abroad and in Turkey, and the Union o f Chambers and Commodity Exchanges (TOBB) and TEPAV in investment climate work. 32 IV. BANK SUPPORT TO THE GOVERNMENT PROGRAM LINK TO CPS 107. The proposed operation forms part of the CPS covering FY2008-11. `The CPS was endorsed by the Executive Board on February 28, 2008. Its goal i s for the Bank Group to partner Turkey in realizing the country's development vision-fast and sustained growth with equity- through full integration with the Government's development strategy. Accordingly, the CPS i s shaped directly by Turkey's Ninth Development Plan and by the Government Program: i t aims to contribute to three o f the Plan's development pillars: ( i ) improved competitiveness and employment, ( i i ) equitable human and social development, and ( i i i ) efficient provision o f high- quality public services. 108. The CPS has just been reviewed with the government in light of the global crisis. A CPS Progress Report, endorsed by the Executive Board on January 7, 2010, summarizes adjustments to the CPS agreed between Turkey and the World Bank Group to reflect global developments and evolving country priorities. The resulting program for the remainder o f the CPS period will focus sharply on areas crucial for renewed growth: stimulating private sector, especially Small and Medium Enterprise (SME), business and job creation; sustainable energy and infrastructure; and human capital and social protection o f the most vulnerable groups.30The agreed adaptation o f the CPS program includes the proposed REGE-DPL, in support o f a program that combines the continuation o f Turkey`s fiscal and public-sector reform agenda (supported by the earlier PPDPL 1 and PPDPL 2 operations) with the private sector development agenda (supported by the earlier CEDPL and CEDPL 2 operations). 109. The proposed loan amount o f USD 1.3 billion i s consistent with the CPS and the increase agreed in the CPS Progress Report. Reflecting economic developments and evolving priorities, the Progress Report sets out new IBRD financial commitments in FY 10 o f up to USD 3 billion, including up to USD 2 billion in DPL financing. The program focus and loan amount o f the REGE-DPL are in line with this agreed increase, with the loan being timed to help Turkey manage the effects o f the global crisis, and with the significance o f the completed program actions, particularly in creating the "exit strategy" from the fiscal expansion o f 2009. As set out in the CPS, the scale o f available Bank financing and its phasing over the CPS period are determined by the Bank's review and approval o f each new loan commitment. This review focuses on sound macroeconomic management, financial sector stability, and progress i n the three CPS development areas mentioned above. COLLABORATION W I T H THE I M F AND OTHER DEVELOPMENT PARTNERS 110. The IMF's most recent Stand-By Arrangement for Turkey was completed successfully in M a y 2008. Since the onset o f global financial turbulence, the Turkish authorities have maintained an active dialogue with I M F staff. 30IBRD and IFC will accelerate financing to the private sector, especially SMEs. The updated CPS program also envisages enhanced Bank AAA and financing for human and social development, including social and poverty monitoring, jobs, and vocational training. Finally, as Turkey has set out to strengthen its contribution to local and global environmental sustainability, the Government and the Bank plan to broaden the electricity DPL program to include energy efficiency, climate change, and environmental sustainability. 33 111. The Bank and the IMF are coordinating and working together closely on Turkey. In recent months topics on which Bank and Fund staff have collaborated include assessment o f developments in the health and social security systems, energy pricing, and local administration finance. Bank staff has provided the fund team with inputs in the form o f the analysis o f social and employment impacts o f the crisis, social security actuarial analysis, health policy analysis, and poverty simulations. I M F staff regularly share macroeconomic files and the detailed fiscal assessments o f fund staff have informed the Bank's own views o f the new M T P . Bank and Fund staff members in Ankara and Washington regularly discuss Turkish policy issues and the IMF staff has been in close consultation with the Bank team in the preparation o f the present proposed operation. There are no significant areas o f disagreement between the two institutions in their assessment o f the broad areas o f priority for structural reforms, as well as the overall appropriateness o f the macroeconomic framework. 112. The World Bank also maintains close dialogue and collaboration with the EC in Ankara and Brussels, with UNICEF and UNDP in Turkey, and with European Bank of Reconstruction and Development (EBRD) and European Investment Bank (EIB). The Bank and the EC hold regular exchanges in their Ankara offices on issues such as social policies and provide prior comments on relevant analytical work. Recent surveys into the impact o f the economic slowdown in Turkey at the household level were conducted jointly with UNICEF (as well as with TEPAV). The Bank and U N D P have begun working together on climate issues, through for instance, UNDP's pilot program on the Ceyhan basin in south-central Turkey. The Bank i s also working together with the German Development Bank, Kreditanstalt fur Wiederaujbau Bankengruppe (KfW) and U N D P in providing technical assistance to industry and financial intermediaries for energy efficiency investments. Bank staff also holds regular consultations with staff from EIB, which has an active portfolio in Turkey including areas o f common interest such as energy and agriculture, and EBRD, which has recently opened an office in Istanbul. The Undersecretariat o f Treasury plays an active role in donor coordination. RELATIONSHIP TO OTHER BANK OPERATIONS 113. The program to be supported by the proposed REGE-DPL operation and the planned REGE-DPL2 operation (1) continues the reform program supported by the programmatic Public Sector DPL series; (2) incorporates key pending reforms from the Competitiveness and Employment programmatic DPL series; and (3) includes critical measures responding to the impact of the global financial crisis. O f the nine prior actions included in REGE-DPL, three are included in or are closely related to the indicative triggers for PPDPL 3; one i s closely related to key next steps for CEDPL 3; four are crisis response measures (of which the one on vocational training i s also closely related to a trigger in the CEDPL agenda); and one i s a new structural prior action in education. The planned REGE-DPL2 i s expected to support a balance between the competitiveness and employment agenda foreseen b y the government in the CEDPL series, and the public sector agenda foreseen by the government in the PPDPL series. Within the former, the REGE-DPL retains focus on labor reforms and an improved regulatory framework for the private sector. The latter includes important reforms underpinning the return to sustainable public-sector balances under the new Medium-Term Fiscal Plan, especially in social security and health. 34 114. Table 8 summarizes how the REGE-DPL and the planned REGE-DPL2 relate to the past PPDPL and CEDPL series. This reflects progress to date on the Government's public sector and competitiveness and employment agendas, respectively. The Government has pressed on with reforms under the PPDPL umbrella. The CEDPL agenda, in contrast, slowed as legislative activity had to focus on protecting workers and firms from the worst effects o f the global crisis. The REGE-DPL series formally continues the PPDPL series while the CEDPL series implementation will formally complete and be subject to review by an ICR. See Annex 5 for fuller explanations o f the relationship between the two prior series and the proposed program, including the results frameworks o f the operations. 115. REGE-DPL complements related investment lending. In health and social protection, the Health and Social Security Adaptable Program Loans support investments in the family health system and technical and administrative improvements in SSI, important components o f Turkey's model for financially sustainable, universal access to healthcare and social security. In private-sector development, the policy measures supported by the proposed program complement the Bank's lending to SMEs and exporters through its credit line f a c i l i t i e ~ . ~ ' 116. The proposed program i s complemented by a second proposed programmatic series o f DPLs focusing on energy and environmentally sustainable development. This operation would grow out o f and broaden the reform areas supported under the Programmatic Electricity Sector Development Policy Loan (PEDPL). The first loan in this series was approved by the Board on June 11, 2009.32 3' Third and Fourth Export Finance Intermediation Loans (EFIL); Access to Finance for SMEs. 32 Programmatic Electricity Sector Development Policy Loan (PEDPL), Report No. 46050-TR, May 18, 2009. 