Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 10852

PROJECT PERFORMANCE AUDIT REPORT

TURKEY

ISTANBUL SEWERAGE PROJECT(LOAN 2159-TU)

JUNE 29, 1992

Operations Evaluation Department

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EgULENT

Currency Unit - Turkish Lira (TL)

December 1981 - TL 130 - US$1.00 (SAR)December 1988 - TL 1790 - US$1.00

GLOSSARY OF ACRONYMS

ISKI - Istanbul Water Supply and Sewerage General Dire-DSI - State Hydraulic WorksIB - Iller Bankasi (Bank of the Provinces)ISI - Istanbul Water Authority

FISCAL eer

January 1 -December 31

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington. D.C. 20433U.S A.

of Director-General-- tinns Evaluation

June 29, 1992

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Performance Audit Report on TurkeyIstanbul Sewerage Project(Loan 2159-TU)

Attached, for information, is a copy of a report entitled "ProjectPerformance Audit Report on Turkey - Istanbul Sewerage Project (Loan 2159-TU)"prepared by the Operations Evaluation Department.

Attachment

This document has a restricted distribution and may be used by recipients only in the performanceof their officiit duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

PROJECT PERFORMANCE AUDIT REPORT

TURKEY

ISTANBUL SEWERAGE PROJECT (LOAN 2159-TU)

TABLE OF CONTENTS

Page No.

Preface ............................................................. iBasic Data Sheet....................... .. ........... .............. ii

Evaluation Summary ...................... iv

I. PROJECT qUMMARy.. ............................ ... 1

A. Background.............................................. 1B. Bank Involvement........................................... 3C. The Projects and its Objectives..o......................... 3D. Project Implementation..................................... 7E. Project Costs and Disbursements............................ 8F. Procurement................................................ 11G. Performance of Contractors................................. 12H. Institutional Developments................................ 12I. Operational Aspects....................................... 12J. Sustainability............................................. 13

II. ISKI's FINANCIAL PERFORMANCE............... .................. 13

A. Compounded Growth Rates of Financial Indicators......o.... 13B. Financial Plan of ISKI................................... 14C. Self-financing of Capital Investments................ 16D. Foreign Exchange Exposure............................... 17E. Government Assistance..................................... 18F. Accounts Receivable..................... . ..... ...... 19G. Financial Covenant..................... ......... .20

H. Current Ratioo.......................................... 21I. Return on Assets.......................................... 21J. Return on Equity................................ . 22K. Debt-equity Ratio...*o**......... .. ......... . 22L. ISKI's Financial Policy......... ooooo...o..*. ooooo. .. 22M. Accounting and Audit.....*................. . . . ...... . 23N. Maturity, Grace Period and Exchange Risk of the Bank Loan. 230. Environmental Aspects.............. .............. 24P. Economic Assessment........... ..... ............ ..... 25

Q. The Role of the Bank ................ 26

III. CONCLUSIONS AND LESSONS.......... ............... . ........... 27

Annex 1

Comments from the Borrower .................................. 30

This document has a restricted distribution and may be used by recipients only in the performanceof their otficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

PROJECT PERFORMANCE AUDIT REPORT

TURKEY

ISTANBUL SEWERAGE PROJECT (LOAN 2159-TU)

PREFACE

1. This report presents the results of the Performance Audit of theIstanbul Sewerage Project for which Loan 2159-TU for US$ 88.1 million wasapproved on May 27, 1982. The Loan was made to the Istanbul Water Supply andSewerage General Directorate (ISKI), the Guarantor being the Government ofTurkey.

2. The Loan Agreement was signed on May 28, 1982 and the loan becameeffective on February 23, 1983 some six month after the originally planned date.The loan was closed on sch-dule on December 31, 1988 but the account was keptopen until September 30, 1989 at which time the amount of US$ 54,000 wascanceled.

3. The Project Performance Audit Report (PPAR) was prepared by theOperations Evaluation Department. The Parts I and III of the Project CompletionReport (PCR) was prepared by the Europe, Middle East and North Africa Region andPart II by the Borrower. The PCR was forwarded to the Board for information onNovember 8, 1991. OED has reviewed the PCR, the Staff Appraisal and PresidentsReport, the legal documents and Bank files and the transcript of the meeting ofthe Executive Directors at which the loan was approved and discussed the projectwith the Bank staff involved. An OED mission visited Turkey in November 1991 anddiscussed the project experience with officials of the borrower and otherinvolved bodies. The cooperation and assistance of these officials is gratefullyacknowledged.

4. The Audit found that the PCR gave a concise and adequate account ofthe project experience and has drawn appropriate conclusions. The PPAR furtheranalyzed certain aspects of the PCR's findings and provides independent commentsand conclusions on various aspecto of the project.

5. The draft PPAR was sent to the government and the borrower forcomments. The comments received from the Government are reproduced asAnnex 1 to the PPAR.

ii

PROJECT PERFORMANCE AUDIT REPORT

TURKEY

ISTANBUL SEWERAGE PROJECT(LOAN 2159-TU)

BASIC DATA SHEET

KEY PROJECT DATA

Actual or Actual as %Appraisal Current of Appraisal

Item Expectation Estimate Estimate

Total Project Cost (US$ m) 222.1 200.7 90.36Loan Amount (US$ m) 88.1 88.05 99.94Economic Rate of Return N/A N/A N/AInstitutional Performance: Good

CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS

Appraisal Estimate (US$M) 88.1Actual (US$M) 88.05Actual as % of Appraisal (%) 99.94Date of Final Disbursement: September 19, 1989

PROJECT DATES

Orisinal Actual

Identification 1977Preparation 1978Appraisal 12/81Negotiations 04/82Board Approval 05/27/82Loan Signature 05/28/82Loan Effectiveness 08/82 02/83Project Completion 12/87 12/90Loan Closing 12/88 12/88

iii

STAFF INPUTS(staffweeks)

FY72 Ft4 FY75 FY76 FY77 FY78 FY7. FY80 FY81 FY82 FY83 FY84 FY85 FY86 FY87

Preappraisat 1.2 1.36 27.43 5.76 5.62 2.99 8.25 28.87 40.12 6.45AppraisaL - - - - - 26.24 -Negotiation - - - - - - - 5.8Supervision - - - - - 1.81 16.94 19.03 12.19 24.o' 13.81Other - 2.42 2.43 1.28 6.78 1.63 0.11 0.74 2.3 8.77 - - - -

FY88 FY89 FY90 FY91 TntaL

Preappraisat - - - - 128.05AppraisaL - - - - 26.24Negotiation - - - - 5.8Supervision 3.03 1.9 2.43 7.65 103.75Other - - 26.56

MISSION DATA

Date No. of No. ofMonth/Year Days Persons

Supervision 07/82 5 2Supervision 12/82 9 2Supervision 06/83 9 2Supervision 09/83 9 2Supervision 03/84 5 2Supervision 05/84 10 3Supervision 12/84 8 2Supervision 02/85 5 1Supervision 07/85 5 1Supervision 09-10/85 8 2Supervision 05/86 5 2Supervision 07/86 4 2Supervision 02/88 5 2Supervision 04/88 5 2Supervision 07/88 3 2Supervision 09/88 6 2Supervision 12/88 3 2Supervision 06/89 9 2

iv

OTHER PROJECT DATA

Borrower Government of Turkey

ExecutingAgencies: IstAnbul Water Suppi 7 and Sewerage General Directorate (ISKI).

V

PROJECT PERFORMANCE AUDIT REPORT

TURKEY

ISTANBUL SEWERAGE PROJECT (LOAN 2159-TU)

EVALUATION SUMMARY

Background water born diseases were annualoccurrences with high incidenct- of

i. At the time of appra..al (1981) death (PPAR pars. 4-5).Turkey's population was about 45million of which some 56% lived it iii. A major national effort tourban areas. The average growth rate improve service levels was launchedwas 2.5% but much higher at 4.1% in in 1978 with the "Conference onurban areas. Istanbul and Ankara, Planning and Development oC Communitythe two largest cities had population Water Supply and Sanitation."of 3.2 and 1.9 million respectively. Ambitious '.argets were set forThe provision of water supply and achieving 100% water supply coveragesewerage services traditionally was by 1990 and sewerage by year 2000.the responsibility of municipalities The impressive progress toward theseand village councils. As these targets were shown by the statisticsusually lacked adequate human and of 1989, indicating water supplyfinancial resources the actual design service levels at 97.7% and sewerageand implementation of service at 56%. The Conference also proposedfacilities were gradually absorbed by improved sector organizationthree major government agencies arrangements. The first major stepnamely the State Hydraulic Works in this direction came with the(DSI), Iller Bankasi (Bank of the creation, in 1981, of the greaterProvinces) and the Directorate for municipal areas and with it theRoads, Water and Electricity (YSA) creation of the autonomous entity of(PPAR paras. 2-3). the Istanbul Water Supply and

Sewerage General Directorate (ISKI).ii. The 1979 sector statistics The new agency (ies) were to becomeindicated that about 63% of the total financially self supporting, throughpopulation had adequate water the charging of appropriate tariffssupplies. Remarkably, service levels and replace the old system of sectorwere about equal in urban and rural investments financed by governmentareas. Sever systems existed in the grant and low interest loans (PPARlarger cities only serving only about paras 5-7).4.4 million people but none of thesesystems had treatment facilities. Bank InvolvementThe indiscriminate discharge ofsewage into local receiving waters iv. Bank involvement started in thecreated unacceptable levels of late 1960a leading to the approval ofpollution and sanitary conditions, Loan 844-TU in June 1972 for IS$37particularly in the densely million for the augmentation ofpopulated, low income areas were Istanbul's water sources. The projecthighly unsatisfactory. Outbreaks of was completed with a six years delay

vi

and substantial cost increases, vii. Preparation of the project hadlargely due to design changes, a long histor7 from the early 1970s

procurement delays and rapid to appraisal in 1981. Much of thisinflation. OED's PPAR (Report No. was taken up by the revision and4853) was issued in December 1983. refinement of the Master Plan but itThe project achieved its physical has also taken several years for theobjectives 'ut it failed to improve Turkish government to create anthe institutional and financial institutional form, ISKI, which wassituation. Nevertheless the efforts acceptable to the Bank.made under this project contributedto the eventual creation of ISKI. viii. Physically the projectThe revision of Istanbul's sewerage consisted of construction of lateralMaster Plan was assisted under IDA sewers, collectors and interceptors,Credit 324-TU (US$2.3 million) pre-treatment works, pumpinggranted for studies for urban facilities and a submarine outfall.developments in Istanbul (PPAR paras. Consulting services, laboratory and8-9). maintenance equipment and rraining

facilities were also provided for.The Proiect and its Obiectives It covered the most densely populated

