MARKETS BUOYANT DESPITE WEAK BUDGET NUMBERS

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 005443

SIPDIS


TREASURY FOR OASIA - MILLS AND LEICHTER
NSC FOR MCKIBBEN
DEPT FOR E, EB/IFD, AND EUR/SCE


E.O. 12958: DECL: 08/25/2008
TAGS: EFIN TU
SUBJECT: MARKETS BUOYANT DESPITE WEAK BUDGET NUMBERS



1. (U) Classified by Deputy Chief of Mission Robert Deutsch
for reasons 1.5 (B) and (D).



2. (SBU) Summary: January-July budget data, combined with a
frankly skeptical assessment by a key budget official,
suggest that the GOT will have difficulty meeting the IMF,s
Sixth Review and end-year fiscal targets. Markets
nevertheless remain buoyant, cheered by the prospect of U.S.
financial assistance, Turkish contributions to the Iraq
stabilization force, and the steady flow of positive numbers
on inflation, the lira, exports and capacity utilization.
End Summary.


Disappointing January-July Budget Numbers:
--------------



3. (SBU) On August 18, the GOT released revenue and
expenditure data for July showing a weaker than expected
primary surplus of TL 395 trillion (USD 282) million. From
January through July, 2003 the Primary Surplus was TL 10.49
quadrillion (USD 7.49 billion). The government,s full-year
2003 target under its IMF program is TL 20.3 quadrillion (USD
14.5 billion) or 6.5% of GDP. With the fall traditionally a
period of lower revenue collection, market analysts are
skeptical that the GOT can meet the end-year target.



4. (SBU) In real terms, both revenue and expenditure were
roughly comparable to the first seven months of 2002 however
individual budget categories showed sharp movements in both
directions. The GOT seems to have done reasonably well in
cutting investment expenditure (down 28 percent in real
terms),and not too badly in controlling the rise of the
public sector wage bill: personnel costs increased 5 percent
in real terms. There were, however, alarming increases in
Social Security expenditure and tax rebates. Social Security
spending increased 25 percent in real terms compared with
January-July 2002 and spending on tax rebates jumped 39
percent in real terms.


Budget Official on Fiscal Problems:
--------------



5. (C) In a meeting with econoffs August 21, Ministry of
Finance Deputy Budget Director Ahmet Kesik shared private
analysts, view that the first seven months budget numbers
were not good. Though Kesik did not seem overly concerned
about the August 31 numbers, he seemed far more concerned
about year-end 2003. Kesik explained that the kind of
remedial budget actions the GOT took to pass the fourth and
fifth reviews would be far more difficult towards the end of
the year. Whereas the GOT had frozen spending in many areas
earlier in 2003, to freeze spending the final quarter will
only create public sector arrears in 2004, because line
agencies have already committed to the spending. Kesik said
more measures could be needed in October to able to meet the
fiscal targets this year.


Social Security Headaches:
--------------



6. (C) Kesik said the problems with the Social Security
system were so severe that the IMF understands it will take
at least a year or two to fix them. The Bag-Kur, the Social
Security system for self-employed workers, is in particularly
bad shape, with payments exceeding collections, according to
Kesik. Exacerbating the problem with Social Security
collections, under IMF pressure, the GOT had raised premiums
leading to increased resistance to paying. In Kesik,s view,
the most important problem for Social Security is
attributable to the frequency and severity of downturns in
the real economy. With crises every few years, employers
have often closed their doors. In many cases, when firms
rehire, employees are glad to get work whether they are on
the books or off. Unemployment is officially eleven percent
but Kesik believes this understates the problem because of
severe underemployment.


Agricultural Sector Issues:
--------------



7. (SBU) According to Kesik, the agricultural sector is a
particular problem for the Social Security system, especially
the Bag-Kur. Kesik put the agriculture sector,s share in
GNP at 16 percent, but said it accounts for 42 percent of
total employment. Yet contributions to Social Security from
agricultural employees are low since much of the employment
is off the books. If employees do not contribute for 4 or 5
years they are removed from the system, but given current
conditions Kesik claimed that many workers accept being
removed from the rolls because they cannot afford to pay.

8. (C) Aside from Social Security-related problems, the ag
sector subsidies also contribute to budget deficits. Kesik
said the problem arose in part from a World Bank push for a
change from production-linked subsidies to direct payments to
farmers. Kesik lamented that the GOT had transitioned to
direct payments without eliminating existing subsidies. He
claimed that the direct payments scheme had led to
questionable claims, and the Ministry of Finance was pushing
for some minimal evidence that the recipients of the direct
payments were actually farmers.


Tax Rebates:
--------------



9. (C) Regarding the sharp increase in Tax Rebates (para 4),
Kesik only noted that Ecevit-era reforms had forced the
Ministry to make tax rebates to exporters within a month. He
also said there were rumors of corruption in tax rebates and
suggested the IMF look more closely at this issue.


Organizational Issues:
--------------



10. (C) Kesik is convinced that the GOT would be able to more
effectively manage its fiscal situation with a more cohesive
bureaucratic structure, rather the than the existing division
of responsibility between the State Planning Office (SPO),
Treasury and the Finance Ministry. Though he enjoys
excellent working relations with his colleagues in Treasury
and SPO*-a fact cited by opponents of a
reorganization*-Kesik said the effectiveness of an
organization shouldn,t depend on individuals. Kesik
confided that he had attended a meeting on the topic at which
Minister Babacan had seemed sympathetic to a reorganization.
Other ministers--and most senior civil servants--however,
were opposed and the idea was shelved despite IMF pressure.


Markets focused on politics and the real economy:
-------------- ---



11. (SBU) Despite the discouraging budget numbers and the
critical importance of the end-year primary surplus target,
Turkish markets remain bullish. On August 22, the principal
Istanbul stock market index, the IMKB 100, reached a high for
the year at 12,001.8. More importantly, the benchmark bond
traded below 40 percent before closing slightly higher at
40.3 percent on a compound basis. At this level, interest
rates are the lowest since before the 2001 financial crisis
and have come down dramatically in the past year, from a
level of over 70 percent. Like the stock and debt markets,
the lira, too continues strong, trading below TL 1.4 million
per USD since August 13.



12. (SBU) The markets, enthusiasm seems to be based on a
combination of political developments and real economy
indicators, rather than public finance. On the political
side, after reacting to to the approval of the Fifth Review
and the IMF's extending Turkey's repayment reschedule,
markets are focusing on the prospects for improved relations
with the U.S. based on the discussion of Turkey contributing
to the stabilization force in Iraq and signs of forward
movement on U.S. financial assistance. With regard to the
real economy, on top of the encouraging July inflation and
export numbers, on August 21 the GOT announced that capacity
utilization in manufacturing had risen to 80.9 percent.
Moreover, the Central Bank released August 21 a favorable
report on expectations. The business people surveyed expect
year-end CPI to be 22.4 percent, down from 23.0 percent in
the previous survey released in early August.





13. (SBU) Though markets retreated slightly on Monday, the
bulls returned on Tuesday despite the prospect of a large
Treasury redemption on Wednesday. Treasury enjoyed great
success in issuing TL 2.2 Quadrillion (USD 1.57 billion) of
t-bills and bonds on Tuesday. Market analysts attributed the
favorable reception in part to Treasury having a borrowing
need below what markets had expected. After the Treasury,s
bond and t-bill sales, the benchmark bond was trading at
39.84 percent.
EDELMAN