35 PPDPL 3 and CEDPL 3 Triggers REGE-DPL Prior Actions I REGE-DPL 2 Triggers/Sollow-up - Met. Included (sliehtly modified): The Social Security and UHI Law has been Follow-uu action Implementation o f the Social Security and implemented as enacted in June 2006 and as amended Implementation o f the Law reforming the Universal Health Insurance Law, as enacted administrative dimensions o f social security, in May 2008 in order to ensure long term fiscal in June 2006 and amended in May 2008, sustainability and equity in the social security systems. including the merging o f data and IT systems including enactment o f secondary o f three social security systems legislation: and the merger o f staff from the three prior systems Met. _ . Included (slightlv modified). Secondary legislation for the implementation o f Article Implementation o f global budgets for M O H FOIIOW-UD action 73 ofLaw N o 5510 as amended by Law N o 5754 has hospitals, the introduction o f spending limits Implementation o f global budgets for been adopted to put in place cost management for university and private hospitals through university and private hospitals mechanisms for the health sector the 2010 budget, and publication o f an SSI budget circular stating pharmaceutical expenditure controls Met. _. I 'Two follow-uu actions: Guidelines for performance based budgeting have been revised and at least 50 institutions have prepared their Included (unmodifiedh Revision of the Guideliiics tor performance I - Implementation o f an effective fiscal rule I consistent with the Medium Term Plan performance budget. based budgeting and prcparation by at least I In line with the time table announced in 2006, all Substantially met. central government institutions and municipalities and ( I I institutions outstanding) Not included. SPASwith a population o f more than 50.000 completed Not included. their first strategic plans. A Law on Mediation for civil disputes has been Not met. Not included. enacted. CEDPL 3 Developing IPR legislation aligned with the ELJ Acquis Not met. in areas including: (a) Patent and Intellectual Property Related urior action. Not included. Law, (b) Geographical Indications Law, (c) Industrial Amendment o f the Customs Law to Design Law, and (d) Trademarks Law streamline customs procedures Commercial Code broadly aligned with the provisions o f the EU Acquis on commercial matters approved by ; Included (slightly modified): Not met. Parliament j Enactment o f the new Commercial Code Privatization program advanced according to market Met. Not included. conditions Not included. 1 Regulations to adopt Base1 I capital adequacy Not met Not included. framework issued according to market conditions New Capital Market Law approved by Parliament and Included (slishtlv modified): Not met I ~ complementary regulations under way Enactment o f the new Capital Market Law Legal requirements for the transfer o f Risk Center to Not met Not included. Bankers Association completed Included Reform law passed that increases labor market ~ Not met I Reform measures taken to increase labor flexibility and worker protection I market tlexibility and worker protection Included (sliahtlv modified). Not met ~ I Establishment o f a performance-based Performance management and monitoring system for Provincial Employment and Vocational Training Crisis-related urior action Included: Accelerated expansion o f the coverage o f 1 management system for ISKUR programs and I launch o f an evaluation o f the effectiveness o f Councils functioning ISKLJR vocational training (and trainee I lSKLJR programs In the context ofthe stipends) reaching 150.000 people I expansion o f training services Sector qualification committees establish competency- Met. Not included. based occupational standards for ten occupations Not included. NEW Central Bank blind broker function Increase and extension o f short-time employment compensation to reduce layoffs Expansion o f guarantees to the credit guarantee fund by T L I billion Hiring o f 15,000 new preschool teachers for Pilot implementation o f preschool education the 2009-10 school year and launch o f expanded to I 3 additional provinces and universal preschool education for children 5 progress reports completed by all 32 pilot years o f age in 32 provinces provinces LESSONS LEARNED 117. The proposed design draws on several World Bank evaluations. The proposed 7 3 REGE-DPL rogram reflects lessons from the recent 1993-2004 Country Assistance Evaluation for Turkey, the Country Assistance Strategy (CAS) FY04-FY07 Completion Report,34as well as the recent review o f World Bank ~ o n d i t i o n a l i t y Conclusions o f these reports include the .~~ importance o f full ownership by government as well as full integration into a government reform program. 118. The CAS Completion Report recommended that the Bank Group's future assistance program should envisage greater support for private sector development. The current and planned future operation are at the heart o f the Bank's strategy for Turkey in that respect, including a comprehensive package o f reforms targeting an improved competitiveness environment for f i r m s . I t also supports labor market reforms intended to increase labor force participation rates for women and youth which, according to the Poverty and Social Impact Assessment carried out for CEDPL 2, would particularly benefit poorer households. The Completion Report also singles out the importance o f combining high quality analytical work with policy-based lending. The proposed operation rests on a large volume o f high-quality analysis, carried out by bank staff in partnership with government organizations, as well as by other institutions (see Analytical Underpinnings below). 119. The design o f the proposed program reflects the experience in Turkey that the government's reform agenda i s best supported through programmatic series o f two o r more operations. Indicative triggers for the future operation reflect the government's own reform priorities as discussed in the Development Plan, the MTP, and in many cases legislation either before parliament or under preparation by the relevant ministries. The government has consistently expressed its preference for programmatic lending encompassing the broad array o f reform areas that the authorities are pursuing. Finally, an important feature o f such lending i s the appropriate flexibility in defining indicative triggers for the next operation. While the government has a well-defined set o f planned actions and planned timing, the actual feasibility o f each reform step in a given period depends on many factors outside the government's control. Past experience, in particular with the CEDPL series, points to the importance of balancing ambition and realism in follow-up triggers. The lesson o f the PPDPL series (which built on the earlier three-loan Programmatic Financial and Public Sector Adjustment Loan series spanning 2001-04) i s that prolonged engagement in Turkey, maintaining commitment to key reform areas, delivers results over time. Accordingly, the inclusion o f ambitious and complex reforms (especially in the business climate and labor market areas) in the program expected to be supported by the follow-up REGE-DPL2 reflects strong Government ownership o f these reforms and the common view o f the authorities and the Bank on their importance. 120. A further lesson from programmatic lending to Turkey i s the importance o f continuity in program design, mirroring the government's rolling MTP. The Bank supports the government's own rolling program and thus mirrors the continuity o f this plan in DPL 33 The World Bank in Turkey, 1993-2004: An Independent Evaluation Group (IEG) Country Assistance Evaluation, Report No. 36584, June 9,2006. 34 Country Assistance Strategy Report for The Republic o f Turkey, Report No. 33995-TU, November 8,2005. 35 Conditionality in Development Policy Lending, Report No. 4 158 1, November 15, 2007 37 programs. Most Analytical and Advisory Activities (AAA) and financing follow this programmatic approach. Consistently pursuing pending reforms over many years has proven critical in several key areas, such as social security reform, disaster management, and energy. ANALYTICAL UNDERPINNINGS 121. I n its 2008 Country Economic Memorandum (CEM),36 the World Bank, in partnership with the Undersecretariat o f Treasury completed a wide-ranging assessment o f the challenges to sustaining Turkey's high rates o f growth since 2002. Key areas emphasized in that study were structural fiscal reforms, PFM, investment climate reforms, and employment regulations. The study reaches conclusions that are consonant with other international studies o f the Turkish economy, notably the annual progress report o f the EC and the 2008 country survey carried out by the OECD. 122. The PFM agenda supported by the proposed operation is the subject o f ongoing programmatic ESW. In collaboration with the steering committee o f the PPER, a World Bank team recently completed (June 2009) the PFMP benchmarking exercise, based on the PEFA methodology. The benchmarking found a high level o f performance in central, "upstream" PFM functions with room to enhance impact in decentralized and "downstream" functions, for example including line agency audit and control functions. The next stage o f this work involves detailed expenditures reviews by sector, subject to agreement with the Steering Committee at each stage. 