US embassy cable - 05ISTANBUL1393

UNCLAS SECTION 01 OF 02 ISTANBUL 001393 
 
SIPDIS 
 
SENSITIVE 
 
DEPARTMENT FOR EB/OMA AND EUR/SE 
TREASURY FOR CPLANTIER 
 
E.O. 12958: N/A 
TAGS: ETRD, ECON, EFIN, TU, Istanbul 
SUBJECT: CURRENT ACCOUNT CONTINUES TO SWELL 
 
REF: ANKARA 4530 
 
This message is sensitive but unclassified-- not for internet 
distribution.  This message was coordinated with Embassy 
Ankara. 
 
1. (SBU) Summary: Turkey's current account deficit set a new 
record in June, reaching 2.35 billion USD, for a year-to-date 
total of 13.7 billion USD and a cumulative total of 19.3 
billion USD over the last 12 months.  The result slightly 
exceeded market expectations, but was not a surprise, as 
Turkey's foreign trade deficit for June (announced earlier 
this month) had also set a record at 4 billion USD.  Istanbul 
analysts see little difficulty in financing the imbalances in 
the short term (indeed strong inflows over the first six 
months of the year enabled the Central Bank of Turkey to 
build up its reserves significantly), but they warn that the 
growing imbalance is the key risk factor hanging over the 
Turkish economy.  They also see little prospect for 
improvement in the near future: exports are beginning to 
weaken slightly (initial figures show only a 1.1 percent 
increase in July exports and declines in many categories), 
and tourism revenues have not met expectations.  Most 
analysts thus predict that this year's current account 
deficit will reach 5.7 percent or more of GDP, and they 
expect it to remain over 5 percent next year.  End Summary. 
 
2. (SBU) A Growing Issue: With exports at 5.8 billion USD and 
imports of 9.8 billion USD, the 4 billion USD June trade 
deficit was in line with market expectations, but still 
highlighted a worrying trend in which the 12-month increase 
in exports (9.7 percent) has remained below that of imports 
(16.3 percent).  Subsequently, July figures released by the 
Turkish Chamber of Exporters (TIM) showed exports slowing 
further, with an increase in July of only 1.1 percent from 
July 2004.  Current account figures released on August 9 also 
showed a widening gap, with the June deficit at an all time 
high of 2.35 billion USD, slightly above the market consensus 
estimate of 2.1 billion.  For the first six months of the 
year, the current account gap grew 38.7 percent to 13.7 
billion USD (exceeding the originally projected figure for 
the year and nearing the current official projection of 15.4 
billion USD).  The 12-month cumulative deficit also set a 
record, reaching 19.3 billion USD.  Analysts pointed to 
disappointing tourism receipts as part of the reason for the 
shortfall: while tourist arrivals increased both in June and 
in the first six months of the year (26 and 27 percent 
respectively), tourism income failed to keep pace, rising 
only 13 percent in June and 16 percent for the six month 
period.  (Note: Turkey's tourism boom has largely centered in 
cheap package holidays; analysts estimated last week that the 
average tourist spends only 650 USD in country over the 
course of a week-long holiday.  End Note.)  As a result of 
these trends, most Istanbul analysts see a current account 
deficit of 5.7 percent or more for the year, with the gap 
remaining over 5 percent in 2006. 
 
3. (SBU) Ready Financing: Though they call attention to the 
quality of its financing, which has traditionally been 
through short-term flows of portfolio investment (hot money), 
analysts see little problem for Turkey in financing the 
current account gap in the short term.  Recent experience 
supports their view.  Financial inflows in the first half of 
the year totaled 16.9 billion USD (excluding the net errors 
and omissions discussed below), enabling the Central Bank of 
Turkey to increase its reserves by some 6.6 billion USD. 
Portfolio investments grew 50 percent (to 6 billion USD), and 
financing provided by the banking and non-financial sector 
also grew, standing at 5.6 billion USD and 5.7 billion USD 
respectively.  In June alone, Turkey had an inflow of 4.9 
billion USD.  Also indicative is the continued growth in "net 
errors and omissions", which was 2.7 billion USD in June (5.9 
billion USD year-to-date).  Most analysts believe this money 
is "under the mattress" money that has either been parked 
overseas or otherwise outside the official economy.  Some 
also ascribe part of it to cash coming into the system from 
border trade, which is typically conducted on a 
cash-and-carry basis.  Whatever the source, it has played a 
role in supporting the lira, which has reached new heights 
even as the trade imbalances have swelled.  One Central Bank 
contact told Embassy's Senior Economist that while the bank 
does not have an official view, he finds it intriguing that 
the "net errors and omissions item" has not zeroed itself out 
over time, as has historically been the case, but instead has 
been in only one direction since 2003 (into Turkey).  In 
addition to cross border trade (which he reminded us occurs 
with Iran and Syria as well as Iraq), he suggested it may 
stem from ineffective accounting for capital inflows into 
Turkey (since most transactions are accounted for in London). 
 Finally, he said, tourism accounting is also problematic, so 
that some tourism revenues may be captured through the 
figure. 
 
4. (SBU) A Risk: Despite their perception that the gap can be 
financed in the short term, Istanbul analysts nonetheless 
view Turkey's current account deficit as the key risk factor 
facing Turkey's economy, a view the IMF increasingly shares 
(reftel).  Together with the short terms flows through which 
it is financed, Baturalp Candemir of EFG Securities sees the 
gap raising the volatility of the foreign exchange market. 
He also sees an absence of policy instruments available to 
the government, given the already high level of Turkey's 
primary surplus under the IMF program.  Only the currency 
remains as an adjustment tool, he wrote in a recent note to 
investors.  Other observers similarly see the need for a 
correction in the real exchange rate, given the slowdown in 
export growth and continued rise in imports.  They are not 
sure this will occur, however, given the continued strong 
interest of foreigners in Turkish assets.  As Candemir told 
us recently, he has spent the last several months seeking to 
convince his firms' clients to reduce their Turkish lira 
exposure, thus far unsuccessfully.  Funds have money to 
place, he commented ruefully, and he said he had 
underestimated the extent to which Turkey would continue to 
attract interest even as the local news flow became less 
positive. 
 
5. (SBU) Comment: Most observers here remain confident that 
the growing current account deficit can be successfully 
financed.  This is based in part on the fact that after a 
long absence, Turkey finally has the prospect of large flows 
of FDI.  Recent banking deals (Yapi Kredi Bank (in part), 
Disbank, and TEB were purchased by foreigners) and 
privatization of a number of state enterprises (including 
Turk Telecom) should all bring significant foreign capital 
into the country.  It is also predicated on a continued 
favorable international climate for emerging markets, 
generally, and on the absence of any Turkish development that 
sparks investor flight, whether domestic or international. 
Certainly, investors' threshold for bad news seems to have 
risen significantly in recent years, and investors have 
either shrugged it off or seen it as a buying opportunity. 
Analysts here stress, however, that this underlying 
complacency is based on Turkey's EU anchor and the October 3 
start of negotiations.  If serious doubts arise about that, 
many bets are likely off.  The larger problem for the Turkish 
economy is that continued financing of the deficit through 
foreign speculative capital will prevent the adjustments in 
the exchange rate that would help correct it by making 
exports more competitive and imports more expensive. 
Turkey's real sector may thus continue to find itself 
squeezed by a strong lira.  End Comment. 
SMITH