US embassy cable - 03ANKARA819

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 000819 
 
SIPDIS 
 
 
STATE FOR E, EB/IFD/OMA AND EUR/SE 
TREASURY FOR OASIA - LOEVINGER, MILLS AND LEICHTER 
STATE PASS USTR - NOVELLI AND BIRDSEY 
 
 
E.O. 12958: DECL: 09/02/2006 
TAGS: ECON, EFIN, PREL, TU 
SUBJECT: MINISTER BABACAN TELLS AMBASSADOR ECONOMIC REFORM 
CONDITIONALITY IS "CLEAR" 
 
REF: A. SECSTATE 22328 
     B. ANKARA 706 
 
 
Classified by Ambassador Robert Pearson for reasons 1.5 
(b,d). 
 
 
1.  (C) Summary: On the evening of January 30, the Ambassador 
pressed Minister Babacan hard on economic reform, underlining 
our conclusion that the government is off track and stressing 
that strong economic reform policy implementation as well as 
full military cooperation were conditions for any potential 
U.S. assistance package.  Babacan replied that the economic 
reform conditionality was clear to the entire GOT.  After 
some initial disagreements, he said, the cabinet was 
committed to taking the steps to finish the Fourth Review. 
Asked about the status of fiscal measures to achieve the 
primary surplus, Babacan said there was no consensus in the 
GOT yet, and some disagreements over specifics with the IMF 
fiscal team, but that the GOT was committed to the 6.5 
percent of GNP target.  The goal was to finalize the 2003 
budget before the 10-day holiday, by February 7.  Babacan 
also noted IMF concerns over the terms of the BRSA's proposed 
resolution of Yapi Kredi and Pamuk Banks.  The GOT supported 
the BRSA's approach of rescheduling the bank owners' debts to 
the two banks.  Babacan raised the U.S. assistance package, 
and said there was still no agreement over magnitude.  He 
said the military and Treasury were working on separate MOUs, 
and that the Treasury MOU had blanks for amounts of loans, 
grants and free oil.  The Ambassador reiterated our 
conditions for any potential package, saying there needed to 
be progress on those conditions before we moved forward on 
the package and that "time is running out."   Babacan in 
closing noted GOT concern with a leak at Davos.  End Summary. 
 
 
2.  (C) On January 30, State Minister in charge of Treasury 
Ali Babacan (also GOT coordinator of relations with the IMF 
and World Bank) met with the Ambassador at the Treasury; 
Babacan had no staff in the meeting. 
 
 
Babacan Says Economic Reform Conditionality "Clear" 
--------------------------------------------- ----- 
 
 
3.  (C) The Ambassador said there are serious concerns in the 
IMF, the World Bank, the USG and other G-7 governments 
regarding the government's economic reform policies.  The 
government, if it acts quickly and decisively on reform 
implementation, has a chance to improve Turkey's debt 
dynamics.  But there is serious concern that the government 
doesn't understand the urgency, the Ambassador continued. 
Populist measures announced thus far have eroded market 
confidence and caused interest rates to rise.  The Ambassador 
underlined that U.S. assistance in the event of an Iraq 
operation is conditioned on both full military cooperation 
and strong economic policy implementation, which includes 
completion of the Fourth Review under the IMF-backed reform 
program.  The Ambassador noted that there is a "big if" from 
our side about the GOT's commitment to implementing the 
reform program. 
 
 
4.  (C) Babacan replied that the "second condition" (economic 
reform conditionality) is very clear to the entire 
government.  He regretted that there was "some 
misunderstanding" and thus a perception of moral hazard in 
the GOT on this point.  But, he continued, "we're not going 
to ignore the IMF program because of U.S. bilateral 
assistance.  We're committed to completing the Fourth 
Review."  Initially, some AK ministers had questioned the 
need for a 6.5 percent primary surplus and other steps, but 
not now.  PM Gul was "very clear" that he wants "everything 
on track with the IMF."  We need to implement this program to 
solve our economic problems, not because we want to satisfy 
the IMF," Babacan concluded. 
 
