US embassy cable - 04ISTANBUL1371

UNCLAS SECTION 01 OF 02 ISTANBUL 001371 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR E, EUR/SE AND EB/IFD 
TREASURY FOR INT'L AFFAIRS -- MILLS AND SCHWARZMAN 
NSC FOR MBRYZA AND TMCKIBBEN 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, EFIN, TU, Istanbul 
SUBJECT: ISTANBUL ANALYSTS ON CURRENT ACCOUNT RISKS 
 
 
Sensitive but Unclassified.  Not for internet distribution. 
 
1. (SBU)  Summary: Despite positive international and 
domestic developments, including the Turkish government's 
recognition of the need for a new stand-by agreement for the 
2005-2007 period, Turkish markets have remained range-bound 
in recent weeks.  Many analysts attribute the markets' 
failure to rally to concern about the burgeoning Turkish 
current account deficit, which grew 95 percent year-on-year 
in the first six months of 2004 and at 9.9 billion for that 
period is now approaching 4 percent of GDP.  Most analysts 
doubt the deficit is near crisis levels; however, there is 
some difference of opinion on the severity of the problem, as 
can be seen by the contrasting positions rating agencies such 
as S and P, Fitch, Moody's, and JCR have taken.  Istanbul 
market observers we have canvassed in recent weeks agree that 
the high level of the current account is the largest cloud on 
Turkey's economic horizon, but largely concur with Fitch and 
S and P that it has not yet reached crisis proportions.  They 
argue instead that currently projected levels are 
financeable, and that the government's attention to the 
problem, while unlikely to be effective in and of itself, 
sent an important message to the markets that it was 
monitoring the issue, a point Economics Minister Babacan 
reiterated on August 25.  End summary. 
 
2. (SBU) A dramatic jump: January to June 2004 figures showed 
the current account gap at 9.9 billion USD, a 95 percent jump 
from the 5.09 billion USD deficit in the same period in 2003. 
 While exports have grown quickly, imports have expanded even 
more rapidly, leaving the trade deficit at 12.2 billion USD. 
(The trade deficit continued to worsen in July, when it 
reached 3.2 billion USD.)  Other negative items include 
investment, whose deficit was 2.8 billion USD for January to 
June.  On the positive side of the ledger, services (largely 
tourism) were in surplus at 3.5 billion, as were transfers 
(from Turks living abroad) at 1.6 billion.  As is typically 
the case in Turkey, tourism revenues are bunched in the third 
quarter, such that the full-year current account deficit may 
not be much higher than the first half number.  For the first 
half, Turkey financed the overall current account gap with 
net capital inflows of 9.4 billion USD and (given an increase 
in official fx reserves of 2.7 billion USD) 3.2 billion in 
net errors and omissions. 
 
3. (SBU) Financing Concern: Indeed, more than the absolute 
level of the deficit, the financing mix on which Turkey 
relies was of more concern to our interlocutors.  Global 
Securities' Cem Akyurek, for instance, told us on August 19 
that he sees an encouraging trend towards repatriation of 
foreign capital by Turkish businesses in the net errors and 
omission total, but finds the overall composition of Turkey's 
capital inflows less inspiring, particularly the country's 
reliance on "hot money," i.e. short-term portfolio 
investment.  Indeed, figures show that of the net inflow only 
1 billion USD came into Turkey as FDI from January to June. 
While this is a significant improvement on the abysmal FDI 
level of the first half of 2003, it falls far short of the 3 
billion in portfolio investment that came into Turkey in 
January-June.  The remainder of Turkey's capital inflow came 
from bank and non-bank borrowing, while government borrowing 
was negative because of net repayments to the IMF.  Bender 
analysts Murat Gulkan and Emin Ozturk concur that dependence 
on portfolio investment leaves Turkey vulnerable to sudden 
shifts in sentiment (the maxi-devaluation scenario which 
briefly spooked the markets when it was raised by a Moody's 
senior credit officer), but they also saw positive financial 
developments on the horizon that should help cover the gap. 
These include the recent agreement between the Cukorova Group 
and the Savings Deposit Insurance Fund (SDIF), whereby the 
group will repay 4 billion USD over the next two years, 
almost exclusively from (admittedly mysterious) foreign 
sources, privatization or sale of big ticket items such as 
Tupras, Telsim, and Petkim (which should bring foreign 
interest), and prospects for a new stand-by agreement with 
the IMF. 
 