area of Istanbul and its principalv. The rapid growth of Istanbul impact was to be the prevention ofafter the post-war years resulted in discharge of waste waters on thelarge squatter settlements with south shore of the Golden Horninadequate and ill maintained water and the North-East shore of the Seasupply and, particularly, sewera&e of Marmara (PPAR paras. 14-18).services. All waste waters weredischarged, directly or indirectly ix. The fundamental premise of theinto the main receiving waters, the disposal aspect of the Master PlanGolden Horn, the Sea of Marmara and was the heavily researched conceptthe Bosphorus. No waste water that the strong bottom currents oftreatment was provided. The shallow the Bosphorus would carry pre-treatedand relatively static waters of the sewage to the anaerobic depth of theGolden Horn became anaerobic at the Black Sea without environmentalupper end and the popular basing damage. Effluent discharged into thebeaches of the Sea of Marmara were Sea of Marmara was to receive fullhighly contaminated. The Bosphorus treatment. In the late stages ofwith its strong currents was less project implementation theaffected but its north to south effectiveness of the "Bosphorussurface currents carried additional current" theory was brought intopollution to the Sea of Marmara. seri,us question, on the grounds that

th? lower and upper currents do mixvi. The desire to improve these and significant volumes of sewageconditions essentially set the would be carried back into the Sea ofobjectives of the project which aImed Marmara. An intensive study toat the rehabilitation and extension examine the issue was lauichizd andof secondary sewer system, this is expected to be completed ininterception of all discharges into 1993. However, this issue may bethe Golden Horn, provision of rendered somewhat academic by thesuitable disposal systems and the decision of the Turkish environmentalimprovement of the institutional and authorities to prohibit the dischargefinancial capacities of ISKI (PPAR of waste waters into any receivingparas. 10-13). waters without full treatment. This

vii

decision has major implications for US Dollar, the refinement of designthe future sewerage developments in during construction and the efticientIstanbul and is discussed later in project management. The financingthis report (PPAR paras. 19-21). plan of the project also changed

significantly. Reduction ofImplementation government contributions required

ISKI to increase its internallyx. The project had a late start generated contribution from thedue to delayed effectiveness of the estimated 1% to 46%. DisbursementsBank loan and further, early, delays of the Bank loan lagged behind in theoccurred due to the initial slow early years due to the delaysaward of major contracts. Once the mentioned, caught up by the fifthworks got under way, implementation year and the loan was closed onwas rapid and efficient resulting in schedule with the eventualhigh quality finish. This is cancellation of US$ 54,000 (PPARparticularly commendable as paras. 26-28).substantial design and alignmentchanges were required during Procurement and Contractorsconstruction largely due to thecongested areas on the route of the xii. The procurement processlarge interceptors and the need to presented no problems. Whileavoid damage to historical buildings. contract awards were delayed in tieFurther changes were brought on by initial stages,, with the growth ofthe addition of the North Halic ISKI's autonomy matters improvedinterceptor which required the considerably. All consultants andamending of the Loan Agreement in contractors performed satisfactorily1985. The originally planned (PPAR paras. 29-30).components of the project werecompleted about one year behind Institutional Aspectsschedule and the loan was closed, asscheduled, on December 31, 1988 (PPAR xiii. The lengthy process leading to

paras. 22-25). the creatiun of ISKI was followed bya remarkable rate of development

Project Costs and Disbursements notwithstanding the magnitude of itstask. At the same time as ISKI took

xi. The original estimated cost of over the management of Istanbul's

the project was US$222 million complex water supply and existingcompared to the final cost of sewer system it also undertook theUS$231.7 million, a 4% apparent implementation of the largest

increase. This small difference infrastructure project in the city.hides considerable variations in the Technical progress was eminentlycost of individual components as successful but the management of

detailed in the PCR and this report. financial affairs was much harder to

While the cost of some components get under control. Particular

were substantially overestimated at problems wL-- faced in billing andappraisal, major, overall, savings collection for which several

permitted considerable additional alternative arrangements were triedworks to be carried out. The main including a semi-private collection

contributing factors were the agency, ultimately, successfully

competitive bids of Turkish (PPAR paras. 31-33).

contractors, the devaluation of theTurkish lira, the fluctuation of the

viii

Operations and SustaLnability whose outcome is uncertain (PPARpara. 57).

xiv. Operations and maintenance ofthe water supply facilities is xviii. The Bank Loan contributed tosatisfactory. ISKI's operating the exchange risk build up as well ascapacity for the sewer system, to the mismatch of maturities betweenparticularly of the proposed advanced borrowings and the economic life oftreatment facilities is yet to be fixed assets (PPAR paras. 59-60).proved but its present performancegives no reason for doubt. A much Environmental Aspectsmore severe test will face ISKI'sfinancial management in the funding xix. Although by nature and designof the planned major investments and the project was a straight forwardthe continued reliable maintenance of urban infra3tructure investment,the expanded facilities. However, in there is no doubt that the principalthe light of the findinge of this motive force for it was environmentalreview. tht %udit sez no reason for protection and improvement. Whileconcern regarding the sustainability concern for public health was also aof either the physical facilities or strong incentive, the formidablethe benefits of the project (PPAR public and government support wasparas. 34-35). "bought" by the promise of clearing

up the Golden Horn and the shores ofFinancial Aspects the Sea of Marmara.

xv. ISKI has shown a very rapid xx. The technical solutions for thegrowth of its balance sheet, partly collection and interception of sewagedue to the large investments carried flows were standard and involve onlyout in the 1980s and partly to the construction difficulties in thehigh rate oi inflation. The congested historical parts of therevaluation of its fixed assets in city. Prevailing scientific andoperation allowed ISKI to justify engineering views also proposedl.Arge tariff increases in recent apparently satisfactory solutions foryears but collection is lagging sewage disposal based on the

behind billings and the ensuing transporting and assimilativearrears are threatening ISKI's credit capacities of the Bosphorus. In theworthiness at the time when another late stages of the project not onlyambitious investment program is were these thsories brought intoplanned for the 1990s (PPAR paras. question but the evolving36-47). environmental awareness of the

relevant Turkish authorities raisedxvi. Although ISKI is not facing the required disposal standards intoliquidity problems the financial all receiving waters to fully treatedindicators based on cash flows have effluent.been negative since 1987. The debt-equity ratio has been between 1 and xxi. The implications of the latter2:1 but the Revaluation Fund which decision are very large. It not onlyhas no cash equivalent makes up most requires the construction of large,of the equity (PPAR paras. 53-56). complex, mechanical and/or biological

treatment plants with associated

xvii. ISKI's financial policy has operational difficulties but, thechanged since 1987 which shows the problems of locating suitable sitesutility being in a transitory period for these plants, due to Istanbul's

ix

topography, would require lonp and The Role of the Bankaxpensive pipelines and tunnels. Thetechnical feasibility of these xxiv. There is every indication thatsolutions is not in question but the Bank's more than twenty yeartheir affordable phasing and funding sustained relationship with Istanbulwill severely test ISKI's capacities and, increasingly, the rest of Turkeyas well as the Bank's guiding hand. was effective and beneficial. In the

earlier years the primary targets ofxxii. Another of ISKI's policies Bank advice were the technical andwhich deserves particular note is the institutional issues with particulardecision to develop, in the future, credit due for helping to createwater supply -and sewerage services ISKI. Consistently competent Bankcompletely in parallel. The findings staff in adequate strength was,of a recent OED study of some 130 undoubtedly a major factor in theBank funded water supply and sewerage effectiveness of the assistance.projects confirm that this is, While sound technical advice willprobably, a unique policy in continue to be required in view ofdeveloping countries. IF fully the ever increasing complexity ofimplementec. it wi'_l not only ensure future developments, the Bank shouldthe full public health impact of increase its emphasis on furtherproviding safe water supply but, in improving ISKI's financial managementview of the service level target and and performance if the monumentalachievements mentioned earlier, it planned investments are to become anwill also ensure equitable service to affordable reality (PPAR paras.72-the poor (PPAR paras.61-68) 73).

Economic Assessment Conclusions and Lessons

xxiii. The benefits resulting xxv. The project achieved all itsfrom the project to public health, physical objectives. Achievement of

increased property values, the the financial viability objecti.ve wasfishing industry, public beaches and made less convincing by the

tourism could not be quantified. The fluctuation evident in some years.SAR calculated the Average (long run)Incremental Cost (ACI) of the project xxvi. After initial delays, due toinvestments, at the time, as a guide highly bureaucratized procedures

for a future tariff study. The PCR project implementation proceeded

recalculated these values using the efficiently. Substantial cost

same methodology but with revised savings materialized on the originalcost and benefit streams. The components partly due to the

resulting ACI, for combined water and competitive performance of Turkish

sewerage services, of 0.65 US$/m3 of contractors and partly towater consumed is less than the 1990 overestimation of the cost of some

average tariff charged by ISKI at components. These savings permitted

0.80 US$/m3 confirming that ISKI the execution of substantial

charges economic prices for its additional works. The quality ofservices. Because of the progressive finished works was high. There were

tariff structure the tariffs are no procurement problems.

affordable to the lowest income groupat an estimated 3% of household xxvii. The beneficial impact of the

income (PPAR paras. 69-71). project is already visible on thequality of water in the Golden Horn

x

and the environmental improvementsare enhanced by the municipality'scity beautification works in the samearea, benefiting both the local andtourist population. The extensivepublic relation work carried out byISKI and the Municipality undoubtedlycontributed to the acceptance by thepopulation of Istanbul of the projectand the corresponding tariffincreases (PPAR paras. 74-76).

xxviii. The principal lessons to bedrawn from this project are thefollowing: (i) sewerage/wastedisposal projects need to be plannedwith not just the consideration ofindividual service improvements butwith the full demonstration of theoverall environmental benefits to thecommunity as a whole and theinforming of the beneficiariesaccordingly if the public is toaccept the cost; (ii) a wellorganized institution with adequateautonomy is essential for successfulimplementation and the Bank is welljustified in waiting for this tomaterialize before proceeding with aproject.

PROJECT PERFORMANCE AUDIT REPORT

TURKEY

ISTANBUL SEWERAGE PROJECT (LOAN 2159-TU)

I. PROJECT SUMMARY

A. Background

1. Some 97% of Turkey's 780,000 km2 territory lies in Asia and 3% in Europe.The country's most developed region is its coastal area which also receives thehighest level of precipitation exceeding 600 mm per annum. The arid plateau ofcentral Anatolia receives around 300 mm and it is less developed. Themountainous Eastern Anatolia with its harsh climate is the least settled anddeveloped region of the country.

2. The country's population in 1980, (appraisal 1981) was about 45 million ofwhich about 24 million (56%) lived in urban areas. In the preceding decade theaverage population growth rate was 2.5% - 4.1% in urban and 0.3% in rural areas.Istanbul and the capital city, Ankara, had populations of 3.2 and 1.9 millionrespectively, together representing about 21% of the total urban population.

