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