123. Ongoing work with YOIKK and several studies o f the business environment have contributed to the policies supported by the proposed operation. Recommendations for improvements in the investment climate are grounded in recent ICAs (2007 and f~rthcoming),~' "Doing Business" surveys,38 and BEEPS. A recent study o f innovation policy in Turkey underpins parts o f the investment climate analysis. A financial sector assessment was completed in September 2007.39 124. I n the area o f employment and labor-market regulations, the Turkey Labor Market Study was published in 2006.40In addition, the 2009 CEM focuses on informal ernpl~yment.~' These studies have developed detailed strategic recommendations for possible approaches to labor market reforms and other policy areas affecting informality such as taxation and business regulations. Social issues relating to education, labor markets, and social programs are analyzed in two further recent studies: "Turkey: Equality o f Opportunities and Early Childhood Development" (2009) which focuses on equality o f opportunity in Turkish society today, most importantly on the l i f e chances o f today's children, and "Female Labor Force Participation in Turkey: Trends, Determinants, and Policy Framework" (2009), which focuses on understanding 36 Turkey Country Economic Memorandum, Sustaining H i g h Growth: Selected Issues, Report No. 39194-TR, April 10, 2008. 37 Turkey: Investment Climate Assessment, Report No. 4 16 1 I -TR, 2007. 3 8 Doing Business 2010: Reforming through D@cult Times, World Bank, IFC and Palgrave MacMillan, 2009. 39 Turkey Financial Sector Assessment Program (FSAP), Report N o . 41 137, September 1, 2007. 40 Turkey Labor Market Study, Report No. 33254-TR, April 14, 2006. 4 ' Turkey Country Economic Memorandum, Informality Cuuses, Conseyuences, Policies, Report No. 48523-TR, June 29,2009. 38 the constraints Turkish women face to enter the labor market. Health sector policy recommendations are based on extensive sector work, including the comprehensive sector study, "Turkey: Reforming the health sector for improved access and e f f i ~ i e n c y . " ~ ~ 125. Finally, the B a n k has undertaken several initiatives to assess the economic and social impacts o f the global financial crisis. These have been largely described elsewhere in this program document. In early 2009 Bank staff held a series o f consultative meetings with government officials to discuss the impact o f the global economic crisis, including labor-force survey-based simulation results, and international experience in responding to it. More recently, the Bank teamed up with TEPAV and UNICEF to field quantitative and qualitative surveys in five urban and two rural areas on the impact o f the economic downturn on Turkish households. 42 OECD: Reviews of Health Systems, Turkey, OECD and IBRDiWorld Bank, 2008. 39 V. THE PROPOSED "RESTORING EQUITABLE G R O W T H AND EMPLOYMENT" DEVELOPMENT POLICY L O A N (RFCGE-DPL) OPERATION DESCRIPTION 126. The proposed operation supports Turkey's crisis response and the transition to a path o f sustainable shared growth. The operation takes an integrated approach to the transition, based on the government program embodied in the Ninth Development Plan and the MTP, the CPS, the recent CPS Progress Report, and the extensive analytical underpinnings described above. As in almost all countries, the crisis response led to a natural deterioration in economic indicators. Private sector activity plummeted in late 2008 and into the first quarter o f 2009. As discussed in Section 11, public debt ratios have worsened; the budget and the combined health and social security system face new fiscal challenges as a result o f the 2009 contraction. Moreover, unemployment and poverty have risen. The policy response o f the government has been in line with these challenges. 127. The Government's crisis response combined monetary and fiscal expansion, employment measures, and social protection; this response i s supported by the proposed operation. REGE-DPL supports the government's crisis response packages, announced between September 2008 and July 2009. I n late 2008, with the emphasis on protecting financial intermediation and reassuring the system that FX liquidity would be maintained, the CBRT announced a series o f liquidity measures in addition to traditional monetary easing. Later, as attention shifted to the slowdown in the real economy and its employment and social consequences, government measures shifted to fiscal expansion beyond automatic stabilizers, through V A T cuts, active labor-market programs to protect employment and help unemployed workers, and expanding credit to SMEs, the main source o f employment. The operation therefore supports prior actions representing crisis response measures. 128. With the stabilization o f the Turkish economy, the proposed operation supports the Government's focus on measures to return to fiscal balance in the medium term. The proposed operation supports the underpinnings o f the government's MTP, the key to this transition. Foremost among these are global health budgeting measures and spending limits to rein in health spending and measures to curtail demand for more costly private health care. Also important i s the continued implementation o f the social security reform passed in 2008, key to maintaining long-term fiscal balance and thus confidence in the economy, and administrative reforms to social security. Third, public financial measures aim to improve fiscal c,ontrol and transparency. 129. The proposed program includes further planned actions to attain fiscal equilibrium through a targeted adjustment over a medium-term horizon. The proposed program supports the extension of this fiscal adjustment agenda into next year and beyond. A second operation in the series would support planned measures i n economic management and PFM such as the adoption o f a fiscal rule (planned from 201 1) and a law currently in parliament governing the TCA. In health, future cost-containment measures will be needed, most importantly the extension o f global budgets to university and private hospitals. Future technical and administrative reforms in the social security system will also help to contain the overall deficit o f this system, financed from the general government budget. 40 130. As growth returns, the measures supported by the proposed operation aim to build s k i l l s and improve the investment climate, fostering equitable growth. The REGE-DPL supports the Government's agenda in the areas o f labor markets, education, and the investment climate. The shift from the protection o f jobs to the protection o f workers i s a key challenge to increase j o b creation. Education - particularly early-childhood interventions, preventing dropouts later, and vocational training - remains the long term key to improving labor productivity and to making growth reach the least well-off. And key constraining factors in the investment climate are "time taxes" (particularly destructive as they generate no corresponding revenue to the government) and access to finance. 13 1. The planned follow-up REGE-DPL2 operation would support key reforms continuing the Government's equitable growth and employment agenda. Pre-school access i s planned to expand to 13 new provinces per year (to 45 by the time o f the REGE-DPL2). MOLSS is implementing a plan to continue recent increases in vocational training delivered by ISKUR and most importantly to improve performance monitoring and management. Further labor market reforms are planned. Key measures for private-sector development include the new Commercial Code (currently in parliament) and Capital Market Law. 132. Overall, the program supported by the proposed REGE-DPL series falls into two pillars: "Fiscal Management" and "Equitable Growth and Employment." 0 Fiscal Management includes continuing to provide inclusive social services (health and social security) while making these sustainable b y reining in costs. Also key to continuing to deliver quality public services at value for money i s the P F M agenda, also included under Fiscal Management. 0 Growth and employment in 2008-09 has been protected (to some extent) by crisis response packages, components o f which are included under the Growth and Employment pillar. 0 Structural measures under Equitable Growth and Employment include investment climate reform driven by the Y O I K K Technical Committee action plan, supported by the Bank, specifically customs streamlining and the Government's agenda to improve educational outcomes. Key elements o f the future agenda here are further labor-market reforms, vocational training, and the new commercial code, which i s currently before parliament. 0 The legal prior actions envisaged under the proposed operation are listed below in Box 1. 