US embassy cable - 03ANKARA1720

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 001720 
 
SIPDIS 
 
 
STATE FOR E, P, EUR/SE AND EB; TREASURY FOR OASIA - MILLS 
AND LOEVINGER; USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO; NSC 
FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: DECL: 03/17/2008 
TAGS: ECON, EFIN, PGOV, PREL, TU 
SUBJECT: AK ECONOMIC POLICY:  REFORM ONLY AS A LAST RESORT 
 
 
(U) Classified by DCM Robert Deutsch.  Reason: 1.5(b,d) 
 
 
1.  (C) Summary:  New Prime Minister Tayyip Erdogan's 
decision not to make any changes in the AK economic team 
suggests he is unlikely to break sharply with the Gul 
government's economic appraoch.  That is unfortunate.  In its 
four months in office, the AK leadership has proven that it 
neither understands economics nor embraces reform, and will 
implement sound policies only if the markets give it no 
alternative.  In that sense, the Gul-Erdogan Government is 
similar to the Ecevit government, with the exception that it 
has no Kemal Dervis to provide leadership.  Abdullah Gul won 
some praise from senior bureaucrats, but was not been able to 
provide sufficient economic leadership.  The prospect of a 
large U.S. financial package has supported financial markets 
in recent weeks, but in doing so also has prevented the 
markets from delivering a tough message to the government, 
which misread market stability as an indication of confidence 
in AK leadership.  Now that the bilateral package is off the 
table, we can expect the markets to send a clear signal to 
the Erdogan government on the need for sound policy.  End 
Summary. 
 
 
2.  (C) The AK Party came into office in mid-November with a 
mixed message on the economy that attempted to please 
everybody.  To the financial markets and the international 
community, AK espoused a strong commitment to fiscal 
discipline, and to improving the investment climate via 
reforms.  To the Turkish electorate, and especially to core 
constituents among small and medium business people, the 
message was "the new government will stimulate growth and 
create more demand for you."  These contradictory goals are 
evident in AK's pre-  and immediate post-election programs, 
including the "Emergency Action Plan" adopted in November. 
The AK government was going to increase social spending, 
stimulate growth, keep a tight budget and accelerate 
disinflation, all at the same time.  But the programs never 
spelled out how. 
 
 
3.  (SBU) In our early meetings with AK leaders, it was clear 
that despite the pro-reform rhetoric, the heart of AK's 
economic policy was with those wanting the GOT to spend its 
way out of recession, "pump priming" as Ali Coskun (AK vice 
chairman for economics and now Minister of Industry) 
repeatedly told us.  It was not enough for AK that exports 
and stock rebuilding in 2002 had resulted in over 6 percent 
growth.  Domestic demand, the key for AK's business 
supporters, remained fairly weak in many sectors going into 
2003. 
 
 
4.  (C)  The rhetoric, however, remained firmly pro-reform, 
buttressed by the market friendly utterances of State 
Minister for the Treasury Ali Babacan (an MBA in marketing 
from Northwestern University), and crafted also by AK Vice 
Chairman for media Murat Mercan (a public relations professor 
at Bilkent University).  This rhetoric, and the prospect that 
the first one-party government in 20 years would be able to 
implement the rhetoric, fueled a six-week post-election 
market rally and raised hopes that Turkey could begin to move 
away from the financial precipice. 
 
 
5.  (C) Although much of AK's rhetoric has remained 
reform-minded, its actions have not.  In its few months in 
office, the government has engaged in populist measures 
(nearly $3 billion in new spending), publicly undermined 
independent regulatory agencies, tried to gut a 
critically-important public procurement law, and passed an 
unwise tax amnesty law.  Even in the area of privatization, 
where AK's public statements have been very positive, the 
government has moved at a snail's pace.  AK has stalled on 
IMF and World Bank conditions, including enactment of a sound 
budget.  Moreover, it has alienated both the Fund and the 
Bank by failing to consult with them before announcing key 
actions, and -- in the case of the IMF -- accusing the Fund 
of being "unfair."  As was clear in our bilateral 
negotiations, the government sees possible U.S. assistance as 
an alternative - not a complement -- to sound policy. 
 
 
6.  (C) The only time the Gul government showed serious 
interest in taking much-needed fiscal measures was when 
markets threatened.  On January 7, weak interest in a large 
Treasury T-bill auction (a 45 percent roll-over rate) led 
Prime Minister Gul to call an emergency meeting and to 
announce significant new fiscal saving measures.  Similarly, 
after dithering with the IMF team for weeks in February, the 
government quickly accepted difficult new taxes and budget 
cuts March 2, immediately after Parliament's rejection of the 
troop deployment (and the corollary U.S. financing package) 
threatened a market meltdown.  IMF Mission Chief complained 
to us that, in the month he was here to conclude an LOI, the 
only days in which the GOT worked seriously were March 2 and 
March 9 (after he informed the GOT he was returning to 
Washington with little progress to report.) 
 
