US embassy cable - 02ANKARA8064

UNCLAS SECTION 01 OF 03 ANKARA 008064 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE ALSO FOR P, E, EB/IFD AND EUR/SE 
TREASURY ALSO FOR OASIA - MILLS 
USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO 
USDA FOR FAS FOR EC AND CCC/FSA 
NSC FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EINV, PGOV, TU 
SUBJECT: THE NEW GOVERNMENT'S ECONOMIC CHALLENGES, AND SOME 
BENCHMARKS 
 
 
1.  (SBU) Summary:  The new Turkish Government's most 
pressing economic challenge is to bolster market confidence 
sufficiently to avoid another financial crisis and begin to 
step away from the financial precipice on which Turkey has 
been perched for the past two years.  Other challenges 
include: reducing inflation, maintaining growth through 
creation of a better investment environment, tax reform, and 
a stronger banking sector; promoting a new business model 
based on competitiveness and sound corporate governance; and 
beginning to address the country's poverty.  Dealing with a 
potential external shock would of course be another 
challenge, but it would not fundamentally change the economic 
steps Turkey needs to take.  We have identified several near 
and medium-term benchmarks for gauging the new government's 
economic performance.  End Summary. 
 
 
Economic Challenges 
------------------- 
 
 
2.  (SBU) The incoming government's most important and urgent 
economic challenge will be to obtain sufficient financing, at 
reasonable rates, to meet its debt obligations in 2003, begin 
to reduce its debt/GNP ratio, and reduce its vulnerability to 
external or internal shocks.  This will require maintaining a 
large primary budget surplus and bolstering market confidence 
sufficiently to (a) lower nominal interest rates to an 
average of 45-47 percent for the year, (b) convince domestic 
holders of t-bills to roll over more than 90 percent of the 
domestic debt, and (c) obtain substantially increased access 
to the Eurobond and private bank credit markets.  If the 
government can do this, it should be able to reduce Turkey's 
sky-high debt/GNP ratio from the current 82-83 percent to 
some 78 percent by end-2003.  Failure would probably mean 
another financial crisis.  Progress, or at least the absence 
of negative developments, on Cyprus and EU accession would 
certainly help boost confidence. 
 
 
3.  (SBU)  The government will face a host of other, related 
economic challenges.  Two key ones are relatively short-term 
(i.e., need to be done next year): 
 
 
-- Reducing inflation:  The Central Bank now expects to 
achieve or surpass its 35 percent end-year inflation target 
for this year, but both the Bank and private analysts wonder 
if it can achieve next year's target of 20 percent. 
Defeating inflation -- meaning bringing it down to single 
digits -- is essential if Turkey is to have any chance of 
maintaining financial stability and generating the productive 
investment needed to enjoy sustained growth.  Because 
expecations play such a huge role in determining inflation 
here, the government must maintain the current positive 
momentum by meeting its 2003 target. 
This will require continuation of tight fiscal and monetary 
policy, avoidance of a sharp depreciation of the lira, 
continued structural reform to encourage competitive pricing, 
and a clear public message from the new government that it is 
committed to defeating inflation. 
 
 
-- Maintaining growth:  The country desperately needs solid 
growth to create jobs, maintain support for the reform 
program, and keep its debt sustainable.  Although Turkey is 
likely to surpass its initial 3 percent GNP growth target for 
this year (probably reaching 4 or 4.5 percent), the recovery 
remains weak.  Sustaining growth in 2003-2004 will require, 
in addition to macroeconomic stability, continued efforts to 
strengthen the banking sector (which is doing very little 
commercial lending), further tax reform, and improve the 
dismal investment environment.  Foreign investment inflows 
through the first eight months of this year totaled a pitiful 
$180 million, and anecdotal evidence indicates Turkish 
companies are equally unenthusiastic about investing. 
 
 
4.  (SBU)  Two other challenges are longer-term (note:  our 
list of challenges is not meant to be exhaustive): 
 
 
-- Promoting a new business model:  One of the fundamental 
weaknesses of the Turkish economy -- and a key contributor to 
the recent economic crisis -- is the reliance of much of the 
private sector on political patronage/favoritism rather than 
efficiency and competitiveness to make money.  Although there 
are many solid businesses in Turkey, too many companies have 
made money for years through subsidized lending, 
politically-connected contracts, protection from competition, 
and -- in the case of agriculture -- guaranteed purchases by 
the State.  The reforms of the past 18 months have made it 
much more difficult to do business this way, but corporate 
Turkey has just begun to change its mentality.  The new 
government can facilitate this essential change in mentality 
(and practice) by making clear that it will not return to the 
old ways of doing business, by promoting a sound, 
pro-competition regulatory environment, by reducing the role 
of the State in the economy, and by publicly stressing the 
need for businesses to adapt to the "new rules of the game." 
 
