US embassy cable - 04ANKARA2628

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 002628 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EB/IFD/OMA, AND EUR/SE 
TREASURY FOR OASIA - RADKINS AND MMILLS 
NSC FOR BRYZA AND MCKIBBEN 
 
 
E.O. 12958: DECL: 05/10/2006 
TAGS: EFIN, ECON, TU 
SUBJECT: TURKISH GOVERNMENT INTEREST RATES SPIKE 
 
 
REF: A. ANKARA 2600 
     B. ANKARA 2599 
 
 
(U) Classified by Economic Counselor Scot Marciel for reasons 
1.4 (b) and (d). 
 
 
(U) This is an Action Reqest. See paragraph seven. 
 
 
1. (C) Summary:  Turkish markets' sell-off accelerated Monday 
with equities, the lira, and, especially government 
securities falling sharply.  The increase in interest rates 
on government debt was very large for a single day, with 
rates over 30 percent for the first time in 2004.  In 
Turkey's case, today's global sell-off in emerging markets 
was compounded by a worse-than-expected current account 
deficit announcement late Friday and local tension between 
the GOT and the military over legislation to ease university 
entrance for graduates of religious high schools. In view of 
the market problems, Post recommends Washington accelerate 
consideration of the GOT's latest proposed language for the 
Financial Agreement, so as to be ready should the GOT press 
us for an answer.  End Summary. 
 
 
Markets Bad Mood Turns even more Sour: 
------------------------------------- 
 
 
2. (Sbu) The sour mood in the markets at the end of last week 
turned significantly worse today.  As reported in ref b, 
after the markets closed Friday, the Central Bank announced a 
worse-than-expected current account deficit for February of 
$2.066 billion.  This set the stage for markets to fall at 
the opening Monday, which they did.  In addition to the 
current account deficit announcement, markets were hit by a 
global sell-off and a particularly negative mood for emerging 
market assets.  Exacerbating the negativity was that 
transaction volume was relatively thin as Turkish markets 
awaited the outcome of this afternoon's Council of Ministers 
meeting (still ongoing at this writing).  Central Bank 
Governor Serdengecti was due to brief the Council, and after 
the markets' close some of his (mostly critical) comments 
were reported by Reuters.  Some Istanbul analysts had told 
econoff last week that they expected a Central Bank 
intervention if the TL/dollar rate moved (i.e. the TL 
depreciated) over 1.5 mm TL to the dollar.  Though the lira 
depreciated through the 1.5 mm barrier, the Central Bank did 
not intervene. 
 
 
3. (Sbu) By the close the dollar was at TL 1.554 mm, vs. TL 
1.502 at Friday's close, and the Euro at TL 1.820 vs. TL 
1.796 mm Friday.  Comparing the rates as fixed by the Central 
Bank, it was a 3.30 percent fall in the exchange rate.  The 
IMKB 100 stock exchange index fell 1.145 percent from it's 
already low level at Friday's close, to 16.807.71.  Most 
worrisome for the GOT, however, was the sharp increase in 
interest rates on government securities.  In the morning, the 
Turkish Treasury held its reference auction.  The interest 
rate on the reference auction is used to set interest rates 
paid to non-market holders of government securities, such as 
state-owned banks.  Though the Treasury had no difficulty 
meeting its targeted issuance amount, the interest rates bid 
were higher than expected, coming in at 26.84 percent.  The 
worse-than-expected results may have helped further drive up 
rates in the secondary market: by the close, the rate on the 
benchmark had risen to 28.76 percent, up 251 basis points in 
one day from Friday's closing rate of 26.25 percent, which 
was already over 400 basis points higher than the early-April 
low point.  Interest rates on the benchmark for next-day 
settlement reached 31.28 percent. 
 
 
Central Bank Hesitates to Intervene: 
----------------------------------- 
 
 
4. (C) Central Bank Director General for Markets Akil Ozcay 
told econ specialist that he thought the markets are waiting 
for the GOT to announce a package of measures against the 
growing current account deficit (such as an increase in the 
tax on consumer loans) or to clarify the future role of the 
IMF. Comment: Post has had no indication that the GOT is 
close to a decision on what kind of IMF role it will request 
from the Fund, let alone be in a position to make a public 
announcement after consultation with the Fund.  End comment. 
Ozcay admitted volatility was high, but said he doubted 
Central Bank intervention by itself would do much to help the 
exchange rate.  He pointed out that it was more difficult for 
the Central Bank to decide to intervene now, when it would 
have to sell its foreign exchange reserves, than it was to 
buy foreign exchange as it did when the lira was 
appreciating. Separately, Central Bank Vice Governor Erdem 
Basci told Econcouns that the Central Bank was not overly 
concerned about the exchange rate, given the floating rate 
regime, but was concerned about interest rates. 
 
 
5. (Sbu) Citigroup Treasurer Tijen Gumusdis told econoff that 
the Central Bank should have intervened today. She said 
markets expected the intervention when the TL fell sharply at 
the opening, with the dollar well above the TL 1.5 mm level. 
According to Gumusdis, foreign players are shorting lira 
assets, accelerating its depreciation.  She explained that 
foreign investors, who had bought into long-dated government 
securities in January and February, cannot get out of these 
instruments because it is a thin market.  Now that sentiment 
has turned against Turkish risk, these investors are hedging 
their exposure by shorting other lira assets, such as Turkish 
Eurobonds, or using options written by Turkish banks. 
Gumusdis also said it was very difficult to know how to deal 
with these market conditions, contrasting the situation today 
with earlier periods of volatility when the market direction 
bore some relationship with fundamentals.  Today, the 
fundamentals are fine, but the markets are very negative. 
 
 
6. (Sbu) Tevfik Aksoy of Deutsche Bank pointed out to Econoff 
that the sell-off in Turkish Eurobonds was the worst among 
emerging market countries today, even though it was a bad day 
for all emerging market debt.  Aksoy noted how far the yield 
on Turkey's 30-year Eurobond had shot up: from 7.6 percent in 
early February to 9.94 percent today.  In the domestic 
government securities market, Aksoy said foreigners were 
selling but that local banks were not willing to try to 
defend their large positions in government securities. 
Gumusdis said the foreign selling had triggered local selling 
of government securities.  Aksoy attributed the local banks' 
unwillingness to defend their positions to their belief it 
was too strong a wave to try to fight.  Likewise, he thought 
the Central Bank might not have been able to stop the fall of 
the lira, had it decided to intervene. 
 
 
Comment and Action Request: 
-------------------------- 
 
 
7. (C) If the sell-off continues, ratcheting up pressure on 
the Government, the GOT may be in more of a hurry to get 
answer from the U.S. on its latest proposed language on the 
Financial Agreement.  Post requests Washington accelerate its 
(preferably positive) consideration of the GOT proposal as 
much as possible. 
EDELMAN