3. Traditionally the provision of water supply and sanitation services hasbeen the responsibility of municipalities and village councils. However, withthe exception of a few large cities, the local bodies generally lacked the humanand financial resources to provide these services efficiently and, over time, theplanning, design and construction of new facilities were gradually absorbed bythree central government agencies which were, originally, created as advisory andfinancing agencies. These were:

The State Hydraulic Works (DSI) of the Ministry of Power and Naturalresources was responsible for national water resources and watersupply development in cities exceeding 100,000 population;

Iller Bankasi (Bank of the Provinces), an autonomous corporationresponsible for water supply in the remaining towns and seweragedevelopments in all urban areas except Istanbul. Iller Bankasi'sshareholders were the municipalities;

Directorate for Roads, Water and Electricity (YSA) in the Ministryof Rural Affairs and Cooperatives was responsible for rural programsexcluding rural sanitation for which no agency carried formalresponsibility.

4. Available statistics for 1979 indicated that some 63% of the total

population had adequate water supplies, 18% were inadequately served and 19% hadno access to public water supplies. Remarkably, the service levels were about

2

equal in urban and rural areas. Sewer systems existed only in the major cities,serving only about 4.4 million (18%) people and none of the systems had treatmentfacilities. Indiscriminate discharge of liquid and solid wastes resulted in theserious degradation of rivers and coastal waters. Sanitary conditions,particularly in densely populated, low income, urban areas were highlyunsatisfactory. These conditions inevitably contributed to the frequentcontamination of drinking water supplies; of water samples tested in 1977, 38%were found bacteriologically unsatisfactory. The outbreak of water born diseaseswas an annual occurrence. In 1977 the recorded cases excaaded 15,000 with 143deaths.

5. A major effort to improve the service levels in the country was launchedwith the organizing, in 1978, the "Conference on Planning and Development ofCommunity Water Supply and Sanitation." The Conference set the following servicelevel targets:

i) by 1990 the total urban and rural population would be servedwith adequate water supply;

ii) by 1990 the rural population would be provided withsatisfactory excreta disposal facilities; and

iii) by year 2000 all urban populations would be served bysatisfactory sewage disposal facilities.

These were ambitious targets yet, as of 1989 (latest statistics) the followingremarkable achievements are reported:

Urban Population served with water = 97.7%Rural Population served with water - 85.0%Total Population served with sewers - 56.0%Total Population served with septic tanks - 29.0%

6. The Conference also proposed alternative sector organizational arrangementsto eliminate the existing gaps and overlaps in responsibilities and increaseoverall efficiency. However, major changes did not take place until 1981following the creation of the greater municipal areas. Under the relevantExecutive Order, the water supply and sewerage services of small municipalitieswere merged with the nearest large urban center. In the case of Istanbul, 24surrounding municipalities were merged with the services of ISI, Istanbul's semi-autonomous Water Supply Authority. In the same year, ISI was "converted" intothe Istanbul Water Supply and Sewerage General Directorate (ISKI), an autonomousentity responsible for the planning, design, construction and operation of allwater supply and sewerage services in Grater Istanbul with the right to set waterand sewerage charges without outside approval.

7. In the past, sector investments were generally financed by governmentgrants or low interest loans (which were seldom repaid). Under the newarrangements the Government's intentions were to enable the sector entities tobecome financially self supporting through the charging of appropriate tariffsand they were expected to finance a gradually increasing proportion of theirinvestments by internally generated funds.

3

B. Bank Involvement

8. The Bank's first involvement in the sector was the approval of Loan 844-TUon June 30, 1972 for US$ 37 million to help finance the Istanbul Water SupplyProject. The primary objectives of this project were the augmentation ofIstanbul's water supply which, at the time, could only meet 60% of the area'swater demand and major improvements in the organization, management and financialperformance of ISI. The project suffered somes 6 years delay in completion duelargely to design changes, procurement delays and institutional inertia. Theproject was completed in December 1982 and OED's PPAR was issued in December1983 (Report No 4853). Project costs have increased from the appraisal estimatesof US$ 85 million to US$ 159 million due to rapid inflation, delays and designchanges. The physical targets were achieved in that ISI's production capacitieswere increased from 115Mm3 to 315Mm3 by 1981. However, water sales lagged farbehind, mainly due to the slow expansion of the distribution system and theincrease rather than the projected decrease of the level of unaccounted for water(43% v. 26%). The project also failed to meet its institutional and financialobjectives. However, the overlapping efforts of this project and the preparatorywork for the Istanbul Sewerage Project did contribute to convincing theGovernment of the need for major changes in the sector which, eventually, broughtabout the creation of ISKI in 1981 and thereby laid the groundwork for thesubsequent significant improvements in all areas of the provision of water andsewerage services in Greater Istanbul.

9. Simultaneously with the water supply project, IDA Credit 324-TU wasapproved for US$2.3 million for the preparation of master plans and relatedstudies for urban development programs in Istanbul. Under this credit,assistance was provided for the review and revision of the Master Plan forIstanbul Sewerage. While this small project was also much delayed and waslargely unproductive, the revised Sewerage Master Plan provided the foundationfor the Istanbul Sewerage Project (Loan 2159-TU) the performance of which is thesubject of this review.

C. The Proiect and its Obiectives

10. Istanbul, the capital of the former Byzantine and Ottoman Empires and oneof the oldest historical cities in the world, is the foremost cultural,industrial and economic center of Turkey. The population of Greater Istanbul,at the time of appraisal, was estimated at 3.73 million, projected to increaseto 7.84 million by the year 2000. The city' industrial growth drew a heavyimmigration of workers and resulted in the proliferation of large squattersettlements. The overall growth rate of the city, in 1980, was recorded as 4.1%projected to decline to about 2.6% by 2000.

11. The rapid growth of the city overtaxed both the water supply and wastedisposal services which, particularly in the densely populated, low income, areasresulted in unsatisfactory maintenance of the old, and frequently poorlyconstructed, sewer lines and holding or septic tanks. All sewage was dischargedinto the nearest receiving waters, usually at the shore line, causing heavypollution. No waste water treatment was provided.

4

12. The topography of the Greater Istanbul area naturally divides it into 14drainage zones. About 90% of the effluent went into the Golden Horn and the Seaof Marmara and 10% into the Bosphorus. The water flows from the Aegean Seathrough the Dardanelles into the Sea of Marmara and the Bosphorus to the BlackSea as a bottom current. A surface current of lower salinity water flows backfrom the Black Sea to the Aegean Sea. While the deep, strong currents of theBosphorus provides effective dispersion of effluent, the weaker surface currentsof the Golden Horn (particularly in its inner portions) and the Bosphorus carrya heavy pollution load to the Sea of Marmara, resulting in unacceptable shorepollution inhibiting leisure use and tourist potentials. Water samples at theSea of Marmara basing beaches frequently showed unacceptable levels of coliformbacteria content. Testing of ocean bottom sediments showed high concentrationof lead and other heavy metals in the upper Golden Horn and chromium in theMarmara near the outlets from tanneries.

13. The conditions described above essentially set the objectives of theproject which were straight forward and appropriate. They are set out in theAppraisal Report as follows:

(i) to extend and improve the coverage of sewerage services byrehabilit&tion and extension of the senondary sewer system tocover 60% of the population of which some 70% would be lowincome people;

(ii) to improve environmental conditions by reducing the amount ofsewage discharged at the shorelines of the Golden Horn and theSea of Marmara by the construction of an interceptor system;

(iii) to provide satisfactory sewage disposal by construction ofpre-treatment facilities and a deep submarine outfall main;

(iv) to improve the institutional capacity in project preparationand implementation, operation and maintenance and financialmanagement by the development of a suitable organization; and

(v) to assure financial self-sufficiency by the introduction ofadequate water supply and sewerage charges.

A broader objective was the development of country wide procedures forpollution control.

14. The preparation of the project had a long history. The first,comprehensive Master Plan for solving Istanbul's sewerage problems was preparedin 1971. Over subsequent years this was repeatedly reviewed and revised and, tothis day, continues to be changed in the light of additional information andsharpened environmental considerations. Focused Bank interest -Ln a sewerageproject is first recorded in 1972 with financing of related studies included inCredit 324-TU, approved for funding the preparation of an urban developmentmaster plan for Greater Istanbul.

15. All variations of the sewerage Master Plan were based on the concept ofdischarging sewage effluent, treated to various degrees, into the Bosphorus

5

and/or the Sea of Marmara through deep or shallow submarine outfalls. The 1983version of the Master Plan recommended 12 separate sewer systems, eightdischarging into the Bosphorus and four into the Sea of Marmara. Prevailingscientific and engineering opinions held that pretreated sewage (removal of grit,oils and floatables) can be discharged into the bottom currents of the Bosphorusthrough deep outfalls where high degree of initial dilution (1:100) will beachieved and all residuals will be safely carried by these currents to the BlackSea, the "world's largest anaerobic digester". As the assimilative capacity ofthe Sea of Marmara was considered much more limited, discharge, deep or shallow,was considered to require higher degree of treatment to achieve environmentallyacceptable disposal of effluent. The Golden Horn was to receive no discharge inany form. The above principles and the topographic delineation of the drainagebasins effectively defined the proposed layout and locations of the interceptorand outfall network to be constructed (in stages) for the Greater Istanbul area.

16. Although the PCR gives the date of "identification" for the project as1977, file records of activities go back to 1972. With appraisal taking placein December 1981, the project had an exceedingly long "preparation" period. Muchof this was occupied by the Bank waiting for revision of studies, decision withregard to priority of components to be constructed and, above all, for theTurkish government to enact legislations creating the institutional format whichsatisfied the Bank.

17. From this process emerged ISKI, the borrowing (with government guarantee)and implementing agency and the Project, as eventually appraised. In this formit covered Istanbul's most densely populated area from the south shore of theGolden Horn to the western end of the medieval walled city encompassing much ofthe Yenikapi-Kabatas drainage basin. Its principal environmental impact was tobe removing sewage discharges from the south shore of the Golden Horn and thenorth-eastern shore of the Sea of Marmara. This impact was further enhanced withthe parallel "beautification" efforts by the city in these areas with therelocation of the proliferating small and medium size industries which alsorepresented major point pollution along the shore lines.

18. The project consisted of the following major components:

(i) laterals and collectors (285 km)(ii) interceptors (26 km)(iii) tunnel (2.4 km)(iv) pre-treatment works and pumping stations(v) pumping mains (2.3 km(vi) submarine outfall (2.0 km)(vii) consulting services, industrial waste water and oceanographic

surveys, laboratory facilities, operation and maintenanceequipment and establishment of a regional training center.

As Istanbul is rich in historical buildings, the proposed alignment, designand method of construction of each facility was subject to review by the TurkishArcheological Commission. The design and method of construction of the largeinterceptors was further influenced by their potential effect on traffic flows

within the already congested city. As these criteria essentially excluded the

possibility of future duplication of the interceptors and the outfall, their

6

hydraulic design was for maximum capacity as dictated by the projected saturationdevelopment of the areas served. On this basis the design flows for theinterceptors along the Golden Horn and the Sea of Marmara were 5.5 and 6.5m3/secrespectively and for the pretreatment plant and the sea outfall 12.0 m3/sec.

