US embassy cable - 03ANKARA6141

UNCLAS SECTION 01 OF 03 ANKARA 006141 
 
SIPDIS 
 
 
SENSITIVE 
 
 
TREASURY FOR OASIA - MMILLS AND JLEICHTER 
STATE FOR E, EUR/SCE, EB/IFD/OMA AND EB/IFD/ODF 
NSC FOR MBRYZA AND TMCKIBBEN 
 
 
E.O. 12958: N/A 
TAGS: EFIN, PREL, TU 
SUBJECT: KEY ECONOMIC CONDITIONALITY ISSUES FOR USG LOAN 
DISBURSEMENT 
 
 
REF: A. ANKARA 5951 
     B. ANKARA 6071 
 
 
1. (SBU) Summary:  For the decision on GOT compliance with 
economic conditionality in the U.S.-Turkish Financial 
Agreement, post recommends Washington focus on the most 
critical issues in the IMF's Sixth Review: staff reductions 
at SEE's, the end-August fiscal target, the 2004 budget, the 
Public Financial Control Law, Direct Tax Reform, 
strengthening the Bank Regulator's ability to seize 
intervened banks' owners' assets, and GOT approval of a plan 
to privatize Turk Telecom.  We are not likely to have enough 
information to judge whether the GOT is on track until the 
IMF mission completes its work around October 10. Separately, 
Post recommends the USG lay down markers for a different set 
of issues we will scrutinize in making our decision six 
months hence on a second tranche disbursement.   End Summary. 
 
 
Critical issues for First FA Disbursement: 
----------------------------------------- 
 
 
2. (SBU) In order to prepare for the U.S. decision on the GOT 
implementation of &strong economic policies8 as required 
under the Financial Agreement (FA), post recommends the USG 
concentrate on a few key issues.  These are all requirements 
(either prior actions or structural benchmarks) for the 
IMF,s Sixth Review.  Though there are other requirements of 
the Sixth Review, post recommends we focus in particular on 
these because they are critical to long-term success of the 
program (e.g. fiscal adjustment) or because they demonstrate 
strong political will to continue reforms (e.g. reducing 
staff at SEE,s). 
 
 
3. (SBU) Post recommends we focus on the following: 
 
 
--End-August fiscal target: Though we do not yet know whether 
the GOT met the end-August primary surplus target, it is 
likely to have fallen somewhat short.  A key issue would be 
then be the GOT elaborating with the Fund a series of 
remedial actions to meet the end-year fiscal target.  We will 
also need to decide how much importance to attach to the GOT 
missing the target, even if it came close. 
 
 
--Credible 2004 budget: By law, the government must submit 
its 2004 budget by mid-October. Government agreement with 
Fund Staff on a credible 2004 budget, in line with 2004 
primary surplus targets, is vital to sustain the economic 
reform program and maintain market confidence. 
 
 
--Progress on SEE staff reduction: Unless there have been 
significant additional actions in recent days, by the end of 
September the GOT will have reduced the number the number of 
redundant SEE employees by only 11,000, far from the 19,000 
end-September target.  The key will be whether the government 
has had the political will to lean on the SEE managers to 
further reduce staff in late September and October. Given the 
high likelihood of this target being missed by a wide margin, 
here, too, we will want to see how the Fund deals with this 
issue and to decide for ourselves how much weight to attach 
to the shortfall. 
 
 
--Passage of the Public Financial Management and Control Law: 
Though this is less politically controversial, it is 
important to improve the transparency of the budget process, 
and to enforce centralized control over line ministry 
spending.  This law will also help maintain the autonomy of 
the independent regulatory bodies such as BRSA, since 
parliament--rather than the executive branch--would approve 
the independent bodies, budgets. The law would also bring 
extra-budgetary spending into the budget framework. 
 
 
--Direct Tax Reform: Though the Sixth Review does not require 
passage of the Direct Tax Reform, it does require GOT 
agreement with the Fund on the specifics.  It remains 
controversial and politicized, with considerable GOT 
resistance--up to the Prime Minister--to eliminating all the 
regional tax incentives.  IFI officials have told us that 
public statements by the Prime Minister in favor of regional 
incentives have translated into GOT insistence that there be 
some form of regional incentive.  Fund staff are reportedly 
working on a &least-bad8 compromise. 
 
