US embassy cable - 04ANKARA259

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 000259 
 
SIPDIS 
 
 
STATE FOR E, EB/IFD, AND EUR/SE 
TREASURY FOR OASIA - JLEICHTER AND MMILLS 
NSC FOR MBRYZA AND TMCKIBBEN 
 
 
E.O. 12958: DECL: 01/13/2014 
TAGS: EFIN, ECON, PGOV, PREL, TU 
SUBJECT: CENTRAL BANK GOVERNOR URGES U.S. TO PRESS ERDOGAN 
ON ECONOMIC REFORM 
 
REF: A. ANKARA 136 
     B. ANKARA 128 
     C. 2004 ANKARA 8014 
 
 
CLASSIFIED BY AMBASSADOR ERIC EDELMAN FOR REASONS 1.5 (B) AND 
(D). 
 
 
1. (C) Summary: Central Bank Governor Serdengecti convoked 
econoffs to raise concerns that Prime Minister Erdogan's 
Washington visit could reinforce the GOT perception that the 
U.S. will back Turkey financially regardless of the quality 
of GOT economic policies.  He urged that U.S. leaders include 
in their comments to the Prime Minister a strong message on 
the need to stick to economic reform.  Serdengecti warned 
that the rally in Turkish markets was fed by "wishful 
thinking," and warned that this rally could easily be 
reversed.  End Summary. 
 
 
2. (C) Central Bank Governor Serdengecti asked Econoffs to 
meet with him January 14.  At the meeting, Serdengecti raised 
Prime Minister Erdogan's Washington trip, and expressed a 
concern that the GOT may perceive that the U.S. will back 
Turkey "no matter what."  Serdengecti said no one knows for 
sure why the Prime Minister pushed through the large increase 
in the minimum wage increase and the larger-than-budgeted 
pension payment increase, despite Economy Minister Babacan 
and Treasury Undersecretary Canakci's best efforts to 
dissuade him.  Serdengecti added that the Prime Minister and 
Babacan's exchange became quite heated.  Serdengecti claimed 
that the PM accused Babacan of sounding like the IMF, to 
which Babacan allegedly responded: "Of course I do--I have to 
work with these people." 
 
 
3. (C) Serdengecti put the GOT's recent populist moves in the 
context of Turkish economic history: whenever inflation comes 
down the Government thinks it can do what it likes.  He fears 
that people may be telling the Prime Minister he need not 
worry too much about fiscal discipline because he can rely on 
the Central Bank to bring down interest rates.  The Central 
Bank Governor characterized the dialogue with the IMF over 
fiscal matters as being "in bad shape," because it will be 
both politically and technically difficult to find fiscal 
measures to compensate for the minimum wage and pension 
payment increases. 
 
 
4. (C) Serdengecti claimed that the financial markets no 
longer provide any constructive pressure on GOT 
policy-making, as markets have tended to ignore bad news in 
recent months, and have been on a sustained rally based on 
"wishful thinking."  Saying he has seen this pattern before 
in Turkey, the Governor attributed market optimism to a 
combination of foreign buying and the domestic private 
sector's keen desire to sustain economic growth at all costs. 
 As in the past, all it will take is a trigger of some 
political shock or natural disaster for the market to fall 
sharply.  In Serdengecti's view, heavy foreign investor 
demand for Turkey's Eurobond issuance last week has led 
domestic investors to believe the foreigners know something 
about Erdogan's U.S. visit that gives them confidence. 
Econcouns noted that, although the U.S. very much wants 
Turkey to succeed, we see the path to success lying through 
strong economic reforms, which is why the $8.5 billion FA has 
economic conditionality. 
 
 
5. (C) Understanding that geo-strategic issues such as Cyprus 
and Iraq are likely to be foremost on the USG agenda with the 
Prime Minister, the Governor argued that this should not 
exclude a helpful message on the need for continued economic 
reform.  This would help counter advice the Prime Minister 
may be receiving from the same AK Party people who last year 
both advised the Prime Minister to resist Central Bank 
disinflation and voted against the Government's position on 
the March 1 "Tezkere" resolution.  As an aside, Serdengecti 
noted that these parliamentarians' betrayal of Erdogan on the 
Tezkere helped discredit their economic arguments, and buoyed 
the Central Bank Governor's standing with the PM. 
 
 
6. (C) Serdengecti was careful not to overdramatize the 
situation: he has not yet felt intense pressure to cut 
interest rates, and he believes the inflation outlook is 
still "ok."  Had it not been for the populist measures, he 
could have cut interest rates in late December or early 
January, but now felt the need to wait and see these 
measures' impact on inflation expectations.    The Central 
Bank also has been considering resuming its auctions of 
Turkish Lira (i.e. purchases of Foreign Exchange), which it 
suspended a couple of months ago.  However, given the revived 
danger of GOT problems with the IMF, the Bank did not want to 
resume auctions and then have to suspend them faced with a 
sharp market correction.  Next weekend's planned payment of 
the first instalment to depositors in the failed Imar Bank is 
also expected to have an impact on the foreign exchange 
market, since the payments will be in TL, a significant 
portion of which may be converted into dollars or euros. 
7. (C) Serdengecti confirmed that he will not be accompanying 
the Prime Minister though he will attend the Davos World 
Economic Forum meeting. 
 
 
8. (C) Comment: Serdengecti's concern, recently echoed by 
both World Bank and IMF officials, tracks with post's recent 
warnings to key economic officials, including the 
Ambassador's recent comments to several GOT economic 
ministers on Turkey's continued economic vulnerability and 
the need to stick to the reform program.  Serdengecti's fears 
reinforce post's belief that it is important to stress 
economic reform during the Prime Minister's Washington 
meetings.  Separately, post requests the Treasury Department 
consider engaging with the World Bank and IMF to ensure that 
Managing Directors Kohler and Wolfensohn deliver a similar 
message to the Prime Minister. 
 
 
 
 
 
 
 
 
EDELMAN