19. As mentioned above, the fundamental assumptions guiding the formulation ofthe Master Plan and, consequently the formulation of the project, were thescientific and engineering understanding of the flow of currents in the Bosphorusand the Sea of Marmara and the capacity of these waters to dilute, absorb andtransfer sewage effluent without adverse environmental effects anywhere. Thecharacteristics of the Bosphorus currents have been studied extensively.Mediterranean water increases in density and salinity from the excess ofevaporation over precipitation as it circulates from Gibraltar along the Africancoast to the Aegean Sea. From the Aegean this heavy, highly saline water flowsthrough the Turkish straights to the anaerobic lower portions of the Black Seawith depth below 2000m. Less dense, brackish, surface waters carry runoff fromthe tributaries of the Black Sea (mainly the Danube and the Dnieper) and createa surface current in the opposite direction. Various surveys attributed a rangeof values to the volumes and velocities of these currents. Generally acceptedfigures range from 3,000 to 6,100 m3/sec for the bottom and from 12,600 to 30,000m3/sec for the upper current. There is a stable boundary layer between the upperand lower currents at depth of about 10 m at the south entrance but it lies below35 m at Kilometer 20 in the Bosphorus. These characteristics indicate thatsewage discharged into the bottom current via deep outfalls with or withoutdiffusers would mix rapidly with sea water and reach the Black Sea in about 18hours. Studies show that neither significant oxygen depletion nor excessivesedimentation would result from this process in the Bosphorus.

20. While the general characteristics of the process described above are notbeing disputed, in the late stages of the project, heavy criticism was leveledby the new administration of Istanbul against another important design assumptionnamely that the lower and upper currents do not mix. It was claimed that suchmixing does occur and that partially treated sewage will enter the upper currentand will be carried back to the Sea of Marmara perpetuating its pollution. Toeliminate this danger it was proposed that full biological treatment be providedat the Yenikapi (and all other proposed) outfall and an extensive oceanographicsampling study of the Bosphorus currents has been commissioned (to be completedin 1993). A further step in this direction which, in effect, overrides thespecific issue of the mixing of the currents, came in mid 1991 when the Turkishenvironmental authorities issued a directive that, in future, all waste watersmust receive full biological treatment before discharge into receiving waters.ISKI has immediately adopted this policy.

21. The project under review has been virtual completed when the issue of themixing of the currents surfaced and the Yenikapi outfall has been functioning,technically in violation of national environmental policies and will do so (inthe absence of possible alternative solution) until such time when a fulltreatment plant can be built. The effect of these environmental policy changesare potential much more serious for the ongoing second project, Istanbul WaterSupply and Sewerage (Loan 2888-TU). This project, for which a loan US$218million was approved in 1987, includes, inter alia, provisions for theconstruction of pre-treatment plants and submarine outfalls at Uskudar, Kadikoy

7

and Baltalimani. On the basis of the new policies the Government is currentlydenying permission ior ISKI to construct the Uskudar outfall (contract due forbidding) and similar action is likely for Baltalimani. The longer termimplications of the policy are a massive increase in costs in ISKI's futuresewerage investment plans. The Audit field mission discussed these matters withISKI's management and the overall impression is that unless a satisfactoryprogram of staged construction of the future facilities can be arrived at, it isdoubtful whether ISKI would have the financing capacity to carry out the programand, perhaps more important, the costs would be affordable to Istanbul'spopulation. These issues are under intensive discussions between the Turkishauthorities and the Bank.

D. Project Implementation

22. The very lengthy preparation period mentioned above was followed by animpressively rapid loan processing. Appraisal was in December 1981, negotiationstook place in April 1982, and Board approval and loan signing followed on the27th and 28th of May 1982. At that point bureaucracy intervened andeffectiveness only took place on February 23, 1983 (there were no special,project related, effectiveness conditions). The loan was closed on theoriginally planned date of December 31, 1988.

23. The originally scheduled components of the project were virtually completeby December 1988, about one year behind schedule. Data in the PCR(Implementation Schedule) clearly shows that all major contracts were delayed atthe start, largely due to a laborious approval process which, however, later muchimproved. Once the contracts were approved, execution times were generallyshorter than estimated. The contract for thG supply of large pipes for theinterceptors was delayed by about on year due to the dispute whether a new pipefactory should be provided or an existing one should be utilized. The lattersolution prevailed.

24. As mentioned above the construction of the interceptors which had to belaid in congested areas and, often, in the proximity of historical buildings.These conditions, inevitably, resulted in changes in the routing and, in somecases the type (tunnel versus pipe) of these large conduits. The comparison ofplanned and actual construction is shown in Table 1. below. A major change whichrequired an amendment of the Loan Agreement (October 23, 1985) took place aboutmid way through the project implementation. At the end of 1984 ISKI reviewed theproject cost estimates and concluded that substantial savings were likely due tothe devaluation of the Lira and lower than expected bid prices. To utilize thesesavings the Bank was requested to agree to the inclusion of additional componentsto be constructed on the north side of the Golden Horn namely the RabatasInterceptors, treatment plant and outfall. Subsequently it turned out that thereestimation of the project costs were erroneous and only the North Halic (GoldenHorn) interceptors could be accommodated and all other additional components wereto be completed under the second project.

8

Table 1.

PROJECT COMPONENTS

Description Appraisal Estimate Actual

South Halic Interceptor 26.0 km 10.5 km

Fatih Tunnel 2.4 km 6.5 km

Yenikapi Treatment Peak Capacity=12 m3/sec As designedPlant

Pumping Mains 2.3 km 2.3 km

Submarine Outfall 2.0 km Twin Pipelines 1.1 km

Laterals/collectors 285.0 km Substantially more

North Halic Interceptor Not foreseen 8.4 km

25. The changes in the project components, while entirely within the projectdescription, were significant though not outside the expectations for this typeof work. To have completed the works within the estimated construction schedulein the congested conditions of Istanbul and with th-- high quality observed by theAudit mission is a credit to all parties involved and augurs well for ISKI'sfuture program.

E. Proiect Costs and Disbursements

26. Actual total cost of the project amounted to US$231.7 million equivalentcompared to the appraisal estimate of US$222.0 million, an increase of 4%. Thecloseness of these figures hide significant differences in component costs aswould be expected from Table 1. above. Furthermore, in addition to the NorthHalic Interceptor substantial amounts of water supply pipes and water meters werefinanced, on an emergency basis, under the project resulting in a total "notforeseen" expenditure of US$46.92 million equivalent. According to the PCR, theactual cost of the secondary sewer system exceeded appraisal estimates by 168%,due entirely to the expanded scope of this component. If this is correct, itimplies that an additional US$60.68 million equivalent extra cost was also metfrom overall savings under the original project components giving a total"savings" of US$107.6 million. A detailed compa-ison of the appraisal and actualcosts is shown in Table 2. below. All costs are expressed in US Dollars and theTurkish Lira costs were converted at the exchange rate ruling at the time theexpenditure was incurred. The line items of the Appraisal cost estimates includethe relevant physical and price contingency elements. Some of the costdifferences represent clear and substantial overestimation at the time ofappraisal such as the treatment plant (75%) and the Fatih tunnel where the actualaverage unit cost per meter length was only 50% of that estimated at appraisal.On the other hand similar unit cost for the interceptors show a mere 7%

9

difference. Precise analysis of the reasons for these differences is hadly everpossible but fil#z search and the Audits field discussions seem to indicatethat the following factors may have had significant influence: (i) theunanticipated competitiveness and competence of local contractors and suppliers;(ii) the thirteen fold devaluation of the Turkish Lira during the implementationperiod; (iii) the fluctuation of the value of the US Dollar; (iv) the continuousrefinement of the design of the works during construction and (v) the efficientsupervision of construction by ISKI and its consultants.

Table 2.(US$ Million Equivalent)

DESCRIPTION APPRAISAL ACTUAL CHANGE Z

Interceptors 42.78 18.56 -57

Fatih Tunnel 11.21 15.03 +37

PretreatmentWorks

-- civil works 40.15 10.34 -74

-- equipment 25.52 6.10 -76

Submarine Outfall 44.41 13.63 -69

Secondary Sewers 36.19 96.97 +168

0 & M Equipment 10.73 14.09 +31

Land Acquisition 1.16 0.90 -22

Proj. Mgt. & SPN, 8.05 7.4 -8TA & Training

PPF 0.50 0.5 0

Front-end Fee 1.30 1.30 0

North Halic Not Included 15.46 New ItemInterceptor

Water Pipes & Not Included 31.46 New ItemMeters

TOTALS 222.00 231.75 +4

10

27. The financing arrangements, as agreed at appraisal and as actually carriedout are shown in Table 3. below:

Table 3.

PROJECT FINANCING

SOURCE APPRAISAL ACTUAL

US$ 2 US$ %Million Million

IBRD 88.1 40 88.0 38

Government Contribution 131.2 59 37.6 16

Internal Cash Generation 2.8 1 106.1 46

TOTAL 222.1 100 231.7 100

The most dramatic change in the financing plan was the increase in ISKI'sself f*nancing percentage. At the time of appraisal the Bank clearly had lowexpectations regarding the revenue generating capacity of ISKI and the financialperformance covenant of the Loan Agreement (Section 5.04 (a)) only required ISKIto generate ... "revenues sufficient to cover its operating and maintenance costsand its debt service in excess of provisions for depreciation". For thefinancing of project expenditures the Guarantee Agreement obligated theGovernment to... "provide the Borrower or cause the Borrower to be provided withsuch funds as are needed to meet such expenditures". ISKI's overall investmentfunding requirements over the "project period" were estimated at appraisal as US$375.2 million of which US$201.6 million were to be provided by the Government "inthe form of contribution (Guarantee Agreement)". The PCR reports that theGovernment's contributions to ISKI's investments started to decline already in1983 and, by 1987, the project financed by Loan 2888-TU shows no Governmentcontribution. The withdrawing of government funds forced ISKI in the rightdirection of financial self sufficiency and the evident success of this isfurther discussed in the financial section of this report.

11

28. Disbursements were scheduled to take place over a period of six and a halfyears, about one year less than the country profile at the time of appraisal.Due largely to a six month delay in effectiveness and the initial slow award ofmajor contracts, disbursements lagged significantly in the first years of theproject but caught up with the forecasts in the fifth year. The Loan was closedas scheduled on December 31, 1988 although disbursements continued untilSeptember 1989 at which time US$54,000 was canceled. The comparison of projectedand actual disbursements is illustrated in Graph 1, below.