133. The program supported by the proposed REGE-DPL i s expected to have positive fiscal impact. The costs o f measures supported by the REGE-DPL are outweighed b y the fiscal benefits o f restraining spending in the health and social security system alone. Four prior actions have potential fiscal costs. The increase and extension o f short-time employment compensation and the expansion o f the coverage o f ISKUR vocational training programs are estimated to have cost about TL 400 million in 2009. All spending for the activities within the scope o f the mentioned programs are covered by the UI fund with no further central government budget contribution. The expansion o f preschool education in 32 provinces has an estimated cost o f about TL 40 million in 2009 and, overall, the cost o f all these measures i s estimated at about 0.05 percent o f GDP in 2009. The short-time employment compensation measure i s scheduled to expire at the end o f 2010 in the absence o f any extensions. For 2010, the vocational training program will have an estimated cost o f about TL 300 million and preschool expansion will cost 41 about T L 240 million. Finally, the Treasury contribution to the Credit Guarantee Fund constitutes a contingent liability for the budget. Depending on usage and default rates, the fiscal cost o f this measure in 2010 could be around T L 100 million. The total cost o f measures supported under the REGE-DPL i s therefore about 0.06 percent o f GDP in 2010. By comparison, the fiscal adjustment for the 2010- 12 period associated with central government health spending and the combined deficit o f the health and social security system i s approximately 0.7 percent o f GDP. 134. T h e results framework o f the operation carries forward the results frameworks o f the PPDPL series and parts o f that o f the CEDPL series, where relevant. Several quantifiable results indicators from PPDPL 2 and CEDPL 2 are included in REGE-DPL (see also Annexes 2 and 5). Some indicators are added to this list, reflecting ( i ) measuring the impact o f the government's crisis mitigation policies, ( i i ) Turkey's recent PFMP benchmarking and planned follow-up own assessment, and ( i i i ) limited new policy areas introduced for REGE-DPL (see Annex 5). Box 1 : Prior Actions for REGE-DPL The government has agreed upon and implemented the following prior actions before the presentation o f the loadcredit to the Executive Board: Implementation o f the Social Security and Universal Health Insurance Law, as enacted in June 2006 and amended in May 2008, including enactment o f secondary legislation; and the merger of staff from the three prior systems (as stipulated by the Social Security Institution Law) Implementation of global budgets for MOH hospitals, the introduction o f spending limits in university and private hospitals through the 2010 budget, and publication o f an SSI budget circular stating pharmaceutical expenditure controls Revision o f the Guidelines for performance based budgeting and preparation by at least 50 institutions o f their performance budget Implementation o f the CBRT blind broker fimction Increase in short-time employment compensation (by 50 percent) and its extension (from 3 to 6 months, and then to 12 months) effective until end 2010 to reduce layoffs (part o f the employment support packages) Amendment of the Public Finance and Debt Management Law to provide authority to expand guarantees to the CGF by T L 1 billion Accelerated expansion o f the coverage of ISKUR vocational training (and trainee stipends), reaching 150,000 people in 2009 Amendment o f the Customs Law to streamline customs procedures Hiring of 15,000 new preschool teachers for the 2009-10 school year and issuance of MONE Circular launching universal preschool education for children 5 years of age in 32 provinces. 42 POLICY AREAS PILLAR 1: Fiscal Management l-A: Maintaining Inclusive Social Programs at Sustainable Cost 136. Key objectives o f Turkey's fiscal reform program are to maintain universal health coverage and to protect the long-run financial sustainability o f the health and social security system. The social security reform has been implemented through secondary legislation and regulation. Administrative reform has been partially completed with the staff merger o f the three previously self-standing social security systems. Now, continued implementation o f the social security reform combined with cost containment in the health sector are even more pressing in the new fiscal environment. 137. The M T P pursues the agenda o f cost containment in health. S S I i s implementing a global budget for MOH hospitals and spending limits for university and private hospitals. Extension o f global budgets based on a defined payment methodology would further enhance S S I capacity to manage hospital expenditures. Expansion o f family medicine without further refinement o f the capitation system to emphasize cost-effectiveness generates fiscal sustainability concerns for the health sector. Rational drug prescription and greater emphasis on prevention are key areas. 138. There are two prior actions for the proposed operation under this pillar: 0 Implementation o f the Social Security and Universal Health Insurance Law, as enacted in June 2006 and amended in May 2008, including enactment o f secondary legislation; and the merger o f staff from the three prior systems (as stipulated by the Social Security Institution Law) 0 Implementation o f global budgets for MOH, the introduction o f spending limits in university and private hospitals through the 2010 budget, and publication o f an S S I budget circular stating pharmaceutical expenditure controls.43 139. Expected triggers for REGE-DPL2 in these areas are the following: 0 Implementation o f the Law reforming the administrative dimensions o f social security, including the merging o f data and I T systems o f three social security systems 0 Implementation o f global budgets for university and private hospitals. In addition to administrative reform, i t i s important that the rules-based approach established in the 2008 social security reform law i s reinforced, in particular through the absence o f any further ad hoc pension increases. A further step to control health costs would be a reformed family medicine capitation system, including rational drug prescription and preventive health care. 140. The impact of these reforms i s expected to be significant and measurable. The impact o f the data merger in S S I will be felt through a new unified administrative structure and 43 See Section 111 for a fuller discussion. 43 potentially the ability to create social security "one-stop shops" at the local level. Continued implementation o f the social security and UHI law and further cost-saving measures in health will be measured by the combined deficit o f the social security and UHI system as a share o f GDP, which the M T P foresees declining gradually from its. 2009 value (4.5 percent). 1-B: P u b l i c F i n a n c i a l Management (PFM) 141. I n o r d e r t o stabilize a n d s t a r t t o bring d o w n the p u b l i c debt burden, a key goal i s t o increase value f o r money in the delivery o f p u b l i c services. To pursue this goal, upstream reforms to central P F M functions such as strategic planning and budgeting now need to translate into improved operational efficiency in line agencies. 142. A k e y development in PFM has been the Government's b e n c h m a r k i n g o f i t s o w n progress in o r d e r t o p r i o r i t i z e f u t u r e reforms. This has been undertaken with the support o f the Bank under the PFMP benchmarking exercise and will not only facilitate priority-setting but also allow the measurement o f future progress. There i s one prior action for the proposed operation in this area: 0 Revision o f the Guidelines for performance based budgeting and preparation by at least 50 institutions o f their performance budget.44 143. T h e i m p a c t o f performance plans i s expected t o b e felt in overall i m p r o v e d p u b l i c service delivery, value f o r money, a n d u l t i m a t e l y p u b l i c welfare across government institutions. For the purposes o f measuring impact o f this reform, measurement o f the quality o f P F M outcomes will be pursued through the Bank's ongoing partnership with the authorities through the PFMP benchmarking, which will be updated at regular intervals. 144. T h e r e a r e two expected triggers f o r R E G E - D P L 2 in the PFM area, focusing o n t h e highest i m p a c t elements o f the government's PFM agenda f o r the c o m i n g year: 0 Enactment o f legislation o f an effective fiscal rule consistent with the concurrent Medium Term Plan; 0 Enactment o f the T C A law. 145. T h e i n t r o d u c t i o n o f the planned fiscal r u l e i s expected reduce uncertainty, p r o m o t e counter-cyclical fiscal policy, a n d strengthen the credibility o f the Government's d e b t targets in t h e MTP. The details and precise legal status o f the fiscal rule remain to be defined. A well-designed law would set targets for one or more key fiscal balances (e.g., overall public sector fiscal deficit) that would be consistent with the pursuit o f M T P debt targets, within a framework o f countercyclical taxation and spending. Key features for the effectiveness o f such a rule are a timely and transparent framework for measuring and reporting, credible values for the key parameters (which can be challenging if the rule covers the whole public sector), and sensible escape clauses to deal with crises and other extreme situations. Such a law would be welcomed by investors in Turkish assets and would, if appropriately designed, increase the certainty surrounding macroeconomic management and thus the credibility o f economic policy. 44 "Institutions" refers to ministries, universities and government agencies. 