US embassy cable - 05ANKARA6292

UNCLAS SECTION 01 OF 02 ANKARA 006292 
 
SIPDIS 
 
TREASURY FOR PLANTIER 
 
SENSITIVE BUT UNCLASSIFIED 
 
E.O. 12958: N/A 
TAGS: EFIN, TU 
SUBJECT: IS TURKEY'S FISCAL POLICY TOO TIGHT? 
 
 
1.  (SBU)  Summary:  The very large size of Turkey's primary 
fiscal surplus target -- 6.5 % of GDP for the last four 
years -- has emerged as a key issue in discussions between 
the IMF and Turkey.  While the IMF seems to have prevailed 
in its insistence on additional fiscal tightening in 2006, 
there appear to be strong economic and political arguments 
for greater flexibility.  Given the importance of sustaining 
and deepening the economic reform effort in Turkey, Post 
recommends that Washington agencies take a close look at 
this issue and discuss its implications with the IMF.  End 
Summary. 
 
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IMF Tightening an Already-tight Fiscal Policy 
--------------------------------------------- 
 
2.  (SBU)  Though frustrated in recent years over the IMF's 
insistence on fiscal austerity, the GOT has bowed to the 
Fund's requirement that it maintain a 6.5% of GDP primary 
surplus (non-interest expenditures less revenues) budget 
target.  2005 will be the fourth year the GOT has met or 
come close to this target, which we understand represents 
the tightest budget constraint of any IMF program, with the 
possible exception of Jamaica. 
 
3. (SBU)  In recent weeks, the GOT quietly pressed the IMF 
to reduce the target slightly for the 2006 budget, to around 
6.25% of GDP.  The Turks argued that this would take into 
account the expected privatization of state companies (Turk 
Telekom, Tupras and Erdemir) that currently contribute about 
0.25% of GDP in net revenue.  The IMF staff, however, has 
insisted on the 6.5% target, so as to restrain domestic 
demand and thereby moderate import growth that is 
exacerbating Turkey's worrisome current account deficit.  In 
fact, maintaining the target despite the loss of state 
company net revenue would represent an additional tightening 
of fiscal policy in 2006. 
 
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The Economic Counterargument 
---------------------------- 
 
4.  (SBU)  The IMF's belief that additional fiscal restraint 
would help trim the current account deficit is not shared by 
all local observers, many of whom believe that the growth in 
the deficit is driven by strong inflows of short-term funds 
attracted by high domestic interest rates rather than by 
import growth.  There is a particular risk of a surge in 
inflows following the start of EU accession negotiations. 
These observers allege the IMF is being doctrinaire in 
sticking with the high primary surplus target and not 
recognizing the progress Turkey has made in reducing its 
vulnerability to shocks. 
 
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The Political Counterargument 
----------------------------- 
 
5.  (SBU)  At the same time, the political cost of 
implementing a very high level of budget austerity keeps 
growing the longer the effort is maintained.  This has 
created pressures for populist responses that are 
increasingly difficult for the AK Government to resist, 
especially as it continues to pursue unpopular political 
reforms linked to EU accession (including vis a vis Cyprus). 
One senior bank economist told us that even a symbolic 
relaxation of the budget target (like that suggested by the 
GOT) could create the political space the GOT needs to 
sustain economic reforms over a longer period.  Factually 
true or not, many Turks believe that that the benefits of 
Turkey's post-crisis economic success have not been felt by 
the man on the street.  Given the GOT's need to show results 
ordinary Turks will appreciate, some flexibility on fiscal 
austerity -- or at least no tightening -- might enable the 
GOT to sustain controversial reforms, including extremely 
unpopular structural reforms and privatizations. 
 
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Comment 
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6.  (SBU)  Although the GOT may be acquiescing to the Fund's 
demands under deadline pressure (the Constitution requires 
that budget parameters be set by October 17), the economic 
argument for increased tightening is not entirely clear.  At 
the same time a calculation that did not let the GOT off the 
fiscal hook but allowed the Government to show that good 
efforts are rewarded has a strong political logic.  Post 
recommends that Washington may want to explore these issues 
in greater detail with the IMF and IMF board. 
MCELDOWNEY