GPAPH 1g0 110

80 100

z 6D0 -80 m)L-70

50- 0-60

r40--50 ~

-40

20 -30

10 x1

0L = -. 1101983 1984 1985 1986 1987 1988 1989 1990

FISCAL YEAPS

Appraisal Estimate A Actual -'- Percentage

F. Procurement

29. In respect of following the Bank's procurement guidelines or generallymanaging the procurement process in a satisfactory manner, neither the PCR northe file search highlighted any significant problems. However, while the processwas satisfactory, efficiency, particularly in the early stages, was far fromlaudatory. Most major contracts suffered nearly a years delay in the awardprocess due to the cumbersome approval process. Subsequently with ISKI'sautonomy increasing this process is also improved significantly. While all majorcontracts were open to international competitive bidding, little foreign interest

12

was shown, a testimony to the known competitiveness of the Turkish constructionindustry.

G. Performance of Consultants and Contractors

30. The conclusion of the PCR that all consultants, contractors and suppliersgenerally performed well was confirmed in the discussions of the field Audit.The Audit mission also visited a number completed and in progress facilities andnoted the high quality workmanship in construction and installation of equipment.

H. Institutional Developments

31. The evolution of ISKI has been described in earlier sections of thisreport. It was along and tortuous process due both to the complexity of theexisting sectoral responsibilities and the political implication of majorchanges. Over the years it took to arrive at the final solution the Bankfollowed a correct and single minded approach which eventually bore fruit. Thepresent organization had a monumental task at its birth namely to take over andmange the existing responsibilities of four organizations, the DSI, IllerBankasi, ISI and the Istanbul Municipal Sewerage Department. At the same time,the new agency had to take in hand, "on the run", the implementation of one ofthe largest infrastructure projects ever launched in Istanbul. The resources forthis were limited. General shortage of skilled manpower, staff drawn fromdifferent organizations and limited experience in managing an organization of thesize and complexity of ISKI. Particularly severe were the shortages in competentfinancial personnel.

32. .lthough progress was far from trouble free, ISKI's development wasremarkable by any standard. It is rare to see, in similar Bank financedprojects, that an implementing agency which is created at the very start of theproject (regretfully a common occurrence) execute a large and complex projectwith the efficiency that ISKI achieved. This project, once again, amplydemonstrate, that adequate autonomy is an absolute prerequisite to successfulinstitutional and managerial development.

33. While the technical side of ISKI's development was steady and satisfactory,the progress of financial management was more uneven. Admittedly there was alonger and, in many ways, harder road to travel and the issues involved, such asnew accounting system, massive tariff increases and improved billing andcollection, were more intractable than the technical aspects with, as is usuallythe case, even grater manpower constraints.

I. Operational Aspects

34. There is limited information on the operating performance of ISKI,particularly on the sewerage side. The project provided the first proper wastedisposal facility in Istanbul, the Yenikapi Pre-Treatment Plant and Outfall andthere is no long term performance record as yet. The Audit mission's visit tothe plant found fully satisfactory operating and maintenance practices. Anothervisit to ISKI's computerized water supply coatrol center confirmed that system

13

control, in terms of sophistication and quality of operating staff had leftlittle to be desired.

J. Sustainability

35. At present, ISKI appear to have the technical, managerial and financial(see following section) capacity to fully sustain the performance and benefitsof its water supply and sewerage facilities. However, ISKI also has adevelopment plan, particularly in sewerage, which, in its scale, dwarfs itspresent facilities. The future introduction of secondary and (perhaps) tertiarywaste treatment facilities will demand a new level of operating skills. This,combined with the projected intensive (and necessary) pollution monitoring andcontrol, on land nd at sea, will demand a quantum increase in both managementand staff training/recruitment. While the task is more than formidable, thefindings of this Audit give no reason to doubt that ISKI will cope with theproblems provided its autonomy is not impaired and realistic staging of itsfuture developments facilitates the maintenance of a sound financial base.

II. ISKI's FINANCIAL PERFORMANCE

A. Compounded Growth Rates of Financial Indicators

36. At the end of 1990, ISKI was still a growing utility with a balance sheettotaling TL2.39 billion or US$816.2 million, but it had been through a rapidgrowth in the 1980s. In nominal or current TL terms, Table I shows growth rateswell above 50% compounded per year for all major components of its incomestatement and balance sheet. In real terms, however, the same growth rates aremuch lower albeit still in the double digit range except for the share capital.Also noteworthy is the marked slowdown of these real terms growth rates in themost recent period which will have a bearing on the implementation of thestrategic plan for the 1990s. The apparent favorable trend of real termsprofitability is entirely due to exceptional profits recorded in 1990 followinga loss in 1989 and which may not be indicative of future profitability. Overall,the inconsistency of growth rates over the last three years (range from 0% to187%) indicates an entity which has not yet absorbed the impact of the largeinvestments undertaken in the early 1980s.

14

Table 1: ISRI's Nominal Growth Rates

in Z compounded p.a. in current terms in real terms'1990/1982 1990/1987 1990/1982 1990/1987

gross fix. assets in op +101.5 + 94.9 + 52.3 + 28.7works in progress +122.6 +113.2 + 73.4 + 47.0

sales of water + 91.1 +106.9 + 41.9 + 40.7net profits + 72.7 +186.8 + 23.5 +120.6depreciation + 92.2 + 86.9 + 43.0 + 20.7cash flows + 76.1 +153.6 + 26.9 + 87.4

reserves +361.2 +109.2 +312.0 + 43.0paid-up capital + 19.9 + 0.0 - 29.3 n.a.long-term loans +129.8 + 76.0 + 80.6 + 9.8

37. Total fixed assets increased 368 times between 1982 and 1990 in current TLterms. In real terms (i.e., before revaluation of fixed assets in operations),the growth is still 52 times. In US dollar terms, it is 24 times as shown inTable 2. At the end of 1990, total fixed assets amounted to TL1,912 billion orUS$653 million, of which 51% were in operation.

Table 2: Fixed Assets

in TL billion/% 82 83 84 85 86 87 88 89 90

Fix.assets in operation 3.6 14.1 41.3 61.? 91.9 132.3 339.1 588.8 978.6Works in progress 1.6 14.6 3.3 11.3 39.7 96.5 177.0 433.0 935.0Total fixed assets 5.2 28.7 44.6 72.5 131.6 228.8 516.1 1022 1912in real terms (ISKI) 3.6 6.0 22.2 26.1 40.9 52.5 130.4 140.9 186.4in US$ terms (million) 27.6 101.4 100.5 125.7 :73.7 224.1 284.4 441.6 653.1

WIP/total fix. assets 30.8 50.9 7.4 15.6 30.2 33.4 34.3 42.4 48.9

B. Financing Plan of ISKI

38. In four years, -otal resources have increased almost sevenfold in currentTL while they more than doubled in constant US dollars. Table 3 provides thefinancing plan for the period 1987-1990 which corresponds to a change in ISKI'sfinancial policy (PPAR, para. 57). ISKI has relied almost equally on long-termborrowings from abroad (mostly from the Bank) and on its Revaluation Fund tofinance its expenditures. Cash flows have not been as steady a source of fundsas the build-up in short-term liabilities. On the use side, a growing share ofresources has been allocated to fixed assets although this is partly due to their

1 Deflated by the consumer price index (IMF, "International FinancialStatistics", January 1992). The compounded rates of inflationwere 49.2% p.a. from 1982 to 1990, and 66.2% since 1987.

15

annual indexation onto the inflation. Indeed, works in progress (WIP), which arenot revalued, have been more erratic in terms of share of total funding. 1987marked a change in ISKI's financial policy when all the share capital was repaid(US$9.8 million) and 68.4% of retained earnings were transferred out of itsbalance sheet.

Table 3: Financina Plans for 1988-19)

1987 1988 1989 1990Sources (in Z of total)Cash flows 6.1 11.5 3.1 15.0Long-term Borrowings 63.3 37.2 31.9 36.9(of which) Foreign loans 58.5 36.2 29.6 31.9Revaluation Fund 16.2 28.6 34.5 29.2Increased Current liabilities 14.5 20.9 19.0 16.9Decreased current assets 0 1.5 11.4 1.4

Uses (in % of total)Increased fixed assets 54.5 63.9 74.0 76.0(of w.) Work in progress 31.9 17.9 36.9 42.7Increased current assets 27.5 34.6 21.7 20.8(of w.) Accounts receivable 9.8 15.6 17.5 17.6Decrease of net worth 18.1 0 0 0

Total funding (TL billion) 178.02 450.56 693.65 1176.18same in US$ million 207.67 316.80 326.93 450.88

39. Table 4 summarizes the recent trends in financing ISKI's various assets.The sum of cash flows, of long-term borrowings, and of fixed assets revaluationhas financed easily the increase in fixed assets during the last five years. Thelarge share contributed by the Revaluation Fund may, however, give the impressionthat ISKI has not relied heavily on long-term borrowings (49% in 1990) to financeits capital investments. This is an accounting presentation required to offsetthe upward revision of fixed assets in operation. Actually long-term borrowingsdo finance a large share of the physical investments (i.e., total fixed assetsless the revaluation for the year). The last line of Table 4 shows that,although the trend has been downward, long-term borrowings financed 90.5% ofcumulative investments between 1986 and 1990. Since foreign loans representedan average 86.9% of total long-term borrowings over that period, 2 it impliesthat a large share of local costs has been financed with foreign currencyresources. Nominal cash flows have financed a small though uneven share of totalfixed assets, but this is misleading because of the large accounts receivablewhich decrease the free cash flows (PPAR, paras. 11-14).

2 In part due to the exchange risk added at the end of year onto theoutstanding balance of foreign borrowings.

16

Table 4: Financing Ratios

1986 1987 1988 1989 1990

Lg-term borrowings/tot.fix. assets 77.6 113.3 58.2 43.1 48.6Foreign loans/total fixed assets 66.7 107.3 56.7 40.0 42.0Cash flows/total fixed assets 16.1 11.1 18.0 4.2 19.7Revaluation Fund/fixed assets 26.9 29.6 44.8 46.6 38.4Cash flows + borrowings + reval/FI 120.6 154.0 121.0 93.9 106.7

Cash flows + revaluation/WIP 89.3 69.6 224.0 101.9 103.5Cash flows + borrowings/WIP 200.4 212.8 272.1 94.9 121.6

Incr. curr.liab./incr. acc. receiv. 222.5 147.9 133.1 108.6 96.0

Long-term borrow./FI not revalued 110.0 164.8 105.7 83.2 78.8

40. While ISKI was planning to issues certificates in 1991 to mobilize domesticsavings (for US$29.9 million), this novel way had not been tested during theperiod under review for this Audit despite the relatively high return on assetsrecorded in two of the last three years. Short-term loans from commercial bankshave been used only for liquidity management purpose twice in the last nineyears: in 1987 for TL6.5 billion, immediately repaid the following year, and in1990 for TL36.5 billion. Until 1990, customer deposits have not been a factorin financing long-term assets, increasing from TL2 billion in 1982 to TL14.6billion in 1989 which translated into a 53% decline in real terms. In 1990 theamount was increased fivefold to TL72 billion. While modest compared to otherlong-term resources, this provided 13.3% of incremental long-term funds in 1990but 44.2% when excluding the exchange risk incorporated into foreign borrowingsat the end of 1990.

