CENTRAL BANK GOVERNOR URGES U.S. TO PRESS ERDOGAN

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 000259 SIPDIS STATE FOR E, EB/IFD, AND EUR/SE TREASURY FOR OASIA - JLEICHTER AND MMILLS NSC FOR MBRYZA AND TMCKIBBEN E.O. 12958: DECL: 01/13/2014 TAGS: EFIN ECON PGOV PREL TU SUBJECT: CENTRAL BANK GOVERNOR URGES U.S. TO PRESS ERDOGAN ON ECONOMIC REFORM REF: A. ANKARA 136 ¶B. ANKARA 128 ¶C. 2004 ANKARA 8014 CLASSIFIED BY AMBASSADOR ERIC EDELMAN FOR REASONS 1.5 (B) AND (D). ¶1. (C) Summary: Central Bank Governor Serdengecti convoked econoffs to raise concerns that Prime Minister Erdogan's Washington visit could reinforce the GOT perception that the U.S. will back Turkey financially regardless of the quality of GOT economic policies. He urged that U.S. leaders include in their comments to the Prime Minister a strong message on the need to stick to economic reform. Serdengecti warned that the rally in Turkish markets was fed by "wishful thinking," and warned that this rally could easily be reversed. End Summary. ¶2. (C) Central Bank Governor Serdengecti asked Econoffs to meet with him January 14. At the meeting, Serdengecti raised Prime Minister Erdogan's Washington trip, and expressed a concern that the GOT may perceive that the U.S. will back Turkey "no matter what." Serdengecti said no one knows for sure why the Prime Minister pushed through the large increase in the minimum wage increase and the larger-than-budgeted pension payment increase, despite Economy Minister Babacan and Treasury Undersecretary Canakci's best efforts to dissuade him. Serdengecti added that the Prime Minister and Babacan's exchange became quite heated. Serdengecti claimed that the PM accused Babacan of sounding like the IMF, to which Babacan allegedly responded: "Of course I do--I have to work with these people." ¶3. (C) Serdengecti put the GOT's recent populist moves in the context of Turkish economic history: whenever inflation comes down the Government thinks it can do what it likes. He fears that people may be telling the Prime Minister he need not worry too much about fiscal discipline because he can rely on the Central Bank to bring down interest rates. The Central Bank Governor characterized the dialogue with the IMF over fiscal matters as being "in bad shape," because it will be both politically and technically difficult to find fiscal measures to compensate for the minimum wage and pension payment increases. ¶4. (C) Serdengecti claimed that the financial markets no longer provide any constructive pressure on GOT policy-making, as markets have tended to ignore bad news in recent months, and have been on a sustained rally based on "wishful thinking." Saying he has seen this pattern before in Turkey, the Governor attributed market optimism to a combination of foreign buying and the domestic private sector's keen desire to sustain economic growth at all costs. As in the past, all it will take is a trigger of some political shock or natural disaster for the market to fall sharply. In Serdengecti's view, heavy foreign investor demand for Turkey's Eurobond issuance last week has led domestic investors to believe the foreigners know something about Erdogan's U.S. visit that gives them confidence. Econcouns noted that, although the U.S. very much wants Turkey to succeed, we see the path to success lying through strong economic reforms, which is why the $8.5 billion FA has economic conditionality. ¶5. (C) Understanding that geo-strategic issues such as Cyprus and Iraq are likely to be foremost on the USG agenda with the Prime Minister, the Governor argued that this should not exclude a helpful message on the need for continued economic reform. This would help counter advice the Prime Minister may be receiving from the same AK Party people who last year both advised the Prime Minister to resist Central Bank disinflation and voted against the Government's position on the March 1 "Tezkere" resolution. As an aside, Serdengecti noted that these parliamentarians' betrayal of Erdogan on the Tezkere helped discredit their economic arguments, and buoyed the Central Bank Governor's standing with the PM. ¶6. (C) Serdengecti was careful not to overdramatize the situation: he has not yet felt intense pressure to cut interest rates, and he believes the inflation outlook is still "ok." Had it not been for the populist measures, he could have cut interest rates in late December or early January, but now felt the need to wait and see these measures' impact on inflation expectations. The Central Bank also has been considering resuming its auctions of Turkish Lira (i.e. purchases of Foreign Exchange),which it suspended a couple of months ago. However, given the revived danger of GOT problems with the IMF, the Bank did not want to resume auctions and then have to suspend them faced with a sharp market correction. Next weekend's planned payment of the first instalment to depositors in the failed Imar Bank is also expected to have an impact on the foreign exchange market, since the payments will be in TL, a significant portion of which may be converted into dollars or euros. ¶7. (C) Serdengecti confirmed that he will not be accompanying the Prime Minister though he will attend the Davos World Economic Forum meeting. ¶8. (C) Comment: Serdengecti's concern, recently echoed by both World Bank and IMF officials, tracks with post's recent warnings to key economic officials, including the Ambassador's recent comments to several GOT economic ministers on Turkey's continued economic vulnerability and the need to stick to the reform program. Serdengecti's fears reinforce post's belief that it is important to stress economic reform during the Prime Minister's Washington meetings. Separately, post requests the Treasury Department consider engaging with the World Bank and IMF to ensure that Managing Directors Kohler and Wolfensohn deliver a similar message to the Prime Minister. EDELMAN