US embassy cable - 05ANKARA2972

UNCLAS SECTION 01 OF 03 ANKARA 002972 
 
SIPDIS 
 
STATE FOR EUR/SE AND EB/IFD 
TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER AND MMILLS 
NSC FOR BRYZA AND MCKIBBEN 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, TU 
SUBJECT: CENTRAL BANK PREPARES TO WEATHER FRENCH "NO" 
 
REF: A) ANKARA 2732; B) ANKARA 2737; C)_ANKARA 2070 
 
1.(SBU) Summary: Governor Serdengecti and Monetary Policy 
Committee member Sak told us separately that the Central 
Bank will focus more on creating the conditions for job- 
creating growth, in part to head off politicians blaming the 
Bank for high unemployment.   Both Serdengecti and Sak 
stressed the need for deepening structural reforms.  The 
Governor thought that any market turbulence if the French 
vote "no" would be manageable, and reiterated his belief 
that the floating exchange rate regime mitigates current 
account deficit concerns.  End Summary. 
 
Need for Structural Reforms to Achieve Sustainable, Job- 
Creating Growth. 
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2.(SBU) In separate meetings with Central Bank Governor 
Serdengecti and Monetary Policy Committee Member Guven Sak, 
both emphasized the need for continued  structural reforms 
to generate sustainable, job-creating growth.  Serdengecti 
said that now that the economy has stabilized--and he is 
confident this year's inflation target will be achieved--the 
Central Bank will focus more on sustainable growth, even 
though its mandate is narrowly-defined as seeking price 
stability.  Serdengecti explained that if the Central Bank 
does not point out the need for continued structural 
reforms, politicians will revert to their traditional 
behavior: as few reforms as possible and more populist 
initiatives.   "They never learn," Serdengecti said.  So far 
in the recovery, price stability has encouraged growth, and 
if the GOT continues with structural reforms, Serdengecti 
believes job creation will catch up.  Rather than 
understanding that the success of the program to date 
provides the Government some room for maneuver to continue 
reforms, the GOT is in danger of  slowing reform momentum. 
Serdengecti attaches great importance to tax reform-- more 
to spread the burden than to increase revenue. 
 
3.(SBU) Sak shed light on the Bank's shift in focus by 
noting the danger that persistently weak employment growth 
could lead the politicians to blame the Central Bank.  He 
also worried about what might happen when Serdengecti's term 
comes to an end next year.  Given the expected constraints 
on job growth arising from a strengthening exchange rate and 
high employment taxes, Sak called for a multi-faceted 
strategy to encourage employment despite these constraints. 
He does not subscribe to the theory-recently articulated by 
IMF Europe Director Deppler-that Turkey was now at a stage 
of the recovery in which firms would need to start hiring to 
sustain sales growth.  Not that Sak disagreed with the IMF's 
overall approach: stabilization is expected to create 
conditions for growth.  However, Sak characterized the 
Fund's approach as a long-term view that will not create 
jobs in the short run. 
 
4.(SBU) Instead, Sak does not believe job-creation will be 
"automatic," and sees the need for the GOT to launch a 
coordinated effort and explain it to the public, with a 
focus on structural reform supportive of employment growth, 
as well as "active" labor market initiatives.   Lamenting 
the absence of a Dervis-style economic czar with 
responsibility for all aspects of economic policy, Sak 
stressed the need for technological innovation-both through 
FDI and by other means-and the need to attract private 
sector investment in all aspects of infrastructure.  Sak 
grumbled about the anti-competitive behavior of Turk 
Telekom, which, if it remained in the public sector would 
continue to hold back the economy.  He was particularly 
dismayed to see regulatory actions that are designed to 
reinforce Turk Telekom's dominant position, with an eye to 
maximizing the sales-price, rather than considering what is 
best for the sector as a whole. 
 
