SCENESETTER FOR THE ECONOMIC PARTNERSHIP

C O N F I D E N T I A L SECTION 01 OF 04 ANKARA 007311

SIPDIS


STATE FOR E, EUR/SE AND EB
TREASURY FOR OASIA - MILLS AND LEICHTER
STATE PASS USTR FOR NOVELLI/ERRION
USDOC FOR 4212/ITA/MAC/OEURA/DDEFALCO
USDA FOR FAS FOR EC AND CCC/FSA


E.O. 12958: DECL: 11/21/2008
TAGS: ECON PREL EFIN EINV TU
SUBJECT: SCENESETTER FOR THE ECONOMIC PARTNERSHIP
COMMISSION MEETING


REF: ANKARA 7121


(U) Classified by DCM Robert Deutsch. Reason: 1.5 (b).



1. (C) Summary: A successful EPC will help our efforts to
strengthen a bilateral relationship that has been through
difficult times this year. Two developments -- the
still-fragile recovery of the Turkish economy, and the
development of economic opportunities in Iraq -- should
create opportunities for stronger economic ties, if managed
properly. There has been less progress on the trade and
investment front, despite Turkish steps to improve the
investment environment. Energy has been a mixed bag, with
continued cooperation on regional efforts but little progress
in reform of Turkey's domestic market. PM Erdogan hopes the
EPC will rejuvenate the QIZ initiative; otherwise, GOT
expectations appear relatively low.


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The Context
--------------

2. (C) The second Economic Partnership Commission meeting
comes at the end of a difficult year in U.S.-Turkish
relations and in the immediate aftermath of terrorist attacks
that have shaken Turkey. Prime Minister Erdogan told the
Ambassador November 15 that he sees the meeting, along with
the just-completed High Level Defense Group discussions, as
evidence that the bilateral relationship is recovering from
recent travails. In that broad sense, a successful EPC can
add to the positive momentum in the overall relationship.



3. (C) Our ability to stage a successful EPC meeting should
be aided by the fact that, so far at least, Turkish
expectations are lower than they were in the lead-up to the
February 2002 meeting. Prime Minister Erdogan hopes the
meeting will rejuvenate the Qualified Industrial Zone
initiative, and the Turks in general want extensive
discussions on Iraq. Beyond these issues, however, the GOT
has not articulated specific goals for the meeting.



4. (SBU) Reftel suggests goals and issues for discussion for
each segment of the EPC. This cable provides an overview of
the state of the relationship in these areas.


--------------
The Economic Relationship
--------------

5. (SBU) Economic Reform: After a rocky start, the AK
Government has presided over positive economic developments
since April. Turkey is now poised to meet its year-end macro
targets: 5 percent real GDP growth, a 6.5 percent primary
surplus, and 20 percent inflation--the lowest rate since the
1970,s. Foreign exchange, equity and debt markets have
enjoyed a sustained rally.



6. (SBU) The GOT,s success in meeting macroeconomic targets
in recent months stems only partly from its economic
policies. Though the GOT has broadly cooperated with the IMF
and shown a commitment to fiscal discipline, it also
benefited from the Iraq war having much less impact on
Turkey,s economy than expected, from lower inflation
achieved by the independent Central Bank and from the lira
appreciation induced by reverse currency substitution in the
markets.



7. (SBU) Senior officials have yet to demonstrate support for
the structural reforms that are essential to Turkey achieving
sustained growth. On privatization, the GOT will end 2003
with unsatisfactory results, having cancelled two major
tenders. The GOT has moved slowly on liberalization of the
agriculture, telecoms and energy sectors, and has not
supported the independent regulatory boards. Though it
claims it is re-energizing its dialogue with the World Bank
on structural reforms, the government has yet to take
meaningful actions outside of the narrow range of reforms
required by the IMF program.



