US embassy cable - 03ANKARA2323

UNCLAS SECTION 01 OF 02 ANKARA 002323 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, P, EUR/SE AND EB 
TREASURY FOR U/S TAYLOR AND OASIA - MILLS 
NSC FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: N/A 
TAGS: ECON, PREL, TU 
SUBJECT: TURKEY'S ECONOMY APRIL 10: MARKETS DROP ON NO. 
IRAQ/U.S. AID CONCERNS; OZTRAK FIRING; DERVIS ON THE ECONOMY 
 
Sensitive but unclassified.  Not for internet distribution. 
 
 
Markets Worry About No. Iraq/U.S. Aid, 
Ignore Positive Trends out of Lack of Trust 
------------------------------------------- 
 
 
1.  (U) As of 2:00 pm local time April 10, local news reports 
that Iraqi Kurds have taken Kirkuk are raising market 
concerns of a Turkish reaction that could jeopardize the U.S. 
aid package.  T-bill yields rose nearly three percentage 
points to 66 percent; the lira depreciated almost two percent 
to TL 1,670,000; the Istanbul Stock Exchange dropped 6.6 
percent. 
 
 
2.  The main concern, per our market contacts, is the ongoing 
story about an explicit northern Iraq condition in the Senate 
to U.S. aid.  Other negative developments, less critical to 
sentiment but also cited by market contacts, are the firing 
of Treasury U/S Oztrak, and telecom company ARIA (a major 
foreign investor, see below) filing an international 
arbitration claim against the GOT. 
 
 
3.  (SBU) Comment:  Market contacts express two concerns on 
northern Iraq:  the GOT for face reasons might be forced to 
reject an explicit Iraq condition; the Turkish military might 
actually intervene whether or not there's any explicit 
condition.  In either case, the concern is that Turkey would 
miss out on $8.5 billion and otherwise further damage the 
U.S. relationship. 
 
 
4.  (SBU) Comment continued:  Today's market declines do not 
reflect some recent positive developments:  the IMF Fourth 
Review is next week; the GOT passed a strong budget and froze 
discretionary spending; the war appears to be winding down 
and oil prices are declining;  The U.S. is poised to offer 
$8.5 billion in concessional long-term loans.  As market 
analyst Murat Ucer told us, "local markets don't like 
anything this government does."  He and others see a very 
high continuing program implementation risk that can only be 
addressed over months of strict carrying out of reform 
commitments.  End Comments. 
 
 
Babacan Confirms Oztrak to Be Replaced; 
Oztrak Says Leaving April 19 
-------------------------------------- 
 
 
5.  (U) Early on April 10, before heading to Washington for 
Fund/Bank meetings, MinState in charge of Treasury Babacan 
confirmed to local press rumors that Treasury U/S Oztrak 
would be replaced shortly.   in his April 10 column, Hurriyet 
newspaper's Erdal Saglam (a friend of Oztrak's from college) 
wrote that Oztrak plans to resign on April 19, the day after 
the IMF Board review.  Oztrak's likely replacement is Mesut 
Pektas, a former Finance Ministry inspector and Istanbul 
Municipality official in charge of finances. 
 
 
Dervis on the Economy - Focus on 
Social Issues, Still an Outsider 
-------------------------------- 
 
 
6.  (SBU) On April 10, we met with opposition CHP member of 
parliament (and former State Minister in charge of Treasury) 
Kemal Dervis.   His main observations on the economy follow: 
 
 
 
 
--  The only way to fundamentally change economic reform 
dynamics in Turkey is through foreign direct investment 
(FDI), a minimum of $5-6 billion is required to ensure 
medium-term stability.  FDI requires two things:  internal 
bureaucratic reforms; an anchor in the EU, meaning a clear 
accesssion path.  Without such inflows, Turkey will see only 
marginal improvements that can be quickly erased through 
reform backsliding. 
 
 
--  Comment:  Dervis is one of many chanting the "we need 
foreign direct investment" mantra, to no discernible 
practical effect on the investment climate.  Turkey's climate 
is not improving.  For example, the country's third largest 
GSM operator Aria (a 50/50 joint venture between Isbank and 
Telecom Italia, making it one of the largest foreign 
investors) this week filed an international arbitration claim 
against the GOT for not honoring the GSM license agreement. 
 
 
--  Dervis had little comment on Turkey's fragile debt 
dynamics.  He sees a "muddle through" scenario working. 
Turkish banks are liquid, and making good returns at current 
high rates, and have an interest in working with Treasury to 
roll-over domestic debt.  Improving debt dynamics beyond that 
will require strong growth, continuing high primary 
surpluses, and careful debt management. 
 
 
--  He is more concerned about "social sustainability" than 
debt sustainability.  While Turkey's official unemployment 
rates, 11-12 percent, are not unusual by European standards, 
there is practically no social safety net in Turkey. 
Unemployed Europeans get 80 percent of their salaries, 
whereas unemployed Turks get only six months of benefits. 
 
 
--  Personnel changes in economic team worry him.  It's key 
to market confidence to have an economic team, especially at 
Treasury, that projects sincere belief in the reform program. 
 Gul as PM understood this, and supported Oztrak's team. 
Erdogan, however, is putting "hard core partisans" in key 
technocrat positions.  Dervis also sees "bad body language" 
when Erdogan talks about reform, sending a message of "I 
don't really believe this" which is not helpful to market 
morale. 
 
 
7.  (SBU) Comment: Dervis, after two years immersed in 
Turkish politics, still comes across as an outsider, not 
comfortable with the need to fight his way up the ranks of 
Turkish politics.  He told us he is going on a speaking tour 
of seven Turkish universities, but we didn't hear any passion 
for speaking out.  He also had little to say on debt or other 
macro-economic issues, without Treasury hands like Faik 
Oztrak around. He was more eager to discuss traditional World 
Bank-type social and sectoral issues. 
 
 
PEARSON