5.(SBU) Sak also sees encouraging regional trade, and 
reducing firms transaction costs in conducting it, as an 
important way to encourage new forms of economic activity. 
The Union of Turkish Chambers of Commerce (TOBB) with which 
Sak is affiliated, has been actively seeking to encourage 
trade with the Middle Eastern countries.  He contrasted this 
interest with TUSIAD (which represents the large, Istanbul- 
based conglomerates) which has not participated in fora like 
BMENA.  Sak finds TUSIAD myopically focused on the EU, 
missing the point that a Turkey with stable, developed 
economic ties to its Middle Eastern neighbors is a more 
attractive candidate for EU membership. 
 
If the French Vote No: Turbulence but no Crisis: 
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6.(SBU) Serdengecti said Turks  had had extensive 
discussions with the IMF on what might happen in financial 
markets if the French vote "no" in their May 29 referendum 
on the EU constitution.  He commended the Government's 
public line that it is an internal EU matter, downplaying 
the link to Turkey.  Serdengecti admitted, however, that if 
the French vote "no" there could be turbulence in Turkish 
markets.  Note: This contrasts with Treasury U/S Canakci 
who, even in private stuck to the GOT line that the 
referendum was not linked to Turkey's EU candidacy, and 
downplayed any market impact.  End Note.  Serdengecti 
insisted, however, that even a bad scenario, in which there 
was a precipitous fall in the exchange rate, would be 
manageable. 
 
Harvard Economists' Current Account Worries: 
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7. (SBU) The issue of the Turkey's vulnerability to a 
reversal of short-term portfolio investment flows, and the 
attendant risk of a sharp exchange rate adjustment was 
raised by a group of Harvard economists with whom 
Serdengecti  and one of his Vice-Governors met on a recent 
trip to the U.S.   The group, including Turkish-origin Dani 
Rodrik, as well as Olivier Blanchard, expressed concern 
about the Central Bank's exchange rate policy and the large 
current account deficit.  Serdengecti responded that the 
Bank had studied the literature and found that in almost all 
balance of payments crises, there were fixed exchange rate 
regimes.  Serdengecti admitted the Bank had not expected the 
magnitude of the current account deficit in 2004, but 
attributed it to the unexpectedly high GDP growth rate.  In 
2005, he expects growth to exceed the 5 percent target, but 
not by much, and sooner or later believes the current 
account deficit will come down.  The exchange rate will 
eventually adjust but "we don't worry about it."  If the 
short-term investors try to leave they will be effectively 
locked in.  If they try to leave they will take large 
losses: "we won't defend the level of the exchange rate."  A 
sharp exchange rate adjustment (perhaps up to a twenty 
percent depreciation) could happen, and could cause 
difficulty to the Central Bank's disinflation campaign, but 
would not constitute a crisis. 
 
8.(SBU) Serdengecti, contrasting the Harvard economists to 
the more market-oriented  "Chicago school," said the group 
advocated measures like increasing bank reserve 
requirements, more aggressive Central Bank purchases of 
foreign exchange reserves, and a softer stance on interest 
rates.  Serdengecti also complained about an unhelpful 
intervention by Ricardo Hausman at a conference in Ankara, 
in which he said the Central Bank was overly focused on 
price stability. 
 
Central Banks Diversifying out of Dollars: 
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9. (SBU) Turning to global risks, Serdengecti questioned the 
theory that Asian Central Banks would abruptly diversify out 
of dollar assets. If they believed the dollar will fall, 
they would have done this earlier, and if they do sell 
dollars, they should do so quietly and slowly so as not to 
perturb markets.  In Turkey's case, this is not an issue, 
according to Serdengecti: because of the Central Bank's 
large Euro liabilities, it keeps two-thirds of its reserves 
in European currencies. 
 
Comment: 
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10. (SBU) Serdengecti's admission of the risk of post- 
referendum turbulence suggests a degree of prudent 
preparation, unlike Canakci's unrealistic line.  The 
Governor's analysis that a bad scenario is unlikely to lead 
to full-blown crisis matches the local economists' analysis 
we described in ref c, although it is impossible to 
completely rule out that a truly horrendous shock would lead 
to a crisis.    The Bank's newfound focus on sustainable 
growth, arising from worries the Bank will be blamed for 
weak employment growth, suggests there is an increasing risk 
of political pressure on the Central Bank.