4. (SBU) Unavoidable Result: Analysts also reminded us that 
given the nature of the Turkish economy, with its dependence 
on imported capital equipment, an expanding deficit is an 
inevitable result of an economic recovery.  Akyurek argued 
that obviously a current account deficit of 5 percent of GDP 
would not be sustainable, but that similarly the economy 
could not grow with a deficit at its post crisis levels of 
1.5-2 percent of GDP.  Citibank Treasury Vice President Cem 
Koksal similarly viewed the deficit as a sign of the 
"success" of the government's economic program, and predicted 
that government measures would be successful in controlling 
it. 
 
5. (SBU) A Demand Explosion?: Though concern has been raised 
recently about the dramatic expansion in consumer loans and 
credit card debt, most analysts, like Deputy Prime Minister 
Sener, were reluctant to attribute the deficit to credit 
expansion.  Citibank noted that while they have increased, 
the absolute level of consumer loans is not that high, while 
Garanti Bank Vice President Kubilay Cinemre argued that 
automotive loans, one of the fastest growing items, simply 
represent the fulfillment of pent-up demand from the 
post-crisis period, and are rapidly reaching their limit. 
Similarly, Murat Ucer of Eurosource saw signs in July 
consumer data that consumption is starting to ease, while 
Global's Akyurek stressed that except for consumer durables, 
for which demand also accumulated in the post-crisis period, 
demand pressures are not excessive. 
 
6. (SBU) Government Policy: While some, particularly in the 
banking sector, are critical of the government's decision to 
increase the natural resources tax to dampen consumer 
lending, market analysts like Baturalp Candemir at HC 
Istanbul were impressed by the government's attention to the 
current account issue.  For the first time, he suggested, the 
government had taken action before a problem had hit the 
market.  On the other hand, the move is likely to complicate 
upcoming negotiations with the IMF.  IMF Deputy Resrep 
Christoph Klingen has told Embassy Ankara econoffs that the 
increase in the resource utilization tax had been taken in 
defiance of Fund staff, which opposed it as contrary to the 
GOT-agreed strategy of reducing bank intermediation costs. 
 
7. (SBU) More generally, however, there is broad consensus 
that current account pressures dictate that the government 
should maintain a tight fiscal policy for the foreseeable 
future, so most analysts in Istanbul are focused on the 
upcoming IMF-GOT negotiations.  Meeting the government's 
inflation target is likely to be tough next year, Akyurek 
suggested, and the government needs to maintain a high 
primary surplus to keep possible demand pressures under 
control.  Both he and Candemir did not see a 6.5 percent 
level as essential, but saw room for some give and take so 
long as the quality of fiscal adjustment is improved and its 
duration lengthened.  Hence a primary surplus of 6 percent 
could be acceptable to the market, as could exclusion of some 
investment items from the primary balance, so long as the 
government made clear its commitment to that level over a 
number of years.  Only such a commitment, Akyurek argued, 
would permit real interest rates to decline from their 
current 15 percent level.  While some are concerned that such 
rate declines could further fuel imports, Candemir pointed 
out that the rates' current high levels themselves help fuel 
the current account deficit by encouraging short-term capital 
inflows that keep the Turkish lira overvalued.  Note: 
Istanbul analysts' willingness to contemplate some loosening 
of the 6.5 percent primary surplus does not take into account 
the likely resistance from the IMF board to easing the GOT's 
contribution to the financing gap that the IMF is being asked 
to fill.  End Note. 
 
8. (SBU) GOT policymakers clearly remain attuned to the 
market's concerns about the current account deficit.  Both 
Economics Minister Babacan and Deputy Prime Minister Sener 
sought to emphasize the government's vigilant attention to 
the current account issue in public comments on August 25, 
with Babacan noting that the government will undertake 
further strong measures to control the deficit if necessary, 
while downplaying the seriousness of the problem in further 
comments on August 31.  For his part, Sener implicitly gave a 
green light to gradual devaluation of the Turkish lira, 
arguing that such a development would inevitably help resolve 
the problem by leading to a decline in imports and rise in 
exports. 
 
ARNETT