 
--Passage of legislation to strengthen the BRSA's hand in 
dealing with court cases involving problem Banks: It has been 
prepared but parliamentary passage will also be needed for 
the Sixth Review. 
 
 
--Privatization:  The Sixth Review requirement of approval of 
a plan to privatize Turk Telekom would seem to be a minimum 
requirement for the USG.  Unless the Fund mission currently 
in country fails to clinch agreement on a Letter of Intent, 
neither the Petkim, Tupras, or Tekel privatizations will have 
reached their bid-submission dates by the time the U.S. needs 
to decide whether to disburse.  Consequently, the only 
reasonable privatization measure we could insist on would be 
the Council of Ministers approval of a plan to privatize Turk 
Telekom. 
 
 
4.  (SBU) Post does not repeat not recommend emphasizing the 
targets for inflation and monetary policy, or for growth. 
 
 
Compressed Timing Dilemma: 
------------------------- 
5. (SBU) Post will confer with key GOT economic technocrats 
and Fund Staff this week to hear how well the GOT is 
progressing on reform implementation, particularly those 
pertaining to the Sixth Review, and will provide ists 
assessment of progress by October 6.  Washington should note, 
however, that there is a real possibility that the USG will 
not have enough information to determine whether the GOT is 
on track by October 6.  In fact, the status will probably not 
be clear until the IMF team completes its work.  Between now 
and October 6 the above-cited legislation may not have been 
submitted to parliament--let alone passed--and there may be 
little news on the fiscal targets, SEE's, direct tax reform 
and Turk Telecom. 
 
 
Potential Markers for the Second Tranche: 
---------------------------------------- 
 
 
6. (SBU) Given the timing of the disbursement decision on the 
first tranche of the FA, it seems unrealistic to push for 
more reforms than those in the Sixth Review. Post recommends, 
however, that we lay down markers--either before or after 
disbursement--about progress we,d like to see before the 
second tranche, including not only staying on track with the 
Fund program but possibly a broader array of reforms which 
the GOT has committed to implement: 
 
 
--Privatization: With Petkim, Tekel and Tupras nearing bid 
submission, post believes it is reasonable to make the point 
now that the USG expects the GOT to consummate the sales of 
all three of these companies by the time of the second 
tranche. In addition, without requiring a sale, there should 
be tangible signs of progress in restructuring and preparing 
state banks for privatization, such as approval of a strategy 
for Vakif Bank. 
 
 
--SEE staff reduction: Complete year-end staff reduction 
targets on SEE,s not on the privatization list (in other 
words, eliminate all 19,000 positions).  Note that 
privatization of Petkim, Tupras, and, especially, Tekel, will 
take care of position-reduction targets at SEE,s on the 
privatization list. 
 
 
--2004 budget measures: pass a budget which is in line with 
the agreement with Fund staff. In the past there have been 
problems with slippage between agreement-in-principle with 
the Fund and the actual measures passed.  We would also 
expect year-end and first quarter fiscal performance to be in 
line with IMF-agreed primary surplus targets.  We could 
stress the need for sustainable, rather than one-off, revenue 
measures. 
 
 
--Maintenance of the independence of regulatory bodies: 
Since the GOT is currently considering a law that would 
undermine the independence of these institutions, this would 
be an important signal to send. 
 
 
--Progress on sectoral reforms in energy, telecoms and 
agriculture: These issues, on which progress has been very 
slow, are the centerpiece of the World Bank,s efforts in 
Turkey.  The GOT has been particularly slow to take advantage 
of World Bank financing by implementing these reforms.  Given 
the complex and difficult nature of these sectoral reforms, 
post recommends making a general point about wanting to see 
progress, rather than requiring anything too specific, with 
one exception. In the telecoms sector, post recommends a 
marker on the GOT implementing its WTO commitment to 
liberalize fixed telephony on January 1, 2004.  Post believes 
the telecoms sector in particular, needs a push towards 
liberalization, and we are only requiring the GOT to live up 
to its commitment. 
 
 
 
 
 
 
EDELMAN