 
5.  (C) The Ambassador said he was anxious to hear Babacan's 
views of the Higher Planning Council's meetings over the last 
two days, and progress towards adopting fiscal measures. 
Babacan said the January 27 meeting had addressed the 
consolidated central government budget, and the second day 
had addressed budget issues for the broader public sector, 
primarily the state economic enterprises.  The bottom line, 
he continued, is that they couldn't reach agreement yet on 
the fiscal saving measures.  GOT officials were working 
closely with two IMF fiscal experts, and there were some 
disagreements. Babacan was consulting with directors general 
of different ministries to get their views.   The goal is 
reach agreement on the budget by February 7, and thus submit 
the 2003 budget to parliament before the 10-day Muslim feast 
of sacrifice holiday.  Babacan said IMF Deputy MD Krueger had 
called him January 29.  Again he stressed to the Ambassador 
that the GOT was committed to achieving the primary surplus 
target. (Note:  the target remains 6.5 percent of GNP.  We 
understand from Central Bank Governor Serdegencti that 
Babacan argued in the Higher Plannning Council for a 6.8 
percent target, to surprise markets on the upside, but PM Gul 
was not encouraging. End Note.) 
 
 
6. (C) Babacan raised what he termed IMF concerns on the 
Pamuk and Yapi Kredi Bank resolution, another issue under the 
draft Letter of Intent.  He said the GOT supported the 
resolution plan proposed by the Banking Regulatory and 
Supervision Agency (BRSA), though the IMF had reservations 
and IMF Europe Director Deppler had called BRSA Chairman 
Akcakoca.  Babacan said rescheduling the Cukurova Group's 
debts to the two banks was the best way forward.  The 
alternative of taking over Yapi Kredi involved systemic risk 
to the banking sector.   Yapi Kredi was the number three 
bank, and represented 35 percent of all retail banking 
transactions, he said.  (Note:  IMF banking resrep told us 
Deppler asked BRSA not to finalize the debt rescheduling 
agreement with Cukurova Group on January 31 as planned.  IMF 
banking experts want more time to study the proposed deal.) 
 
 
7.  (C) The Ambassador replied that he had nothing new to 
convey on this issue.  As the minister was aware, the markets 
are a state of suspension, and awaiting concrete steps on GOT 
implementing reforms and finalizing the IMF Fourth Review. 
The Ambassador concluded that "you know the concerns in the 
market." 
 
 
U.S. Assistance Package  "Time Running Out" 
------------------------------------------- 
 
 
8.  (C) Babacan raised the status of the U.S. assistance 
package, noting that there had been no progress since 
Treasury U/S Taylor's visit in late December.  While there 
was "mutual understanding" on the terms of the assistance, 
"we are not close in terms of magnitude."  Babacan said the 
GOT had looked at the magnitude issue in four different ways 
(potential GNP loss, budget effect, current account effect, 
and effect on debt dynamic).   But, he continued, there are 
so many unknowns about the effects of a war. The GOT would 
like a USG commitment to seek a second supplemental from 
Congress, if the initial assumptions agreed to now turned out 
to be too optimistic. 
 
 
9.  (C) The Ambassador said, first, he appreciated the 
minister's hospitality during Undersecretary Taylor's visit. 
On the assistance package, he pushed back strongly, saying 
that the composition of the package - the mix between grant 
and loan - was flexible.  The assumptions Babacan appears to 
be using to calculate magnitude in areas like potential GNP 
loss were simply not tenable.  He stressed that we needed 
progress on the two conditions before moving forward.  "Time 
is running out," the Ambassador underlined. 
 
 
10.  (C) Babacan said the GOT has been cooperative on Iraq, 
but that some decisions take time.  The GOT was concerned 
with opinion surveys showing that the Turkish people wanted 
the government "to stay out of the war."  The GOT needed to 
convince both the public and the parliament.  In the 
meantime, Memoranda of Understanding are being prepared, both 
by the military and the Treasury.  In the Treasury MOU, there 
are blanks for amounts of "grants" "loans" and "free oil." 
(Note: The MOU draft we just received does not appear, at 
first glance, to include such discussion items.  End Note.) 
 
 
11.  (C)  Babacan concluded the meeting by raising a leak at 
Davos that caused "unhappiness" in the GOT.  A U.S. Treasury 
document had been leaked to both press and market 
participants, and Mr. Soros had a copy marked "market 
sensitive."  The GOT was committed to continuing IMF 
relations, he stressed, regardless of what happened on Iraq. 
Babacan said he wanted the Ambassador to know he sent a 
letter to both IMF Deputy MD Krueger and Treasury U/S Taylor 
about the leak. 
PEARSON