MINISTER BABACAN TELLS AMBASSADOR ECONOMIC REFORM

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 000819

SIPDIS


STATE FOR E, EB/IFD/OMA AND EUR/SE
TREASURY FOR OASIA - LOEVINGER, MILLS AND LEICHTER
STATE PASS USTR - NOVELLI AND BIRDSEY


E.O. 12958: DECL: 09/02/2006
TAGS: ECON EFIN PREL TU
SUBJECT: MINISTER BABACAN TELLS AMBASSADOR ECONOMIC REFORM
CONDITIONALITY IS "CLEAR"

REF: A. SECSTATE 22328

B. ANKARA 706


Classified by Ambassador Robert Pearson for reasons 1.5
(b,d).



1. (C) Summary: On the evening of January 30, the Ambassador
pressed Minister Babacan hard on economic reform, underlining
our conclusion that the government is off track and stressing
that strong economic reform policy implementation as well as
full military cooperation were conditions for any potential
U.S. assistance package. Babacan replied that the economic
reform conditionality was clear to the entire GOT. After
some initial disagreements, he said, the cabinet was
committed to taking the steps to finish the Fourth Review.
Asked about the status of fiscal measures to achieve the
primary surplus, Babacan said there was no consensus in the
GOT yet, and some disagreements over specifics with the IMF
fiscal team, but that the GOT was committed to the 6.5
percent of GNP target. The goal was to finalize the 2003
budget before the 10-day holiday, by February 7. Babacan
also noted IMF concerns over the terms of the BRSA's proposed
resolution of Yapi Kredi and Pamuk Banks. The GOT supported
the BRSA's approach of rescheduling the bank owners' debts to
the two banks. Babacan raised the U.S. assistance package,
and said there was still no agreement over magnitude. He
said the military and Treasury were working on separate MOUs,
and that the Treasury MOU had blanks for amounts of loans,
grants and free oil. The Ambassador reiterated our
conditions for any potential package, saying there needed to
be progress on those conditions before we moved forward on
the package and that "time is running out." Babacan in
closing noted GOT concern with a leak at Davos. End Summary.



2. (C) On January 30, State Minister in charge of Treasury
Ali Babacan (also GOT coordinator of relations with the IMF
and World Bank) met with the Ambassador at the Treasury;
Babacan had no staff in the meeting.


Babacan Says Economic Reform Conditionality "Clear"
-------------- --------------



3. (C) The Ambassador said there are serious concerns in the
IMF, the World Bank, the USG and other G-7 governments
regarding the government's economic reform policies. The
government, if it acts quickly and decisively on reform
implementation, has a chance to improve Turkey's debt
dynamics. But there is serious concern that the government
doesn't understand the urgency, the Ambassador continued.
Populist measures announced thus far have eroded market
confidence and caused interest rates to rise. The Ambassador
underlined that U.S. assistance in the event of an Iraq
operation is conditioned on both full military cooperation
and strong economic policy implementation, which includes
completion of the Fourth Review under the IMF-backed reform
program. The Ambassador noted that there is a "big if" from
our side about the GOT's commitment to implementing the
reform program.



4. (C) Babacan replied that the "second condition" (economic
reform conditionality) is very clear to the entire
government. He regretted that there was "some
misunderstanding" and thus a perception of moral hazard in
the GOT on this point. But, he continued, "we're not going
to ignore the IMF program because of U.S. bilateral
assistance. We're committed to completing the Fourth
Review." Initially, some AK ministers had questioned the
need for a 6.5 percent primary surplus and other steps, but
not now. PM Gul was "very clear" that he wants "everything
on track with the IMF." We need to implement this program to
solve our economic problems, not because we want to satisfy
the IMF," Babacan concluded.