44 Measurement o f the results o f such a rule would be through the attainment o f the debt targets set out in the MTP in place at the time o f the design and adoption o f the rule. 146. The planned new TCA law will extend the audit mandate of TCA to the entire public sector and enables implementation of the reforms foreseen in the PFMC. Inconsistency between the PFMC and the current TCA laws prevents adequate functioning o f external audit, one o f the pillars o f a modern PFM structure. In addition, the current TCA audit function i s limited to "conformity" audit, impeding the development o f full and credible public reporting. The draft law extends the scope o f TCA audit to include regularity, financial, and performance audits, with less focus on the judicial function. The draft law defines audit as a planned activity, to be carried out in accordance with the international standards. The implementation o f this draft law will thus promote public accountability. PILLAR 2: Equitable Growth and Employment 2-A: Employment and Social Protection during the Crisis 147. Prior actions for the REGE-DPL in this area focus on banking stability, employment, and SME access to finance. The proposed first REGE-DPL operation focuses on four prior actions to mitigate the effects on Turkey o f the global crisis: Implementation o f the CBRT blind broker function45 Increase in short-time employment compensation (by 50 percent) and i t s extension (from 3 to 6 months, and then to 12 months) effective until end 2010 to reduce layoffs (part o f the employment support packages) Amendment o f the Public Finance and Debt Management Law to provide authority to expand the CGF by T L 1 billion Accelerated expansion o f the coverage o f ISKUR vocational training (and trainee stipends), reaching 150,000 people in 2009.46 148. Impact measures are related to the take-up o f each o f these measures during the crisis. The blind broker facility "insured" more than USD one billion o f inter-bank FX transactions at the height o f demand in November 2008. Take up o f short-time employment compensation was about 40,000 workers in December 2009. Vocational training i s expected to reach 300,000 trainees over the two years 2009-10. The CGF i s expected to increase credit intermediation to SMEs by several billion T L from 201 0. 149. N o future crisis-related triggers are envisaged for REGE-DPL2. This reflects the time-bound nature o f the crisis and the Government's response. 45 Blind brokerage implies the Central Bank making a market anonymously between banks who wish to demand and supply foreign exchange on the interbank market, Le., guaranteeing to purchase from sellers and to sell to purchasers at the market rate, in effect insuring foreign exchange default risk. 46 See Section 11 for a fuller discussion o f all these measures and section I11 for a discussion of vocational training.. 45 2-B: Private-Sector Led G r o w t h and Job Creation after the Crisis 150. Job creation in the private sector depends p r i m a r i l y o n labor market r e f o r m and in the long term o n improved matching o f worker s k i l l s w i t h labor-market needs, through improved education and vocational training. Given the young demographic structure o f the Turkish labor force and the need for more flexible labor regulations, these are the main priorities. New laws currently before parliament, such as the Commercial Code and the Capital Market Law, will also represent important strides forward in the business climate and would be welcomed by investors. 151. There are two p r i o r actions supported by the proposed operation related t o this long-term agenda: 0 Amendment o f the Customs Law to streamline customs procedures (part o f YOIKK Technical Committee actions) 0 Hiring o f 15,000 new preschool teachers for the 2009-10 school year and issuance o f MONE Circular launching universal preschool education for children 5 years o f age in 32 province^.^' 152. Expected triggers f o r the planned R E G E - D P L 2 operation in the investment climate area focus o n labor reform, the new Commercial Code a n d the new Capital Markets Law, a n d the continuation o f policies to expand pre-school education and improve a n d expand vocational training: 0 Reform measures to increase labor market flexibility and worker protection 0 Enactment o f the new Commercial Code 0 Enactment o f the new Capital Market Law 0 Establishment o f a performance-based management system for ISKUR programs and launch o f an evaluation o f the effectiveness o f ISKUR programs in the context o f the expansion o f training services 0 Pilot implementation o f preschool education expanded to 13 additional provinces and progress reports completed by all 32 pilot provinces. 153. The impact o f many measures in the REGE-DPL p r o g r a m i s difficult to measure directly, as they are cross cutting in nature. The impact o f the streamlining o f customs can be measured directly by the decline in the average number o f days to clear customs (15 as o f September 2009). The impact o f labor-market reform could potentially be assessed by the fraction o f unemployed workers covered b y UI or other safety nets. An effect o f the pew Capital Markets L a w i s expected to be an increase in non-bank financial intermediation, such as the value o f insurance and leasing assets as a proportion o f the financial system, which stood at 3 percent in 2007. The impact o f the preschool expansion will be measurable through preschool enrollment rates in the pilot provinces. In addition, the expansion o f ISKUR services and improvements to i t s monitoring and performance management system will be measurable as increased rates and numbers o f trainees placed in lasting employment. 47 See the relevant parts of Section Ill,"Business Climate Reforms" and "Education" for a fuller discussion o f these measures. 46 A -ULY ~ ~ ~ i t rIiczbt dual (I\ n a ~ ~ ~ crarching the crisis rcsponse and t r a ~ s i t i ~ ? ~ i 10 a long-term siistainablc g r m th path I'lie crisis response I ures s ~ ~ p ~ i ) bq ithe operation r~ td mitigate the 1 orset i Ing in de rnand c t) ndit Io 13 s atid t 1$ten ing 8 1obal 1itiuici it i thro ti gh ti seal and % monetary nieasurcs as \\ c l l as cmplo>inent prninoting nicasrires, including temporar) ones. The second set o f nieaswcs fitcuscs on the strrtcturd retixiit agendrz, i s longer term in nature. and supports long-tcri-n sustainahlc gram th 155. ~ ~ e ~ ~ s to r ~ is t ~ g a ~ e l o fina ~cia1 crisis u e the ~ ~ l VI ill help vulnerable groups t h e n~o~t* World 13nnk s ~ ~ ~ ~ i i 'iho~lithat~(1~ t i s l ~ ~ ~ i sizeablc c o n t r ~ ~ c t iin~2009 and a mild ~ Ii recatcry in 2fflU. in the aksencc tti' policy changes, 'rc otdd increase the povcrtl rate by about 5 pe~-c~iit~~git in 2 Q l t i o i e r points i t s 2008 level. Vulnerable groups such as ture n o n - a ~ ~ i c ~ i ~informal i\orkrrs. childritn and yo~iiigi'rorkers arc most at r i s k o f poverty (b~igurc 11). The policies supported b) the tUXiE-l~PL mitipate thc iinpact o f the crisis on the poor aiid 1iio1-ei d n e r a h l e groups in 'l'urkcy. 157. Analjsis of the d i s t r i b ~ t ~ o ~ a limpact of t h e i n t r o ~ ~ u ~ t ~ ~ n of o ~ t p a t i e n visits to p ~ b and~private h ~ a l ~ ~ ~ ~ ~ ~ ~ i~ ee as mild n e t ~ c t c s t s t s poverty; this impact must bc ~5 eighed against the i m ~ ~ r t apositis e imnt the flsueal s u s t ~ ~ n f~ ~ h e ai ~~ h o the i ~ slotem a n d the c e ~ ~ n o nI'hc *pot ~ i~ REGIS-DI'l,, requires rl.. 2 ror each tisit to primarj health care facilities. 11, 8 for t i s i t s to state and unitersitj hospitals and I I, 15 f\,r ii s i ~ s prn'ate hospitals. t hew ratcs are reduced to ~ e r o , to TI, 5 and 11, I ! if no prescription i s providcd fhllo\&irig the Cisit. The policj i s aimed at : containing grou ing hcalth expeiiditures and disctturaging excesshe hospital \,isits and p h ~ ~ ~ n a c e L ~purchascs. !\ s i i i i u l ~ ~cxercisc ~ica1 ~i~n carried out a s part o f the preparation for 37 popuiarion, n ne11 a inorc r c ~ i i i s t t c TU v rrl 1y Poverty Severity scenario i s constructed \\ here people S Baseline Introduction ofco-payments with ~ u b s ~ i t u t i ~ t ~ cfioosc to visi1 primary cnre fhcilirics 1 1 <1 L ' , .. \pisits to hospitals, thc m q i n a l increasc i n the pot, e r g lieactcount rate i s ~ m d l e r .at 0.2 pcrccntage points. with health expenditures rising from 2.4 pcrcerit to .3.4 pcrccnt of n ~ ) n - ~ t ~ ~ ~ d expenditures (Figure 14). lising the depth o f pox crt?; and sct crit) of po\ ertq inciicators thc inipact IS 0.1 percc"rtage points and 0.0 respectively . Furtherruorc, i f - as a result o f the ~iitro~luctittn eo-pa) ments, unnece ctt" v i s i t s to the hospitals arc reduced ( i t hich i s not m o d c l c d in thc anal! sis). the tiiial impact on poverty m i l l he lower stilt. 