8. (SBU) Some analysts fear that the GOT's laxity in
implementing structural reforms, combined with a growing
current account deficit and a sense that markets may have
overshot in a positive direction, could leave financial
markets vulnerable to a sharp downturn at some point in 2004.
Trade
--------------

9. (SBU) With some isolated exceptions (such as passage of
modern copyright legislation in 2001),there has been little
progress on outstanding issues in our bilateral trade
relationship in recent years. The USG has repeatedly pressed
for the elimination of WTO-inconsistent restrictions on
agriculture imports, stronger intellectual property
protection, and an end to policies that discriminate against
imported drugs. The Turks respond that the USG maintains
significantly higher tariff and non-tariff barriers
(including textile/apparel quotas and anti-dumping,
countervailing duty actions) on Turkey,s products overall
than they do on ours.



10. (SBU) Our trade with Turkey is approximately balanced,
with each country exporting about USD 3 billion in goods to
the other annually. Turkey,s exports are highly
concentrated in sensitive sectors such as textiles, apparel
and steel, which face higher-than-average levels of
protection.



11. (SBU) Turkey sharply cut its industrial tariffs on third
countries to just over four percent under the EU customs
union. Although Turkey did this unilaterally to obtain the
benefits of duty-free access to European markets, the Turks
argue that they made trade concessions to the United States
and others without compensation in the form of better access
for Turkish products. This is a bogus argument, but one they
continually make.



12. (SBU) Turkey,s relatively low current industrial tariffs
are one ingredient in Turkey,s ambivalent approach to the
WTO talks. The GOT is hesitant to endorse multilateral
liberalization in industrial goods that would erode the
benefit to Turkey of duty-free access to the EU market. It
is also wary of tariff reductions in agriculture, maintaining
that high tariffs are Turkey,s only tool to protect its
agricultural producers from highly-subsidized EU and U.S.
imports. In the WTO talks, Turkey insisted with the G-21 on
elimination of these subsidies and proposed asymmetrical
tariff reductions on industrial goods.



13. (SBU) The Prime Minister has indicated he wants to move
forward on Qualifying Industrial Zones for Turkey at the EPC,
but we do not yet know what the Turks will say on this
subject at the meeting. Foreign Trade officials are
skeptical that companies from eligible sectors could both
satisfy QIZ requirements (primarily Israeli content) and
derive a trade benefit (since many if not most of the sectors
with the highest tariffs would be excluded).


Investment
--------------

14. (SBU) Turkey has underperformed many other emerging
markets in attracting foreign direct investment, with inflows
well under one percent of GDP for most of the last decade.
The Erdogan Government is more receptive to FDI and private
sector concerns than were its predecessors, and has taken
steps to improve the climate for FDI, including a law ending
screening of foreign investors and another streamlining
company establishment. Inflation accounting--long sought by
investors--is due to come into effect January 1, 2004. The
GOT It is also considering establishment of a public-private
agency to promote investment in Turkey. The GOT has taken a
few helpful steps for individual U.S. companies, such as
authorizing higher quotas for corn syrup producers under the
Sugar Law.



15. (SBU) Notwithstanding these actions, U.S.--and other
foreign-- companies continue to face a difficult business
environment. This affects large multinationals, like
Motorola, Cargill, Pfizer and the other pharmaceuticals
companies, and small business persons like Victor and Kristy
Bedoian, who have struggled for several years to operate a
hotel they renovated in Van. Other policies ) like the
failure to honor contract sanctity on build-operate-transfer
(BOT) projects in energy or the lack of data exclusivity
protection ) send a negative signal about the GOT,s
willingness to adhere to agreements previously undertaken.

16. (SBU) We have pressed the GOT at high levels to solve
these issues prior to the EPC. Thus far, our GOT
interlocutors have provided few clues as to what they may be
prepared to do in this area in the near future.


