US embassy cable - 05ANKARA6593

UNCLAS SECTION 01 OF 03 ANKARA 006593 
 
SIPDIS 
 
TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER 
NSC FOR MERKEL AND MCKIBBEN 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN, EPET, ECON, TU 
SUBJECT: Turkey's Policies Moderate Impact of High Oil 
Prices 
 
REF: SECSTATE 186514 
 
This cable has been coordinated with Congen Istanbul. 
 
1.(SBU) Summary: With Turkey importing over 90% of the oil 
it consumes, higher energy prices have aggravated Turkey's 
large and growing current account deficit.  A recent 
Standard and Poor's analysis named Turkey as one of the most 
vulnerable Emerging Market countries to higher energy 
prices.   However, Turkey's high taxation of petroleum 
products, full pass-through of market prices and trade and 
investment ties with energy-exporting countries all mitigate 
the impact. End summary. 
 
--------------------------------------------- ------ 
High Oil Prices Exacerbate Current Account Concerns 
--------------------------------------------- ------ 
 
2. (SBU) As Turkey's other vulnerabilities--particularly its 
debt situation--have moderated, economists' concerns have 
increasingly focused on the large and growing current 
account deficit.  Whereas the deficit was 5.1% of GDP in 
2004, it is expected to rise to over 6% of GDP in 2005, 
despite real GDP growth of about 5%. 
 
3. (SBU) The principal cause of the ballooning current 
account deficit is widely considered to be the flood of 
portfolio investment inflows, which drive up the exchange 
rate.  The appreciation of the lira causes imports to grow 
faster than exports.  The advent of sharply higher energy 
prices in 2005 has substantially added to Turkey's import 
bill, aggravating the current account deficit problem. 
Comparing January through August 2005 to the same period in 
2004, out of a roughly $12 billion increase in imports, 
nearly $4 billion stemmed from higher energy imports (crude 
oil, petroleum products and natural gas).   The dollar value 
of energy imports grew by nearly 50% from the same period in 
2004.  This result is hardly surprising: Turkey imports 
about 91 percent of its oil and a higher percentage of its 
natural gas.  Looking at crude oil imports in isolation, the 
increase in the dollar amount was entirely due to higher 
prices: imported crude volumes actually declined slightly. 
 
--------------------------------------------- - 
Standard and Poor's Report Highlights Turkey's Vulnerability 
--------------------------------------------- -- 
 
4. (SBU) Turkey's relative vulnerability to high oil prices 
was highlighted in a Standard and Poor's Report October 11 
on the impact of higher oil prices on Emerging Market 
countries.  Among these countries, the ratings or outlooks 
for only Turkey and Pakistan were considered threatened by 
current energy prices, with the source of vulnerability 
these countries' "external positions" (read current account 
deficit).  The singling out of Turkey created a bit of a 
stir in Turkish financial markets. 
 
--------------------------------- 
Fiscal Impact Neutral to Positive 
--------------------------------- 
 
5. (SBU) However, a closer look at the report and other 
sources shows that the risks have been substantially 
moderated by other factors.  First, from a fiscal 
standpoint, increased energy prices will not lead to an 
Indonesia-type situation, since there are no subsidies on 
petroleum products, natural gas or electricity.  Nor are 
petroleum product prices administered.  One of the IFI- 
sponsored reforms in Turkey is a complete pass-through of 
petroleum product market prices to the retail point of sale. 
Retail sales are also heavily taxed: one report on global 
taxation of petroleum products placed Turkey as having the 
eleventh highest tax burden on gasoline and diesel sales in 
Europe.  When compared to Asian countries, Turkey had the 
second highest level of fuel taxation in all of Asia, after 
Hong Kong.  The S & P report acknowledges that Turkey's 
fiscal situation is unlikely to be hurt by higher oil 
prices: although Turkey reduced the rate of its ad valorem 
Special Consumption Tax (SCT) on petroleum products in 2005, 
revenues from petroleum taxes increased because of the 
increase in the underlying prices,. 
 
