TURKEY'S ECONOMY APRIL 10: MARKETS DROP ON NO.

UNCLAS SECTION 01 OF 02 ANKARA 002323

SIPDIS


SENSITIVE


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


E.O. 12958: N/A
TAGS: ECON PREL TU
SUBJECT: TURKEY'S ECONOMY APRIL 10: MARKETS DROP ON NO.
IRAQ/U.S. AID CONCERNS; OZTRAK FIRING; DERVIS ON THE ECONOMY

Sensitive but unclassified. Not for internet distribution.


Markets Worry About No. Iraq/U.S. Aid,
Ignore Positive Trends out of Lack of Trust
--------------



1. (U) As of 2:00 pm local time April 10, local news reports
that Iraqi Kurds have taken Kirkuk are raising market
concerns of a Turkish reaction that could jeopardize the U.S.
aid package. T-bill yields rose nearly three percentage
points to 66 percent; the lira depreciated almost two percent
to TL 1,670,000; the Istanbul Stock Exchange dropped 6.6
percent.



2. The main concern, per our market contacts, is the ongoing
story about an explicit northern Iraq condition in the Senate
to U.S. aid. Other negative developments, less critical to
sentiment but also cited by market contacts, are the firing
of Treasury U/S Oztrak, and telecom company ARIA (a major
foreign investor, see below) filing an international
arbitration claim against the GOT.



3. (SBU) Comment: Market contacts express two concerns on
northern Iraq: the GOT for face reasons might be forced to
reject an explicit Iraq condition; the Turkish military might
actually intervene whether or not there's any explicit
condition. In either case, the concern is that Turkey would
miss out on $8.5 billion and otherwise further damage the
U.S. relationship.



4. (SBU) Comment continued: Today's market declines do not
reflect some recent positive developments: the IMF Fourth
Review is next week; the GOT passed a strong budget and froze
discretionary spending; the war appears to be winding down
and oil prices are declining; The U.S. is poised to offer
$8.5 billion in concessional long-term loans. As market
analyst Murat Ucer told us, "local markets don't like
anything this government does." He and others see a very
high continuing program implementation risk that can only be
addressed over months of strict carrying out of reform
commitments. End Comments.


Babacan Confirms Oztrak to Be Replaced;
Oztrak Says Leaving April 19
--------------



5. (U) Early on April 10, before heading to Washington for
Fund/Bank meetings, MinState in charge of Treasury Babacan
confirmed to local press rumors that Treasury U/S Oztrak
would be replaced shortly. in his April 10 column, Hurriyet
newspaper's Erdal Saglam (a friend of Oztrak's from college)
wrote that Oztrak plans to resign on April 19, the day after
the IMF Board review. Oztrak's likely replacement is Mesut
Pektas, a former Finance Ministry inspector and Istanbul
Municipality official in charge of finances.


Dervis on the Economy - Focus on
Social Issues, Still an Outsider
--------------



6. (SBU) On April 10, we met with opposition CHP member of
parliament (and former State Minister in charge of Treasury)
Kemal Dervis. His main observations on the economy follow:




-- The only way to fundamentally change economic reform
dynamics in Turkey is through foreign direct investment
(FDI),a minimum of $5-6 billion is required to ensure
medium-term stability. FDI requires two things: internal
bureaucratic reforms; an anchor in the EU, meaning a clear
accesssion path. Without such inflows, Turkey will see only
marginal improvements that can be quickly erased through
reform backsliding.


-- Comment: Dervis is one of many chanting the "we need
foreign direct investment" mantra, to no discernible
practical effect on the investment climate. Turkey's climate
is not improving. For example, the country's third largest
GSM operator Aria (a 50/50 joint venture between Isbank and
Telecom Italia, making it one of the largest foreign
investors) this week filed an international arbitration claim
against the GOT for not honoring the GSM license agreement.


-- Dervis had little comment on Turkey's fragile debt
dynamics. He sees a "muddle through" scenario working.
Turkish banks are liquid, and making good returns at current
high rates, and have an interest in working with Treasury to
roll-over domestic debt. Improving debt dynamics beyond that
will require strong growth, continuing high primary
surpluses, and careful debt management.


-- He is more concerned about "social sustainability" than
debt sustainability. While Turkey's official unemployment
rates, 11-12 percent, are not unusual by European standards,
there is practically no social safety net in Turkey.
Unemployed Europeans get 80 percent of their salaries,
whereas unemployed Turks get only six months of benefits.


-- Personnel changes in economic team worry him. It's key
to market confidence to have an economic team, especially at
Treasury, that projects sincere belief in the reform program.
Gul as PM understood this, and supported Oztrak's team.
Erdogan, however, is putting "hard core partisans" in key
technocrat positions. Dervis also sees "bad body language"
when Erdogan talks about reform, sending a message of "I
don't really believe this" which is not helpful to market
morale.



7. (SBU) Comment: Dervis, after two years immersed in
Turkish politics, still comes across as an outsider, not
comfortable with the need to fight his way up the ranks of
Turkish politics. He told us he is going on a speaking tour
of seven Turkish universities, but we didn't hear any passion
for speaking out. He also had little to say on debt or other
macro-economic issues, without Treasury hands like Faik
Oztrak around. He was more eager to discuss traditional World
Bank-type social and sectoral issues.


PEARSON