US embassy cable - 04ANKARA1319

UNCLAS SECTION 01 OF 02 ANKARA 001319 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EUR/SE, AND EB/IFD 
TREASURY FOR JLEICHTER AND MMILLS 
NSC FOR MBRYZA AND TMCKIBBEN 
BUDAPEST FOR WSUDMANN 
 
 
E.O. 12958: N/A 
TAGS: ECON, PGOV, TU 
SUBJECT: IMF NEAR AGREEMENT WITH GOT ON SEVENTH REVIEW 
 
REF: ANKARA 1161 
 
 
1. (Sbu) Summary: According to IMF Resident Representative 
Odd Per Brekk, the Fund Mission is near agrement with the GOT 
on a Letter of Intent for the Seventh Review.  On the fiscal 
side, the GOT and Fund have agreed on measures to plug the 7 
Quadrillion TL fiscal gap: increasing the cut in 
discretionary spending from 10 to 13 percent, reallocating 
0.5 Quadrillion TL from earmarked Special Revenues to the 
general budget, cutting investment incentives and imcreasing 
natural gas, alochol, and tobacco prices.  The GOT-proposed 
cut in VAT rates on textiles is off the table, though the 
Fund has accepted a VAT rate cut on pharmaceuticals.  Fund 
Staff is likely to consider the enactment of all these 
measures to be prior actions required before the board vote. 
On banking sector issues, the Fund has reached agreement with 
the head of the Bank Regulatory Agency and Economy Minister 
Babacan to increase legal protections for bank regulatory 
staff, narrow the ability of the higher court to overturn 
lower court banking-related rulings, and strengthen on-site 
inspection.  Babacan has also reportedly agreed to help lower 
public expectations about potential Deposit Guarantee Fund 
collections.  Brekk said the World Bank continues to work 
with the GOT on developing a new strategy for the State 
Banks.  The IMF is likely to wrap up discussions next week, 
with a board vote in April.  End Summary. 
 
 
IMF and GOT Close Fiscal Gap: 
---------------------------- 
 
 
2. (Sbu) IMF Resident Representative Odd Per Brekk told us 
today that the Mission and the GOT had reached broad 
agreement on the measures needed to close the 7 Quadrillion 
($5.2 billion) 2004 fiscal gap.  According to Brekk, about 
two-thirds of the adjustment would come from the spending 
side.  By increasing the previously-announced 10 percent 
across-the-board cut in discretionary spending to 13 percent 
the Fund estimates this cut will save 3.8 Quadrillion TL. 
The Parliament's Budget Committee approved the increased cut 
last night, and Brekk said the full Parliament was supposed 
to vote on the amendment today. 
 
 
3. (Sbu) Another 0.5 Quadrillion TL will be gained by 
reallocating funds from Special Revenues to the General 
Budget, i.e. by cutting the spending for which these 
off-budget funds were allocated.  There would also be 
(unspecified) reductions in investment incentives.  The 
remainder of the fiscal gap will be filled through a 
combination of increased taxes on alcohol, tobacco and 
natural gas (contrary to the public statements by the Energy 
Minister).  The Mission has agreed to let the GOT have 
another week to try to convince Turkey's Iranian gas supplier 
to lower prices, but if this fails the GOT has agreed to 
raise local gas prices instead. 
 
 
4. (Sbu) Brekk also confirmed that the GOT proposal to reduce 
the Value-Added tax rate on the textile sector from 18 to 8 
percent was no longer under discussion--in fact, he said it 
was a condition of the IMF Mission even coming to Turkey that 
the GOT stop pushing this idea.  The proposed decrease in VAT 
rates on pharmaceuticals, however, had been accepted by the 
Mission, which believes it will be revenue neutral.  Note: 
In a separate meeting, the leading opposition parliamentarian 
on the budget committee, who is also a former director of the 
tax administration, told econoff this measure would entail a 
net loss to the State.  End Note. 
 
 
5. (Sbu) Brekk said the IMF has yet to take a formal decision 
but he believes all of the above revenue and tax measures 
will become prior actions. 
 
