US embassy cable - 03ISTANBUL465

UNCLAS SECTION 01 OF 02 ISTANBUL 000465 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EUR AND EB 
TREASURY FOR U/S TAYLOR AND OASIA - MILLS 
NSC FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, PREL, TU, Istanbul 
SUBJECT: ISTANBUL ECONOMIC PESSIMISM: "MUDDLING THROUGH" AS 
THE UPSIDE 
 
 
REF: ANKARA 2151 
 
 
Sensitive but unclassified.  Not for internet distribution. 
 
 
1. (SBU)  Summary: While not quite so pessimistic as they 
were two weeks ago about Turkey's immediate economic 
prospects, Istanbul financial analysts remain decidedly 
gloomy about the country's mid-term future.  All agree that 
the Treasury seems to have next week's debt auction well in 
hand.  In the mid-term, however, there is consensus that 30 
percent real interest rates are not sustainable, and will 
shift for better or worse.  Though an upside is "technically 
possible," in the words of former Disbank Chairman Vural 
Akisik, such an evolution would require government 
credibility in the markets, currently a sorely lacking 
commodity.  Akisik and others stressed that at root (and 
counterintuitively) the problem is not fiscal.  Turkey today 
enjoys the best economic fundamentals it has had in a decade. 
 But without unstinting government commitment to 
half-heartedly accepted and long-delayed structural reforms, 
interest rates will not come down to a sustainable level. 
End Summary. 
 
 
2. (SBU) Less short-term angst...: In a round of meetings 
during the week of March 31 with visiting Ankara DCM, Ankara 
Econ Counselor, and Istanbul Pol/Econ Chief, financial and 
real sector interlocutors indicated that their concerns had 
eased about the short-term sustainability of Turkey's debt. 
All agreed that the Treasury should be able to roll over the 
4.8 quadrillion TL in treasury bills that come due on April 
9.  Analysts point to several factors: most importantly, the 
country's sentiment-driven markets, initally alarmed by a 
perceived breach in U.S.-Turkish relations at a time the 
country appeared increasingly isolated in Europe, have been 
calmed by Secretary Powell's visit and the proposed 1 billion 
USD assistance package.  A range of technical factors also 
provide a safety margin to the Treasury: tax collections in 
March and April should provide some ready cash, while the 
state banks (little used in recent auctions)  can step in as 
a last resort. 
 
 
3. (SBU) ...but long-term gloom: Our interlocutors concurred, 
however, that in the medium to long-term it is hard to be 
hopeful.  ING Barings Managing Director John McCarthy noted 
that given the current situation, one is "stretched for 
positive arguments" about Turkey's situation.  With the 
economy at a standstill, the country is coming to a "dark 
time," he warned, and will have to seriously face up to the 
structural issues it has long ducked, or face a crisis along 
the lines of Mexico in the 1990s.  Others were similarly 
pessimistic--Bender analysts Murat Gulkan and Emin Ozturk see 
"muddling through" as the best case scenario for Turkey, and 
can see no scenario for growth in the mid-term.  Ozturk noted 
that there are few engines for growth this year (only exports 
seem poised for a positive performance, while consumption, 
public sector investment and tourism are all down), and a 
business decision to draw down inventories (which accounted 
for a large proportion of the growth in the fourth quarter of 
2002) could cause the economy to contract. 
 
 
4. (SBU) Positive fundamentals, but: Gulkan and Ozturk 
stressed that at root the problem is not fiscal, given that 
Turkey currently enjoys the best economic fundamentals it has 
seen in a decade.  Continued strong performance on the fiscal 
side is a necessary but not sufficient condition for turning 
the economy around.  Instead, they argued, the government 
must stop sending mixed signals to the markets and instead 
push the reform program wholeheartedly.  Former Disbank 
Chairman Vural Akisik echoed this point, noting that Turkey's 
macro base is better than it has been since 1994.  Because of 
that, observers believe the government can get through the 
next months by "spending the ammunition" it has accumulated. 
But to achieve a sustainable real interest rate (which Akisik 
calculates at 35 percent), the government must have 
credibility with the markets, something that is now almost 
totally lacking.  Reviewing the missed opportunities and 
missteps that have characterized the last few months, Akisik 
likened the situation to that of a husband who has cheated on 
his wife and now even when guiltless must pay attention to 
every nuance.  In such a situation it is not enough that the 
government get the main issues right--the details must be 
perfect too. 
 
 
5. (SBU) Captive audience: Many of our interlocutors concur 
that ultimately a restructuring of Turkey's domestic debt-- 
either orderly or chaotic--is inevitable.  They do not expect 
it soon, however.  Most believe that the government can 
sustain the debt through 2003.  Questions deepen for the 
following years, and one leading international bank has 
adjusted its baseline scenario to reflect a 2005 default as 
the most likely outcome.  HSBC General Manager Antika concurs 
that restructuring is inevitable, but she (and the bank's 
Treasurer) do not see it happening this year.   Indeed, she 
noted that HSBC's own interests militate against such a 
development, in that they mirror (though to a lesser degree) 
the predicament of the sector as a whole.  With exposure to 
Turkish debt both on its balance sheet and in collateral for 
corporate loans, as HSBC's Treasurer told us, "we have an 
interest in keeping the boat afloat, not in profiteering from 
the situation."  Other banks' situation is similar.  Bender's 
Ozturk and Gulkan stressed (as they have repeatedly in recent 
months) that Turkish banks are captives of the system, and 
are essentially prevented from cashing out, since a decision 
by one bank to do so could bring the whole "house of cards" 
down. 
 
 
6. (SBU) Restructuring: Intriguingly, however, we heard this 
week our first hint that the banks themselves may be 
receptive to some sort of controlled restructuring, in an 
effort to escape the treadmill on which they find themselves. 
 Bank of New York Representative Neslihan Tombul told us on 
April 3 that she has heard that at least two banks (Isbank 
and Garanti) have sent feelers to the Treasury on the 
subject.  Beyond the costs a restructuring might impose, 
depending on how it is formulated, she also sees benefits, in 
that with longer-term securities banks have a more stable 
balance sheet on which to operate. 
 
 
7. (SBU) Comment: With reassurance on U.S.-Turkish ties 
helping to soothe Turkish markets in the short term, 
attention is again focused on the key imponderable of 
government credibility.  We see little sign that the 
government will be able to recoup that commodity any time 
soon.  Given its missteps, each government move has been 
closely scrutinized, and in many cases (as in the case of 
recent nominations to the board of Halkbank and Ziraat Bank) 
found wanting.  Most Istanbul analysts remain decidedly 
downbeat on the government economic team, expressing grudging 
respect only for Finance Minister Unakitan.  Only by reaching 
outside the government for a "Dervis," in Gulkan and Ozturk's 
view, can the government regain credibility.  They (and we) 
see this as an extremely remote possibility, however.  End 
Comment. 
ARNETT