US embassy cable - 03ANKARA4480

UNCLAS SECTION 01 OF 02 ANKARA 004480 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EB/IFD AND EUR/SE 
TREASURY FOR OASIA - LOEVINGER, MILLS AND LEICHTER 
NSC FOR BRYZA 
 
 
E.O. 12958: N/A 
TAGS: EFIN, EAID, PREL, PGOV, TU 
SUBJECT: IMF AND GOT CLOSE TO AGREEMENT ON FIFTH REVIEW 
 
REF: ANKARA 4316 
 
 
1.  (SBU) Summary:  IMF and Turkish officials are close to an 
agreement that would pave the way for the Fifth Review to 
proceed, and hope to announce agreement by Friday, July 18. 
Discussions this week have focused on closing the estimated 
$1.8 billion fiscal gap.  Although there has been some talk 
here that the Fund staff has been "lenient" on the fiscal 
side, ResRep and Mission Chief insist Turks have agreed to 
ambitious and credible measures to close the gap.  On the 
structural side, Parliament passed the final piece of social 
security legislation July 17.  We understand other structural 
conditions will be pushed into the Sixth Review.  Mission 
Chief has urged Turks to travel to Washington as soon as they 
complete the LOI to finalize and sign the financial agreement 
on U.S. assistance.  Meanwhile, markets have strengthened 
this week due to investor perceptions of progress on the 
review and on U.S.-Turkish relations, with an added boost 
from the Central Bank's July 16 interest rate cut.  End 
Summary. 
 
 
2.  (SBU) IMF and GOT officials told us late July 16 that 
they have made substantial progress this week, and hope to 
announce agreement on an LOI by Friday, July 18.  IMF ResRep 
said the discussions have focused on fiscal issues, 
specifically how to fill the fiscal gap -- the expected 
shortfall in this year's primary surplus target of 6.5 
percent of GNP.  According to both IMF and GOT officials, the 
gap -- identified by the last mission at approximately TL 1 
quadrillion -- has grown, due in part to the government's 
recent wage hike for civil servants, and now is projected at 
TL 2.5 quadrillion (approximately $1.8 billion). 
 
 
3.  (SBU) Treasury Acting Director General Melih Nemli and 
Finance Deputy DG for the Budget Ahmet Kisik outlined to us 
on July 16-17 the measures the GOT has agreed to take fill 
the gap:  (a) continuing until year-end a freeze on TL 1.2 
quadrillion in spending (of the TL 4 quadrillion in spending 
that was temporarily frozen in the spring); increasing the 
Special Transaction Tax and Educational Levy (TL 210 
trillion); sale of Treasury's hazelnut stock (TL 70 
trillion); savings on the foreign currency element of certain 
investment projects resulting from the lira's strength (TL 
200 trillion); and shifting "special revenues" normally 
earmarked for individual agencies to the general budget (TL 
580 trillion).  Kisik explained that the "special revenues" 
were a remnant of Turkey's various off-budget funds, most of 
which have been closed.  Beginning next year, nearly all of 
these revenues will go to the general budget.  This year was 
a transition period, but the government has decided to shift 
the revenues to the general budget to help close the fiscal 
gap.  He added that any remaining gap should be filled by 
higher-than anticipated petroleum taxes. 
 
 
4.  (SBU) A few observers, incluidng an Istanbul economist 
and a mid-level GOT economic official, have suggested to us 
that the Fund team was "lenient" in accepting the GOT's 
proposed fiscal measures.  IMF ResRep and Mission Chief 
insisted, however, that they were being tough and that the 
Turkish measures were credible and serious.  ResRep said 
Mission Chief had given a strong opening statement in the 
initial Fund-GOT meeting that had caused State Minister 
Babacan's face to fall.  Mission Chief said the Turkish team 
seemed to have a different -- much more serious -- attitude 
this time around, and had agreed to an "impressive" series of 
measures, something he attributed in part to the  efforts of 
Treasury U/S Canakci.  He addeed that he had warned Ministers 
Babacan and Unakitan that the GOT's populist "noise" was 
undermining market confidence, and that they needed to step 
up their peformance (and improve their rhetoric) to begin to 
regain that confidence. 
 
 
5.  (SBU)  The often-skeptical Ahmet Kisik agreed that the 
fiscal measures were credible.  While complaining that the 
GOT could and should have completed this review two months 
ago, potentially saving TL 2-3 quadrillion (through lower 
interest rates), he argued that the government has become 
more serious.  He suggested that Finance Minister Unakitan's 
recent roadshow to the U.S. -- during which U.S. investors 
had stressed the importance of completing the Fifth Review -- 
had a major impact on GOT thinking.  He added that the new 
fiscal measures would not cause much pain to the public and 
could be implemented through administrative action. In fact, 
he already has sent a letter to all the line ministries 
advising them that the Ministry has frozen TL 1.2 quadrillion 
in spending, and the government announced the increase in the 
Special Transaction Tax and Educational Levy in the July 17 
official gazette. 
 
 
6.  (SBU) IMF ResRep said Fund staff had agreed to push some 
structural measures into the next review, though it would 
turn at least a few of them into prior actions to ensure 
their completion.  He said the one remaining structural prior 
action for the Fifth Review, passage of the last of three 
laws strengthening and reorganizing the government's social 
security institutions, should be completed shortly -- in 
fact, press reports indicate Parliament passed it on the 
morning of July 17.  (Note:  Embassy will report more fully 
on the structural side once LOI is completed, when Fund staff 
and GOT officials have more time to provide details.  End 
note) 
 
 
7.  (SBU) Turkish markets, meanwhile, have rallied this week, 
with the lira strengthening to 1.381 million/dollar, bond 
yields on the benchmark t-bill falling to 47.09, and the 
stock exchange rising to 10,758 (as of the close of morning 
trade July 17). Analysts attribute the rally to investor 
perceptions that the GOT was making progress on completing 
the Fifth Review and on addressing the flap with the U.S. 
over the July 4 detention of Turkish soldiers in Northern 
Iraq.  In addition, the Central Bank's July 16 decision to 
cut overnight interest rates 3 percentage points created room 
for t-bill yields to fall, per several investors.  Analysts 
were surprised by the timing of the announcement -- they had 
expected it after the GOT and IMF had agreed on the LOI -- 
but generally agreed it was justified by recent indications 
that inflation is declining. 
 
 
8.  (SBU) IMF Mission Chief told us July 16 that he had urged 
GOT officials to travel to Washington as soon as possible 
after completion of the LOI to finalize and sign the 
financial agreement related to the U.S. assistance package. 
He said an early signing of the agreement, coupled with 
completion of the IMF review, would boost markets 
substantially.  He was not sure if GOT officials would heed 
his advice, as they seemed concerned about some of the 
language in the draft agreement (he did not provide further 
details). 
PEARSON