Energy
--------------

17. (SBU) Regional energy cooperation has been a success
story. We have worked closely and effectively with Turkey to
begin building the Baku-Tbilisi-Ceyhan oil pipeline and to
attain sanctioning of the Shah Deniz natural gas pipeline.
Both projects are proceeding, albeit with some delays on BTC.
The Turks are concerned that Washington has lost interest in
these projects, considering them done. They also are worried
about the possible impact of political developments in the
Caucasus on the pipelines and about the possible reversal of
Odessa-Brody. Although Turkey is committed to Shah Deniz,
prospects for a significant natural gas surplus over the next
several years could affect Turkey,s decision making unless
potential markets are identified in Europe for the surplus.



18. (SBU) On the domestic front, the Energy Regulatory Market
Authority (EMRA) has made substantial progress in
implementing both the Natural Gas Law and the Electricity Law
and aligning Turkey with the EU,s acquis; however, much more
needs to be done to establish a liberalized market. The
credibility of the deregulation program is at stake unless
BOTAS and the state generation and trading companies comply
with EMRA,s regulations, especially to establish a tariff
system and to end BOTAS,s gas market monopoly.



19. (SBU) The other major domestic issue concerns the GOT,s
treatment of U.S. energy investors. First, the government
decided not to implement a number of Build-Operate-Transfer
(BOT) and Transfer of Operation Rights (TOR) projects,
including several involving U.S. firms, despite having signed
contracts with those firms. More recently, the government
has been pressing existing BOT companies*including two
involving major U.S companies*to lower tariffs unilaterally.
In addition to the U.S. private investment in these
projects, OPIC and Eximbank have provided financing. The
Energy Minister has publicly threatened to take over the
companies, and has said that they should not rely too much on
their contracts. Moreover, the government has launched
several investigations into the projects, which the companies
believe constitutes a form of harassment.


Regional Cooperation
--------------

20. (SBU) Turkey continues to assert itself as a force for
stability in the region. Turkey,s efforts derive from its
own view of how best to contribute, and in many areas, such
as Afghanistan and the East-West Energy Corridor, it has
enthusiastically followed the U.S.



21. (SBU) Afghanistan: Turkey has already disbursed its $5
million Tokyo pledge and hopes to increase its pledge even
more. Turkish companies are also playing a significant role
in reconstruction efforts.



22. (SBU) Iraq: In Madrid, Turkey pledged $50 million for
Iraq Reconstruction. Turkey has also made numerous offers to
help with humanitarian needs. Turkey provides a vital
overseas corridor for supplies for U.S. troops in Iraq, as
well as humanitarian supplies and fuel. In addition, Turkey
has begun exporting electricity to Iraq and plans to
significantly increase exports to help fill Iraq,s urgent
power deficit.



23. (SBU) Several Iraq-related items remain on the agenda:
timing of the re-opening of the Kirkuk-Yumurtalik oil
pipeline; mechanisms to enhance Turkish-Iraqi trade,
including Turkey's desire to open a second border gate, ways
to reduce delays in getting supplies through Habur Gate, and
Turkey's interest in revitalizing Turkey-Iraq rail links;
projects -- proposed by U.S. companies AIG and Washington
International Group ---to increase the capacity of
Turkey-Iraq electricity transmission lines; our request that
the Turkish Export-Import Bank negotiate an agreement with
the Iraqi Trade Bank (along the lines of U.S. Ex-Im's
agreement); Ziraat Bank's interest in establishing branches
in Iraq; and of course the great interest of Turkish
companies in obtaining Iraqi reconstruction contracts.



24. (SBU) Caucusus: Turkey is an essential partner in the
BTC project and the East-West Energy Corridor that will
bolster the economies of Georgia and Azerbaijan and provide a
new oil supply to world markets.



25. (SBU) Water to Israel: Turkey hopes that reducing water
tensions in the Mideast will contribute to peace. It is
negotiating with Israel a plan to send by tanker 50 million
cubics meters of fresh water per year and has made the same
offer to other Mideast countries.
EDELMAN