C. Self-financing of Capital Investments

41. ISKI's performance in self-financing its large investments depends on theindicator chosen. Cash flows have been always positive since 1982 despite a lossrecorded in 1989. Table 5 shows that the trend has been too erratic to bepredictable. The depreciation component of cash flows has shown a steady rise,however, both in nominal and dollar terms, the latter particularly since 1987.On the other hand, the continuous increase of accounts receivable (PPAR, para.48) has reduced available cash flows to the point of being negative in the lastfour years.

17

Table 5: Structure of Cash Flows

in TL million 82 83 84 85 86 87 88 89 90

Cash Flows 1903 2523 9247 26256 9503 10784 52014 3899 175919Depreciation 107 2172 1363 1179 2320 4752 12351 21494 33676Deprec./Cash flows (%) 5.6 86.1 14.7 4.5 24.4 44.1 23.7 551.4 19.1Deprec. in US $ million .66 9.63 3.72 2.56 3.44 5.54 8.68 10.13 12.91

Cash flows adj. acc.rec. n.a. 2826 5729 9414 7197 -6642 -18489-44318-16076

42. Table 6 summarizes the contradicting picture of self-financing (SF).Nominal self-financing measured by the Corporate Self-financing ratio3 wasbetween 10 and 20% whenever a profit was recorded (not in 1989). The same self-financing of actual fixed assets (i.e., excluding of revaluation) was above 30%.However, after correcting cash flows for the accounts receivable, SF has beennegative since 1987. If, furthermore, debt-servicing in principal was deductedfirst, the resulting SF ratio was even more negative.

Table 6: Self-financing

in % 83 84 85 86 87 88 89 90

Corporate self-financing 10.7 57.7 94.4 16.1 11.1 8.1 .8 19.7adjusted for Reval. Fund 16.3 186.2 222.2 59.7 37.5 32.8 1.5 32.1same adj. for receivables 18.3 115.4 79.7 17.7 -9.7 -11.7 -16.7 -2.9

43. The ex post financing plan of the Bank project shows a far greater self-financing than anticipated at appraisal. It is partly due to the Government'sdecision after project launch of not fulfilling its commitment to contribute 59%to the project. ISKI did not mobilize additional loans to fill the financinggap, but instead relied on tariff increases to generate cash flows. The strategywas timely to take advantage of the grace period on the Bank loan, thus freeingany cash flows generated during project construction to finance investments. Nowthat debt servicing is under way, this policy is not as effective, but it is tothe credit of ISKI to have taken a unique window of opportunity. Not only itallowed the project to be implemented without delay, but it demonstrated thattariff increases do not need to wait until the project is commissioned in orderto service the debt, but should be implemented as soon as the project is startedto enable self-financing.

D. Foreign Exchange Exposure

44. Foreign debt has increased 755 times between 1982 and 1990. This is partlydue to the exchange risk which is included in the outstanding debt amount. Thereare two types of revaluation working concurrently:

3 Defined as cash flows divided by the increase in total gross fixed assets(including works in progress) during the same year.

18

(1) revaluation of fixed assets in operation according to domesticinflation to approximate their replacement cost; and

(2) revaluation of foreign borrowings to take into account the

depreciation of the TL in terms of the currencies required for debtservice.

The former has generated TL791.7 billion since 1983 and represented 80.9% of

fixed assets in operation at the end of 1990. The latter is not disclosed as aseparate item in the balance sheet. Over 1989-1990,,the incremental exchange

risk amounted to TL464.8 billion and accounted for 80.1% (79.6% in 1989, 80.3%

in 1991). The Bank loans have contributed to this increased exchange risk (PPAR,para. 59). It is not clear from the financial annexes to the PCR whether ISKI

is bearing the exchange risk when it is servicing its debt. Given the rapiddecline of the Lira, it is important to display separately ISKI's foreignexposure which could be a major cause of financial under-performance in thefuture.

E. Government Assistance

45. Tax Sharing Fund. Municipalities in Turkey obtain resources from theGovernment through the Tax Sharing Fund (FIA). Table 7 shows that this resourcewas allowed to decline in real terms until 1990 when the n-minal amount was

doubled. Given that cash flows have been reduced by inc-aase in accountsreceivable, the tax sharing is comparatively a reliable reuource to supportISKI's self-financing. Still ISKI has been assuming that this source would leveloff at only 1% of sales in its 1992-2000 projections while it was 6-7% during thelast three actual years. This conservative stance is explained in part by the

subsidy nature of the Tax sharing and the importance of not relying excessively

on it to balance its accounts.

Table 7: Tax Sharing Fund

TL million 1987 1988 1939 1990.

Tax sharing 12281 12109 18626 35437

in % of profit 203.6 30.5 loss 24.9

in real terms ($ mill.) 14.3 8.5 8.8 13.6

46. ISKI has borrowed from the Public Participation Fund but only three times

in the last eight years (in 1986, 1987 and 1989). At the end of 1990 theoutstanding balance was TL27.97 billion which represented only 3.0% of total

long-term borrowings, partly due to the fact that all foreign loans are revaluedwhereas domestic borrowings are not. There was no other domestic borrowing which

indicates the low leverage of ISKI in the local financial market despite goodnominal returns. A recent attempt in 1991 at mobilizing funds on the domestic

market has been successful albeit limited in scope US$4 million at 85% p.a.interest and maturity as short as six years.

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F. Accounts Receivable

47. Accounts receivable are one of the two majors causes of utilities'financial distress (with inadequate borrowing maturities). ISKI is no exceptionto this observation. The most appropriate indicator is the comparison ofincrease in receivables with sales which are both flows. Table 8 shows that thearrears increased generally several times faster than sales. As a result,additional arrears represented a larger share of sales, up to almost four monthsin 1990. Although no age structure of arrears was available, the 1989 externalaudit disclosed that TL60.7 billion (or 34.9%) of total were over one year old.The situation must have worsened in 1990, as Table 9 seems to indicate, due tothe relative pace of arrears and sales.

Table 8: Sales and Arrears

TL million 82 83 84 85 86 87 88 89 90

Sales 3438 8774 12366 36087 28575 69034 163662 272330 611303% change 155 41 192 -21 41 42 60 45Receiv. increase -304 3518 16842 2307 17426 70503 48216 191995% change 379 -86 655 305 -32 298

Receiv./salea 28.5 46.7 8.1 25.2 43.1 17.7 31.4same in days of sales 104 170 30 92 157 65 115

Table 9: Receivables in relation to other Indicators

% 82 83 84 85 86 87 88 89 90

Receiv./Current assets 66.3 42.4 40.3 56.2 50.3 43.3 45.6 50.5 64.4Cash & bank/Receiv. 15.0 49.8 99.7 51.3 18.7 5.1 3.3 5.9 3.3Current liab./Receiv. 101.8 172.2 62.9 49.2 64.0 96.8 113.6 153.4 116.5Incr. Receiv./Cashfl. n.a. n.a. 38.0 64.1 24.3 161.6 135.6 1,237 109.1

48. The above table shows two distinct periods. Prior to 1986, ISKI's effortswere to offset the increase in accounts receivable by retaining more cash anddeposits in banks. After 1986, the offset is done by running up currentliabilities which is typical of corporations which are not in complete controlof their finances. The collection of accounts receivable remains the best avenuefor ISKI. It is currently entrusted to a subsidiary which is staffed entirelyfrom outside ISKI. Although the public is aware that Suser is ISKI's subsidiary,it is well accepted partly because it is responsible for bringing water tooutskirt municipalities through a fleet of 160 trucks. As an incentive,collection staff is paid on commissions linked to actual collection. As a resultof the vigorous effort sustained in the recent years, recovery has improved from52% in 1988 to 68% as of September 1991. Since the billing cycle is around onemonth, the actual collection rate was above 70%.

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Table 10: Recent Collection Performance

Sept. 1991 in % of total billingsDomestic customers 63 48(of w.) billed monthly 86 (5.7)Hotels 97 n.a.Industries 88 13Public institutions 36 14Municipalities 84 n.a.

49. There are both room for improvement and limitations due to theaffordability of tariffs. Customers billed monthly have a 40% better paymentrecord than those billed quarterly, but the formers are only 30,000 out of 1.1million. To convert more customers would improve ISKI's intra-year liquidity andreduce arrears. Similarly the number of collection locations was increased fromonly three until 1991 to 22, therefore it is too early to assess the resultalthough the change is in the right direction. Conversely the unavailability ofan age structure of arrears makes a little dubious the effort to manage arrearswhich are becoming bad debts. The latter can be provisioned only after all legalpursuits have been exhausted which delays the recognition of losses.Neither the PCR nor the external audit report for 1989 mention any provisions forunrecoverable arrears.

50. The affordability of water charges is achieved through subsidization. Thefirst 10 m3 of water is free if the monthly consumption is below this figure;only a nominal sewerage surcharge is then billed. The same approach is takenwhen handling poverty groups in arrears. ISKI waives their water bills, but notthe sewerage bills if they pay all outstanding arrears (often paid ininstallments) and commit to consume less than 10 m3 a month; if the consumptionis above 10 m3 there is no waiver. This accommodating stance concerns only 2%of ISKI's individual consumers.

G. Financial Covenant

51. The covenant in Loan 2159-TU required ISKI to adjust its tariffs wheneverrevenues are insufficient "to cover its operating and maintenance costs and itsdebt service in excess of provision for depreciation" (Loan Agreement, section5.04 (a)). The validity of this covenant was tested on the first differencebetween operating revenues and operating expenses as shown in Table 11. Exceptfor a loss in 1986, the operating margin has been comfortably positive. As shownin the same table, the second difference between depreciation and debt-servicingwas negative only twice (in 1987 and 1988) but not enough to reduce significantlythe operating margin. Overall the covenant was met. Yet, the above analysis onaccounts receivable shows the Bank covenant to be inadequate.

4 As none was made available to the field mission for this Audit.

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Table 11: Financial Covenant

in TL billion 82 83 84 85 86 87 88 89 90

Operating revenues 3.4 8.8 12.4 36.1 28.6 69.0 163.7 272.3 611.3Operating expenses 4.3 8.0 10.4 21.5 32.8 53.0 99.2 175.5 419.4Operating margin -.8 .8 1.9 14.6 -4.2 16.0 64.5 96.9 191.9Depreciation .1 2.2 1.4 1.2 2.3 4.8 12.4 21.5 33.7Debt service n.a. n.a. .6 .8 1.0 7.5 12.5 18.7 23.0

52. Table 12 summarizes the trend of operating margin before and afterdeducting the yearly increase in accounts receivable from the operating revenues.Except for 1989, the adjusted margin was always below I in recent years.Although the impact of growing arrears was clear, the covenant in the follow-upproject (Loan 2888-TU) was changed to require ISKI to self-finance 100% of theProject expenditures which are not covered by the Loan plus at least 45% of theother capital expenditures. This is not more realistic than the previouscovenant given the impact of arrears on the actual self-financing (PPAR, para.42).