 
-- Begin to address poverty:  Large segments of the Turkish 
population, particularly in the rural East and Southeast but 
also in the cities, remains impoverished.  This is an issue 
of both regional disparity and of rural development. 
Defeating inflation and promoting growth are necessary but 
not sufficient to address this problem.  There is no easy 
solution to the problem of underdevelopment, of course, but 
one area in which the new government might focus is promoting 
agricultural productivity.  Currently, more than 40 percent 
of the Turkish population is engaged in farming, but they 
produce only 15 percent of GNP.  This lack of productivity is 
a drag on the entire economy and a key contributor to poverty. 
 
 
Benchmarks 
--------------- 
5.  (SBU)  We have come up with a brief list of benchmarks to 
help us gauge the new government's efforts to meet these 
challenges, with particularly attention to steps the 
government could take to bolster market confidence. 
 
 
Short-term (by end-2002) 
------------------------ 
 
 
-- Invite IMF back to complete the 4th review as quickly as 
possible. 
 
 
-- Present 2003 budget that meets primary surplus target of 
6.5 percent of GNP (and, as much as possible, ensure that 
necessary fiscal measures are taken in the coming weeks to 
ensure GOT meets this year's primary surplus target). 
 
 
-- Move ahead with scheduled privatization of Petkim, 
strategic sale of part of Tupras, approve privatization plans 
for state sugar company, Tekel, Turk Telekom. 
 
 
-- Pass direct tax reform legislation. 
 
 
-- Reduce the number of ministries and state ministers. 
 
 
 
 
Medium-term (2003) 
------------------ 
 
 
-- Announce, at the senior political level, full support for 
the end-2003 20 percent inflation target. 
 
 
-- Make clear through public statements as well as actions 
government's full support for independent regulatory boards 
(energy, banking, and telecom) as well as full independence 
of Central Bank.  (This also means not taking steps -- as AK 
has indicated it might -- to weaken the bank regulatory 
board.) 
 
 
-- Accelerate privatization, including by selling Erdemir 
(steel), Tekel, Turk Telekom (or parts of it), and sugar 
companies. 
 
 
-- Implement social security reform to prevent a major fiscal 
problem as retirements accelerate over the coming years. 
 
 
-- Announce accelerated liberalization of fixed telecom 
services (now scheduled to be open to competition at 
end-2003), and grant licenses to companies in 
already-liberalized sectors such as GSM and local wireless 
services. 
 
 
-- Appoint strong official to lead Capital Markets Board, and 
give that person a mandate to promote improved corporate 
governance and broadened capital markets. 
-- Create public-private sector commission to develop 
national energy policy. 
 
 
-- Resolve at least some of pending foreign investment 
problems, including Cargill, cola tax, long-pending energy 
contracts, and pharmaceutical-related IPR issues. 
 
 
-- Either establish a true one-stop shop for foreign 
investment or appoint a senior official (preferably in the 
Prime Ministry's office) to resolve foreign 
investment-related problems. 
 
 
-- Privatize the Istanbul Stock Exchange 
 
 
-- Create a technical-level marketing advisory board to help 
farmers, who have long sold their crops to the state, shift 
toward selling to domestic and international markets. 
 
 
-- Encourage development by private sector of business plans 
for Qualifying Industrial Zones, assuming U.S. Congress 
passes QIZ legislation. 
 
 
Important First Steps 
--------------------- 
 
 
6.  (SBU)  The key right now is for AK Party, as it prepares 
to assume the reins of government, to build on the positive 
momentum resulting from its election victory (and the initial 
market reaction).  If it reassures markets that it will 
follow sound economic policies, including taking some of the 
steps identified above, it will have a good chance of keeping 
interest rates on their downward track.  The new government 
would then have significantly better prospects for achieving 
greater financial stability in 2003 and thus for addressing 
Turkey's many other economic challenges. 
PEARSON