IMF RESREP PREPARES FOR BUSY SEASON;

UNCLAS SECTION 01 OF 02 ANKARA 005551

SIPDIS


SENSITIVE


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


E.O. 12958: N/A
TAGS: EFIN PREL TU
SUBJECT: IMF RESREP PREPARES FOR BUSY SEASON;
POSITIVE INFLATION AND FISCAL NUMBERS ANNOUNCED


REF: ANKARA 5443





1. (SBU) Summary: IMF Resident Representative Odd Per Brekk
told us the Fund is gearing up for an intense period of work
towards the Sixth Review. The jury is still out on a series
of structural reforms, especially direct tax reform, and big
questions remain on the budget, though a Treasury
announcement suggests the GOT is likely to at least come
close to meeting the end-August primary surplus target.
Separately, the Central Bank announced better than expected
August inflation numbers. End Summary.



2. (SBU) In a lunch with Emboffs September 2, IMF Resident
Representative Odd Per Brekk and his new deputy, Christoph
Klingen, provided an overview of the state of play on the
economic reform program. With Turks and expatriates alike
returning from holidays, the IMF is gearing up for a period
of intense activity with three teams due to start work in
Turkey over the next couple of weeks. Next week, two
technical teams will start work with GOT counterparts: one on
the second phase of the direct tax reform and the second on
the high cost of bank intermediation. The direct tax reform
issue, including investment incentives and free trade zones,
is quite political according to Brekk, and is an area in
which the GOT has been guilty of backsliding in the past. In
fact, in an August meeting with Emboffs, the Finance Ministry
Undersecretary had advocated investment incentives for the
poorer regions of Eastern Turkey. The second team will focus
on how policies contribute to high credit intermediation
costs.



3. (SBU) Starting September 25, a mission will begin work on
the sixth review. Brekk and Klingen said it was too early to
get a good fix on how well the GOT has done in meeting the
end-August fiscal targets. Klingen said they are working with
GOT counterparts right now to try to get a better fix on
this, but that GOT officials seem more optimistic about
meeting the end-year than the end-August targets. Klingen
noted that the continued strong growth in the real economy
augured well for tax collections, despite the fact that
stronger-than-anticipated growth will increase the
denominator of the primary surplus-to- GDP target.



4. (SBU) Regarding the disappointing January-July fiscal
performance (Ref A),Brekk noted that the Fund and the GOT
hoped that many of the additional measures introduced to meet
the fifth review would make up for the weakness earlier in
the year. The bad social security numbers also may improve
because they were the result of the amnesty. On both issues,
however, Brekk admitted that the jury was still out.



5. (SBU) After the meeting, Treasury released surprisingly
favorable August numbers on its cash position, suggesting to
at least one Istanbul analyst that his earlier pessimism
based on January-July targets was unwarranted. According to
the Treasury report, on a cash basis the August based primary
surplus was TL 4.6 Quadrillion (USD 3.3 billion),bringing
the January-August primary surplus on a cash basis to TL
11.96 Quadrillion (USD 8.5 billion). Though the IMF uses a
different definition of the primary surplus, incorporating
the positions of some State Enterprises and the Social
Security system, the good Treasury numbers suggest--and a
well-placed Finance Ministry official confirms--that the GOT
is likely to come close to the end-August primary surplus
target.



6. (SBU) With regard to the Uzans and the Imar Bank scandal,
Brekk pointed out that any GOT payments to BRSA to finance
the cost of intervention are not expected to have a
significant short-run budget impact. Legitimate deposits
would be transferred to Ziraat Bank, which would then be
compensated by the issuance of government bonds, though this
would add to the government,s interest bill over time.



7. (SBU) Brekk characterized the issue of BRSA,s handling of
Imar Bank as posing a dilemma. On the one hand, it is hard
to understand how BRSA failed to detect the problems at Imar
Bank at an earlier stage. On the other hand, there is a
danger of the Government using the case to undermine BRSA.
Brekk agreed on the importance of both the USG and IMF
stressing to the GOT the broader point about the importance
of the independent institutions (especially the BRSA and
Central Bank) in sustaining the economic reform program.
Brekk mentioned the importance of passage of laws, drafted by
the BRSA, that streamline the judicial process for intervened
banks and prevent against frivolous lawsuits.

8. (SBU) Another key IMF-sponsored structural reform, passage
of the Public Financial Management and Control law, is a
prior action under the sixth review. Brekk was cautiously
optimistic that it would be passed.



9. (SBU) On the privatization program, Brekk agreed that the
GOT should not be faulted for the delay on Petkim caused by
the Uzans. Brekk admitted it now seems unlikely that the GOT
would meet the Fund,s indicative targets for receipts from
privatization--both for September 30 and for December 31.
If, however, the GOT can clinch the sales of Tupras and Tekel
by the end of the year, even if the cash has not yet been
received, this would be significant progress. Council of
Ministers approval of a plan for the sale of Turk Telekom (a
structural benchmark for the sixth review) will also be key
to judging progress on privatization.



10. (SBU) From a bigger picture perspective, Brekk made the
case that Turkey has considerably reduced its vulnerability
to a financial crisis. The built-in adjustment mechanism of
a floating rate currency regime, a longer average maturity of
government debt, a considerably strengthened and
better-regulated banking sector, and an independent Central
Bank have all played a role in reducing the danger of a
crisis. A stronger fiscal situation and declining inflation
are also important. On the other hand, the lengthening of
maturities has come at the cost of increasing the
government,s exposure to foreign exchange-denominated or
foreign exchange-linked debt instruments, such that a sudden
turn in the lira,s fortunes could have a painful fiscal
impact. Though the Government,s foreign exchange risk
profile bears watching, banks, are no longer permitted to
take large open positions, so the banking sector,s foreign
exchange risk profile is much better than in years past.
Though corporate foreign exchange risk may be of concern,
noone has good data on the extent of the problem.



11. (SBU) Late on September 3, the State Statistical
Institute announced better-than-expected inflation numbers
for August. The Wholesale Price Index decreased repeat
decreased 0.2 percent such that the year-to-date WPI increase
is 10.7 percent and year-on-year 22.7 percent. The Consumer
Price Index, on the other hand, increased in August, but by
only 0.2 percent. The year-to-date CPI increase was 11.7
percent and the year-on-year increase is 24.9 percent.






EDELMAN