US embassy cable - 05ANKARA686

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 000686 
 
SIPDIS 
 
TREASURY FOR INTERNATIONAL AFFAIRS - MMILLS AND CPLANTIER 
NSC FOR BRYZA AND MCKIBBEN 
 
E.O. 12958: DECL: 02/03/2014 
TAGS: EFIN, TU 
SUBJECT: TURKISH TREASURY WORRY ON IMF STATE OF PLAY 
 
REF: ANKARA 606 
 
Classified By: Deputy Chief of Mission Robert Deutsch for reasons 1.4(b 
) and (d). 
 
1. (C) Summary:  Showing considerable frustration and concern 
about Turkey's relations with the IMF, Treasury 
Undersecretary Ibrahim Canakci explained the GOT's thinking 
in its recent decision to expand the investment incentives 
law despite the strong opposition of top IMF management. 
With the Prime Minister reportedly adamant on the need for 
the expanded investment incentive, Canakci hoped the GOT 
could work out a solution with the Fund with compensating 
measures and not jeopardize the program, but admitted this 
will not be easy and take time, delaying the program. Markets 
remain ignorant of this potentially program-derailing 
situation.  Canakci insisted that, outside the new investment 
incentive issue, the delays on the prior actions are not 
related to differences with the IMF. End Summary. 
 
Expansion of Investment Incentives: 
---------------------------------- 
 
2. (C) Canakci confirmed February 4 that the Council of 
Ministers had approved an amendment to the investment 
incentives law at its January 31 meeting (reftel).  He 
explained that the incentives law, adopted a year ago after a 
compromise with the IMF, had drawn criticism from NGO's, 
politicians and business people.  The law had allowed rebates 
on income tax and employers' social security premia and 
partial state support for electricity costs both for existing 
companies that increased payrolls by at least 20% or for 
newly-established operations that created at least 10 jobs. 
These incentives applied only in the 36 provinces whose per 
capita GDP is under $1500. 
 
3.  (C) The criticisms centered on the perceived unfairness 
that arose from this design.  Existing companies felt they 
were put at a disadvantage.  Provinces where the per capita 
GDP was above $1500 protested the use of this threshold given 
that some of these provinces' apparently higher income level 
did not reflect the employment situation or the overall level 
of development.  Canakci cited the example of Elazig, in 
Eastern Turkey, where the value-added from a large hydropower 
project lifts GDP per capita above the $1500 threshold, but 
the province remains relatively poor and underdeveloped. 
 
4. (C) Consequently, Canakci said the new amendment uses the 
State Planning Organization's socioeconomic index, which uses 
50 indicators, including health and education as well as 
income data.  The amendment provides that all provinces 
falling below the national average using this index will be 
eligible for incentives.  By this measure, the incentives 
would apply to 49 provinces rather than 36.  The amendment 
would also apply to all employees of existing companies in 
these provinces, not just to newly-created jobs.  He said the 
GOT calculates the additional annual cost at between 1.2 and 
1.5 billion New Turkish Lira or about 0.2-0.3% of GNP. 
However, he said Fund staff put the cost at 2.5 billion NTL 
or 0.5% of GNP. 
 
IMF Concerns: 
------------ 
 
5. (C) Canakci confirmed that the IMF has insisted on 
compensating measures, including in a meeting in Davos 
between Deputy M.D. Krueger and the Prime Minister.  Canakci 
also noted the IMF concern on a broader, theoretical level 
with this kind of investment incentive.  (Note: The IMF never 
liked the law in the first place and only agreed grudgingly a 
year ago after obtaining substantial narrowing of the scope 
of the GOT's original proposal. End Note.)  Canakci admitted 
it would have been far better to have discussed this issue 
during the program negotiations in November and December, but 
the political leadership had only raised the issue 
afterwards.  In an earlier conversation Ozgur Demirkol, the 
Treasury staff-level official coordinating work on the IMF 
program, said that personally he sympathized with the IMF 
view that the GOT should stick with what it committed to. 
Canakci did not contradict this. 
 