Table 12: Sensitivity of Operating Margin to Arrears

% 82 83 84 85 86 87 88 89 90

Operating margin 80.3 110.3 118.6 167.6 87.2 130.2 165.0 155.2 145.8adj. for acc. receiv. n.a. 114.1 84.8 89.4 80.2 97.3 93.9 127.7 99.9

H. Current Ratio

53. Table 13 shows a steady declining trend of the current ratio. While aratio above one is usually a positive sign, in the case of ISKI the downwardtrend means that it has offset the growing arrears with current liabilities.While the latter have to be repaid eventually, the former do not provide anadequate collateral as long as 35% are more than one year old and the outstandingarrears increase faster than sales.

Table 13: Current Ratio

times current liab. 82 83 84 85 86 87 88 89 90

Projected (SAR) 1.0 1.2 1.0 .6 .6 .9 1.1 1.2 n.a.Current ratio 1.48 1.37 3.95 3.61 3.11 2.38 1.93 1.29 1.33

I. Return on Assets

54. Table 14 shows that the traditional return on fixed assets in operations(ROA) usually covenanted in Bank projects has declined in the second half of the1980s (average of 13.8% since 1987) compared to the first half and that it hasbeen more erratic. After correcting for the yearly increase in accountsreceivable, the ROA has been negative since 1987, averaging -6.4% whichrepresents a 20-point drop from the nominal average. The more meaningful return

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on total assets (Corporate ROI) shows a similar pattern at lower levels thoughbecause of the larger assets base. The nominal rate averaged 8.1% since and -3.9% after adjusting for receivables. Unless the arrears is being reversed,ISKI's creditworthiness may be jeopardized by negative return on assetsregardless of the definition.

Table 14: Rates of Return on Fixed Assets

% 82 83 84 85 86 87 88 89 90

Return on Assets 52.9 28.5 33.4 51.2 12.4 9.6 22.1 .8 22.5adj. for Receiv. n.a. 32.0 20.7 18.4 9.4 -5.9 -7.8 -9.6 -2.1Corporate ROI 36.9 14.9 25.2 44.8 9.3 6.0 14.1 .5 12.0adj. for Receiv. n.a. 16.7 15.6 16.1 7.1 -3.7 -5.0 -5.8 -1.1

J. Return on Equity

55. Since the initial capital was repaid in 1987, equity was defined here ascapital plus the Revaluation Fund for purpose of computing the return (ROE). Thetrend shows large variance although it is downward overall. After correcting forcash flows which are tied up in arrears, the ROE has been negative since 1987which is also a worrisome sign not mentioned in the PCR.

Table 15: Rates of Return on Equity

% 82 83 84 85 86 87 88 89 90

Capital + Reval.Fund n.a. 41.5 58.8 111.5 19.7 15.5 36.1 1.2 28.4adj. for Receiv. n.a. 46.4 36.4 32.2 14.9 -9.6 -12.8 -13.5 -2.6

K. Debt-equity Ratio

56. The SAR projected that the debt-equity ratio (DE) would never rise above.69:1, but it did 5 out of the last nine years, remaining above 1.1:1 in the lastfour. Given the size of the investment program carried out by ISKI, this isnot, however, excessive. The strategic plan until 2000 assumes more than adoubling of long-term borrowings in dollar terms which may not be compatible withthe accounts receivable situation which deplete free cash flows for self-financing and debt-servicing.

Table 16: Debt-equity Ratios

% 82 83 84 85 86 87 88 89 90

Projected (SAR) .64 .69 .64 .52 .45 .47 .41 .37 n.a.Actual .60 1.28 .47 .27 .64 1.88 1.48 1.10 1.12

L. ISKI's Financial Policy

57. The above tables show a clear change of ISKI's financial policy since 1987.It has been more aggressive with some riskier results. Short-term loans fromcommercial banks have been used for liquidity purpose; consumer deposits have

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been increased advantageously given their quasi-equity nature; depreciation hasbeen increased in dollar terms; the initial capital has been repaid; a realliability such as the foreign exchange risk has been offset with a bookkeepingrevaluation of fixed assets; the arrears from customers have allowed an increasein current liabilities. Despite nominal returns which are positive, ISKI doesnot have the real financial autonomy derived from positive returns adjusted foraccounts receivable. It is therefore in weak position to undertake the largeinvestment program outlined in its strategic plan without reversing the trend inarrears which reduce its effective cash flow generation ability.

M. Accounting and Audit

58. ISKI has been audited by Government auditors during project implementation,but was in the process of shifting to private auditors for the accounting year1990. The last external audit report available was, however, the one for 1989prepared by the Auditors' Council of the Ministry of Finance (MOF). They havefocused on compliance of recording with domestic regulations and with provisionsof the Loan Agreement, but raised no issue with the unfavorable aspects of ISKI'sfinancial situation, such as arrears, unaccounted-for-water, exchange risk, etc.The follow-up project required the appointment of private auditors starting withFY 1990, but invitations to bid were only recently sent and the audited 1990accounts should be ready only early 1992, too late compared to the covenantrequesting audited accounts within seven months. It is hoped that the newarrangement will eventually allow these documents to be circulated within areasonable time after the end of the FY.

N. Maturity, Grace Period and Exchange Risk of the Bank Loan

59. The Loan was granted to ISKI fcr 18 years of maturity, including 4 yearsand 7 months of grace, and with a commitment charge equal to .75% p.a. of theundisbursed principal. A front-end fee of .25% or US$1, 301,970 was alsocharged. The exchange risk is borne by ISKI and the portion due to the currency-pooling system amounted to US$11.26 million as of the end of 1991 or 21% of thenominal outstanding debt. Between May 1982 (signature) and September 1991 theLira depreciated by 97% against the US dollar, thus adding far more to the debt-servicing burden.

60. From ISKI's viewpoint, the availability over time of borrowed funds can bemeasured by an indicator called the Average Loan Life (ALL). It is defined as:the ratio of (a) the sum, until maturity, of the loan balances (in US dollars)outstanding at the end of each year over (b) the loan amount net ofcancellations. This indicator measures the number of years during which theentire loan prDceeds stay effectively at the borrower's disposal assuming up-front disbursement. The faster the disbursements and the slower the repayments,the longer the availability of loan funds. In the case of Loan 2159-TU, it hadan expected average loan life of 7.4 years at the time of appraisal. The slowerthan expected disbursements reduced it to 6.5 years. The exchange risk due tothe currency-pooling system realized on past repayments (but that accumulateduntil September 30, 1991)s cut it back by seven months to 5.9 years. Assuming

5 Deadline for data collection for this PPAR.

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this accumulated risk does disappear but does not worsen, the ALL is furtherreduced by five months to 5.48 years. This indicates that the actual terms ofthe Bank loan were short to finance slow-recoverable investments such as sewerageand suggests that ISKI will be effectively relying on Istanbul Municipality'sgeneral budget for its debt-servicing.

0. Environmental Aspects

61. While in its design and implementation the project is, essentially, astraight forward urban infrastructure project, its real focus was entirelyenvironmental improvement, in particular the cleaning up and permanent protectionof the Golden Horn, the Sea of Marmara and the less effected Bosphorus. Theearliest sewers in Istanbul were built during the Ottoman times and furtherdevelopments took place in the 1920s and 1930s. The rapid and largelyuncontrolled developments of the post World War II era eventually completelyoverwhelmed not only the sewage collector system but the indiscriminately usedreceiving waters, particularly the Golden Horn and the Sea of Marmara. It isdifficult to pinpoint the exact time of what one might call an environmentalawakening in Istanbul but take place it did.

62. The first, fully comprehensive plan to clean up the city and itssurrounding waters was the so called "DAMOC Master Plan Revision" (a revision ofan earlier Drainage Master Plan) in 1974. This plan remains valid to this dayto the extent that it envisaged the complete prevention of discharge of untreatedsewage at the shore line of any receiving waters by building a network ofinterceptors that would transport all sewage to specific disposal points.However, as mentioned earlier, this plan still envisaged discharge of only pre-treated sewage into the bottom current of the Bosphorus as an environmentallyacceptable solution. The Bank has, in general, supported this plan and theproject under review was its first major stage to be implemented.

63. The review of the project documentation and the Audit's discussions withBank staff and Turkish officials clearly indicate that parallel with ISKI'sgeneral development there has been a steady sharpening of the environmental focusboth within ISKI and the central environmental agencies. This process was bothfueled and supported by the increased environmental awareness of the public andgreater visibility and involvement of the Turkish scientific community. Membersof the latter were the principal actore in challenging the full effectiveness ofthe "bottom current" theory resulting in the extensive study of this phenomenonwhich is due to be completed in 1993.

64. Although the findings of this study should be of major importance, itssignificance, in a sense, has already been diminished by a far reaching decisionof the Turkish environmental authorities in the late 1980s. This decisioneffectively prohibits the discharge of any but fully treated effluent into anyreceiving waters. ISKI declared its full support for this decision and proceededto revise its sewerage Master Plan accordingly by incorporating the provision of(at least) secondary sewage treatment plant in all drainage basin designs. Asclaimed, this, indeed, puts Istanbul in the forefront in the terms ofenvironmental protection policies just about anywhere in the world. In addition,studies are under way for the recycling of sewage effluent for irrigation andcooling water purposes.

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65. In the context of the ever increasing pressure, on a world wide basis, forbetter protection of the natural environment these policies can not be faulted.However, one of ISKI's many useful publications describing and justifying futureplans, repeatedly uses a seemingly innocuous phrase which points to the problemsto come. This states: "Our Administration's objective is to establish a chain offull treatment plants using the most appropriate technology available, whateverthe cost,' in order to solve this environmental problem once and for all".

66. The new policy not only adds, at several disposal points, the cost of largescale secondary treatment plants to designs previously providing for pre-treatment only but, because of Istanbul's topography, suitable level sites forlarge treatment plants can only be found in remote areas. This, in turn, addsthe substantial extra cost of long puning mains/tunnels (the proposed Kadikay -Riva tunnel is 28.5km). All in all, the implementation of the new policyrepresents a quantum increase in ISKI's projected investment costs planned forthe next 10 to 30 years with little indication that much thought has been givenas to where that level of funding might come from.

