TURKEY
MUNICIPAL SECTOR REVIEW
September 2004
Turkey Country Unit
Infrastructure and Energy Services Department
Europe and Central Asia Region
The World Bank
Abbreviations, Acronyms and Currency Equivalents
EIB=European Investment Bank,
GDP=Gross Domestic Product
GNP=Gross National Product
IDF=Institutional Development Facility
IFI=International Financial Institution
Iller Bankasi=Bank of Provinces
KfW=Kreditanstalt fur Wiederaufbau
MoF=Ministry of Finance
MoI=Ministry of Interior
PFPSAL=Programmatic Financial and Public Sector Adjustment Loan
PIP=Public Investment Program
PTT=Turkish Post, Telegraph and Telecom
SPA=Special Provincial Administration
SPO=State Planning Organization
TGS=Treasury Guarantee Scheme
Currencies and GDP Estimates
Year / GDP, Current. Trillion TL / Average Exchange rate, TL per US$ / GDP, Current, Million US$1997 / 28,836 / 151,239 / 190,665
1998 / 52,225 / 260,080 / 200,804
1999 / 77,415 / 417,758 / 199,670
2000 / 124,583 / 623,947 / 199,669
2001 / 181,409 / 1,225,490 / 148,040
Vice President:
Country Director:
Sector Director:
Sector Manager:
Task Team Leader: / Shigeo Katsu
Andrew N. Vorkink
Hossein Razavi
Lee Travers
Sudipto Sarkar
TURKEY
MUNICIPAL SECTOR REVIEW
Table of Contents
FOREWORD
EXECUTIVE SUMMARY
1.INTRODUCTION
Need for a Strategy
2.OVERVIEW OF URBAN AND LOCAL GOVERNMENT ISSUES
Urbanization Issues
Overview of Local Government
Local Government and the National Economy
An Example: Municipal Services of Water and Wastewater
3.CENTRAL GOVERNMENT FINANCING AND CONTROL
Central Government Oversight
Issues
Reforms
Central Government Transfers
Issues
Reforms
4.MUNICIPAL REVENUES
Locally Raised Revenues
Locally Raised Revenues and Population Size
Collection of Real Estate Tax
Issues
Reforms
5.MUNICIPAL BORROWING
Current Situation
The Treasury Guarantee Scheme (TGS)
Iller Bank
Issues
Reforms
Iller Bank Reform
Iller Bank Reform - Long Run
6.CONCLUSIONS AND NEXT STEPS
Approach Towards the Reform
Potential Role of the World Bank
ANNEXES
Annex 1IllerBank Income Statements
Iller Bank Balance Sheets
Iller Bank Cash Flow Statements
Annex 2Iller Bank Investments
Annex 3Iller Bank – An Option for Reform
Annex 4World Bank Guarantee Schemes
TURKEY MUNICIPAL SECTOR REVIEW
FOREWORD
During the last few years concerns about the sustainability of the Turkish municipal sector as a whole have emerged as many towns and cities have not met their financial obligations to the State. Treasury loan guarantees have been invoked as many municipalities and water utilities have failed to honor their debt service commitments. Excessive dependence on the State on the part of the municipalities is limiting the quality of local services and reducing the accountability of local authorities.
The current Government recognizes the issues related to the municipal sector and has embarked on an overall public sector reform program that includes activities for the municipal sector. A draft framework law on Public Administration has been prepared and is currently under discussion. This framework law will be followed by other laws such as the Municipal Law, Municipal Revenue Law that are expected to enhance municipal financial management, strengthen the local institutional capacity, and increase local revenues.
This report forms the basis of the discussions the Bank is currently having with the Government regarding the municipal sector in the context of the public sector reform agenda. While the issues presented in the paper will be addressed through the various initiatives taken by the Government, the report summarizes the current state of affairs, reflects the discussions the Bank has had with the Government, and is assisting the Government in forming policies. The suggestions made in this note have been taken into account at the formulation of the draft Public Administration Law and amendments to the Iller Bank Law.
The report is a compilation of three background papers on central government oversight and control, local government operations, and activities related to municipal borrowing. These papers were discussed in a two-day consultative workshop in Ankara and the discussions were reflected in the draft report that was submitted to the Government in October 2002. Given the ongoing changes in the sector, the Government provided two sets of comments – in April 2003 and October 2003. These comments are reflected in the report.
The primary authors of this report are Anders Zeijlon and Sudipto Sarkar (Task Team Leader). Other team members are: Anwar Shah, Samir El Daher, Alptekin Orhon, Kyoichi Shimazaki, Jane Ebinger, Bülent Özgün (consultant), Sinan Erer (consultant), Hakan Mat (consultant) and Elif Yukseker. Contributions and comments are gratefully acknowledged from Lee Travers, James Parks, Motoo Konishi, Takao Ikegami, Ismail Arslan, Kamer Karakurum Özdemir, Mathew Verghis, Jean-Jacques Dethier, Serdar Yilmaz, and Jan Brzeski. The team also appreciates the comments received from many officials in central and local government agencies in Turkey, including Treasury, Ministry of Interior, Iller Bank, the State Planning Organization, and a number of municipalities and other local government organizations. The peer reviewers for the document are Deborah Wetzel and William Dillinger.
