RESTORING CONFIDENCE IN TURKEY'S ECONOMY - BACK TO

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 001787

SIPDIS


STATE FOR E, P, EUR/SE AND EB
TREASURY FOR U/S TAYLOR AND OASIA - MILLS
NSC FOR FRIED, QUANRUD AND BRYZA


E.O. 12958: DECL: 09/02/2006
TAGS: ECON PREL TU
SUBJECT: RESTORING CONFIDENCE IN TURKEY'S ECONOMY - BACK TO
BASICS


Classified by Ambassador W. Robert Pearson for reasons 1.5
(b,d).



1. (C) This is an action request. See paragraph 6.



2. (C) The Turkish Government has put itself in a precarious
financial situation on the eve of war with Iraq. To get the
economy on even fragile ground, it needs to implement strong
reforms. Unfortunately, it has shown no inclination to do
so. It has not finalized the letter of intent with the IMF
nor moved forward on key reforms in that letter. It has not
passed the full-year 2003 budget. It did not pass a
parliamentary resolution authorizing U.S. troops, which would
have unlocked our aid. As a consequence, nominal interest
rates on Turkish lira debt are moving upward, now at 67
percent. The possibility of reaching the average annual
interest rate at which Turkey's debt is sustainable this
year, 45 percent, looks increasingly remote. Real interest
rates on lira debt are currently 33 percent, again not
sustainable for long, given the short maturity of much of
this debt.



3. (C) The Government may/may have bought itself three weeks
in the debt market, by raising $2 billion in the March 18
auctions. It facilitated these auctions by incorrectly
assuring markets of the availability of the full U.S.
package. The next large-scale debt service comes on April 9
(a total payment of TL 5.2 quadrillion or about $3 billion),
and Treasury will build up its cash reserves during March, a
major tax collection month. But raising several billion
dollars more in the markets will be hard.



4. (C) Market analysts here differ on whether the Government
has three weeks to restore some confidence and thereby scrape
together another $3 billion debt payment. While there may be
three weeks to avoid a GOT debt payment failure, continuing
sharp lira depreciation could panic enough Turkish bank
customers to cause a run on banks, triggering the
Government's GOT's 100 percent guarantee of all bank
liabilities (which it wouldn't have cash to honor).



5. (C) In our view, the GOT needs to implement a
strengthened program of reforms immediately, and thereby
shift focus back towards its own reform efforts. This
program is supported by at least $3 billion of potential IMF
and World Bank disbursements over this year. As a practical
matter, the existing program will have to be revised
following the outbreak of hostilities, since it does not
account for this scenario. The result - which will need to
be reached very quickly - would provide an opportunity to
take action to bolster market confidence through steps such
as:


-- Surprise market on the upside by signing a revised LOI
that includes further fiscal saving measures beyond the 6.5
percent of GNP primary surplus (thus creating more resources
to meet debt payments).


-- Announce an accelerated schedule of 2003 privatizations
to include money earners like THY, Erdemir and TEKEL (each of
these have major foreign investor interest, per investment
bankers.)


-- Implement now further structural reforms beyond the
existing commitments, focusing on major market impact issues,
especially: announce further lay-offs and restructuring of
the state enterprises.



6. (C) Embassy requests instructions; we would plan to
deliver a demarche to Deputy PM and FM Gul, bypassing
MinState Babacan as much as possible.



7. (C) Even if the GOT engages in this kind of major
campaign, its ability to avoid the worst case scenarios is
not assured. Restoration of market confidence may be too
gradual and incremental to meet upcoming needs. According to
some analysts, only a U.S. commitment of financial assistance
will suffice to restore confidence over the next three weeks.
Others are more optimistic, and believe that Turkish banks
even at this date are still interested in supporting credible
GOT efforts. All agree, however, that bold reform "back to
basics" steps are essential, even if as some believe they may
be not sufficient.
PEARSON