Identifier
Created
Classification
Origin
03ANKARA1720
2003-03-19 08:35:00
CONFIDENTIAL
Embassy Ankara
Cable title:  

AK ECONOMIC POLICY: REFORM ONLY AS A LAST RESORT

Tags:  ECON EFIN PGOV PREL TU 
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C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 001720 

SIPDIS


STATE FOR E, P, EUR/SE AND EB; TREASURY FOR OASIA - MILLS
AND LOEVINGER; USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO; NSC
FOR QUANRUD AND BRYZA


E.O. 12958: DECL: 03/17/2008
TAGS: ECON EFIN PGOV PREL TU
SUBJECT: AK ECONOMIC POLICY: REFORM ONLY AS A LAST RESORT


(U) Classified by DCM Robert Deutsch. Reason: 1.5(b,d)


C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 001720

SIPDIS


STATE FOR E, P, EUR/SE AND EB; TREASURY FOR OASIA - MILLS
AND LOEVINGER; USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO; NSC
FOR QUANRUD AND BRYZA


E.O. 12958: DECL: 03/17/2008
TAGS: ECON EFIN PGOV PREL TU
SUBJECT: AK ECONOMIC POLICY: REFORM ONLY AS A LAST RESORT


(U) Classified by DCM Robert Deutsch. Reason: 1.5(b,d)



1. (C) Summary: New Prime Minister Tayyip Erdogan's
decision not to make any changes in the AK economic team
suggests he is unlikely to break sharply with the Gul
government's economic appraoch. That is unfortunate. In its
four months in office, the AK leadership has proven that it
neither understands economics nor embraces reform, and will
implement sound policies only if the markets give it no
alternative. In that sense, the Gul-Erdogan Government is
similar to the Ecevit government, with the exception that it
has no Kemal Dervis to provide leadership. Abdullah Gul won
some praise from senior bureaucrats, but was not been able to
provide sufficient economic leadership. The prospect of a
large U.S. financial package has supported financial markets
in recent weeks, but in doing so also has prevented the
markets from delivering a tough message to the government,
which misread market stability as an indication of confidence
in AK leadership. Now that the bilateral package is off the
table, we can expect the markets to send a clear signal to
the Erdogan government on the need for sound policy. End
Summary.



2. (C) The AK Party came into office in mid-November with a
mixed message on the economy that attempted to please
everybody. To the financial markets and the international
community, AK espoused a strong commitment to fiscal
discipline, and to improving the investment climate via
reforms. To the Turkish electorate, and especially to core
constituents among small and medium business people, the
message was "the new government will stimulate growth and
create more demand for you." These contradictory goals are
evident in AK's pre- and immediate post-election programs,
including the "Emergency Action Plan" adopted in November.
The AK government was going to increase social spending,
stimulate growth, keep a tight budget and accelerate

disinflation, all at the same time. But the programs never
spelled out how.



3. (SBU) In our early meetings with AK leaders, it was clear
that despite the pro-reform rhetoric, the heart of AK's
economic policy was with those wanting the GOT to spend its
way out of recession, "pump priming" as Ali Coskun (AK vice
chairman for economics and now Minister of Industry)
repeatedly told us. It was not enough for AK that exports
and stock rebuilding in 2002 had resulted in over 6 percent
growth. Domestic demand, the key for AK's business
supporters, remained fairly weak in many sectors going into

2003.



4. (C) The rhetoric, however, remained firmly pro-reform,
buttressed by the market friendly utterances of State
Minister for the Treasury Ali Babacan (an MBA in marketing
from Northwestern University),and crafted also by AK Vice
Chairman for media Murat Mercan (a public relations professor
at Bilkent University). This rhetoric, and the prospect that
the first one-party government in 20 years would be able to
implement the rhetoric, fueled a six-week post-election
market rally and raised hopes that Turkey could begin to move
away from the financial precipice.



5. (C) Although much of AK's rhetoric has remained
reform-minded, its actions have not. In its few months in
office, the government has engaged in populist measures
(nearly $3 billion in new spending),publicly undermined
independent regulatory agencies, tried to gut a
critically-important public procurement law, and passed an
unwise tax amnesty law. Even in the area of privatization,
where AK's public statements have been very positive, the
government has moved at a snail's pace. AK has stalled on
IMF and World Bank conditions, including enactment of a sound
budget. Moreover, it has alienated both the Fund and the
Bank by failing to consult with them before announcing key
actions, and -- in the case of the IMF -- accusing the Fund
of being "unfair." As was clear in our bilateral
negotiations, the government sees possible U.S. assistance as
an alternative - not a complement -- to sound policy.



6. (C) The only time the Gul government showed serious
interest in taking much-needed fiscal measures was when
markets threatened. On January 7, weak interest in a large
Treasury T-bill auction (a 45 percent roll-over rate) led
Prime Minister Gul to call an emergency meeting and to
announce significant new fiscal saving measures. Similarly,
after dithering with the IMF team for weeks in February, the
government quickly accepted difficult new taxes and budget
cuts March 2, immediately after Parliament's rejection of the
troop deployment (and the corollary U.S. financing package)
threatened a market meltdown. IMF Mission Chief complained
to us that, in the month he was here to conclude an LOI, the
only days in which the GOT worked seriously were March 2 and
March 9 (after he informed the GOT he was returning to
Washington with little progress to report.)