158. ~ ~ ~ l o ~ ~ 1 e n t -measures introduced in response to the crisis are estimated to ~ela~cd dominate the above negath e effect o f the intro~i~ction copaynients on poiof Thc ere. c n ~ p l o } n i e tprogram had ttho important features; i t \\as linked to the labor-market reforin ~~ agenda intrctduced in Maq 2008 and it included rargcted iiit'as~ircsto contain la:, offs resulting from the crisis and gciierrite jobs. The first labor package o f 2008 aiincd at prrmotiiig job creation ~ s u ~ ~ ~ by~ r t TI:IlPt, series) and fociiseci mostly on reducing the labor tax kvedge ~ tiie c c i and cnharicing labor shills. Ih e crisis rcspctrisc ni urcs for ~ i n ~ ~ l ~ ~ ?introduced in earl) ineiit 2009 incfitiied ( i ) an eutcniion of the ~ o t n c ia i d .voltti? subsid! scheme tntroduced b! thc h3q i 2008 packagc and tfic introduction *) ti1c"asLm.s. inciuding ill)TQ Youth literacy rare [ x of people ages 15.24) 93 Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education [XI LQ/ W L Women employed in the nonagriculturalsector ( x of nonagriculturalemployment] 17 17 19 Proportion of seats held by women in national parliament [ Z ) 1 2 4 Goal 4: reduce under-5 mortality by two-thirds Under.5 mortality rate (per 1,0001 82 63 44 Infant mortality rate (per 1,000 live births] 67 52 38 Measles immunization[proportion of one-year olds immunized,Z ) 78 65 86 Goal 5: reduce maternal mortality by three-fourths Maternal mortality ratio (modeled estimate. per 100,000 live births] Births attended b skilled health staff [ Z of total] y ,w LQ/ Contraceptive prevalence [ Z of women ages 15-49) fi.? fi.? 64 Goal 6: halt and begin to reverse the spread of HIVlAIDS and other major diseases Prevalence of HIV [ Z of population ages 15-49] Incidence of tuberculosis (per 100,000 people] 49 40 31 Tuberculosiscases detected under DOTS [ X ) Goal 7: halve the proportion of people without sustainable access to basic needs Access to an improved water source [ Z of population] 85 89 93 Access to improved sanitation tacilities [ Z of population] 85 86 87 Forest area ( Z of total land area] 12.6 12.8 13.1 Nationally protected areas ( Z o f total land area] C 0 2 emissions [metric tons per capita) 2.5 2.8 3.3 GDP per unit of energy use (constant 2005 PPP $ per kg of oil equivalent) 8.3 8.3 8.1 Goal 8: develop a global partnership for development Telephone mainlines (per 100 people] 12.2 21.3 27.3 24.6 Mobile phone subscribers [per 100 people] 0.1 0.7 23.9 83.9 Internet users (per 100 people] 0.0 0.1 3.7 16.5 Personal computers (per 100 people] 0.5 1.5 3.7 c c7 Education indicatorsi (%) I Measles immunization (%of 1-year olds) ICT indicators (per '100 people) 1 I tco :. o 1 I 3 - w -5 Note Figuresin italics are for years other than those sprcified indicates data are not available 12H6109 Development Economics, Development Data Group [DECDG) Annex 4 Page 1 o f 4 ANNEX 4: RELATION TO EARLIER PPDPL AND CEDPL SERIES 1. The Government's planned actions supported by the Programmatic Public Sector DPL series (operations in FY2006 and 2008) covered the following policy areas: ( ) IMacroeconomic Stability; (11) Social Security and Social Assistance Reform; (111) Budget and PFM Reform; (IV) Public Administration and Governance Reform. Indicative triggers for the envisaged PPDPL 3 at the time o f PPDPL 2 are shown in Table A5-1, 2. Within the REGE-DPL, PPDPL's social security, UHI, and social assistance content (11) i s included under Pillar 1-A (Inclusive Social Programs at Sustainable Cost). Measures relating to the health system have been grouped with further social security administrative reform. Both indicative triggers for PPDPL 3 on social security have been met although the recession, by holding down revenues in relation to expenditures that cannot be cut in real terms in line with the GDP contraction, has hurt the overall balance o f the system, an effect that persists throughout the 2010-12 period covered by the Medium Term Fiscal Plan. 3. PPDPL's PFM content i s included under Pillar 1-B (Enhancing PFM), linked directly to improving overall fiscal performance through public sector efficiency gains. Both indicative triggers have largely been met: 50 institutions have prepared performance-based budgets and, with the exception o f 11 administrations, government entities covered by the second indicative trigger have prepared strategic plans. The former action i s included as a prior action in the REGE-DPL. 4. PPDPL's judicial content under pillar (IV) i s described (but not included as a prior action) in Section 111. The main outcome associated with this reform program i s improvement in Turkey's business climate. The Mediation Law, included as an indicative trigger in PPDPL 2, remains on the agenda o f parliament, while the Judicial Strategy and associated Action Plan have been endorsed by cabinet and published, viewed as an important prerequisite for further progress. In the interest o f selectivity, PPDPL policy actions in the area o f regional development have been excluded from the REGE-DPL prior actions. 5. The Government's planned actions supported by the Programmatic CEDPL series (operations in FY07 and FY08) covered the following policy areas: (I) Macroeconomic Stability; (11) Enhancing Competitiveness and F D I through Investment Climate Reforms; (111) Improving Financial Intermediation; (IV) Expanding Employment Opportunities. Key next steps for the envisaged CEDPL 3 at the time o f CEDPL 2 are shown in Table A5-2. 6. Although the REGE-DPL i s not formally considered as a follow-on operation to CEDPL 2, it does adopt much o f the substantive content o f the CEDPL series, which w i l l now be closed. Within REGE-DPL, CEDPL's investment climate and financial intermediation content areas (11) and (111) are included under Pillar 2B (Private-Sector Led Growth and Job Creation). O f the three next steps listed for the investment climate, only parts o f the YOIKK action plan have advanced far enough to be considered a prior action for REGE-DPL (which focuses on customs streamlining as most significant given the importance o f reinvigorating trade flows post-crisis). O f the three next steps listed for financial intermediation, none has been completed. However, in this area the Government's broad range o f financial-sector measures to mitigate the impact o f the Annex 4 Page 2 of 4 .global financial crisis on credit conditions for f i r m s in Turkey, particularly SMEs, are considered important, with the expansion o f credit guarantees constituting a prior action for REGE-DPL. 7. The areas o f the Government's employment generation reforms supported by the CEDPL series are included under Pillars 2-A and 2-B o f REGE-DPL. O f the three next steps in this area, one has been completed, with competency-based occupational standards now defined in 23 occupational categories. For reasons o f selectivity this i s not included as a prior action for REGE-DPL. In the employment area as in financial intermediation, the design o f the REGE-DPL reflects the Government's priorities in responding to the circumstances created by the global financial crisis. The part o f the Government's employment support package relating to expanded vocational training i s included here as a prior action for the REGE-DPL. 8. In summary, o f the nine prior actions included in REGE-DPL, three are included in or are closely related to the indicative triggers for PPDPL 3 (PFM, social security law implementation, and health sector measures); two are related to key next steps for CEDPL 3 (customs streamlining under the Y O I K K Action Plan and increased vocational training); three are purely crisis response measures; and one i s a new structural prior action in education. In terms o f the future agenda, REGE-DPL supports an even balance between the competitiveness and employment agenda foreseen by the Government in the CEDPL series, and the public sector agenda foreseen by the Government in the PPDPL series, with the former incorporating much o f the planned content o f CEDPL 3 and the latter including important reforms underpinning the return to sustainable public-sector balances under the new Medium-Term Fiscal Plan. Results 9. O f the 13 indicators used for the results framework for the REGE-DPL series, three are taken directly or slightly modified from the results framework for PPDPL 2 (UHI, social security deficit, and unified administrative structure), two are taken directly from the results framework for CEDPL 2 (non-banking assets and ISKUR's placement rate), and eight are newly proposed for this operation. This overlap reflects the common aims and objectives that the REGE-DPL series inherits from the two earlier series, as implied by the overlap in policy areas, prior actions, and indicative triggers in Annex 2, combined with the need for greater selectivity in tying results indicators closely to prior actions and triggers, a basic principles o f DPL design. 10. The eight new indicators not only reflect attempts to monitor the impact o f the government's policies to mitigate the impact o f the crisis, but also developments i n Turkey's policies. Thus, capturing post-crisis impact are the following indicators: 0 Usage o f blind broker function during the crisis 0 Take-up o f extended short-time employment compensation 0 Credits to SMEs 0 ISKUR vocational training programs reaching 300,000 people. Reflecting developments in Turkey's own assessment environment are the following: 0 Improved indicators under the PFMP benchmarking exercise (from baseline study). Finally reflecting new policy areas introduced for REGE-DPL are the following: 0 Public debt sustainability, measured by meeting MTP targets 0 Days to clear customs (baseline: 15 in 2009) 0 Participation rates in preschool in the 32 pilot provinces (baseline: 2009). Annex 4 Page 3 of 4 Table A5-1: Indicative Triggers and Milestones for the Planned P P D P L 3 (Indicative Triggers are in Bold) Component 1. Sustaining Macroeconomic Stability The government has maintained a satisfactory macroeconomic framework, Component 11. Social Security and Social Assistance Reform Short term fiscal sustainabilit) o f the social security system i s maintained as evidenced by a combined deficit not exceeding 3 percent of new-GDP. 0 The Social Security and UHI L a w has been implemented as enacted in June 2006 and as amended in M a y 2008 in order to ensure long term fiscal sustainability and equity in the social security systems. Continued satisfactory implementation o f the action plan resulted in (a) creation of a combined data warehouse, (b) establishment o f financial management and decision support systems. (c) unified work processes, (d) completed personnel assignments, (e) establishment of a system for the coordinated monitoring of patient visits to hospitals and the use o f pharmaceuticals. Roadmap for introducing proxy-means testing for non-contributors has been issued. 