US embassy cable - 03ISTANBUL1200

UNCLAS SECTION 01 OF 02 ISTANBUL 001200 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EB/IFD AND EUR/SE 
TREASURY FOR OASIA - MILLS AND LEICHTER 
NSC FOR BRYZA 
USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO 
 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, EFIN, PGOV, TU, Istanbul 
SUBJECT: ISTANBUL ECONOMISTS CHEER RECENT GOOD NEWS, BUT 
REMAIN WARY 
 
 
1.  Sensitive but Unclassified.  Not for internet 
distribution. 
 
 
2.(SBU) Summary: Istanbul market analysts are pleasantly 
surprised by recent positive developments in the economy, and 
accept the rationale for the IMF's preemptive decision to 
reschedule much of Turkey's 2004 and 2005 debt repayments. 
They warn, however, that the government will have to use the 
current opportunity to best advantage, and that much of the 
recent good news (including on the inflation front) is 
dependent on the strong Turkish lira, which may begin to give 
back its gains in early fall.  The market, they suggest, will 
continue to take its cues from Turkish-IMF relations, and 
from developments relating to promised U.S. assistance.  Some 
argue disbursement of the latter's initial tranche itself 
could bring interest rates down 2-3 percent.  End Summary. 
 
 
3.(SBU) Good News: A range of senior bankers and market 
analysts told Pol/Econ Chief and visiting Ankara Deputy Econ 
Counselor on August 12 that they are relatively optimistic 
about the Turkish economy for the short term, given recent 
positive developments, including good inflation, industrial 
production, and export figures, and most significantly the 
IMF's decision to defer repayments of 2004 and 2005 debt. 
They noted that the timing of the rescheduling had surprised 
the market, though most believed it was unavoidable, given 
the volume of debt coming due, particularly in 2004.  In 
Bender Securities' Murat Gulkan's view, the Fund made a 
virtue of necessity, making the move at a time when it would 
be welcomed by the market.  Had it occurred in the fall, he 
suggested, markets would have reacted negatively, viewing it 
as a sign of IMF weakness. 
 
 
4.(SBU) Lira Appreciation: Most analysts stress, however, 
that much of the recent good news, including especially the 
recent decline in inflation, is tied to the appreciation of 
the Turkish lira.  They suggest that the lira's strength may 
not persist beyond October, given seasonal factors, and warn 
too that its high level may also begin to negatively affect 
exports, which have played a key role in leading the recent 
recovery.  Our contacts had a variety of explanations for the 
lira's strength, but almost all now see money from Iraq 
playing a significant role.  Bender's Murat Gulkan and Emin 
Ozturk noted the recent disconnect between the foreign 
exchange and bondmaret, wththefomerriingstongy, 
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thirvie--ecoed byYapi Kedi Bak conmit Hsa 
rsl--ony lira puchasesaimed rimariy at cnsumption or 
investments outsid the financial markets explain the 
discrepancy, since otherwise bond yields would have fallen as 
well.  Another factor in the discrepancy may also be the 
relative thinness of the foreign exchange market, a point 
cited by an Akbank executive in a recent meeting with the 
DCM.  Ersel posited that many ordinary Turks, having sharply 
curtailed consumption during the 2001 financial crisis, 
finally feel enough short-term confidence to spend more. 
Since their income has not increased, however, Ersel said 
they are dipping into their wealth in the form of foreign 
exchange holdings.  HC Istanbul Chief economist Banturalp 
Candemir credited promised U.S. assistance with calming the 
market and permitting the lira to appreciate, and predicted 
that actual loan disbursement would bring rates down another 
2-3 percent. 
 
 
5.(SBU) Future Steps: Candemir raised another cautionary note 
for next year, noting that two-thirds of the government's 
revenue measures this year have been "one off."  Given that 
many have been amnesties which are relatively painless but 
which can only go so far, new more painful measures will be 
required next year for Turkey to maintain a strong primary 
surplus.  That will be tough for the government, he 
predicted, "since they want to avoid hurting people," 
especially in an election year.  Bender's Gulkan and Ozturk 
agreed that the government's fiscal performance has been a 
problem, in that while "good" in Ozturk's view, it has not 
kept pace with the IMF program's "extremely ambitious" 
targets. 
 
 
6.(SBU) A Weak Banking Sector: Banking contacts also hailed 
the recent good news, but were less sanguine about the 
banking sector itself.  TEB CEO Akin Akbaygil identified the 
size of Turkey's banking sector as the key problem facing the 
country, arguing that the country's debt would be less of a 
problem if the sector were more developed.  Yapi Kredi Senior 
Vice President and Chief Economist Hasan Ersel concurred, 
noting that steps to increase bank capitalization last year 
had been a "static solution to a dynamic problem."  Both 
expressed concern about the impact of the IMAR bank scandal 
on the BRSA, with Akbaygil predicting that the scandal's 
scope may ultimately eclipse that of the BCCI scandal.  He 
noted that banking regulators appear to have been fixated on 
simply confirming basic measures such as the bank's capital 
adequacy ratio, and were blind to the scope of the apparent 
fraud being carried out at the bank.  More generally, while 
conceding that the BRSA has done an enormous amount to clean 
up the sector, and "surviving banks" are appreciative of its 
efforts, problems remain, including lack of liquidity (too 
many bank assets are tied up in treasury paper, leaving the 
banks "prisoners" of the system).  Incentives remain skewed 
against conducting actual banking, however, as good profits 
are available only in buying and selling government paper. 
 
 
7.(SBU) Comment: Our contacts were more sanguine about 
prospects for the fall than they have been in the past, given 
the IMF's surprise decision, and concurred that it, together 
with promised U.S. assistance, could create a "virtuous 
circle" that brings down interest rates and lessens the 
financing burden on the Treasury.  They warned of the extreme 
fragility of this scenario, however.  Candemir noted that AK 
Party officials are convinced that their successful policies 
brought down interest rates.  In his view, however, the rate 
decline is not a success story, in that it could have been 
even more dramatic if the IMF review process had not been so 
drawn out.  End comment. 
ARNETT