US embassy cable - 02ANKARA8846

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 008846 
 
SIPDIS 
 
 
STATE FOR E, EB/IFD/OMA AND EUR/SE 
TREASURY FOR OASIA - MILLS AND LEICHTER 
STATE PASS USTR - NOVELLI AND BIRDSEY 
 
 
E.O. 12958: DECL: 09/02/2006 
TAGS: ECON, EFIN, PREL, TU 
SUBJECT: READ-OUT OF IMF VISIT TO TURKEY:  FOCUS ON BUDGET 
 
REF: ANKARA 8797 
 
 
Classified by DCM Robert Deutsch for reason 1.5 (d). 
 
 
1.  (C) Summary:  On December 4, IMF resident representative 
briefed EU member countries and us on the December 2-4 visit 
of IMF Europe Director Deppler.  It provided a first 
impression of the new economic ministers:  well-intentioned, 
and committed to continuing the existing program, but not 
united on economic policy measures and facing a daunting list 
of conditions under the program. The IMF plans two staff 
missions, December and January, before going to the board, 
probably in February, to release the next tranche of $1.7 
billion.  The most controversial issue before IMF and GOT is 
the primary budget surplus, including both measures to meet 
this year's projected shortfall and next year's target.  Also 
key is the composition of budgetary measures to meet the 
surplus target (i.e. not just raising taxes, but expenditure 
reform that addresses chronic deficits in the pension funds). 
 The primary surplus is the one key element of debt 
sustainability that is completely in the GOT's control, and 
thus will be an important signal to the markets.  We 
recommend supporting a firm IMF approach to this issue.  End 
Summary. 
 
 
IMF First Impressions 
--------------------- 
 
 
2. (C) IMF resrep began with some general impressions:  the 
new economic ministers are well-intentioned and haven't 
painted themselves into a corner by committing to bad 
policies.  However, there appears to be some fragmentation. 
Deputy PM Sener has the role of overall economic policy 
coordinator, and State Minister Babacan has the role of 
coordinating with the IMF and World Bank. 
 
 
3. (C) In addition, IMF resrep said the ministers have yet to 
decide on economic policy specifics.  Their policy statements 
to date (election platform, government program) are very 
general.  The differences became clear on the key issue of 
the year 2003 primary budget surplus:  Deputy PM Sener told 
the IMF visitors the 6.5 percent target would be fine (and 
publicly said this target was "reasonable"); while State 
Minister Babacan in a later meeting stepped back, saying he 
needed to see budget realizations this year before committing 
to next year's target. 
 
 
4.  (U) IMF Europe 1 Director Michael Deppler and Turkey 
Mission Chief Juha Kahkonnen met with PM Gul, Deputy PMs 
Sener and Sahin, Finance Minister Unakitan, and State 
Ministers Babacan (Treasury) and Tuzmen (Trade), as well as 
with senior officials in the Treasury, Central Bank and 
Banking Regulation and Supervision Agency (BRSA). 
 
 
IMF Schedule and Mission Timing 
-------------------------------- 
 
 
5.  (SBU) The new government plans to continue the existing 
program, and will seek to finish the Fourth Review, per IMF 
resrep.  But the new ministers are facing a long list of 
outstanding Fourth Review.  Furthermore, they need time to 
formulate a detailed program for 2003, including the full 
year 2003 budget to be presented to parliament in January. 
Thus the IMF plans to proceed as follows: 
 
 
--  December 9-20: full mission to examine conditions for the 
Fourth Review, and begin working on the 2003 letter of 
intent. 
 
 
--  January 2003: follow-up mission to finalize the Fourth 
Review and the 2003 letter of intent. 
 
 
--  February 2003:  IMF Board meeting on the Fourth Review, 
release of $1.7 billion tranche. 
 
 
6.  (SBU) IMF resrep stressed that the GOT doesn't need the 
Fourth Review tranche at the moment.  The Treasury is taking 
advantage of favorable market sentiment to overborrow in the 
domestic market.  (Note:  the Treasury has also borrowed 
$1.15 billion in the Eurobond market since the November 3 
elections.) 
 
 
Fourth Review Conditions - 
Structural Reform Issues Loom Large 
----------------------------------- 
 
 
7.  (U) IMF resrep proceeded with a status report on 
outstanding program conditions. 
8.  (SBU) Fiscal Policy:  The IMF Mission next week will 
assess the size of the shortfall towards meeting the 6.5 
percent primary surplus target, but the October Mission had 
calculated it to be as large as 1 percent of GNP, about $1.6 
billion.  (Comment: MinFin sources also tell us about one 
percent of GNP shortfall.)  IMF resrep speculated that the 
shortfall could have grown given some post-election spending 
measures. Very little has been done to address this shortfall 
to date, except that payments under public works contracts 
have been frozen (the prior government signed many such 
contracts in its last days). 
 
 
--  IMF resrep noted that the primary surplus performance 
criterion in the program is a key condition; however, "a key 
objective of the primary surplus is to maintain debt 
sustainability, and the debt situation is currently good. 
They have built a financial buffer through over-borrowing." 
 