Prime Minister Adamant: 
---------------------- 
 
6. (C) Canakci also confirmed that the GOT position comes 
directly from Prime Mininster Erdogan, whom Canakci described 
as adamant that the amended law go forward.  Canakci said he 
had never seen the PM quite so impervious to others' 
arguments.  Recalling last year's post-IMF negotiation 
populist increases in the minimum wage and pension payments, 
Canakci said the economic team had gone out of its way this 
year to brief the entire cabinet in great detail on the 
program, in the hopes of avoiding a repeat.  At the time, 
noone had raised this or other issues. 
Prior Actions: 
------------- 
 
7.(C) Regarding the GOT's slowness to move forward on the 
three key prior actions required for a Letter of Intent, 
Canakci admitted the GOT had moved more slowly than he would 
have liked, but insisted there was no substantive problem. 
He said the reasons for the delays had to do with the 
difficulty of these reforms, such that they required 
extensive consultations with politicians and with other 
stakeholders.  On the Social Security reform, for example 
there had been meetings with "social partners" which had 
taken some time.  (In a recent meeting with the director of 
the Social Security Fund who is spearheading this reform, he 
told us that the consultations with labor unions had been 
delayed by the unions' protests over the merger of social 
security and Ministry of Health hospitals.)  Canakci also 
noted that persistent rumors of an impending cabinet 
reshuffle may have delayed GOT action. 
 
8. (C) Canakci insisted that, on the substance, the GOT is 
fully in agreement with the Fund on these prior actions. 
Unspecified differences between ministers on the Tax 
Administration reform had been resolved by the Prime 
Minister, and the final version is closer to what the IMF 
wanted.  (This tracks with press reports and what Ministry of 
Finance contacts have been telling us: the final version 
keeps tax policy outside the Tax Administration.)  Canakci 
also said the Banking Law is close to being "finalized." 
 
Next Steps, Timing: 
------------------ 
 
9. (C) Canakci was vague on what happens next and how long it 
will take.  He said the Fund is proposing sending a fiscal 
team to evaluate the cost of the expanded incentives and to 
study compensatory measures.  He claimed, however, that the 
Fund is sending mixed signals on the exact role of this 
mission, and that the IMF should not come with any false 
hopes of changing the Prime Minister's mind on the incentives 
law.  Canakci said the Prime Minister has accepted the need 
for compensatory measures and is willing to cut the 
investment budget.  Canakci said the investment budget, 
previously 1.6% of GNP, had been increased for 2005 to around 
2.1% of GNP.  But he feared a difficult negotiation with the 
Fund on compensatory measures, given the need for high 
quality measures and Fund opposition to one-off measures or 
reversion to too low a proportion of investment spending.  He 
said that if the compensatory measures involved reduced 
spending or certain kinds of tax increases, a supplementary 
budget law would be required.  For other tax increases only a 
decree is needed. 
 
10. (C) Canakci confirmed that the economic team had managed 
to delay submission of the amendment to parliament for 2-3 
days, but he doubted they could delay much further as the 
Prime Minister yesterday instructed his staff to go ahead. 
Canakci hoped that a solution could be found with the Fund. 
But showing his lack of maneuvering room, he hoped the Fund 
would accept compensating measures, and some sort of 
framework to avoid this kind of problem in the future  (i.e. 
the GOT committing not to do this again....again).  Canakci 
hoped to avoid "substantive termination of the program." 
 
Meanwhile, the Markets Don't Know: 
--------------------------------- 
 
11. (C) Canakci was understandably nervous about the fact 
that the markets were not aware of this problem.  He said 
that if a solution could not be found quickly, the GOT should 
disclose that the problem existed, even though he realized it 
could cause a "deterioration" in the market's very positive 
recent mood. 
 
Comment: 
------- 
 
12. (C) Both the normally optimistic Canakci and the IMF 
Resrep (reftel) are taking a more worried tone than IMF 
Department Head Deppler seems to have taken at the informal 
board meeting on February 2.  The Prime Minister seems 
determined to take the risk of a serious problem with the 
program and risk a possible market problem to get his 
investment incentive through.  The Economic technocrats, 
apparently including Minister Babacan, seem to be powerless 
to stop him.  This situation is yet another example of the 
Prime Minister's erratic decision-making on economic policy, 
and his inability or unwillingness to play by the IMF's rules 
in a consistent fashion. 
13.  (C) The markets have indeed been rallying in recent 
weeks, driven by the continuing drumbeat of positive data 
releases and strong foreign investor appetite, with the yield 
on the benchmark bond hitting new lows around 18 percent. 
With no leaks yet about the new IMF problem, and the markets 
assuming the program will happen sooner or later, news of 
serious danger to the program should be a significant 
negative.  On the other hand, Turkish markets have tended to 
bet the IMF will always work things out with Turkey.  If 
markets do react, the risk is of a sharp, disruptive sell-off 
from perceived endangerment of the IMF policy anchor, rather 
than from any urgent Treasury need for the IMF disbursement. 
Treasury has just issued a $2 billion Eurobond and has had a 
recent series of successful domestic issuances. 
EDELMAN