US embassy cable - 04ANKARA2874

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 002874 
 
SIPDIS 
 
 
DEPARTMENT FOR E, EUR/SE, AND EB/IFD/OMA 
TREASURY FOR OASIA - DLOEVINGER, MMILLS, AND RADKINS 
NSC FOR BRYZA AND MCKIBBEN 
 
 
E.O. 12958: DECL: 05/06/2007 
TAGS: EFIN, ECON, PREL, TU 
SUBJECT: FUTURE IMF ROLE IN TURKEY 
 
 
REF: ANKARA 2699 
 
 
Classified by Ambassador Eric S. Edelman for reasons 1.4 b 
and d. 
 
 
1. (C) Summary and introduction: Post offers its analysis of 
issues associated with the IMF's future 
role in Turkey.  In our view, the primary goals are to reduce 
the Fund's exposure and to encourage 
Turkey to implement sound policies and pursue the reform road 
to sustainable growth.  In theory, this 
would argue for no new Fund program so as to rapidly reduce 
exposure and force markets to discipline 
the GOT.  However, in practice, nearly all of our economic 
contacts agree that, without the policy 
discipline such a program provides, there is too great a risk 
that the GOT lacks the policy savvy and 
credibility to keep the markets from spinning out of control, 
ultimately costing the IMF or the U.S. 
far more.  Though the U.S. Financial Agreement--assuming the 
Turks tap into it-- may be sufficient to 
take care of any financing requirement, without the 
independent judgment of the IMF the markets, the 
GOT, and Turkish public opinion are likely to conclude that 
our disbursement decisions will be the 
result of geopolitical considerations rather than good 
economics. It will also keep alive the moral 
hazard problem, as we have seen markets relying on the 
expectation of U.S. disbursements rather than 
disciplining the government.  For this reason, Post 
reluctantly believes a Precautionary or small 
Standby would be in the best interest of the U.S., should the 
GOT request it. End Summary. 
 
 
Background: IMF Options at the End of the Current Standby: 
--------------------------------------------- ------- 
 
 
2. (Sbu) Turkey's current Stand-by Arrangement(SBA) ends in 
February, 2005. At a minimum, the IMF would 
have a Post-Program Monitoring Arrangement (PPMA) under which 
the Fund staff would review the GOT's 
policy framework. The PPMA reviews, however, do not have to 
be approved at the IMF's board, and there 
is no policy conditionality with teeth.  A second option, a 
Precautionary Standby, requires IMF Board 
approval of the reviews, but would not involve disbursements 
unless drawn upon by the GOT.  The third 
option, involving the strongest IMF role, would be a new, 
disbursing Standby Arrangement. 
 
 
 
 
The Importance of a (Gradual) Reduction in the IMF's Role... 
--------------------------------------------- ------ 
 
 
3. (Sbu) The IMF understandably wants to take advantage of 
currently positive Turkish macroeconomic 
trends to reduce its outsized exposure, far exceeding normal 
rules about the percentage of quota a 
country can borrow.  Post also understands the USG's interest 
in the Fund returning as much as 
possible to return to its original role of resolving 
short-term financial crises.  Moreover, in 
Turkey's case, the IMF's role (and the perceived strong U.S. 
hand behind it) has compounded the moral 
hazard problem.  An abrupt end to IMF supervision might end 
the moral hazard play, but many in the 
market will bet the international support remains anyway. 
 
 
 
 
...Needs to be Weighed Against Turkey's continuing 
Vulnerability... 
--------------------------------------------- -------- 
 
 
4 (Sbu) On the other hand, there are serious risks to a 
relatively weak PPMA.  Even before the recent 
bout of market volatility, Post's private sector economist 
contacts were unanimous on this point: 
Turkey needs at least a Precautionary.  While these analysts 
fully accept the need for Turkey to be a 
net payer to the IMF, they worry about the GOT's ownership of 
the reform agenda, and the likelihood of 
potentially damaging market volatility without a strong IMF 
role.  Most local economists (and we've 
received similar hints from key Turkish Treasury officials) 
fully expect the IMF to smooth out Turkey's 
2005-2006 repayment hump to the Fund.  Even so, analysts have 
doubts about Turkey's ability to handle 
its external debt service requirements.  Analysts do not see 
a balance-of-payments problem: Turkey's 
Central Bank should be able to come up with the necessary 
foreign exchange.  Rather, the issue is the 
additional domestic debt that the GOT would have to issue to 
fund the purchases of foreign exchange. 
Cem Akyurek, an economist at Global Securities, recently told 
econoff that he had doubts that Treasury 
could issue an additional $5 billion plus to the market next 
year.  Even if the Treasury could issue 
the additional debt, Akyurek argued that the crowding out 
effect of absorbing additional domestic 
savings into the public sector could constrain economic 
growth. 
 
 
5. (C) Deputy IMF ResRep Christoph Klingen (protect) provided 
econoffs with an updated--and still 
confidential--Fund staff calculation of GOT repayment 
 
SIPDIS 
obligations to the Fund.  The current schedule 
is a hybrid approved last August between an "expectations 
basis" and a more spread out "obligations 
basis."  It has the GOT paying $8.3 billion in 2005 and $11.8 
billion in 2006, up from $5.6 billion 
in 2004 and $2.6 billion in 2003.  Of the 2005-6 payments, 
$2.7 billion in 2005 and $4.0 billion in 
2006 are still on an expectations basis, such that the board 
could agree to push them back by one year. 
Though this would help smooth out the hump, especially in 
2005, Klingen noted that in 2006 it would 
only reduce payments by $1.3 billion because the $2.7 billion 
in 2005 payments would be pushed into 
2006.  Turkey would still have to pay $10.5 billion in 2006. 
Klingen doubted the board would object 
to moving these payment obligations even if Turkey only had a 
PPMA. 
 