--------------------------------------------- --------- 
Pass-through of Market Prices Allows a Demand Response 
--------------------------------------------- --------- 
7. (SBU) The full pass-through of market prices combined 
with the high level of taxation, has another benefit besides 
its positive fiscal effects: it allows market forces to work 
and produce a demand response.  Though energy demand tends 
to be inelastic around the world, the full pass-through is 
likely to produce greater efforts at conservation and 
investment in alternative energy sources over time.  The 
full pass-through is a relatively recent reform: it dates 
from the beginning of 2005. 
------------------- 
Inflationary Impact 
------------------- 
8. (SBU) Higher oil prices have made the Central Bank's 
disinflation campaign that much harder.  They were a factor 
in the Central Bank's slower pace of rate cuts in recent 
months, following its steady rate-cutting in the first half 
of 2005.  The inflationary effects of higher oil prices seem 
manageable, however.   For example, Morgan Stanley's Turkey 
analyst estimates their cost at 1-2 percentage points in the 
inflation rate this year, concluding higher energy prices 
will cause a slowdown in the pace of disinflation, not a 
burst of inflation. 
 
--------------------------------------- 
Recycled Petrodollars Coming to Turkey? 
--------------------------------------- 
 
9. (SBU) There are two other potentially mitigating factors 
arising from Turkey's proximity to-and relations with-the 
energy-exporting countries of the Middle East and former 
Soviet Union.  First, Turkey typically is able to access 
energy prices slightly lower than those quoted on global 
commodity exchanges:  in 2004, Turkey's average crude oil 
import price was $34.50 versus $38 for Brent Crude.  Turkey 
is also able to access relatively inexpensive natural gas 
from Russia. 
 
10. (SBU) The other mitigating factor, though harder to 
qualify, may end up being more important: there are signs 
Turkey is benefiting from increased trade and investment 
ties with cash-rich oil-exporting countries.  Turkey's 
economic ties with Russia are increasingly important, and 
not just as a result of Russian gas sales.  Turkish 
construction companies are active in Russia, Russia is the 
second most important country of origin for Turkey's 
critical tourism industry, the "suitcase trade" with 
Russians has long been a staple for Istanbul retailers, and 
Russian companies are increasingly looking for purchases in 
Turkey.   Russian telecoms company Alfa has bought a large 
stake in Turkey's leading mobile telephony group, Turkcell. 
 
11. (SBU) Turkey's attractiveness as a destination for 
Middle Eastern investors also seems likely to attract 
substantial investment.  The highest-profile recent example 
of this was the Saudi Oger-led consortium, with its $6.5 
billion bid emerging as the winning bidder of the Turk 
Telekom privatization tender in July.  It is notable that 
the second place bidder was also from the Middle East: UAE- 
based Etisalat.  In October, the Crown Prince of Dubai came 
to Istanbul and announced it would be investing in a huge 
business tower project with a $500 million dollar price tag 
(septel from Congen Istanbul).  Portfolio flows from the 
Middle East are thought to be substantial, if hard to 
quantify.  Many of these investors invest via European 
subsidiaries and funds such that the flows do not show up as 
Middle Eastern in origin in the balance of payments data. 
To the extent these investors are putting more money into 
Emerging Market funds, they are undoubtedly including 
nearby, fast-growing and now EU accession candidate Turkey. 
 
------- 
Comment 
------- 
 
12. (SBU) Turkey has mitigated the adverse impact of higher 
energy prices through a combination of passing through world 
energy prices and high taxes on petroleum products. 
Significantly, S&P's sovereign analyst for Turkey-as opposed 
to the global oil analysts who wrote the report-downplayed 
the Turkey-specific implications of his colleagues' report 
in an e-mail to econoff, saying there were many other 
factors in Turkey's overall vulnerability.  His e-mail may 
be more significant than the oil analysts' warnings: market 
watchers have generally taken a more favorable view of 
Turkish risk since the October 3 start of EU accession 
negotiations.  Fitch Ratings sovereign analysts recently 
visited on a periodic review, and have virtually ruled out a 
downgrade.   They expect to either hold Turkey's rating at 
its current BB- with a stable outlook, or upgrade it 
slightly. 
 
McEldowney