TURKEY MUNICIPAL SECTOR REVIEW
EXECUTIVE SUMMARY
1.Objective: The objective of this review is to highlight strategic directions and actions that would strengthen the operational and financial performance of the local government sector, and in particular the municipalities. The Government’s current reform proposals are focused on the provisions developed in the draft Public Administration Law. The draft law proposes an increase in central government funding for the local authorities. These increases would have to be put in perspective of the overall macroeconomic and fiscal constraints as well as current absorptive capacity in the municipalities. This report outlines strategic directions and actions that are designed as a comprehensive reform program for the municipal sector.
2.Rapid Urbanization: Currently, about 65% of the population lives in urban areas and it is expected that this percentage will increase to between 75% and 85% before it stabilizes. The urban population has grown by 4.4% per year during the last fifty years compared to an average national population growth of 2.3% in the same period. Although the pressures related to urbanization have been high, Turkey has been able to provide urban services to its citizens. Overall coverage of transport, water, and solid waste management is high, and on a per capita basis municipal expenditure has increased over time.
3.Need for a Strategy: In the past urbanization related demands were met by assigning basic responsibilities for service delivery to the municipalities. The central government was the main source of financing, and to ensure proper use of resources a number of oversight and control measures were put in place. While this strategy worked in the past, it is now becoming increasingly difficult for the central government to oversee the 3,200 municipalities in the country. Thus, while the municipal sector is functional, the current strategy does not adequately address increasing urbanization demands for the following reasons:
- Fiscal pressures rule out the past practice of meeting the growing service demands through increased allocations from the central budget. The public sector’s share of GDP is high and this is especially relevant for municipal investments which have been dependent on the central government through the Treasury guarantee scheme and heavily subsidized borrowing through Iller Bank.
- The system of local transfers and borrowing does not provide incentives for financial discipline. There is limited support to improve financial accountability at the local level, although financial accounting and management reforms have been mandated for the whole public sector and measures are being taken in the central agencies on this matter. The reforms include a new procurement law, new accounting standards and budget classification system, and new measures for internal control and audit. A major training and extension effort is needed to implement these reforms in the local authorities.
- Large shares of central government funding for both operational and capital expenses at the local level have caused a split in the responsibility for taxation (by the center) and usage of resources (by the municipalities), thus reducing local accountability. Also, continued reliance on traditional administrative control has become increasingly ineffective to oversee, influence, and guide Turkey’s large and growing urban sector and economy.
- The role of the private sector in the delivery and financing of urban services is minimal, excepting urban transport, due to the perceived high political risks and lack of a supporting regulatory framework. With greater involvement of the private sector, the service efficiency would increase and fiscal pressures would decrease.
- Significant investments (tentatively estimated at US$20 billion) are needed for Turkey to meet EU standards in the areas of water, wastewater and solid waste. Reforms are needed to ensure that municipalities and their utilities can raise the required financing and manage their assets in an economic manner.
4.The Economy and the Municipal Sector: The size of the municipal sector is currently about 4% of the GNP. While there is little room for growth in the short term, sector growth in the long run may be possible provided there is a reduction in fiscal pressures and a shift from central government to local government responsibilities. The reforms proposed for the municipal sector are also linked to the financial sector. Long-term domestic loans are not available today and the high cost of borrowings from external sources, without State guarantees, limits debt financing by the municipalities. This in turn affects investment financing since municipalities on average use as much as 1/3 of their current revenues to fund capital costs.
5.Overall Approach Towards the Reform: Reforms in the municipal sector cover many areas and a strategic approach should be taken by identifying the type of reform, defining the role of various agencies, and outlining a schedule. A key factor in designing the reforms would be differences in the size, economic conditions, and institutional capacity of the municipalities. The proposed improvements may vary between municipalities and would be linked to their size and capacity. This review suggests municipal sector improvements in the following two broad categories:
- Public Sector Reform: With the objective to create a system for sustainable delivery of urban services, reforms would center around the passage and implementation of the Public Administration Law covering three broad areas: central government oversight functions, central government transfers, and locally raised revenues. Particular emphasis would be placed on local implementation of the recently adopted public sector legislation and measures related to financial accountability, budget classification and control, and public procurement; and
- Municipal Borrowing Reform: Reforms would focus on re-establishing local financial discipline, addressing the issue of municipal arrears, and the operations of Iller Bank to help establish a sustainable system of central government support for local investments. In the long term, an appropriate legal and regulatory framework should be established to facilitate the use of commercial funding for municipal investment. Before such financial intermediation takes place, several conditions would need to be met including an increase in financial discipline at the municipal level and an improved macroeconomic climate with room for expanded public lending.