 
6. (C) Ultimately, it is the policy anchor, rather than the 
money, that most concerns local economists, 
a view Embassy Ankara shares.  Even with a Precautionary 
Standby, the IMF's leverage may be limited, 
but at least the IMF can be somewhat prescriptive, and 
Ministers Babacan and Unakitan can argue to 
the Prime Minister that failure to obtain IMF board approval 
could spook the still-fragile markets. 
Though he is  pragmatic, Prime Minister Erdogan is widely 
thought to have little understanding of 
economic policy, nor does he seem to fully grasp the 
tenuousness of recent economic success and the 
GOT's financial dependence on volatile, short-term domestic 
debt issuance.  Central Bank Governor 
Serdengecti has often complained privately to econoffs of the 
absence of any GOT minister with a strong 
grasp of economics.  In public remarks on May 5, Serdengecti 
implied that Turkey would be well-advised 
to continue having an IMF program next year, noting that 
other EU accession countries have continued 
to have IMF programs during the pre-accession period.  On May 
14, Serdengecti called for relations 
with the IMF that are "as close as possible." 
 
 
7. (Sbu) Had the GOT moved far more aggressively on economic 
reform--much faster privatization, rapid 
liberalization of telecoms and energy markets, improvements 
in the investment climate through resolution 
of disputes and judicial reform--both the financing and the 
policy credibility problems might have 
taken care of themselves and obviated the need for the 
continued strong IMF role.  Unfortunately, the 
GOT failed to grasp this opportunity and has demonstrated 
only a limited interest in reform. 
 
 
..Particularly if the EU Does not Give a Date or Political 
Tensions Increase: 
--------------------------------------------- --------------- 
 
 
8. (Sbu) Though a positive EU decision is far from certain, 
the GOT will almost certainly need at least a 
Precautionary Standby  if the EU hesitates to commit to a 
date to begin accession talks.  Though the 
markets have not fully priced in Turkey getting a date, they 
have attached a high enough probability for 
there to be a major sell-off, very possibly a crisis, if the 
EU rejects Turkish accession negotiations. 
Another risk is the recently-heightened potential for 
political instability, arising out of the GOT's 
friction with the President, the military and the Kemalist 
establishment over the "Imam Hatip" legislation. 
Should this dispute elevate to a serious clash that unnerved 
portfolio investors, the absence of a 
strong IMF backstop would make it that much harder to avoid a 
financial crisis. 
 
 
The U.S. Financial Agreement: 
---------------------------- 
9. (C) If the U.S. and GOT agree on revised wording in the 
Financial Agreement (FA) and the GOT is able 
and willing to overcome its domestic political opposition to 
the FA--two big ifs--the policy dilemma 
becomes more complicated.  Though the U.S. money and policy 
conditionality would go a long way towards 
reassuring markets, the U.S. Government needs to take a hard 
look at the risks of our effectively playing 
the role of lender of last resort, without the IMF.  Though 
the FA conditions disbursements on strong 
economic policies, there is--in all honesty--a risk that 
geopolitical considerations could override economic 
conditionality in USG decision-making.  Even if economic 
conditionality is, in fact, driving U.S. decisions, 
the GOT, the markets and Turkish public opinion will suspect 
that everything the U.S. does is driven by 
geopolitics.  Consequently, the USG will have a powerful 
interest in having the IMF reviews as an independent 
and broadly respected judgment on the quality of Turkish 
economic policy.  Moreover, the presence of the U.S. 
money will distort markets, meaning that markets may not 
provide the policy discipline that one would expect 
in the absence of an IMF program.  Put another way, one of 
the best arguments for not supporting a follow-on 
Fund program--eliminating moral hazard--is effectively 
undermined by the presence of the U.S. money. 
 
 
What Will the GOT Ask For? 
------------------------- 
 
 
10. (C) At this stage it is far from certain what role the 
GOT will ask the IMF to play in 2005 and beyond. 
There is little doubt that the Prime Minister and many of his 
colleagues chafe under IMF strictures. 
Whether better briefed and savvier economic ministers like 
Babacan and Unakitan are sufficiently worried 
about the risk of a crisis to push for an IMF Precautionary 
or even a Standby remains unclear.  Babacan has 
repeatedly said that the GOT will decide this summer, in 
consultation with the IMF. 
 
 
Conclusion: 
---------- 
 
 
11. (Sbu) Turkey narrowly escaped financial collapse only a 
year ago, and is still highly dependent on the 
need to roll over billions of dollars of short-term debt 
every month.  Post believes there is a serious risk 
inherent in a mere Post-Program Monitoring Arrangement.  The 
mere presence of a board-reviewed Precautionary 
Standby will reduce the probability of a crisis, the cost of 
which would far outweigh concerns about moral 
hazard or the IMF's exposure to Turkey.  Moreover, even with 
a Precautionary or small Standby, Turkey would 
remain a significant net payer to the Fund, enabling the Fund 
to substantially reduce its exposure. Though 
the U.S. should not push the GOT to request a board-reviewed 
program--the Turks need to come to this conclusion 
themselves--Post believes the U.S. should seriously consider 
supporting a Turkish request in the IMF Board. 
EDELMAN