0 SSI has undertaken an actuarial analysis for the appropriate premium rates for the targeted poor. A satisfactory social assistance reform law aimed at increasing the effectiveness and targeting o f the social assistance system through coordination o f social assistance policies has been enacted. UHI actuarial baseline estimates including SUT has been completed in order to assess the fiscal impact o f the benefit package. Secondary legislation for the implementation o f Article 73 of L a w No. 5510 as amended by L a w No. 5754 has been adopted to put in place cost management mechanisms for the health sector. DRG pilot implementation has been expanded to 10 percent o f university hospitals and 5 percent o f private hospitals i n order to manage expenditures at hospital level. M O H restructuring law has been enacted in order to complete separation o f provision and regulatory functions of MOH. A Law on the Establishment o f the National Pharmaceutical and Medical Devices Agency has been enacted. - . The Public Hospital Unions Pilot Implementation Law has been enacted. Component 111. Budget and PFM Reform Continued satisfactory implementation of the PFMC Law Guidelines for performance based budgeting have been revised and at least 50 institutions have prepared their performance budget. I n line with the time table announced in 2006, all central government institutions and municipalities and SPAS with a population of more than 50,000 completed their first strategic plans. Five public sector accounting standards in conformity with IPSAS have been issued. Financial statements o f consolidated general government have been prepared on an accrual basis for 2007. The budgetary annex on tax expenditures has been expanded to include refined l i s t and cost estimate o f tax expenditures in 2009 budget proposal. Public expenditure and financial management reforms have been advanced through one or more measures such as adoption o f satisfactory TCA law or satisfactor) state aid law consistent with the government's program for E U , harmonization. Pilot implementation for the selected agencies for establishing an Operation and Maintenance (O&M) framework has 1 started and guidelines for asset maintenance for all public institutions have been finalized by SPO. The government has put in place a program of capacity enhancement for selected three pilot public institutions to improve project cycle management and particularly preparation o f sound feasibility studies for investment projects. Component IV. Public Administration and Governance Reform Ministry o f Justice has developed an implementation plan for the funding, housing and staffing o f the Regional Courts of Appeal including an implementation timetable A law establishing a Judicial I T Agency has been enacted, in order to integrate, operate, manage and maintain the UYAP network. The government has published a strategy for judicial reforms. A L a w on Mediation for civil disputes has been enacted. A new Civil Procedural Code has been enacted in order to reduce backlogs in courts. A satisfactory law on SPA and Municipality Revenues has been enacted and i s being implemented through secondary legislation. At least five more DAs have been established and are operational. including in the less developed regions. A national level regional development plan has been prepared. Regional level investment support offices have been established in at least two DAs. Annex 4 Page 4 of 4 Acquis on commercial matters approved by Parliament Performance management and monitoring system for Provincial Employment and Vocational Training Councils Annex 5 Page 1 of 3 ANNEX 5: SOCIAL SECURITY Fiscal developments 2000-08 1. The rapid GDP growth experienced in 2002-2007 period translated into significant expansion o f pension coverage among the active workers. In addition, the Government introduced important measures to increase coverage further, the most influential being two "amnesty" campaigns in 2006 and 2008 which allowed eligible workers to "buy" pension rights by paying contributions for previous years at beneficial terms. While projections o f pension system finances performed jointly by World Bank and the Undersecretariat o f Treasury in 2002 assumed 20 percent growth in private sector contributors to 2007, actual coverage growth came to 47 percent in contributors. immediately, Incentives to take Figure A6-1: Cumulative Growth in the Total Number of advantage o f these amnesties were Active Contributors and Beneficiaries (SSK, BK, ES Combined)'* sharpened common expectations o f 50% pension reforms that may be viewed to a threaten to reduce pensions, driving I 40y0 ! r) \ * * some people to retire immediately. This 1 30% 1 1 2oyo , fast rise in beneficiaries may thus / reduce the future flow o f new retirees, j ,o% / although more in-depth analysis at the / 0% ' 1 - . " - ," - - individual record level would be 1 _I_ _r 2003 2004 2005 2006 2007 2008 2009 required to estimate this effect. --- Growth ofActives Growth of Beneficiaries 3. Developments in pension- system revenues and expenditures have Source' ssl j 2 SSI refers to the unified Social Security Institute. SSK i s the main social security system; BK i s for self-employed workers; and ES i s the civil servants' system. Annex 5 Page 3 of 3 percent revenue-matchingintroduced with the 2008 pension law, and reimbursements for various payments that SSI makes on behalf o f the state. 6. I t i s instructive to compare the "structural" S S I deficit - defined as the difference between regular unsubsidized contribution revenues (including employer contributions for civil servants) and total spending on pensions and health - as presented in Figure A6-5. This demonstrates that the structural deficit has been increasing since January 2008, mirroring budget transfers to SSI, and showing a very different pattern from reported deficit. This i s primarily due to social security spending continuing to increase while increases in regular unsubsidized contribution revenue have stalled during the recession. Figure A6-5: Structural SSI Deficit, Reported SSI Deficit, and Budget Transfers -- ~ ___ 7,000 6,000 5,000 4,000 .- 5 0 3,000 2,000 1,000 0 . . " . ., . , . , I . - ., . , . .-- . - * .T . --/1 --- Structural Deficil Reported Deficit -BudgetTransfers -- - - _I -- _ _ I - -- - __ - - - -- -_ -_ - I I - _ - - _ I. lurce: SSI Annex 6 Page 1 of 4 ANNEX 6: THE ENHANCED CREDIT GUARANTEE FUND (CGF) Structure o the CGF until 2009 f 1. The idea o f a credit guarantee scheme in Turkey was initiated in 1991 with a motivation to ease the credit constraints faced by small and medium sized enterprises (SMEs). A partnership was later formed between TOBB, KOSGEB (Ministry ofJndustry and Trade General Directorate for Small and Medium Sized Enterprise Development), occupational groups "TOSYOV, TESK, MEKSA"54 Halkbank to realize this initiative. CGF became operational in early 1990s, but it and grew substantially in mid 2000s. By Figure A7-1: Guarantees Provided by the CGF as a Percentage 2009, the CGF had accumulated a - ~ ~ - -l.__lthe Total SME- ~ - VolumeS3 - of - - - ~ - - Loan ~ - total capital o f USD 55 million, ~ 250,000 m o 0.30% ~ 24 generating a guarantee volume o f 200,000 0 25% USD 160 million, and with a 0 20% potential" o f USD 275 million. $150,000 ' 0 15% Figure A7- 1 demonstrates the -0 2 100,000 0 10% increased capacity o f the CGF after a I n 3 t " , 50000 0 051% - capital injection from i t s shareholders 005% t k in 2007. 0 - * 000% 2005 2006 2007 2008 Real guarantee volume (2035 prices) (LHS) 2. Under the scheme, only loans - t Ratio of CGF cdlaterals / SME loans - with a maximum volume o f about I I USD 500,0OOs6 were collateralized, Source: CGF, BRSA with the amount o f support provided by the CGF ranging between 50-80 percent o f the loan, in return for a commission o f 1-2 percent o f the outstanding loan amount. In this setup, CGF worked with 27 financial institutions through individual protocols, and was the responsible body for undertaking the follow-up procedures o f non-performers o f i t s collateral share o f the loans. A new modelfor the CGF and its legal basis 3. The MTP57for 2010-2012 calls for a stronger and more influential CGF backed by the Undersecretariat o f Treasury. With the aim o f providing liquidity to the real sector, in June 2009, the Parliament approved the laws8amending the Law on Public Finance and Debt Managements9 and called for the provision o f guarantees totaling USD 650 million to the Credit Guarantee 53 Total loan volumes are calculated including cash and non-cash loans. End-year values were taken into account. 