6.Institutional Responsibilities: A number of agencies would be involved in the implementation of these reforms – including the Ministry of Interior, Treasury, Ministry of Finance, Ministry of public works, State Planning Organization, and the Association of Municipalities. For public sector reforms, it would be logical for the Ministry of Interior to be the lead agency. For municipal borrowing reform, Treasury should take the lead role given their close link to macroeconomic issues and the financial sector.
7.Municipal Responsibilities and Institutions: The core municipality responsibilities are: a) transportation which includes urban road construction and maintenance, and public transportation; b) water and wastewater services; and c) solid waste management. The municipalities are also responsible for land use planning and development, management of the environment, and conservation of natural and cultural/historical assets. The services are provided either by municipalities or through municipal enterprises. In addition, there are municipal enterprises that run commercial operations that are not directly connected to the core services. This review proposes that the municipalities disengage themselves from commercial operations that may attract the private sector.
8.Municipal Revenues and Expenditure: Municipal accounts are kept on a cash basis. Cash inflow for the municipalities is as follows: central government transfers – 50%; local revenue generation – 39%; borrowings – 11%. On cash outflow the breakdown is (2000): current expenditure – 43%; investment expenditure - 25%; and transfers – 32%. The cash outflow has traditionally been higher than the cash inflow and the deficit has been financed through debts held by the State. The current outstanding municipal debt to the State is around US$ 5.1 billion and it corresponds to about one year of municipal revenues. Due to statistical uncertainties, it is not clear whether information on revenues and expenditures captures all municipal activities, i.e. commercial and enterprise activities, and as a result it is difficult to determine the effectiveness of the use of funds compared to services delivered. A stronger local financial management system is needed to provide accurate information to guide the development of policies and to support day-to-day management decisions.
9.Central Government Oversight: The central government exercises considerable control over Turkey’s municipalities mainly through the Ministry of Interior and the provincial and district governors. The central government oversight relies largely on ex-ante controls and emphasizes the center’s obligation to ensure compliance with laws. The control measures fall under three categories – administrative, budgetary, and financial. As evidenced by the increasing financial arrears, the traditional reliance on ex-ante controls has become increasingly ineffective as the urban economies have become too large and complex for the center to control directly. Further, the oversight system is not outcome oriented and fails to provide information about municipal performance and actual service delivery. Reforms proposed to improving the central government’s oversight functions include:
- Technical Assistance and Training. Training and advisory support should be provided to improve financial and operational performance. On the financial side, efforts should focus on local implementation of already legislated reforms that cover the entire public sector related to financial accountability and control, budget classifications and public procurement.
- Increase performance monitoring. To this end, the Government has started a pilot project that will benchmark operational and financial performance across many municipalities. Development of the pilot is being supported by a grant from the Bank’s Institutional Development Fund (IDF).
- Reduce administrative control. This would include increased local control over taxes and fees, modification or elimination of cumbersome administrative procedures that lead to delays, and replacement of the existing system of central government authorization for staffing decisions with increased authority at the local level.
- Introduce a participatory budgeting process. International experience shows that the accountability of municipalities increases if citizens are involved in planning and budgeting processes. Increased accountability leads to better governance at the local level. This type of budgeting process could be considered in the medium to long term.
- Central Government Transfers: Central government transfers to municipalities amount to about 2% of GNP and represent 50% of the municipal revenues. The transfers take place through three mechanisms: 6% of national taxes are distributed to the municipalities based on population levels (55% of transfers); 4.1% of taxes collected within the province of a metropolitan municipality are transferred back to the metropolitan municipality (30% of transfers) and; transfers through special government programs (15% of transfers). The transfer system has many appealing features as it is simple and objective and provides stability and predictability in municipal revenues. The transfer system also results in a modest form of equalization. However, the large share of central transfers de-links taxation and spending, weakening taxpayer accountability. Further, the transfers are not linked to actual service levels and extra transfers to the metropolitan municipalities foster preferential treatment of these urban areas. Also, the equalization scheme is merely a by-product of the proposed transfer scheme. Reforms related to improving the transfer system could include:
- Reduce dependence on transfers. Larger cities should be allowed to levy additional taxes, linked to centrally defined taxes, such as income tax. Thus increased revenues would be generated through locally controlled taxes and fees rather than through increases in the central transfers.
- Link transfers to service. Central transfers could be linked to some degree to the level of service actually provided by the municipalities. This would create an incentive for the municipalities to be more service oriented. A sanction mechanism should be established and enforced in case of inadequate performance.
- Review of the equalization mechanism. In the short to medium term it is unlikely that the equalization system would be amended since the current system is functional and allows a modest level of transfer from richer to poorer municipalities. However, in the longer term, as infrastructure needs of the larger cities are met, institutional capacity of the municipalities is increased and a benchmarking system is in place, amendments to the equalization program should be considered to establish clear objectives for the equalization scheme and to assist the smaller and the poorer municipalities.
- Municipal Revenues: Revenues raised locally correspond to 39% of total municipal revenues (about US$72 per urban citizen) although the tax rates and fees are almost exclusively centrally determined.