US embassy cable - 03ANKARA5551

UNCLAS SECTION 01 OF 02 ANKARA 005551 
 
SIPDIS 
 
 
SENSITIVE 
 
 
DEPT FOR E, EB/IFD/OMA, AND EUR/SCE 
TREASURY FOR OASIA - MILLS AND LEICHTER 
NSC FOR MCKIBBEN 
 
 
E.O. 12958: N/A 
TAGS: EFIN, PREL, TU 
SUBJECT: IMF RESREP PREPARES FOR BUSY SEASON; 
POSITIVE INFLATION AND FISCAL NUMBERS ANNOUNCED 
 
 
REF: ANKARA 5443 
 
 
 
 
1. (SBU) Summary:  IMF Resident Representative Odd Per Brekk 
told us the Fund is gearing up for an intense period of work 
towards the Sixth Review.  The jury is still out on a series 
of structural reforms, especially direct tax reform, and big 
questions remain on the budget, though a Treasury 
announcement suggests the GOT is likely to at least come 
close to meeting the end-August primary surplus target. 
Separately, the Central Bank announced better than expected 
August inflation numbers.  End Summary. 
 
 
2. (SBU) In a lunch with Emboffs September 2, IMF Resident 
Representative Odd Per Brekk and his new deputy, Christoph 
Klingen, provided an overview of the state of play on the 
economic reform program.  With Turks and expatriates alike 
returning from holidays, the IMF is gearing up for a period 
of intense activity with three teams due to start work in 
Turkey over the next couple of weeks.  Next week, two 
technical teams will start work with GOT counterparts: one on 
the second phase of the direct tax reform and the second on 
the high cost of bank intermediation.  The direct tax reform 
issue, including investment incentives and free trade zones, 
is quite political according to Brekk, and is an area in 
which the GOT has been guilty of backsliding in the past. In 
fact, in an August meeting with Emboffs, the Finance Ministry 
Undersecretary had advocated investment incentives for the 
poorer regions of Eastern Turkey.  The second team will focus 
on how policies contribute to high credit intermediation 
costs. 
 
 
3. (SBU) Starting September 25, a mission will begin work on 
the sixth review.  Brekk and Klingen said it was too early to 
get a good fix on how well the GOT has done in meeting the 
end-August fiscal targets. Klingen said they are working with 
GOT counterparts right now to try to get a better fix on 
this, but that GOT officials seem more optimistic about 
meeting the end-year than the end-August targets.  Klingen 
noted that the continued strong growth in the real economy 
augured well for tax collections, despite the fact that 
stronger-than-anticipated growth will increase the 
denominator of the primary surplus-to- GDP target. 
 
 
4. (SBU) Regarding the disappointing January-July fiscal 
performance (Ref A), Brekk noted that the Fund and the GOT 
hoped that many of the additional measures introduced to meet 
the fifth review would make up for the weakness earlier in 
the year.  The bad social security numbers also may improve 
because they were the result of the amnesty.  On both issues, 
however, Brekk admitted that the jury was still out. 
 
 
5. (SBU) After the meeting, Treasury released surprisingly 
favorable August numbers on its cash position, suggesting to 
at least one Istanbul analyst that his earlier pessimism 
based on January-July targets was unwarranted.  According to 
the Treasury report, on a cash basis the August based primary 
surplus was TL 4.6 Quadrillion (USD 3.3 billion), bringing 
the January-August primary surplus on a cash basis to TL 
11.96 Quadrillion (USD 8.5 billion).  Though the IMF uses a 
different definition of the primary surplus, incorporating 
the positions of some State Enterprises and the Social 
Security system, the good Treasury numbers suggest--and a 
well-placed Finance Ministry official confirms--that the GOT 
is likely to come close to the end-August primary surplus 
target. 
 
 
6. (SBU) With regard to the Uzans and the Imar Bank scandal, 
Brekk pointed out that any GOT payments to BRSA to finance 
the cost of intervention are not expected to have a 
significant short-run budget impact.  Legitimate deposits 
would be transferred to Ziraat Bank, which would then be 
compensated by the issuance of government bonds, though this 
would add to the government,s interest bill over time. 
 
 
7. (SBU) Brekk characterized the issue of BRSA,s handling of 
Imar Bank as posing a dilemma.  On the one hand, it is hard 
to understand how BRSA failed to detect the problems at Imar 
Bank at an earlier stage.  On the other hand, there is a 
danger of the Government using the case to undermine BRSA. 
Brekk agreed on the importance of both the USG and IMF 
stressing to the GOT the broader point about the importance 
of the independent institutions (especially the BRSA and 
Central Bank) in sustaining the economic reform program. 
Brekk mentioned the importance of passage of laws, drafted by 
the BRSA, that streamline the judicial process for intervened 
banks and prevent against frivolous lawsuits. 
8. (SBU) Another key IMF-sponsored structural reform, passage 
of the Public Financial Management and Control law, is a 
prior action under the sixth review. Brekk was cautiously 
optimistic that it would be passed. 
 
 
9. (SBU) On the privatization program, Brekk agreed that the 
GOT should not be faulted for the delay on Petkim caused by 
the Uzans.  Brekk admitted it now seems unlikely that the GOT 
would meet the Fund,s indicative targets for receipts from 
privatization--both for September 30 and for December 31. 
If, however, the GOT can clinch the sales of Tupras and Tekel 
by the end of the year, even if the cash has not yet been 
received, this would be significant progress.  Council of 
Ministers approval of a plan for the sale of Turk Telekom (a 
structural benchmark for the sixth review) will also be key 
to judging progress on privatization. 
 
 
10. (SBU) From a bigger picture perspective, Brekk made the 
case that Turkey has considerably reduced its vulnerability 
to a financial crisis.  The built-in adjustment mechanism of 
a floating rate currency regime, a longer average maturity of 
government debt, a considerably strengthened and 
better-regulated banking sector, and an independent Central 
Bank have all played a role in reducing the danger of a 
crisis. A stronger fiscal situation and declining inflation 
are also important.  On the other hand, the lengthening of 
maturities has come at the cost of increasing the 
government,s exposure to foreign exchange-denominated or 
foreign exchange-linked debt instruments, such that a sudden 
turn in the lira,s fortunes could have a painful fiscal 
impact.   Though the Government,s foreign exchange risk 
profile bears watching, banks, are no longer permitted to 
take large open positions, so the banking sector,s foreign 
exchange risk profile is much better than in years past. 
Though corporate foreign exchange risk may be of concern, 
noone has good data on the extent of the problem. 
 
 
11. (SBU) Late on September 3, the State Statistical 
Institute  announced better-than-expected inflation numbers 
for August.  The Wholesale Price Index decreased repeat 
decreased 0.2 percent such that the year-to-date WPI increase 
is 10.7 percent and year-on-year 22.7 percent.  The Consumer 
Price Index, on the other hand, increased in August, but by 
only 0.2 percent. The year-to-date CPI increase was 11.7 
percent and the year-on-year increase is 24.9 percent. 
 
 
 
 
 
 
EDELMAN