2005 SME loan volume uses an estimate based on the SME loan volume/Total loan volume in the following years. " TOSYOV: Small and.Medium Industry Owners and Managers Foundation o f Turkey TESK: Merchants and Artisans Confederation of Turkey MEKSA: Occupational Training and Small Industry Support Foundation o f Turkey '' Banks accepted guarantees up to 5 times the total capital o f CGF (Leverage multiplier is 5). " Maximum loan volume was T L 750,000. In this Annex, amounts legally declared in T L terms have been converted into US dollars using the interbank rates on dates which apply to associated legal arrangements. '' Official Gazette no. 27351 dated 09/16/2009. '* Law no. 5909 published on Official Gazette no. 27268, dated June 04/2009. 59 Law no. 4749. Annex 6 Page 2 o f 4 Fund.60 Immediately after the Council o f Ministers' decree on the principles o f the support, 20 banks became shareholders to the CGF, and i t s structure changed radically. 4. In this new setup, the capital o f the CGF has increased to TL 240 million (with the decision taken at the Annual Meeting held on 9 September, 2009). The CGF i s envisaged to undertake two separate functions: (i)Fund under Undersecretariat of Treasury support: After a period o f negotiations at ministerial level among the Undersecretariat o f Treasury, CGF (including each o f i t s existing shareholders) and banks (under the umbrella o f the Bankers' Association), all parties agreed o n the establishment o f a new credit guarantee system, for which the Undersecretariat o f Treasury support under L a w No. 4749 will remain in effect for 2 years following i t s establishment. A major reform in the new setup is, in addition to the endorsement o f the Undersecretariat o f Treasury for extending guarantees, the participation o f banks in the shareholding structure o f the CGF. Under this arrangement, 20 banks have now become shareholders in the CGF with equal shares (Table A7-l), quadrupling i t s paid-in capital and lending capacity. This gives these banks the right o f representation in the CGF Board o f Directors (with 2 members out o f 9). O f the remaining members, two are appointed by the Undersecretariat o f Treasury, two by KOSGEB and three by TOBB, with T O B B also appointing the chairman o f the Board. (ii) Traditional role of CGF: The CGF will carry on extending guarantees under the scheme explained above in Section I.Maximum volumes were increased from TI, 750,000 to TL 1,000,000 per SME and if the applicant i s a group company the maximum volume can be increased to TL 1,500,000, The number o f financial institutions CGF works with was increased from 27 to 36. For the utilization o f this fund, banks may send a request to the CGF for it to support the debtor under i t s own risk, [ Figure A7-2: Flow o f Funds in Guarantee Agreements abiding b y the previous protocols. - under Undersecretariat of Treasury Support Decisions over loan guarantees are taken by credit committees, which are composed o f five members, namely, the I Credit Commitee Accepts to provide I General Manager o f the CGF and one the guarantee representative from each o f (i) TOBB, (ii)KOSGEB, (iii) banks and (iv) occupational groups. -_._._ ... .... r-. pays back (I) I Debtor cannot pay .. ' ~ - pays back(ll) I... b a c k ' N P L (11) F I ... ..._ ~ I.,_I . . _ c 5. In the new fund structure, loan Followup procedures undertaken iy.'. .......-. the Bank Bank then returns part of ....':;;.. applications will be channeled through the proceeds from liquidated collateral tD CGF according t o its the 20 banks which participate in the initial contribution ( 1 1 ) ?Treasury pays I 65% giiarantee system. Other banks that have a protocol I amount to CGF (11) with the CGF may obtain guarantees through the traditional scheme. 1 Decisions o n loan guarantees will be made by "credit approval committees", composed o f five members, namely, the General Manager o f the CGF and one representative from each o f (i) 6oThe principles o f the reformed CGF are set out in the Council of Ministers Decision no. 200911 5 197, published in Official Gazette no. 27289, dated July 15, 2009. Annex 6 Page 3 of 4 TOBB, (ii) KOSGEB, (iii) banks and (iv) Undersecretariat o f Treasury. The representative o f the Undersecretariat o f Treasury i s empowered with a veto power over decisions related to the loans under i t s support. 6. For each "Treasury-supported" loan, 65 percent o f the risk will be borne b y the Undersecretariat o f Treasury and the remaining 35 percent will be collateralized, leaving no risk to the CGF. Loans with maturities less than 4 years and a maximum volume o f about USD 685,000 will be supported. As mentioned above, if the applicant i s a group company, the maximum volume can be increased to TL 1,500,000 (about USD 1 million). Ufilike in the traditional role o f the CGF, follow-up procedures will be fully undertaken by the associated banks, with a payback mechanism channeled from the Undersecretariat o f Treasury to the banks through the CGF. The banks will later transfer the collected collateral amount to the CGF, for it to pass on to the Undersecretariat o f Treasury. This support will be provided to beneficiaries in exchange for a "guarantee commission" (0.9 percent). 7. The timeline for the new system to be operational i s shown in Figure A7-3. 1Jun`OgJul'Og/II~/~Jul.111 Fi ure A7-3: New CGF Timeline I I I I I Law 110.4749 Publication of Protocols New CGF Closure amended to new signed between Scheme is extend shareholders CGF and operational Treasury and capital individual banks S'JPPortto Council of Ministers increase of CGF U n dersecretari at of SMEs decide on the in the Trade Treasury signs obtaining credit conditions and Registty protocol with CGF from banks via procedure for Gazette guarantees of Treasury support CGFs Conclusions 8. The new CGF scheme i s an important part o f the Government's efforts to tackle the consequences o f the global financial crisis. The approach o f the Undersecretariat o f Treasury to extending guarantees to f i r m s in hardship has proven effective in a number o f other countries during crises. Indeed, in Turkey, the scheme i s being put in place somewhat later than expected and could probably have had greater impact if adopted at an earlier stage o f the domestic credit crunch. 9. Some independent observers have raised concerns over the new CGF structure s t i l l requiring complementary collateral o f about 35 percent from beneficiary firms. This requirement will constrain access to credit for some SMEs, possibly limiting the program's impact on post- crisis recovery. Notwithstanding this criticism, a collateral rate o f 35 percent i s reasonable in international comparison to avoid misuse o f funds and minimize the N P L ratio, in a period where the country i s in need o f sjrict control over public expenditures. The procedures related to the Annex 6 Page 4 of 4 establishment o f the new CGF scheme have been undertaken following a fully transparent legal process, in line with international good practices. Table A7-1: Shareholding Structure of CGF Shareholder Participation in Participation in (Total capital = USD 165 million) Reformed CGF Previous Setting TOBB 33.20% 5 l.O0?4O KOSGEB 33.20% 48.50% TESK 0.30% 0.30% TOSYOV 0.0 1Yo 0.0 1Yo MEKSA 0.01% 0.01% Halkbank 1.70% 0.0 1Yo Akbank 1.70% 0.00% Albaraka Turk Participation Bank 1.70% 0.00% Asya Participation Bank 1 ,70% 0.00% Denizbank 1.70% 0.00% Eurobank Tekfen 1.70% 0.00% Finansbank 1.70% 0.00% Fortis Bank 1.70% 0.00% HSBC 1.70% 0.00% ING Bank 1.70% 0.00% Kuveyt Turk Participation Bank I.70% 0.00% Sekerbank 1.70% 0.00% TEB 1.70% 0.00% Ziraat Bank 1 .To% 0.00% Turkiye Finans Participation Bank 1.70% 0.00% Garanti Bank 1.70% 0.00% EXIM Bank 1.70% 0.00% Isbank 1.70% 0.00% Vakifbank 1.70% 0.00% Yani Kredi Bank 1.70% 0.00% Source: CGF MAP SECTION TU R K E Y PROVINCE CAPITALS* NATIONAL CAPITAL RIVERS TURKEY MAIN ROADS RAILROADS PROVINCE BOUNDARIES* This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information INTERNATIONAL BOUNDARIES shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. *Province names are the same as their capitals. 26°E 28°E 30°E 32°E 34°E 36°E 38°E R US S I AN F E DE R AT I ON US AN DE ON B U L G ARIA ULG A R I A Blac k Sea 0 50 100 150 200 Kilometers To To Burgas 42°N Kurdzhali 0 50 100 150 Miles GEORGI GE OR GI A 42°N Edirne Sinop Kirklareli To Istanbul Strait Bartin Batumi (Bosphorus) Zonguldak Ku zey CE a Tekirdag Samsun Artvin Kur Istanbul Kastamonou Ana To EE To Komatini Sea of Kocaeli (Izmit) Düzce Karabük Devr ez dolu Dag Ordu Trabzon Ardahan Kirovakan AZER- GR lari Rize Marmara Yalova Sakarya Giresun BAIJAN Bolu il ruh Kars (Adapazari) Çankiri Kiz Amasya Ço ARMENIA Çorum Kelki 40°N Çanakkale Bilecik t Gümüshane 40°N Çanakkale Bursa Tokat Bayburt Ara s Agri Dagi Strait Sakar ya (5166 m) (Dardanelles) erek Igdir Balikesir Eskisehir Cek Agri ANKARA Erzincan Erzurum Kirikkale Yozgat Sivas t Kütahya Fira To Maku AZER. zil Ki Kirsehir Tunceli Afyon Bingöl Mus Izmir Manisa Usak Tuz Gölü Nevsehir Elazig Mu ra t Lake Van Van To Salmas ISLAMIC Aksehir 38°N Gölü Aksaray Kayseri Bitlis REP. OF Malatya Aydin Hoyran Gölü Nigde Diyarbakir Siirt IRAN Denizli Batman To Baysehir Konya Adiyaman Oroumieh Burdur Gölü Kahraman Tigris Hakkari Isparta Maras Sirnak an yh n Mugla Ce ates Mardin yha r Euph To Se Dahuk GR Gö Karaman Osmaniye Gaziantep Sanliurfa To Damir Antalya ks Kabu To ri EE u Adana E Gulf of g la Icel Kilis Al Hasakah C IBRD 33501R2 Antalya s Da (Mersin) I R AQ AQ o To r 36°N To Hatay (Antakya) Aleppo SYRIAN AB SY RIA N A R A B JULY 2008 Mediterranean Sea 28°E 30°E 32°E 34°E To Ladhiqiyah REPUBL I C REPUB L 42°E 44°E