US embassy cable - 03ANKARA5443

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 005443 
 
SIPDIS 
 
 
TREASURY FOR OASIA - MILLS AND LEICHTER 
NSC FOR MCKIBBEN 
DEPT FOR E, EB/IFD, AND EUR/SCE 
 
 
E.O. 12958: DECL: 08/25/2008 
TAGS: EFIN, TU 
SUBJECT: MARKETS BUOYANT DESPITE WEAK BUDGET NUMBERS 
 
 
 1.  (U) Classified by Deputy Chief of Mission Robert Deutsch 
for reasons 1.5 (B) and (D). 
 
 
2. (SBU) Summary: January-July budget data, combined with a 
frankly skeptical assessment by a key budget official, 
suggest that the GOT will have difficulty meeting the IMF,s 
Sixth Review and end-year fiscal targets.  Markets 
nevertheless remain buoyant, cheered by the prospect of U.S. 
financial assistance, Turkish contributions to the Iraq 
stabilization force, and the steady flow of positive numbers 
on inflation, the lira, exports and capacity utilization. 
End Summary. 
 
 
Disappointing January-July Budget Numbers: 
----------------------------------------- 
 
 
3. (SBU) On August 18, the GOT released revenue and 
expenditure data for July showing a weaker than expected 
primary surplus of TL 395 trillion (USD 282) million. From 
January through July, 2003 the Primary Surplus was TL 10.49 
quadrillion (USD 7.49 billion).  The government,s full-year 
2003 target under its IMF program is TL 20.3 quadrillion (USD 
14.5 billion) or 6.5% of GDP.  With the fall traditionally a 
period of lower revenue collection, market analysts are 
skeptical that the GOT can meet the end-year target. 
 
 
4.  (SBU) In real terms, both revenue and expenditure were 
roughly comparable to the first seven months of 2002 however 
individual budget categories showed sharp movements in both 
directions.  The GOT seems to have done reasonably well in 
cutting investment expenditure (down 28 percent in real 
terms), and not too badly in controlling the rise of the 
public sector wage bill: personnel costs increased 5 percent 
in real terms.  There were, however, alarming increases in 
Social Security expenditure and tax rebates.  Social Security 
spending increased 25 percent in real terms compared with 
January-July 2002 and spending on tax rebates jumped 39 
percent in real terms. 
 
 
Budget Official on Fiscal Problems: 
---------------------------------- 
 
 
5.  (C) In a meeting with econoffs August 21, Ministry of 
Finance Deputy Budget Director Ahmet Kesik shared private 
analysts, view that the first seven months budget numbers 
were not good.   Though Kesik did not seem overly concerned 
about the August 31 numbers, he seemed far more concerned 
about year-end 2003.  Kesik explained that the kind of 
remedial budget actions the GOT took to pass the fourth and 
fifth reviews would be far more difficult towards the end of 
the year.  Whereas the GOT had frozen spending in many areas 
earlier in 2003, to freeze spending the final quarter will 
only create public sector arrears in 2004, because line 
agencies have already committed to the spending.  Kesik said 
more measures could be needed in October to able to meet the 
fiscal targets this year. 
 
 
Social Security Headaches: 
------------------------- 
 
 
6. (C) Kesik said the problems with the Social Security 
system were so severe that the IMF understands it will take 
at least a year or two to fix them.  The Bag-Kur, the Social 
Security system for self-employed workers, is in particularly 
bad shape, with payments exceeding collections, according to 
Kesik.  Exacerbating the problem with Social Security 
collections, under IMF pressure, the GOT had raised premiums 
leading to increased resistance to paying.  In Kesik,s view, 
the most important problem for Social Security is 
attributable to the frequency and severity of downturns in 
the real economy.  With crises every few years, employers 
have often closed their doors.  In many cases, when firms 
rehire, employees are glad to get work whether they are on 
the books or off.  Unemployment is officially eleven percent 
but Kesik believes this understates the problem because of 
severe underemployment. 
 
