KEY ECONOMIC CONDITIONALITY ISSUES FOR USG LOAN

UNCLAS SECTION 01 OF 03 ANKARA 006141

SIPDIS


SENSITIVE


TREASURY FOR OASIA - MMILLS AND JLEICHTER
STATE FOR E, EUR/SCE, EB/IFD/OMA AND EB/IFD/ODF
NSC FOR MBRYZA AND TMCKIBBEN


E.O. 12958: N/A
TAGS: EFIN PREL TU
SUBJECT: KEY ECONOMIC CONDITIONALITY ISSUES FOR USG LOAN
DISBURSEMENT


REF: A. ANKARA 5951

B. ANKARA 6071



1. (SBU) Summary: For the decision on GOT compliance with
economic conditionality in the U.S.-Turkish Financial
Agreement, post recommends Washington focus on the most
critical issues in the IMF's Sixth Review: staff reductions
at SEE's, the end-August fiscal target, the 2004 budget, the
Public Financial Control Law, Direct Tax Reform,
strengthening the Bank Regulator's ability to seize
intervened banks' owners' assets, and GOT approval of a plan
to privatize Turk Telecom. We are not likely to have enough
information to judge whether the GOT is on track until the
IMF mission completes its work around October 10. Separately,
Post recommends the USG lay down markers for a different set
of issues we will scrutinize in making our decision six
months hence on a second tranche disbursement. End Summary.


Critical issues for First FA Disbursement:
--------------



2. (SBU) In order to prepare for the U.S. decision on the GOT
implementation of &strong economic policies8 as required
under the Financial Agreement (FA),post recommends the USG
concentrate on a few key issues. These are all requirements
(either prior actions or structural benchmarks) for the
IMF,s Sixth Review. Though there are other requirements of
the Sixth Review, post recommends we focus in particular on
these because they are critical to long-term success of the
program (e.g. fiscal adjustment) or because they demonstrate
strong political will to continue reforms (e.g. reducing
staff at SEE,s).



3. (SBU) Post recommends we focus on the following:


--End-August fiscal target: Though we do not yet know whether
the GOT met the end-August primary surplus target, it is
likely to have fallen somewhat short. A key issue would be
then be the GOT elaborating with the Fund a series of
remedial actions to meet the end-year fiscal target. We will
also need to decide how much importance to attach to the GOT
missing the target, even if it came close.


--Credible 2004 budget: By law, the government must submit
its 2004 budget by mid-October. Government agreement with
Fund Staff on a credible 2004 budget, in line with 2004
primary surplus targets, is vital to sustain the economic
reform program and maintain market confidence.


--Progress on SEE staff reduction: Unless there have been
significant additional actions in recent days, by the end of
September the GOT will have reduced the number the number of
redundant SEE employees by only 11,000, far from the 19,000
end-September target. The key will be whether the government
has had the political will to lean on the SEE managers to
further reduce staff in late September and October. Given the
high likelihood of this target being missed by a wide margin,
here, too, we will want to see how the Fund deals with this
issue and to decide for ourselves how much weight to attach
to the shortfall.


--Passage of the Public Financial Management and Control Law:
Though this is less politically controversial, it is
important to improve the transparency of the budget process,
and to enforce centralized control over line ministry
spending. This law will also help maintain the autonomy of
the independent regulatory bodies such as BRSA, since
parliament--rather than the executive branch--would approve
the independent bodies, budgets. The law would also bring
extra-budgetary spending into the budget framework.


--Direct Tax Reform: Though the Sixth Review does not require
passage of the Direct Tax Reform, it does require GOT
agreement with the Fund on the specifics. It remains
controversial and politicized, with considerable GOT
resistance--up to the Prime Minister--to eliminating all the
regional tax incentives. IFI officials have told us that
public statements by the Prime Minister in favor of regional
incentives have translated into GOT insistence that there be
some form of regional incentive. Fund staff are reportedly
working on a &least-bad8 compromise.


--Passage of legislation to strengthen the BRSA's hand in
dealing with court cases involving problem Banks: It has been
prepared but parliamentary passage will also be needed for
the Sixth Review.


--Privatization: The Sixth Review requirement of approval of
a plan to privatize Turk Telekom would seem to be a minimum
requirement for the USG. Unless the Fund mission currently
in country fails to clinch agreement on a Letter of Intent,
neither the Petkim, Tupras, or Tekel privatizations will have
reached their bid-submission dates by the time the U.S. needs
to decide whether to disburse. Consequently, the only
reasonable privatization measure we could insist on would be
the Council of Ministers approval of a plan to privatize Turk
Telekom.



4. (SBU) Post does not repeat not recommend emphasizing the
targets for inflation and monetary policy, or for growth.


Compressed Timing Dilemma:
--------------

5. (SBU) Post will confer with key GOT economic technocrats
and Fund Staff this week to hear how well the GOT is
progressing on reform implementation, particularly those
pertaining to the Sixth Review, and will provide ists
assessment of progress by October 6. Washington should note,
however, that there is a real possibility that the USG will
not have enough information to determine whether the GOT is
on track by October 6. In fact, the status will probably not
be clear until the IMF team completes its work. Between now
and October 6 the above-cited legislation may not have been
submitted to parliament--let alone passed--and there may be
little news on the fiscal targets, SEE's, direct tax reform
and Turk Telecom.


Potential Markers for the Second Tranche:
--------------



6. (SBU) Given the timing of the disbursement decision on the
first tranche of the FA, it seems unrealistic to push for
more reforms than those in the Sixth Review. Post recommends,
however, that we lay down markers--either before or after
disbursement--about progress we,d like to see before the
second tranche, including not only staying on track with the
Fund program but possibly a broader array of reforms which
the GOT has committed to implement:


--Privatization: With Petkim, Tekel and Tupras nearing bid
submission, post believes it is reasonable to make the point
now that the USG expects the GOT to consummate the sales of
all three of these companies by the time of the second
tranche. In addition, without requiring a sale, there should
be tangible signs of progress in restructuring and preparing
state banks for privatization, such as approval of a strategy
for Vakif Bank.


--SEE staff reduction: Complete year-end staff reduction
targets on SEE,s not on the privatization list (in other
words, eliminate all 19,000 positions). Note that
privatization of Petkim, Tupras, and, especially, Tekel, will
take care of position-reduction targets at SEE,s on the
privatization list.


--2004 budget measures: pass a budget which is in line with
the agreement with Fund staff. In the past there have been
problems with slippage between agreement-in-principle with
the Fund and the actual measures passed. We would also
expect year-end and first quarter fiscal performance to be in
line with IMF-agreed primary surplus targets. We could
stress the need for sustainable, rather than one-off, revenue
measures.


--Maintenance of the independence of regulatory bodies:
Since the GOT is currently considering a law that would
undermine the independence of these institutions, this would
be an important signal to send.


--Progress on sectoral reforms in energy, telecoms and
agriculture: These issues, on which progress has been very
slow, are the centerpiece of the World Bank,s efforts in
Turkey. The GOT has been particularly slow to take advantage
of World Bank financing by implementing these reforms. Given
the complex and difficult nature of these sectoral reforms,
post recommends making a general point about wanting to see
progress, rather than requiring anything too specific, with
one exception. In the telecoms sector, post recommends a
marker on the GOT implementing its WTO commitment to
liberalize fixed telephony on January 1, 2004. Post believes
the telecoms sector in particular, needs a push towards
liberalization, and we are only requiring the GOT to live up
to its commitment.






EDELMAN