US embassy cable - 03ISTANBUL418

C O N F I D E N T I A L SECTION 01 OF 02 ISTANBUL 000418 
 
SIPDIS 
 
 
STATE FOR E, EUR AND EB 
TREASURY FOR U/S TAYLOR AND OASIA - MILLS 
NSC FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: DECL: 03/25/2013 
TAGS: ECON, EFIN, PREL, TU, Istanbul 
SUBJECT: ISTANBUL ECONOMIC ANALYSTS: LOOKING FOR A LIFELINE 
 
Classified By: Pol/Econ Chief Stuart Smith.  Reasons 1.5 (b) and (d). 
 
 
1. (SBU)  Summary: After a rocky start to the week on Monday, 
word that the U.S. Iraq supplemental contains 1 billion USD 
for Turkey has been seized on as a lifeline by Istanbul 
markets and analysts.  Concern persists about the 
sustainability of Turkey's debt, however.  Analysts suggest 
any problem is unlikely to emerge immediately, as banks will 
remain in the market and move to shore up their balance 
sheets at the end of the quarter and cooperate with the 
government to bring interest rates down.  The key wildcard 
that could hinder that effort: individual bank's dollar 
liquidity.  One banking contact estimates that 5 percent of 
the system's 44 billion USD in assets has been withdrawn or 
transferred overseas in recent days, a figure confirmed in 
Ankara by BRSA sources (septel).  Other banks report that 
after an initial "leakage" on the first day of hostilities, 
the situation has stabilized.  Banking industry leaders 
reviewed the situation in Ankara on March 26 with the 
Treasury, Central Bank and BRSA.  End Summary. 
 
 
2. (C) No credibility: Our contacts in Istanbul's financial 
community are extremely critical of the AK government and its 
mishandling of U.S. relations on Iraq.  Its mixed signals on 
reintroducing the motions to support the U.S., and the 
perception that State Minister Babacan deliberately misled 
the markets before the Treasury's last debt auction, have 
left its credibility in shreds.  The distrust was evident 
over the weekend as Prime Minister Erdogan's message of 
commitment to economic reform failed to sway market 
sentiment.  Analysts at Bender Securities argue that "this 
government is finished."  But, of equal concern, many 
perceive that the problem extends beyond the government. 
Yapi Kredi's Huseyin Imece characterizes the failure as one 
in which the entire Turkish state shares responsibility, from 
the President and military through the oppositin as well. 
 
 
3. (SBU) Isolation: Beyond the loss f American financial 
assistance, which some see s survivable (Finansbank's Kerim 
Kemahli notes tat Turkey was expected to muddle through 
before he package appeared, and can still do so), concern 
among Istanbul observers focused especially on a erception 
that Turkey's bridges to the West and articularly to the 
U.S. have been cut.  EU warnigs on Cyprus, coupled with 
warnings from all quaters against Turkish intervention in 
Northern Ira ("the last error remaining for Turkey to 
commit" in Imece's description), shook the markets and 
contributed to 
nday's sharp sell-off.  Tuesday'sreport of 
a new and more modest U.S. assistance ackage has thus been 
seized on as a lifeline.  Analysts recognize that the amount 
(in the Turkish ontext) is relatively insignificant, and 
congresional approval by no means assured, but nonetheless, 
in Kemahli's and others' view, the aid is an important signal 
that the U.S. administration is not abandoning Turkey. 
(Garanti Bank's Baris Kokoglu argued that even a promise of 
billions from the EU would have less market impact than the 
U.S. billion.) 
 
 
4. (SBU) Debt Sustainability: All observers are now focused 
on interest rates, Turkey's key economic indicator.  While 
pessimism is marked at local brokerages (Bender's Murat 
Gulkan and Emin Ozturk see an economy trying to navigate 
between muddling through and "doomsday," with no real 
upside), some bankers are more sanguine.  Kemahli argues that 
the "moderate" reaction of the past week shows that the 
Turkish economy has matured since the 2001 crisis, and will 
weather the storm.  The banking sector is strong, he argues, 
with banks liquid and without exposure to short positions on 
the dollar.  Banks are taking paper losses because current 
high rates negatively impact their balance sheet, but he and 
his colleague Ozlem Cinemre characterize this more as an 
"opportunity cost," in that deposit rates are so low the 
banks are still making money on their entire portfolio. 
Garanti's Kokoglu agrees, noting further that the banks have 
no alternative but to stay in the bond market.  There is no 
demand in the real sector for loans, reserve requirements 
provide an incentive for bond holdings over loans in any 
case, and other securities (such as U.S. bonds) do not offer 
a high enough return to cover Turkish deposit rates.  Bender 
analysts characterize the situation as a "Hotel California," 
where all players are enjoying good profits, but cannot exit 
the game. 
 
 
5. (SBU) Dollar liquidity: Given that ten banks constitute 
the key market for Turkish t-bills, their liquidity is 
critical to debt turnover.  On this issue, we are hearing 
mixed messages.  Yapi's Huseyin Imece warned that "leakage" 
from the system has reached 5 percent of its 44 billion USD 
in total dollar assets, a figure confirmed by BRSA's Engin 
Akcakoca, who told Embassy Ankara (see Ankara septel) that FX 
withdrawals from March 14-15 totaled 1.8 billion USD.  Not 
all banks are being equally affected, however.  Cinemre and 
Kemahli noted that while there were some withdrawals on the 
first day of military operations in Iraq (2 percent of the 
Finansbank's 1.8 billion USD holdings), the situation had 
since stabilized and that on Wednesday there was even a 20 
million USD inflow.  They noted too that withdrawals were not 
driven by panic, as they were 2 years ago (when Finans was 
forced to turn to merchants in the Grand Bazaar and its 
German branches for stopgap liquidity), but by large 
depositors comparison shopping in pursuit of increased 
returns.  Kokoglu reported a similar pattern at Garanti. 
However, he confirmed that the CEO's of major banks were 
meeting in Ankara on March 26 with the BRSA, Central Bank, 
and Treasury to review the situation and emphasized the 
importance of Turkey's continued commitment to its reform 
program.  The government no longer has any margin for error, 
he stressed, and the markets will "swiftly punish" any 
missteps. 
 
 
6. (SBU) Comment: From the Istanbul perspective, what started 
as an extremely problematic week has been salvaged by the 
public perception that the U.S. is not abandoning Turkey. 
Analysts are united in their belief that to further soothe 
the markets Turkey should avoid raising tensions by going 
into Northern Iraq.  After the announcement of U.S. 
assistance, they also see value in a reciprical goodwill 
gesture by Turkey--such as opening airbases-- without seeking 
a quid pro quo.  Most of all, they are looking for actions 
rather than words from the government on the economy.  We 
were struck, however, by the dividing line between the views 
of Istanbul's bankers and stock market analysts.  While the 
latter are uniformly gloomy, some of the former were more 
sanguine--convinced that Turkey has seen worse before and 
will ultimately weather the crisis, provided the war is short 
and the government continues to follow IMF guidance.  End 
Comment. 
ARNETT