US embassy cable - 03ANKARA3265

UNCLAS SECTION 01 OF 02 ANKARA 003265 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, P, EB/IFD AND EUR/SE 
TREASURY FOR OASIA - MILLS AND LEICHTER 
NSC FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, PGOV, TU 
SUBJECT: TURKEY'S ECONOMY:  SOME POSITIVE SIGNS, BUT LITTLE 
LONG-TERM CONFIDENCE 
 
 
REF: ISTANBUL 0671 
 
 
1.  (SBU) Summary:  The rapid end of the Iraq war, prospect 
of U.S. and IMF money, and a global emerging market rally 
have combined to boost the Turkish currency and reduce 
interest rates substantially in recent weeks.  Meanwhile, 
exports and industrial production continue to rise, while 
inflationary expectations have fallen, increasing the 
prospects for Turkey meeting its 2003 growth and inflation 
targets.  On the other hand, conversations with foreign 
investment bankers and local business executives reveal 
little confidence in the GOT's ability to build on these 
positive trends and to manage the economy effectively in the 
year ahead.  The bottom line:  although the mood is more 
buoyant than two months ago, investors realize the 
fundamentals have not changed and thus remain reluctant to 
look beyond the next several months.  End Summary 
 
 
2.  (SBU) Although they have weakened slightly in the past 
few days, Turkish markets have staged a huge rally in the 
past seven weeks.  From their March 25 lows, the lira has 
strengthened from TL 1.750 million/dollar to TL 1.485 
million/dollar, and yields on the benchmark t-bill have 
fallen from 73.5 percent to just over 50 percent.  Investment 
bankers (we have spoken this week to Goldman Sachs, 
Deutschbank, Merrill Lynch, HCIstanbul, ING Barings, and 
several of their clients) attribute this rally to a 
combination of positive developments:  the rapid, successful 
conclusion of the Iraq war (with relatively limited impact on 
Turkey's economy), the prospect of significant U.S. financial 
assistance, completion of the Fourth Review under the IMF 
program, and the post-war global rally in emerging markets, 
as investor risk appetite has returned.  Central Bank Markets 
Department General Manager Akil Ozcay told us May 14 that two 
internal factors also played a role:  the shift by Turkish 
depositors of about 7 percent ($3 billion) of their foreign 
exchange deposits to lira deposits at the time the lira 
reached its low (i.e., a significant bet on the lira); and, 
related to that, some shift from dollars to lira as people 
made payments under Turkey's "tax peace" program.  (Note;  Of 
course, some of the lira's rally against the dollar reflects 
the dollar's global weakness.  End note) 
 
 
3. (SBU)  The real economy also has shown signs of 
improvement (reftel), although not as dramatic as in 
financial markets.  Industrial production rose 5.6 percent in 
March (year-on-year), above expectations, and 7.5 percent for 
the quarter.  Exports increased 27.5 percent in March (and 27 
percent for the first quarter), and the Exporters Association 
estimates strong growth for April as well.   March's sharp 
(44.8 percent) rise in imports suggests growing domestic 
demand, though it is also raising concerns about the size of 
Turkey's current account deficit this year.  In the past 
week, State Minister for Trade Kursad Tuzmen has joined a 
growing chorus of exporters warning that the lira's 
appreciation is hurting their competitiveness.  Oyak 
Executive VP Ergun Okur told us May 14 that the company was 
now losing money on some auto exports because of the lira's 
strength. 
 
 
4.  (SBU) The Central Bank's latest inflationary expectations 
survey also came in positive, as expectations for year-end 
CPI fell from 28 to 26.6 percent.  Central Bank officials, 
along with Treasury U/S Ibrahim Canakci, remain hopeful that 
they can still hit the 20 percent CPI target for the year, 
though they acknowledge they will miss the 17 percent WPI 
target.  The seasonal decline in agricultural prices, 
combined with the strength of the lira, lower oil prices, and 
declining expectations, should all help keep inflation in 
check in the months ahead. 
 
 
5.  (SBU) That is the good news.  The bad news is that, based 
on our conversations with local business executives and 
several groups of foreign investment banks in the past week, 
there is little optimism that the government will be able to 
build on recent positive developments.  As Deutschbank 
economist Marco Annunziato put it, "the recent confluence of 
events gives Turkey a great opportunity to begin a virtuous 
economic cycle, but we have been struck in our conversations 
by the complete lack of confidence (in Istanbul) in this 
government's ability to take advantage of the opportunity." 
Turkish Young Businessmen's Association Ankara Chairman Murat 
Sarayli said Turkish companies are still reluctant to invest 
(other than those involved in exports) because they cannot 
plan beyond the next 3-6 months. 
 
 
6.  (SBU) Investment banker contacts note that the government 
continues to move slowly and half-heartedly to meet IMF 
conditions, while intermittently offering populist measures 
that undermine whatever credibility it has built up via the 
reform measures it has taken.  As a result, they say, 
financial markets are likely to remain vulnerable to even 
minor shocks, with little prospect of a long-term, steady 
decline in interest rates of the sort that would reduce 
concerns about debt sustainability.  They predict that, in 
the next few months, investors will begin to focus on 
Turkey's very large external debt repayment schedule for 
2004, and will want to see strong evidence that the 
government is faultlessly implementing its reform program. 
The bottom line, therefore, is that, while the government has 
been able to lengthen t-bill maturities to some extent, there 
remains little appetite -- among both financial and 
non-financial investors -- for medium and long-term investing. 
 
 
7.  (SBU) Comment:  Three times in the past year, nominal 
interest rates on t-bills have fallen to the 50 percent 
level, only to rise again due to policy failings or political 
developments (eg. the declining health of then-PM Ecevit last 
year).  Based on our latest conversations, our sense is that 
investors almost expect a repeat of this pattern.  One 
foreign investment banker told us his company was making a 
list of the "trigger points" that would cause markets to fall 
again.  Changing this mentality will require improved 
economic policy performance (eg. surprising the markets by 
quickly completing the Fifth Review) at a time when many fear 
all the good news will encourage GOT complacency. 
 
 
 
 
 
 
PEARSON