7. (C) The obvious question is why AK has failed to take the
measures most outside observers believe are essential to
avoid renewed crisis, despite the fact that the party came in
on the back of a big electoral win. Part of the answer lies
in the demands of the many small entrepreneurs and
shopkeepers in its constituency, who want continued
government support, easy credits and protection from big-time
competition, foreign or Turkish. There is also a widely held
perception that AK politicians, having been out of office for
so long, want to enjoy the spoils the existing system offers.
This would explain, for example, AK's desire to gut the new
public procurement law. Another, factor has been the
perception that further fiscal austerity measures would not
help AK's chances in future elections (including Tayyip
Erdogan's election March 9, and nation-wide local elections
next year). Moreover, few if any in AK understand
macroeconomics, so -- per Central Bank Governor Serdengecti
-- they are blissfully unaware of the consequences of their
poor policies (and in some cases believe the U.S. will bail
Turkey out if necessary). A senior economic official
confided to us that the Cabinet as a whole still views the
economic program as something imposed on the government by
the IMF. Finally, the markets have been artificially buoyed
by the prospect of a large U.S. financial assistance package,
and thus have failed to send the warning signals one normally
would expect in the face of bad policies.



8. (C) In some ways, the AK government has been similar to
its predecessor, the Ecevit government, which implemented
reforms only under intense IMF and market pressure. One
important difference, however, is that the Ecevit government
-- while hardly full of economic wizards -- included Kemal
Dervis, who understood the need for reform and used the
leverage provided by the IMF to force through
politically-unpalatable reforms. In contrast, AK's State
Minister for the Treasury, Ali Babacan, has failed to push
through reforms. According to one international reporter,
Babacan has been mainly interested in enhancing his standing
in the Party by demonstrating his toughness in negotiations
with the IMF and the U.S. He is, in that sense, striving to
be the "anti-Dervis." IMF Mission Chief said March 7 that
Babacan had not even read the draft Letter of Intent that he
supposedly is negotiating on behalf of his government.
Others, including Treasury U/S Faik Oztrak, claim that
Babacan has advocated sound policies in Cabinet meetings, but
has lacked the clout to push them through.



9. (C) The rest of the economic team is no better than
Babacan, and possibly worse. At least Babacan understands
the need to communicate to the markets. IMF Mission Chief
(strictly protect) called the team "totally incompetent" and
a "hopeless bunch." Central Bank Governor Serdengecti (also
strictly protect) said it was like having a bunch of
small-town politicians run a government. Deputy Prime
Minister Abdullatif Sener, who is responsible for economic
issues, is best known for having advocated abolition of
interest rates during his tenure as Finance Minister during
the Erbakan government. He has been such an enigmatic figure
in meetings with us and other foreign diplomats that none of
us can say with any confidence that we know where he stands
on any issue. Finance Minister Kemal Unakitan (a former tax
inspector who became a consultant and reportedly has a
pending tax fraud case) also appears to be in over his head.
Central Bank Governor Sureyya Serdengecti told us recently
that Unakitan dismissed the Banks highly-praised inflation
expectation surveys, asking how a survey of only 50-100
people in a country of 67 million could be useful. IMF
sources say Unakitan "doesn't get it." State Minister for
Trade Kemal Tuzmen is a bombastic self-promoter who sees
Turkey's future in trade with Iraq, Algeria, and other nearby
states and who has no apparent understanding of economics.
European diplomats believe Industry Minister Ali Coskun, who
has long advocated populist spending and was a strong
proponent of the government's tax amnesty, is exercising
significant, negative behind-the-scenes influence with
Erdogan. The opposition CHP, including Kemal Dervis, has
failed to offer useful criticism or policy alternatives.



10. (C) As Prime Minister, Abdullah Gul received relatively
good marks from economic bureaucrats, who say he had the best
understanding of the economic picture of anyone in the
cabinet. However, Gul was so busy with other issues that he
was not been able to provide steady economic leadership.
Moreover, he was often undermined by others within AK.
Tayyip Erdogan, for example, committed the government to high
hazelnut support prices, and has supported other populist
measures. Per IMF sources, when Gul (at urging of Treasury
U/S Oztrak) agreed to some key budgetary and regulatory steps
during Ali Babacan's absence, Babacan returned, complained to
Erdogan, and took back the measures to which Gul had agreed.
(Gul subsequently announced these same measures, and others,
on March 3, in the aftermath of Parliament's negative vote on
troop deployment.)



11. (C) The case for optimism rests not with the new
Erdogan government, which appears likely to continue the
policies of the Gul government. Rather it is with the
continuation of certain structural reforms already enacted
(e.g., Central Bank independence, and reductions in banking
sector exposure to foreign exchange risk),the current set of
senior economic bureaucrats (particularly Central Bank
Governor Serdengecti and Treasury U/S Oztrak),and with the
prospect that -- with the U.S. economic package off the table
-- markets will begin to deliver a clear message on the need
for sound policy.
PEARSON