 
--  Asked about the tax amnesty issue, Resrep noted there 
were two separate measures: First, the "Financial Year Zero" 
law, first passed in 1998 and scheduled to be implemented in 
January 2003, which the GOT plans to annul; Second, the 
proposed tax amnesty would establish a cut-off date for 
overdue tax files - those more than one year old would not be 
pursued.  IMF wouldn't fight these measures, per IMF resrep, 
but has told the GOT that these measures make it more 
difficult to increase the tax base and tax revenue, and thus 
meet the new GOT's social spending goals.  (Comment:  The 
"Financial Year Zero" law intends to shift the burden of 
proof from the GOT to the taxpayer in tax audits:  after a 
short grace period following the implementation date, 
taxpayers who have not declared their income are subject to 
audits and possibly penalties.  It is intended to establish 
an incentive to file taxes.) 
 
 
9.  (SBU) Monetary Policy: Though the Central Bank is 
reaching its ceiling under the base money performance 
criterion (the nominal anchor of monetary policy), both 
inflation and inflationary expectations are on track. 
November inflation shows annualized CPI to be 31.8 percent, 
under the 35 percent target.  (Comment:  The under target CPI 
has been achieved partly through delays in raising 
state-controlled prices of consumer goods, thus building up 
some inflationary pressure.  The GOT needs to raise prices of 
goods it controls in December, to keep inflationary 
expectations trending downwards.) 
 
 
10. (SBU) Structural Reforms: IMF resrep stressed that the 
new government faced a lot of decisions. 
 
 
--   Public Sector Reform:  First, the Government must submit 
a direct tax reform bill along the lines agreed to with the 
prior GOT.  (Comment: this law would seek to lower overall 
tax rates by eliminating a lot of special exemptions and 
pork, thus very politically sensitive.) Second, the GOT needs 
to show progress on eliminating redundancies in the state 
economic enterprises (SEEs):  the end October condition was 
30,000 and latest numbers show 21,000.  (Comment: Also 
politically sensitive, but key to slimming down the state 
sector and making permanent improvements to the budget.) 
 
 
--  Privatization:  The new GOT has stressed privatization is 
a top priority, but they have to translate this into a 
detailed program, per Resrep.  The two major outstanding 
issues are preparing state alcohol and tobacco giant TEKEL 
and Turk Telekom for privatization.  Political level 
decisions are needed on both: for TEKEL, the issues are 
reducing overstaffing, cutting tobacco support prices, paying 
tax arrears.  For Turk Telekom the issue is passing a new law 
that allows parts of the newly created holding company 
structure to be sold off. 
 
 
--  Banking Sector Reform:  While there has been good 
progress on some issues (in December, BRSA plans to tender 
$250 million of assets assumed from bankrupt banks), the 
major outstanding condition is resolving Pamukbank, and the 
Cukurova Holding's shares of Yapi Kredi Bank.  IMF resrep 
said, "The issue is in the courts, but we urged the GOT to 
give public support to the BRSA so the judges and public 
understand the GOT position."  He added that it would be 
"difficult" to complete the Fourth Review without resolution 
of this condition.  Otherwise, it would look like the IMF is 
providing $1.7 billion to bail out these two banks' owner. 
 
 
Outlook for Next Year's Program 
------------------------------- 
11.  (U) Resrep said the new government stressed the 
importance of taking ownership of the program to be developed 
for 2003, and IMF agreed.  The IMF was open to discussing 
changes in the program, provided there were three key 
elements:  a "prudent budget - we still think 6.5 percent 
primary surplus is a reasonable target;" BRSA independence - 
meaning BRSA has the ability to intervene with problem banks 
and resolve them on a best practices basis without political 
interference; Disinflation, including setting an ambitious 
yet realistic inflation target, i.e., 20 percent CPI 
increase, and preserving Central Bank independence. 
 
 
12. (U) On next year's macro targets, Resrep was firm on the 
20 percent CPI target, but stated the 5 percent GNP growth 
target could be changed by the GOT.   On the 6.5 percent 
primary budget surplus, he noted that given a 5-6 percent 
growth target, this level of primary surplus represented no 
fiscal tightening over 2002.  In fact, he continued, in real 
terms discretionary social spending has increased by 12 
percent over the last two years. 
 
 
Comment 
------- 
 
 
13.  (U) We need to keep a close eye on the banking reform 
issues.  Beyond that, the main debate ahead for the IMF and 
GOT lies over the primary surplus, both in meeting this 
year's shortfall and in establishing next year's target.  Out 
of the three main ingredients in debt sustainability - real 
interest rates, growth and primary budget surplus - only the 
third lies completely in the GOT control and is thus the most 
stable element.  The GOT cannot count on the current market 
sentiment continuing throughout 2003. 
 
 
14.  (U) The 6.5 percent target may not be sacrosanct, but a 
major change (as in one percent of GNP or $1.6 billion) would 
mean the Turks will forgo the chance to pay down their debt 
in 2003, and thus improve their debt dynamics in a more 
sustainable way.  It could also raise significant market 
concerns.  In addition, the composition of budget measures 
taken to meet the 6.5 percent is also important and directly 
related to structural changes such as pension reform 
(deficits in the GOT pension funds equal 3 percent of GNP, 
reftel).  In short, we should not be neutral in the IMF - GOT 
discussions on the budget, and we should support the need for 
a strong surplus, and one that maintains a high level of 
social spending by strengthening public sector reforms. 
PEARSON