FIFTH REVIEW DELAY RAISES NEW CHALLENGES

UNCLAS SECTION 01 OF 02 ANKARA 003916 SIPDIS SENSITIVE STATE FOR E, EUR/SE AND EB TREASURY FOR OASIA - MILLS AND LEICHTER NSC FOR QUANRUD AND BRYZA USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO USDA FOR FAS FOR EC AND CCC/FSA E.O. 12958: N/A TAGS: EFIN EINV PGOV TU SUBJECT: FIFTH REVIEW DELAY RAISES NEW CHALLENGES REF: A. A. ANKARA 3693 ¶B. B. ANKARA 3815 Sensitive but Unclassified. Not for Internet distribution. ¶1. (SBU) Summary: IMF Resident Representative Odd Per Brekk indicated to us today that, even with speedy conclusion of the GOT's letter of intent, the IMF's fifth review "cannot" be completed by the end of June, bringing into full play tough end-of-June performance targets. Benign markets stemming largely from external factors, he suggested, have made the government complacent. For the fifth review, Breck highlighted two key outstanding issues-- government agreement to additional fiscal measures to close the one-half percent of GNP shortfall the Fund sees in the primary surplus, and agreement on technical measures to implement a compromise "case-by-case" approach to the government's desired social security amnesty. State Minister Babacan will chair a meeting at Treasury today to review the government's commitments under the fifth review. Brekk stressed that the Fund has not discussed the idea of merging the fifth and sixth reviews, and that he would argue strongly against such a course, as it would essentially reward "bad" behavior. While the Treasury's initial auctions this week have been successful, Brekk characterized the Treasury's current cash position as "not comfortable," and suggested it would only "scrape by" in tomorrow's large bond redemption. End Summary. ¶2. (SBU) Oustanding Issues: Brekk noted that internal IMF timelines virtually preclude completion of an IMF board meeting on Turkey before the end of June, even if all outstanding issues were resolved quickly. Several key issues remain outstanding, notably agreement on additional fiscal measures to achieve the targeted 6.5 percent primary surplus, and completion of "technical work" to implement agreement on a "case-by-case" approach to a social security amnesty, in place of the general amnesty that the government had earlier proposed and at which the Fund had balked. (Brekk noted that he believes Erdogan, at heart, still wants the latter.) Brekk noted that a range of measures to reduce the primary surplus shortfall (which the Fund estimates at 0.5 percent of GNP) have been agreed, including indexing certain taxes, increasing petroleum excise taxes, raising alcohol and tobacco prices, and allocating some special revenues to the general budget (though a final figure for the latter has not been agreed). Brekk noted that additional measures are required, and the IMF does not believe the government's proposal to maintain a freeze on non-essential spending is sufficient. However, the GOT at the political level is balking at some suggested measures, such as raising electricity prices. ¶3. (SBU) Tight finances: Brekk noted that the overall negative trend in the budget is essentially revenue driven, as the government is consistently falling short on its revenue targets (mainly due to weakness in tax and social security contribution collections),and only making up the shortfall by squeezing capital expenditures. State Minister Babacan will chair a Treasury meeting on these and other issues related to the fifth review this evening (June 17), before departing for a conference in London on June 18. ¶4. (SBU) Tough line: Brekk stressed that the IMF will maintain its tough approach on budget issues, as even with additional revenues from the government's tax amnesty, there are "no excess revenues." He reiterated that this has been a hard message to sell in the government, as few ministers have understood the country's true financial situation, and instead have been living in a false "psychology of excess revenue." Brekk noted that the Treasury's cash position is very tight. He predicted that it would "scrape by" in tomorrow's large (TL 6.4 quadrillion auction),but would not have much to spare. One reason for the lack of cash, despite good rollover rates, is the fact that the Treasury had to pay out some USD 1.4 billion in April that had been collected in enforced savings accounts. ¶5. (SBU) June Targets: Brekk conceded that any delay into July will automatically bring into full play tough end-of-June financial targets. Given that data will not be available until August, however, the government will have to seek a "waiver of applicability," requiring it to make an effective case that the data will show it met the targets. "Strong measures will help," he emphasized. Brekk added that to date the Fund has given no consideration to the idea of merging the fifth and sixth reviews, and that he would argue strongly against the idea. Any such proposal, he argued, would "reward bad behavior," and move the IMF away from its policy of regular bimonthly and quarterly reviews to keep the pressure on the Turkish government to proceed with program implementation. ¶6. (SBU) Quiet Markets: Meanwhile, Turkish markets remained flat on June 17, with the stock exchange rising from Monday's close of 11,036 to 11,169, while the lira strengthened slightly to 1.414 million (from 1.417). Brekk noted that he had seen some weakening in markets earlier in the day, based on concern about Prime Minister Erdogan's apparent flirtation with the "Malaysia model" on his Asian trip, but "modestly favorable" (in one brokerage's estimation) budget results for May brought some relief. Those May figures included a central government primary surplus of USD 1.7 billion, for a cumulative January-May surplus of USD 5.9 billion. Real non-interest fiscal expenditures rose 2.9 percent, while real revenues rose 9 percent. PEARSON