READ-OUT OF IMF VISIT TO TURKEY: FOCUS ON BUDGET

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 008846

SIPDIS


STATE FOR E, EB/IFD/OMA AND EUR/SE
TREASURY FOR OASIA - MILLS AND LEICHTER
STATE PASS USTR - NOVELLI AND BIRDSEY


E.O. 12958: DECL: 09/02/2006
TAGS: ECON EFIN PREL TU
SUBJECT: READ-OUT OF IMF VISIT TO TURKEY: FOCUS ON BUDGET

REF: ANKARA 8797


Classified by DCM Robert Deutsch for reason 1.5 (d).



1. (C) Summary: On December 4, IMF resident representative
briefed EU member countries and us on the December 2-4 visit
of IMF Europe Director Deppler. It provided a first
impression of the new economic ministers: well-intentioned,
and committed to continuing the existing program, but not
united on economic policy measures and facing a daunting list
of conditions under the program. The IMF plans two staff
missions, December and January, before going to the board,
probably in February, to release the next tranche of $1.7
billion. The most controversial issue before IMF and GOT is
the primary budget surplus, including both measures to meet
this year's projected shortfall and next year's target. Also
key is the composition of budgetary measures to meet the
surplus target (i.e. not just raising taxes, but expenditure
reform that addresses chronic deficits in the pension funds).
The primary surplus is the one key element of debt
sustainability that is completely in the GOT's control, and
thus will be an important signal to the markets. We
recommend supporting a firm IMF approach to this issue. End
Summary.


IMF First Impressions
--------------



2. (C) IMF resrep began with some general impressions: the
new economic ministers are well-intentioned and haven't
painted themselves into a corner by committing to bad
policies. However, there appears to be some fragmentation.
Deputy PM Sener has the role of overall economic policy
coordinator, and State Minister Babacan has the role of
coordinating with the IMF and World Bank.



3. (C) In addition, IMF resrep said the ministers have yet to
decide on economic policy specifics. Their policy statements
to date (election platform, government program) are very
general. The differences became clear on the key issue of
the year 2003 primary budget surplus: Deputy PM Sener told
the IMF visitors the 6.5 percent target would be fine (and
publicly said this target was "reasonable"); while State
Minister Babacan in a later meeting stepped back, saying he
needed to see budget realizations this year before committing
to next year's target.



4. (U) IMF Europe 1 Director Michael Deppler and Turkey
Mission Chief Juha Kahkonnen met with PM Gul, Deputy PMs
Sener and Sahin, Finance Minister Unakitan, and State
Ministers Babacan (Treasury) and Tuzmen (Trade),as well as
with senior officials in the Treasury, Central Bank and
Banking Regulation and Supervision Agency (BRSA).


IMF Schedule and Mission Timing
--------------



5. (SBU) The new government plans to continue the existing
program, and will seek to finish the Fourth Review, per IMF
resrep. But the new ministers are facing a long list of
outstanding Fourth Review. Furthermore, they need time to
formulate a detailed program for 2003, including the full
year 2003 budget to be presented to parliament in January.
Thus the IMF plans to proceed as follows:


-- December 9-20: full mission to examine conditions for the
Fourth Review, and begin working on the 2003 letter of
intent.


-- January 2003: follow-up mission to finalize the Fourth
Review and the 2003 letter of intent.


-- February 2003: IMF Board meeting on the Fourth Review,
release of $1.7 billion tranche.



6. (SBU) IMF resrep stressed that the GOT doesn't need the
Fourth Review tranche at the moment. The Treasury is taking
advantage of favorable market sentiment to overborrow in the
domestic market. (Note: the Treasury has also borrowed
$1.15 billion in the Eurobond market since the November 3
elections.)


Fourth Review Conditions -
Structural Reform Issues Loom Large
--------------



7. (U) IMF resrep proceeded with a status report on
outstanding program conditions.

8. (SBU) Fiscal Policy: The IMF Mission next week will
assess the size of the shortfall towards meeting the 6.5
percent primary surplus target, but the October Mission had
calculated it to be as large as 1 percent of GNP, about $1.6
billion. (Comment: MinFin sources also tell us about one
percent of GNP shortfall.) IMF resrep speculated that the
shortfall could have grown given some post-election spending
measures. Very little has been done to address this shortfall
to date, except that payments under public works contracts
have been frozen (the prior government signed many such
contracts in its last days).


-- IMF resrep noted that the primary surplus performance
criterion in the program is a key condition; however, "a key
objective of the primary surplus is to maintain debt
sustainability, and the debt situation is currently good.
They have built a financial buffer through over-borrowing."


