OCTOBER 3 UPDATE ON IMF MISSION

UNCLAS SECTION 01 OF 02 ANKARA 006241 SIPDIS SENSITIVE STATE FOR E, EB/IFD AND EUR/SE TREASURY FOR OASIA - MILLS AND LEICHTER NSC FOR MCKIBBEN AND BRYZA E.O. 12958: N/A TAGS: EFIN PREL TU SUBJECT: OCTOBER 3 UPDATE ON IMF MISSION REF: A. (A) ANKARA 6199 ¶B. (B) ANKARA 6141 ¶1. (SBU) Summary: IMF ResRep told us late today that progress in reaching agreement on measures for the 6th review had been a bit slower than they had planned, but he remained hopeful the mission could wrap things up by the end of next week. The main issues remain winning GOT political-level support for a compromise approach on direct tax reform, and sorting out the details of the 2004 budget. He and State Planning Organization U/S Tiktik said intensive technical level discussions on the budget would continue through the weekend, with the focus on how much the GOT should rely on continuation of so-called "one-off" measures to meet its 2004 primary surplus target. End Summary. ¶2. (SBU) IMF ResRep told us late today that talks with the GOT had progressed more slowly than staff had planned. The main delay occurred yesterday, when an important internal GOT meeting with Prime Minister Erdogan to discuss proposed measures on direct tax reform (and a few lesser issues) was cancelled due to the PM's heavy schedule. Discussions on the 2004 budget had also gone slowly until last night, when a long, intensive meeting "got things going." ¶3. (SBU) ResRep provided a quick update on the key issues: -- Public Sector Management and Control bill: Fund staff and the GOT have agreed on a text, which the GOT was to submit to Parliament today. -- Legislation to strengthen BRSA's hand: Deputy PM Sahin told the Fund mission that Parliamentary passage of this bill would be "no problem.' Fund staff is unhappy that this legislation, drafted months ago, apparently fell through the cracks, and is waiting to see how quickly this proceeds now. Parliamentary passage by end-October is a performance criteria for the 6th review. -- Redundant SEE workers: Turkey missed the end-September target by a wide margin, but IMF staff deems credible the GOT's proposal to accelerate the process by offering extra-large severance packages (10-30 percent more than normal packages) to workers who agree to retire by year-end. Deputy PM Sahin told Fund staff today that the government should be able to issue a decree authorizing this by October 
¶15. Fund staff is less moved by the GOT's argument that any reductions in excess of company=-specific targets (ref a) should count toward the target; ResRep pointed out that the World Bank's original number of redundant SEE workers had already been "watered down" significantly, so Fund staff was not inclined to be too generous in flexible how the GOT reached the target. On the other hand, given the generally positive economic trends, it would be hard for the Fund to delay the review -- and perhaps rock the markets -- because the GOT had not fired enough workers. -- Direct Tax Reform: The Fund's intent was to phase out tax incentives, both in economic free zones and elsewhere. Instead, PM Erdogan had publicly committed to offer additional tax incentives in poor provinces, and State Minister Tuzman was strongly opposing any reduction of incentives in free zones. Fund staff has reached tentative agreement with GOT technocrats on a compromise approach on tax incentives in the poor regions; the idea is to offer an approach that is "more refined" than the original GOT proposal. ResRep said that, given the lack of economic activity and tax receipts in these regions, the Fund was not concerned too much about direct tax losses resulting from incentives. Rather, staff is deeply suspicious that the GOT will not be able to monitor and control the incentives scheme to prevent companies from outside of the incentive areas from evading taxes. On free zones, the Fund wants to phase out some tax benefits (i.e. corporate and personal income tax exemptions) for existing investors, and eliminate those "unnecessary" benefits completely for new investors. On both tax incentives for poor regions and free zones, GOT technocrats need to convince Prime Minister Erdogan and, to a lesser extent, State Minister Tuzmen to go along with compromise approaches. (SPO U/S Tiktik said the PM was insisting on tax incentives for the 36 provinces with per capita income under $1500, and also wanted to offer them subsidized energy and corporate tax exemptions. He noted that private sector proponents of these incentives were "determined and persuasive.") -- Budget: Tiktik said there should be no problem reaching this year's primary surplus target of 6.5 percent of GNP. He and ResRep agreed the more difficult task will be the 2004 budget. Tiktik, like Treasury U/S Canakci (ref a),argued that the GOT would easily be able to continue or replicate a number of the "one-off" measures taken this year, reducing the size of the problem in 2004. For example, payments from the 2003 "tax amnesty" will continue into 2004, and the GOT can continue the additional Special Consumption Tax and other measures. He added that budget transfers to the social security funds had declined in the aftermath of the social security arrears amnesty, and the GOT expected that trend to continue. ResRep said the Fund was wary of excessive reliance on these one-off measures, and wants to see more sustainable measures to reach the 6.5 primary surplus target next year. He cautioned, however, that intensive budget discussions had just begun last night (and would continue through the weekend),so Fund staff would not be able to provide a fuller assessment of the budget situation until early next week. EDELMAN