US embassy cable - 03ANKARA6364

UNCLAS SECTION 01 OF 02 ANKARA 006364 
 
SIPDIS 
 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ETRD, PGOV, TU 
SUBJECT: LOCAL BUSINESSES LESS EUPHORIC THAN FINANCIAL 
MARKETS 
 
 
1.    Summary. Recent discussions with business executives in 
Bursa, Istanbul, Kayseri and Izmir indicate increased 
optimism about the economic recovery and the AK Government. 
But business people show none of the euphoria exhibited by 
the IMF- and politics-focused financial markets. There is 
widespread unhappiness over high tax rates and electricity 
costs. Though the executives are concerned over the lira's 
strength, their comments track with analysts, explanations 
of continued export strength.  Corporate managers, 
complaints that the government needs to cut taxes while 
providing increased support reflect a lack of understanding 
of the GOT,s fiscal constraints. End Summary. 
 
 
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The Economic Recovery 
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2.    In a series of recent meetings with visiting Econoffs 
in Istanbul, Kayseri, Bursa and Izmir, corporate executives 
were divided over how much the economy is improving. In 
Kayseri, business people cited the easing of inflation and 
concomitant reduction in interest rates, the end of the Iraq 
war (which has improved consumer confidence), and the Iraqi 
reconstruction effort as all contributing to economic growth. 
Both Ford/Koc and Toyota representatives confirmed press 
reports that, after a disastrous 2002, 2003 domestic car 
sales are up significantly. However, businesses are also 
concerned that the recovery remains fragile, and do not fully 
share the enthusiasm that has recently been displayed by the 
financial markets. Several businesses commented that domestic 
demand remains weak.  Comment: These contradictory views are 
in line with positive but uneven GDP growth numbers, and 
highlight the fact that the financial markets, with their 
near-obsession with political and external factors, are way 
ahead of the "real economy."  End Comment. 
 
 
3.    Despite the relatively undeveloped financial sector, 
businesses claimed they had adequate access to capital -- 
mostly in the form of their own equity.  They say, however, 
that they are hesitant to invest until they are more 
confident about the durability of the recovery, and until the 
government reduces tax rates and otherwise improves the 
investment environment. 
 
 
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Exports/Competition 
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4.    Executives confirm that exports are  driving the 
recovery. For instance, TV/appliance maker Vestel expects 
exports to rise from $1.1 billion in 2002 to $1.5 billion 
this year. The lira,s strength versus the dollar is a 
concern, particularly to the textile/apparel sector. One 
exporter said he had shifted production from Turkey to Egypt, 
and government and analyst contacts have told of Turkish 
companies moving production to lower-cost Bulgaria and 
Romania.  Because of high prices, manufacturers report being 
unable to fill many of their U.S. import quotas. However, the 
relative stability of the Euro vs. the TL has better 
protected businesses that export to the EU (70 percent of 
Kayseri,s exports are to the EU zone, and but 7-8 percent to 
the U.S.). Also, businesses with significant 
dollar-denominated inputs are not being hurt as much. 
Kayseri's Boydak conglomerate (which has just opened a New 
Jersey office), echoing comments made by others, stated that 
it is prepared to accept low profits for some time in order 
to maintain or build market share. Businesses that are more 
thinly capitalized, however, do not have this luxury. 
Comment: These statements track with analysts, theories as 
to why Turkish exports remain strong despite the appreciation 
of the Lira.  A large share of the Turkish export sector -- 
particularly electronics and automotive companies -- has a 
natural hedge against lira volatility because of their 
foreign exchange-denominated inputs.  Moreover, analysts and 
bankers have told emboffs that the 2001 crisis drove out all 
but the most efficient and fast-reacting entrepreneurs, 
especially in the textile sector, and led to significant 
productivity increases. End Comment. 
 
 
5.    Some textile/apparel manufacturers predicted the demise 
of their sector after quotas are lifted in 2005. They report 
already losing sales to Chinese competition in the U.S. and 
other export markets, and are keen to see U.S. trade 
safeguard action against Chinese goods. Others are more 
sanguine, viewing Turkey's customs union with the EU as 
providing them with a competitive advantage over Chinese 
goods.  In contrast to their counterparts in Izmir and Bursa, 
executives in Kayseri were surprisingly indifferent to EU 
accession, and suggested it would not provide much of an 
economic boost beyond that already provided by the customs 
union. 
 
 
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Role of Government/Free Zones 
---------------------------------- 
 
 
6.    Businesses consistently complained about high taxes and 
electricity costs. Because of widespread non-compliance, 
taxpaying businesses are charged very high rates.  Several 
executives blamed the IMF for forcing GOT to raise taxes, and 
want the government to provide more incentives or 
infrastructure, showing little appreciation for the GOT's 
severe budget constraints. 
7.    The Aegean Free Zone and Kayseri Organized Industrial 
Zone, unlike most such economic zones, are doing well. 
Aegean Free Zone exports are up 42 percent through August, 
and employment is up from 10,000 to 10,500, with perhaps 
another 500 jobs to be added by year-end.  Executives 
attribute this to tax breaks, and warn that a GOT decision to 
end those breaks would mean the end to new investment in the 
Zone. Comment: The IMF,s direct tax reform proposal is 
designed to eliminate some of the Free Zone tax breaks, 
including exemptions from corporate and personal income tax. 
Though high tax rates are unquestionably a problem for the 
Turkish economy, the executives, complaints need to be 
balanced against the GOT,s severe fiscal constraints and the 
IFI's legitimate concerns about the distortionary impact of 
so many generous tax incentives. End Comment. 
 
 
8.    With the exception of those in Izmir, the business 
people with whom we spoke were relatively satisfied with the 
current government, viewing it as business-friendly and 
trying to reduce corruption. Executives praised the GOT,s 
commitment to privatization and the recently-streamlined 
company establishment procedures, under which businesses can 
now register in as little as one day.  Izmir-based executives 
stressed the need for the government to continue to reduce 
its role in the economy, although this did not stop them from 
complaining that the government needed to offer more 
incentives and provide better infrastructure. 
 
 
9.  Comment:  Our visits to regional commercial centers 
served as a useful reminder that Turkey's "real economy" is 
still going through difficult times, despite the financial 
markets' recent rally.  This is not a criticism of Turkey's 
IMF-backed economic reform program, as there inevitably will 
be a time lag between implementation of reforms and increased 
domestic demand.  However, our discussions highlighted the 
need for further structural reform -- privatizations, tax 
reform, improved investment environment, and better 
regulation -- if Turkey is to achieve the sustained growth 
and international competitiveness it needs to prosper. 
EDELMAN