 
7.  (C) The obvious question is why AK has failed to take the 
measures most outside observers believe are essential to 
avoid renewed crisis, despite the fact that the party came in 
on the back of a big electoral win.   Part of the answer lies 
in the demands of the many small entrepreneurs and 
shopkeepers in its constituency, who want continued 
government support, easy credits and protection from big-time 
competition, foreign or Turkish.  There is also a widely held 
perception that AK politicians, having been out of office for 
so long, want to enjoy the spoils the existing system offers. 
 This would explain, for example, AK's desire to gut the new 
public procurement law.  Another, factor has been the 
perception that further fiscal austerity measures would not 
help AK's chances in future elections (including Tayyip 
Erdogan's election March 9, and nation-wide local elections 
next year).  Moreover, few if any in AK understand 
macroeconomics, so -- per Central Bank Governor Serdengecti 
-- they are blissfully unaware of the consequences of their 
poor policies (and in some cases believe the U.S. will bail 
Turkey out if necessary).  A senior economic official 
confided to us that the Cabinet as a whole still views the 
economic program as something imposed on the government by 
the IMF.  Finally, the markets have been artificially buoyed 
by the prospect of a large U.S. financial assistance package, 
and thus have failed to send the warning signals one normally 
would expect in the face of bad policies. 
 
 
8.  (C)  In some ways, the AK government has been similar to 
its predecessor, the Ecevit government, which implemented 
reforms only under intense IMF and market pressure.  One 
important difference, however, is that the Ecevit government 
-- while hardly full of economic wizards -- included Kemal 
Dervis, who understood the need for reform and used the 
leverage provided by the IMF to force through 
politically-unpalatable reforms.  In contrast, AK's State 
Minister for the Treasury, Ali Babacan, has failed to push 
through reforms.  According to one international reporter, 
Babacan has been mainly interested in enhancing his standing 
in the Party by demonstrating his toughness in negotiations 
with the IMF and the U.S.  He is, in that sense, striving to 
be the "anti-Dervis."  IMF Mission Chief said March 7 that 
Babacan had not even read the draft Letter of Intent that he 
supposedly is negotiating on behalf of his government. 
Others, including Treasury U/S Faik Oztrak, claim that 
Babacan has advocated sound policies in Cabinet meetings, but 
has lacked the clout to push them through. 
 
 
9.  (C) The rest of the economic team is no better than 
Babacan, and possibly worse.  At least Babacan understands 
the need to communicate to the markets.   IMF Mission Chief 
(strictly protect) called the team "totally incompetent" and 
a "hopeless bunch."  Central Bank Governor Serdengecti (also 
strictly protect) said it was like having a bunch of 
small-town politicians run a government.  Deputy Prime 
Minister Abdullatif Sener, who is responsible for economic 
issues, is best known for having advocated abolition of 
interest rates during his tenure as Finance Minister during 
the Erbakan government.  He has been such an enigmatic figure 
in meetings with us and other foreign diplomats that none of 
us can say with any confidence that we know where he stands 
on any issue.  Finance Minister Kemal Unakitan (a former tax 
inspector who became a consultant and reportedly has a 
pending tax fraud case)  also appears to be in over his head. 
 Central Bank Governor Sureyya Serdengecti told us recently 
that Unakitan dismissed the Banks highly-praised inflation 
expectation surveys, asking how a survey of only 50-100 
people in a country of 67 million could be useful.  IMF 
sources say Unakitan "doesn't get it."  State Minister for 
Trade Kemal Tuzmen is a bombastic self-promoter who sees 
Turkey's future in trade with Iraq, Algeria, and other nearby 
states and who has no apparent understanding of economics. 
European diplomats believe Industry Minister Ali Coskun, who 
has long advocated populist spending and was a strong 
proponent of the government's tax amnesty, is exercising 
significant, negative behind-the-scenes influence with 
Erdogan.  The opposition CHP, including Kemal Dervis, has 
failed to offer useful criticism or policy alternatives. 
 
 
10.  (C) As Prime Minister, Abdullah Gul received relatively 
good marks from economic bureaucrats, who say he had the best 
understanding of the economic picture of anyone in the 
cabinet.  However, Gul was so busy with other issues that he 
was not been able to provide steady economic leadership. 
Moreover, he was often undermined by others within AK. 
Tayyip Erdogan, for example, committed the government to high 
hazelnut support prices, and has supported other populist 
measures.  Per IMF sources, when Gul (at urging of Treasury 
U/S Oztrak) agreed to some key budgetary and regulatory steps 
during Ali Babacan's absence, Babacan returned, complained to 
Erdogan, and took back the measures to which Gul had agreed. 
(Gul subsequently announced these same measures, and others, 
on March 3, in the aftermath of Parliament's negative vote on 
troop deployment.) 
 
 
11.   (C) The case for optimism rests not with the new 
Erdogan government, which appears likely to continue the 
policies of the Gul government.  Rather it is with the 
continuation of certain structural reforms already enacted 
(e.g., Central Bank independence, and reductions in banking 
sector exposure to foreign exchange risk), the current set of 
senior economic bureaucrats (particularly Central Bank 
Governor Serdengecti and Treasury U/S Oztrak), and with the 
prospect that -- with the U.S. economic package off the table 
-- markets will begin to deliver a clear message on the need 
for sound policy. 
PEARSON