-- Asked about the tax amnesty issue, Resrep noted there
were two separate measures: First, the "Financial Year Zero"
law, first passed in 1998 and scheduled to be implemented in
January 2003, which the GOT plans to annul; Second, the
proposed tax amnesty would establish a cut-off date for
overdue tax files - those more than one year old would not be
pursued. IMF wouldn't fight these measures, per IMF resrep,
but has told the GOT that these measures make it more
difficult to increase the tax base and tax revenue, and thus
meet the new GOT's social spending goals. (Comment: The
"Financial Year Zero" law intends to shift the burden of
proof from the GOT to the taxpayer in tax audits: after a
short grace period following the implementation date,
taxpayers who have not declared their income are subject to
audits and possibly penalties. It is intended to establish
an incentive to file taxes.)



9. (SBU) Monetary Policy: Though the Central Bank is
reaching its ceiling under the base money performance
criterion (the nominal anchor of monetary policy),both
inflation and inflationary expectations are on track.
November inflation shows annualized CPI to be 31.8 percent,
under the 35 percent target. (Comment: The under target CPI
has been achieved partly through delays in raising
state-controlled prices of consumer goods, thus building up
some inflationary pressure. The GOT needs to raise prices of
goods it controls in December, to keep inflationary
expectations trending downwards.)



10. (SBU) Structural Reforms: IMF resrep stressed that the
new government faced a lot of decisions.


-- Public Sector Reform: First, the Government must submit
a direct tax reform bill along the lines agreed to with the
prior GOT. (Comment: this law would seek to lower overall
tax rates by eliminating a lot of special exemptions and
pork, thus very politically sensitive.) Second, the GOT needs
to show progress on eliminating redundancies in the state
economic enterprises (SEEs): the end October condition was
30,000 and latest numbers show 21,000. (Comment: Also
politically sensitive, but key to slimming down the state
sector and making permanent improvements to the budget.)


-- Privatization: The new GOT has stressed privatization is
a top priority, but they have to translate this into a
detailed program, per Resrep. The two major outstanding
issues are preparing state alcohol and tobacco giant TEKEL
and Turk Telekom for privatization. Political level
decisions are needed on both: for TEKEL, the issues are
reducing overstaffing, cutting tobacco support prices, paying
tax arrears. For Turk Telekom the issue is passing a new law
that allows parts of the newly created holding company
structure to be sold off.


-- Banking Sector Reform: While there has been good
progress on some issues (in December, BRSA plans to tender
$250 million of assets assumed from bankrupt banks),the
major outstanding condition is resolving Pamukbank, and the
Cukurova Holding's shares of Yapi Kredi Bank. IMF resrep
said, "The issue is in the courts, but we urged the GOT to
give public support to the BRSA so the judges and public
understand the GOT position." He added that it would be
"difficult" to complete the Fourth Review without resolution
of this condition. Otherwise, it would look like the IMF is
providing $1.7 billion to bail out these two banks' owner.


Outlook for Next Year's Program
--------------

11. (U) Resrep said the new government stressed the
importance of taking ownership of the program to be developed
for 2003, and IMF agreed. The IMF was open to discussing
changes in the program, provided there were three key
elements: a "prudent budget - we still think 6.5 percent
primary surplus is a reasonable target;" BRSA independence -
meaning BRSA has the ability to intervene with problem banks
and resolve them on a best practices basis without political
interference; Disinflation, including setting an ambitious
yet realistic inflation target, i.e., 20 percent CPI
increase, and preserving Central Bank independence.



12. (U) On next year's macro targets, Resrep was firm on the
20 percent CPI target, but stated the 5 percent GNP growth
target could be changed by the GOT. On the 6.5 percent
primary budget surplus, he noted that given a 5-6 percent
growth target, this level of primary surplus represented no
fiscal tightening over 2002. In fact, he continued, in real
terms discretionary social spending has increased by 12
percent over the last two years.


Comment
--------------



13. (U) We need to keep a close eye on the banking reform
issues. Beyond that, the main debate ahead for the IMF and
GOT lies over the primary surplus, both in meeting this
year's shortfall and in establishing next year's target. Out
of the three main ingredients in debt sustainability - real
interest rates, growth and primary budget surplus - only the
third lies completely in the GOT control and is thus the most
stable element. The GOT cannot count on the current market
sentiment continuing throughout 2003.



14. (U) The 6.5 percent target may not be sacrosanct, but a
major change (as in one percent of GNP or $1.6 billion) would
mean the Turks will forgo the chance to pay down their debt
in 2003, and thus improve their debt dynamics in a more
sustainable way. It could also raise significant market
concerns. In addition, the composition of budget measures
taken to meet the 6.5 percent is also important and directly
related to structural changes such as pension reform
(deficits in the GOT pension funds equal 3 percent of GNP,
reftel). In short, we should not be neutral in the IMF - GOT
discussions on the budget, and we should support the need for
a strong surplus, and one that maintains a high level of
social spending by strengthening public sector reforms.
PEARSON