67. Over the years the Bank and ISKI have developed a close workingrelationship. This now needs to be put to good use in finding a solution thatpreserves the principles of the commendable environmental protection program ofTurkey and ISKI without hasty commitment to an unaffordable level of expendituresthat would jeopardize ISKI's even now shaky financial situation. Such chain ofevents could not only halt the progressive improvements of the past years but mayput at risk the full sustainability (effective maintenance etc.) of thefacilities already built and endanger the already spectacular achievements of theprogram such as the transformation of the Golden Horn.

68. It should also be noted that while the most visible effects of thisimpressive pollution control effort have and will be on the shores and waters ofthe Golden Horn and the Sea of Marmara, an equally important policy of ISKI isthe commitment to develop water supply and sewerage in parallel in Istanbul. Acurrent review of some 120 past Bank financed water supply/sewerage projectsrevealed that in virtually all countries/cities these developments were grosslyuneven with water supply much in advance. The resulting mismanagement of wastewaters not only resulted in a vast backlog of sewerage investments (which maynever catch up in some places) but the polluted streets and receiving watersclearly diminished the health improvement effects of the safe(er) water suppliesprovided.

P. Economic Assessment

69. The SAR presents (paras. 6.01 - 6.04) a brief qualitative assessment of theexpected project bsnefits on public health, property values, fishing in the Seaof Marmara, the use of public beaches and tourism and rightly points out thatnone of these are realistically quantifiable. The SAR also calculated theAverage (Long Term) Incremental Cost (AIC) of the sewer system extensionsprojected to the year 2010 at discount rates of 8% and 10%. The benefit side of

6 Author's italics for emphasis

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these calculations is represented by water consumption per year as the chargesfor sewer services would be in the form of a surcharge on water consumed. Theresulting values were 0.072 and 0.079 US$/m3. These were essentiallytheoretical figures as no sewer charges were in effect at the time but they wereto be considered in the recommendations of the forthcoming tariff study. Thesecalculations were flawed in that the incremental benefits were derived from totalinstead of incremental water sales.

70. The PCR (Para. 6.04) recalculated the ACI using actual costs andincremental water sales for the project period and revised projections based oncurrent estimates. The changes are particularly dramatic in the projected watersales which take into account a much higher growth rate (5.4%) in Istanbul thanforeseen in the SAR. The recalculated ACIs, at the same 8% and 10% discountrate, are 0.126 and 0.138 US$/m3. The PCR further states that the combinedwater/sewerage ACI is "in the order of 0.65-0.75 US$/m3. As the average combinedwater/sewerage tariff in 1990 was 0.80 US$/m3 equivalent, ISKI has, indeed,appear to be charging economic prices for its services.

71. The Audit also attempted to assess the direct effect of these investmenton the poor. The SAR provided a brief statistical assessment of the pr-jectedbenefits of the project for the poor stating that the drainage areas c 4red bythe project house some 50% of Istanbul's low income population and that thesewerage service levels in the area would be increased from 73% to 95%, in otherwords, virtually full service coverage will be achieved providing service to anadditional 300,000 lower income people. The Audit has not been able to obtainspecific statistics relating to low income service provisions but sees no reasonto argue with the conclusion that the 95% service level confirmed to have beenachieved in the area does provide the projected coverage for the poor. As to theaffordability of the services by the poor, ISKI's tariff structure is highlyprogressive with industrial/commercial rates up to 130% of domestic tariffs,permitting substantial cross subsidization. Water, for consumers using less than10 m3, is free but the 100% sewerage surcharge is levied. These tariffs, forhouseholds below the poverty level, result in charges of less than 3% ofhousehold income and appear to be well accepted by the public.

Q. The Role of the Bank

72. Bank involvement in water supply and sewerage in Istanbul now spans anunbroken 20 years and this has spread to Izmir and Ankara in the late 1980s.Over this 20 years sector developments in Istanbul have been immense. From theacute water shortages and primitive sewer services of the late 1960s, handled byISI with only 34 engineers to today's 90% service levels and a strong andcompetent ISKI with a multi billion dollar investment program is remarkableprogress by any standard. In development work it is never possible to stateprecisely who should get the credit for what. However, there can be little doubtof the Bank's major role in the Istanbul developments. For more than 20 yearsit provided sustained and consistent advice, patiently working through years ofinertia, flexible when appropriate but it also stood firm when justified (a nottoo frequent attitude). Above all, the Bank should get substantial credit forthe steady effort exerted to create ISKI. The records appear to show that theBank - Turkey/Istanbul relationship was always cordial, more of a partnership

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than anything else. The individual staff were competent, the skill mix generally

right. As a result, supervision work was well received and was effective.

73. As sector developments expand further, both in Istanbul and Turkey as awhole, the Bank should maintain and strengthen this relationship. Projects aregetting increasingly complex technically, environmentally and economically.Selection of priorities an judicious financial planning will be the utmostimportance and to play its rightful role, the Bank must ensure that it devotesadequate resources to it both in terms of quantity and, above all, quality.

III. Conclusions and Lessons

74. The PCR gives a frank and concise assessment of the project experience.The efficient implementation of the project required little additional analysisand the Audit concentrated its work on the broader environmental aspects of thecomplex and sensitive waste disposal problems of Istanbul and ISKI's financialsituation. The two are closely interrelated in that the massive proposeddevelopments, resulting largely from the increased environmental awarenessgenerated by the project, have financial.implications which are, perhaps, notfully reflected in the PCR. The detailed analysis of ISKI's finances, aspresented in this ieport, highlight the critical issues which will need to be inview in all future Bank involvement in this complicated but rewarding area ofIstanbul's development.

75. The SAR listed five specific objectives for the project (see paragraph 13of this report) the first four of which were met in full. A question mark mustremain against the fifth, the objective of financial self-sufficiency. Whileimprovements in this are were also very significant, performance tends tofluctuate from year to year sufficiently to raise concern. This is furtherdiscussed below.

76. After initial, largely bureaucratic, delays the project was implementedefficiently, on schedule and well within cost estimates. Designs and quality ofconstruction were of high standard and ISKI has proved .tself to be a competentorganization well capable of maintaining and expanding its facilities. Asmentioned above, the project was first and foremost an environmental improvementeffort. While this was only the first stage of the Master Plan, the Audit hasno reason to doubt, that the eventual completion of the Plan will further enhanceand expand the already dramatic envirotmental impact visible on the Golden Horn.It should also be mentioned that the Istanbul Municipality has reinforced theeffects of the cleaner waters by extensive beautification of the shore lines.ThZs, apart from being sound urban management, much increased the visibility ofthe results of the project to the people of IstanbAl and, importantly, to thetourists.

77. ISKI and the Municipality have been jointly conducting a sustainedpublicity campaign on the project and the program. Impressive publications keepthe public informed of work in progress, results and future plans. There is

little doubt that this is instrumental in the general acceptance (so far, at anyrate)of the substantial tariff increases implemented by ISKI in recent years.

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78. Over the years of project implementation, possibly as a result of thevisible improvements in reducing pollution, environmental awareness within ISKI,the Turkish scientific community and the country at large, appear to have beensteadily increasing. The demands of environmentalists for ever stricterstandards of protection are increasing. This, apart from internal pressures,probably also (at least partly) due to Turkey being "sandwiched" between two verylarge environmental efforts, the Mediterranean Action Plan and the forthcoming3lack Sea Convention. A direct result of all this has been the decision torequire full treatment for all effluent to be discharged into the Istanbulwaters. As already stated, the Audit can not dispute the principles of thisdecision but wishes to emphasize the need for prudent and economically andfinancially viable planning with the full consideration of affordability by thepeople, the industries and institutions of Istanbul and the country in general.Just to launch into such undertaking " whatever the cost" would be irresponsible.

79. Regarding financial issues ISKI is a case where the twin revaluation offoreign debt and fixed assets in operation creates some confusion about the truestate of its finances. The exchange risk added to the original foreign debt isnot really a resource available for financing capital investments as the formalfunds flow statement suggests. Similarly, the yearly addition to the fixedassets through revaluation and the creation of the Revaluation Fund neitherprovides any new real funds to finance actual expenditures nor can it substitutefor the original capital endowed to ISKI (repaid in 1987) and then being usedexclusively to support the leveraging (although moderate) of the utility.Furthermore, the current levels of accounts receivable curtail cash flows to thepoint of generating negative returns on assets and equity when the impact ofthese arrears is fully taken into account. Coupled with the more aggressivefinancial policies, implemented since 1987, ISKI is carrying greater risks dueto the arrears and foreign exchange risk exposures.

80. The main problem likely to be faced by ISKI in the future will be passingor, through the tariffs, the heavy cost of the planned investments when theaffordability to the consumers will be in question. Users could be reluctant topay an ever rising share of their income for water and sewerage on the untestedassumption that they also want a cleaner Bosphorus and Marmara. Furthermore, ifthe past is any indication ISKI's finances could suffer a set back if the arrearssituation was to worsen further. For this reason, it is proposed that any futurelending operation be subordinated to the reduction of arrears, particularly frompublic sector institutions, so as to produce a positive return on assets and,secondly, a minimum return on total fixed assets should be covenanted afterdiscounting cash flows by any increase in accounts receivable.

81. Financial reporting could be improved by disclosing items which arerelevant for assessing ISKI's exposure to risks as well as its real cash flowgeneratirg capacity. To achieve this the following items should be disclosed onthe balance sheet:

- the outstanding exchange risk on foreign borrowings;- the accumulated interest during construction capitalized in the

fixed assets;- the operating costs capitalized, if any, in the fixed assets;- the debt falling due in the coming year.

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82. Notwithstanding the cautionary notes above, the principal lesson from thisproject is that sewerage and urban waste disposal in general, should be treatedas not just another form of necessary urban infrastructure, but planned, withfull information of the beneficiaries, as an indispensable environmentalprotection act that will impact on every facet of the city's life.

83. The project also reinforces the often repeated lesson in this sector thata sound and well organized institution with adequate autonomy is a prerequisiteto successful implementation. In Istanbul's case the Bank is to be commended forholding back until satisfactory actions have been taken to achieve this. It didtake a long time and the Audit noted in its file search the management'sconsideration of terminating the project. Well done the staff that persevered.

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Annex 1Page I of I

Comments from the Borrower

THE REPUBLIC OF TURKEYPRIME MINISTRY

THE UNDERSECRETARIAT OF TREASURY AND FOREIGN TRADE

lef: DEt-IV-3-t42 0 92 26934 Ankara,

Mr. Yves AlbouvChietInfrastructure and Energy DivisionOperations Evaluation Department

Ref: tstanbul Sewerage Project Draft Project PerformanceAudit Report.

Dear Mr. Albuuy

We are very pleased to receive the Draft Project PerformanceAudit Report. We are of the opinion that this Report will be verycontributive and useful reference material to evaluate theperformance of the other projects.

We have examined the Report in depth with all the relatedinstitutions and appreciated the efforts for the preparation ofthis Report. It is a pleasure for us co express our fullyagreement on the context of the Draft Report.

With our best regards.

lead of ppartmelnb-