 
Banking Sector Issues: 
---------------------- 
 
 
6. (Sbu) The Mission has reached agreement at the level of 
Bank Regulatory Agency (BRSA) Chairman Tevfik Bilgin, 
reportedly with Economy Minister Babacan's support, on three 
politically-sensitive revisions to the banking law.  First, 
Bilgin and Babacan agreed to incorporate increased legal 
protections for staff at the BRSA and the Deposit Guarantee 
Fund (SDIF). Note: IMF staff have long been pushing for these 
protections, and these agencies risk paralysis if official 
acts are constantly questioned and investigated, as now seems 
to be happening.  End Note.  Second, the high court of 
appeals--which has been revisiting the substance of the 
decisions made by the lower court specialized in banking 
issues--would be allowed to review only the process by which 
the lower court decision was taken.  Third, the BRSA's 
on-site inspection powers would be strengthened.  The BRSA 
would be authorized to bring in outside expertise, besides 
the sworn auditors who have monopolized bank inspection. 
Bilgin, himself a former sworn auditor, is reportedly unhappy 
with this measure. 
 
 
7. (Sbu) Brekk said Babacan has also agreed to help try to 
lower public expectations about the sums likely to be 
collected by SDIF from failed bank owners or from assets 
currently held by the SDIF. Several current and former bank 
regulators have complained to econoffs about this problem, 
and Brekk said Babacan agreed to a press conference at which 
the public would be informed about the GOT's more realistic 
expectations. 
 
 
8. (Sbu) Brekk noted the ongoing work of the World Bank team 
that has been in Turkey studying the issue of the state-owned 
banks.  Though there is no concrete plan as yet, according to 
Brekk, one idea the Bank is looking into is to remove the 
large government securities portfolios from the state banks, 
and try to create a "real bank" from what's left and run it 
professionally.  Econcouns noted with concern that the GOT 
seems to have completely reversed course on state bank 
privatization (see septel). 
 
 
9. (Sbu) Brekk said the GOT and bank regulators have decided 
to merge SDIF-intervened Pamuk Bank with state-owned Halk 
Bank, a far better approach in the Fund's view than a 
possible cession of Pamuk Bank to Demir Bank's former owner. 
The latter idea had been briefly under consideration as a way 
to get Demir Bank's owner to drop his lawsuits against SDIF 
and HSBC, which bought Demir Bank from SDIF.  Note: Current 
and former BRSA officials have told econoffs that the 
Pamuk-Halk merger makes sense because: a) it reduces the cost 
to the GOT of recapitalizing Pamuk and, b) it will help Halk 
improve both the quality of its staff and its systems. End 
Note. 
 
 
10. (Sbu) Brekk said the consideration of SDIF's appeal of 
the Danistay's (State Court of Accounts) initial decision to 
overturn SDIF's takeover of Demir Bank is still pending. 
(Brekk revealed that IMF Managing Director Koehler had raised 
this issue with Prime Minister Erdogan, and wondered whether 
the court's delay stems from pressure from Erdogan.) 
Separately, HSBC CEO Piraye Antika told EconCouns that 
Demir's former owner has also filed a suit against HSBC 
istelf, and that HSBC global management is quite concerned. 
 
 
11. (Sbu) Brekk said the controversial Cukurova group 
continues to push for regulatory approval to allow the Cayman 
Islands-based "North Way" Production Company to repay 
Cukurova's debts to Yapi Kredi Bank and take over management 
of that bank.  According to Brekk, BRSA Chairman Bilgin has 
been good so far about not accepting Cukurova's proposal. 
Brekk said the IMF continues to press the GOT to name a 
widely-respected person to lead an inquiry into the Imar Bank 
collapse but the GOT has not been able to identify a suitable 
candidate. 
 
 
Next Steps: 
---------- 
 
 
12. (Sbu) Brekk was optimistic the Fund Mission would leave 
more or less on schedule next week.  He doubted there would 
be a board vote before April, however, given the necessary 
preparation time and prior actions.  Brekk said the Fund 
might reduce the planned number of reviews this year from 
five to three for practical reasons. 
EDELMAN