5. (C) The Ambassador said he was anxious to hear Babacan's
views of the Higher Planning Council's meetings over the last
two days, and progress towards adopting fiscal measures.
Babacan said the January 27 meeting had addressed the
consolidated central government budget, and the second day
had addressed budget issues for the broader public sector,
primarily the state economic enterprises. The bottom line,
he continued, is that they couldn't reach agreement yet on
the fiscal saving measures. GOT officials were working
closely with two IMF fiscal experts, and there were some
disagreements. Babacan was consulting with directors general
of different ministries to get their views. The goal is
reach agreement on the budget by February 7, and thus submit
the 2003 budget to parliament before the 10-day Muslim feast
of sacrifice holiday. Babacan said IMF Deputy MD Krueger had
called him January 29. Again he stressed to the Ambassador
that the GOT was committed to achieving the primary surplus
target. (Note: the target remains 6.5 percent of GNP. We
understand from Central Bank Governor Serdegencti that
Babacan argued in the Higher Plannning Council for a 6.8
percent target, to surprise markets on the upside, but PM Gul
was not encouraging. End Note.)



6. (C) Babacan raised what he termed IMF concerns on the
Pamuk and Yapi Kredi Bank resolution, another issue under the
draft Letter of Intent. He said the GOT supported the
resolution plan proposed by the Banking Regulatory and
Supervision Agency (BRSA),though the IMF had reservations
and IMF Europe Director Deppler had called BRSA Chairman
Akcakoca. Babacan said rescheduling the Cukurova Group's
debts to the two banks was the best way forward. The
alternative of taking over Yapi Kredi involved systemic risk
to the banking sector. Yapi Kredi was the number three
bank, and represented 35 percent of all retail banking
transactions, he said. (Note: IMF banking resrep told us
Deppler asked BRSA not to finalize the debt rescheduling
agreement with Cukurova Group on January 31 as planned. IMF
banking experts want more time to study the proposed deal.)



7. (C) The Ambassador replied that he had nothing new to
convey on this issue. As the minister was aware, the markets
are a state of suspension, and awaiting concrete steps on GOT
implementing reforms and finalizing the IMF Fourth Review.
The Ambassador concluded that "you know the concerns in the
market."


U.S. Assistance Package "Time Running Out"
--------------



8. (C) Babacan raised the status of the U.S. assistance
package, noting that there had been no progress since
Treasury U/S Taylor's visit in late December. While there
was "mutual understanding" on the terms of the assistance,
"we are not close in terms of magnitude." Babacan said the
GOT had looked at the magnitude issue in four different ways
(potential GNP loss, budget effect, current account effect,
and effect on debt dynamic). But, he continued, there are
so many unknowns about the effects of a war. The GOT would
like a USG commitment to seek a second supplemental from
Congress, if the initial assumptions agreed to now turned out
to be too optimistic.



9. (C) The Ambassador said, first, he appreciated the
minister's hospitality during Undersecretary Taylor's visit.
On the assistance package, he pushed back strongly, saying
that the composition of the package - the mix between grant
and loan - was flexible. The assumptions Babacan appears to
be using to calculate magnitude in areas like potential GNP
loss were simply not tenable. He stressed that we needed
progress on the two conditions before moving forward. "Time
is running out," the Ambassador underlined.



10. (C) Babacan said the GOT has been cooperative on Iraq,
but that some decisions take time. The GOT was concerned
with opinion surveys showing that the Turkish people wanted
the government "to stay out of the war." The GOT needed to
convince both the public and the parliament. In the
meantime, Memoranda of Understanding are being prepared, both
by the military and the Treasury. In the Treasury MOU, there
are blanks for amounts of "grants" "loans" and "free oil."
(Note: The MOU draft we just received does not appear, at
first glance, to include such discussion items. End Note.)



11. (C) Babacan concluded the meeting by raising a leak at
Davos that caused "unhappiness" in the GOT. A U.S. Treasury
document had been leaked to both press and market
participants, and Mr. Soros had a copy marked "market
sensitive." The GOT was committed to continuing IMF
relations, he stressed, regardless of what happened on Iraq.
Babacan said he wanted the Ambassador to know he sent a
letter to both IMF Deputy MD Krueger and Treasury U/S Taylor
about the leak.
PEARSON