 
Agricultural Sector Issues: 
-------------------------- 
 
 
7. (SBU) According to Kesik, the agricultural sector is a 
particular problem for the Social Security system, especially 
the Bag-Kur.  Kesik put the agriculture sector,s share in 
GNP at 16 percent, but said it accounts for 42 percent of 
total employment.  Yet contributions to Social Security from 
agricultural employees are low since much of the employment 
is off the books. If employees do not contribute for 4 or 5 
years they are removed from the system, but given current 
conditions Kesik claimed that many workers accept being 
removed from the rolls because they cannot afford to pay. 
8. (C) Aside from Social Security-related problems, the ag 
sector subsidies also contribute to budget deficits.  Kesik 
said the problem arose in part from a World Bank push for a 
change from production-linked subsidies to direct payments to 
farmers.  Kesik lamented that the GOT had transitioned to 
direct payments without eliminating existing subsidies.  He 
claimed that the direct payments scheme had led to 
questionable claims, and the Ministry of Finance was pushing 
for some minimal evidence that the recipients of the direct 
payments were actually farmers. 
 
 
Tax Rebates: 
----------- 
 
 
9. (C) Regarding the sharp increase in Tax Rebates (para 4), 
Kesik only noted that Ecevit-era reforms had forced the 
Ministry to make tax rebates to exporters within a month.  He 
also said there were rumors of corruption in tax rebates and 
suggested the IMF look more closely at this issue. 
 
 
Organizational Issues: 
--------------------- 
 
 
10. (C) Kesik is convinced that the GOT would be able to more 
effectively manage its fiscal situation with a more cohesive 
bureaucratic structure, rather the than the existing division 
of responsibility between the State Planning Office (SPO), 
Treasury and the Finance Ministry.  Though he enjoys 
excellent working relations with his colleagues in Treasury 
and SPO*-a fact cited by opponents of a 
reorganization*-Kesik said the effectiveness of an 
organization shouldn,t depend on individuals.  Kesik 
confided that he had attended a meeting on the topic at which 
Minister Babacan had seemed sympathetic to a reorganization. 
Other ministers--and most senior civil servants--however, 
were opposed and the idea was shelved despite IMF pressure. 
 
 
Markets focused on politics and the real economy: 
--------------------------------------------- --- 
 
 
11. (SBU) Despite the discouraging budget numbers and the 
critical importance of the end-year primary surplus target, 
Turkish markets remain bullish.  On August 22, the principal 
Istanbul stock market index, the IMKB 100, reached a high for 
the year at 12,001.8.  More importantly, the benchmark bond 
traded below 40 percent before closing slightly higher at 
40.3 percent on a compound basis.  At this level, interest 
rates are the lowest since before the 2001 financial crisis 
and have come down dramatically in the past year, from a 
level of over 70 percent.  Like the stock and debt markets, 
the lira, too continues strong, trading below TL 1.4 million 
per USD since August 13. 
 
 
12. (SBU) The markets, enthusiasm seems to be based on a 
combination of political developments and real economy 
indicators, rather than public finance.  On the political 
side, after reacting to to the approval of the Fifth Review 
and the IMF's extending Turkey's repayment reschedule, 
markets are focusing on the prospects for improved relations 
with the U.S. based on the discussion of Turkey contributing 
to the stabilization force in Iraq and signs of forward 
movement on U.S. financial assistance.  With regard to the 
real economy, on top of the encouraging July inflation and 
export numbers, on August 21 the GOT announced that capacity 
utilization in manufacturing had risen to 80.9 percent. 
Moreover, the Central Bank released August 21 a favorable 
report on expectations.  The business people surveyed expect 
year-end CPI to be 22.4 percent, down from 23.0 percent in 
the previous survey released in early August. 
 
 
 
 
13. (SBU) Though markets retreated slightly on Monday, the 
bulls returned on Tuesday despite the prospect of a large 
Treasury redemption on Wednesday.  Treasury enjoyed great 
success in issuing TL 2.2 Quadrillion (USD 1.57 billion) of 
t-bills and bonds on Tuesday.  Market analysts attributed the 
favorable reception in part to Treasury having a borrowing 
need below what markets had expected. After the Treasury,s 
bond and t-bill sales, the benchmark bond was trading at 
39.84 percent. 
EDELMAN