CENTRAL BANK GOVERNOR ON MACRO SITUATION, MONETARY

UNCLAS SECTION 01 OF 02 ANKARA 006427 SIPDIS SENSITIVE STATE FOR E, EUR/SE, EB/IFD TREASURY FOR INTERNATIONAL AFFAIRS - MMILLS AND RADKINS NSC FOR BRYZA AND MCKIBBEN E.O. 12958: N/A TAGS: EFIN TU IZ SUBJECT: CENTRAL BANK GOVERNOR ON MACRO SITUATION, MONETARY POLICY AND IRAQ DEBT REF: A. ANKARA 6354 ¶B. ANKARA 6426 ¶1. (Sbu) Summary: Turkey's Central Bank Governor is optimistic about disinflation and downplays the risk inherent in the current account deficit. He favors a cautious approach to moving monetary policy to explicit inflation-targeting. Serdengecti is opposed to forgiving Turkish claims on Iraq. (The Governor,s comments on IMF negotiations are reported septel.) End Summary. Positive Inflation Outlook: -------------- ¶2. (Sbu) In a November 12 meeting, Central Bank Governor Sureyya Serdengecti was optimistic that the 2004 consumer price inflation target of less than 12% would be met. Though the October CPI and WPI numbers had come in surprisingly high (at 2.2% and 3.2%, respectively),the Governor did not think this represented a trend. In addition to seasonal factors, he said the October numbers were driven up by unusual factors in agricultural prices and the advent of Ramadan, which typically causes prices to rise. In addition, higher world oil prices began to have an impact on consumer prices. (Serdengecti noted that he had been urging the Government to pass through the full effect of higher world oil prices in 2004, rather than in 2005, when, he thought, meeting the 8% CPI target would be difficult.) ¶3. (Sbu) While many structural components of inflation had been eliminated, Serdengecti continued to be concerned about rigidities in rents and services prices. Overall, he believes the economy is neither overheating nor slowing down in a way that would imply a need for changes in current monetary policy. The Bank had begun focusing on this objective several months ago, keeping in mind that achieving next year's target is important for Central Bank credibility. He was pleased that the exchange rate was not the cause of the higher October inflation numbers. Structural Changes in the Turkish Economy: -------------- -------------- ¶4. (Sbu) Serdengecti pointed to a number of favorable trends in the Turkish economy. On oil prices, he asserted that companies can no longer pass on the full extent of their cost increases to consumers. He said that the State Statistical Institute is working on changes to the CPI basket. He believed this change may lead to a finding that inflation has been lower than previously reported. The Institute will also develop a new calculation of core inflation -- CPI minus food and energy prices -- which the Central Bank could then begin targeting directly. Serdengecti pointed to the huge increases in productivity in the private sector and the shrinking share of the public sector in the economy as evidence of the non-inflationary nature of growth. Overall, he considers that most of the remaining problems lie in the public sector. Inflation Targeting: -------------- ¶5. (Sbu) Though Serdengecti agrees with the IMF that the Bank should move to "full-fledged" explicit inflation targeting over the medium term, he continues to urge caution: "If you are not successful with inflation targeting, what do you do? You cannot target the exchange rate and you cannot target money supply in a high inflation environment." He nevertheless accepts the need to prepare for explicit inflation targeting once a new program with the IMF has been agreed to and there has been a long period in which Central Bank has built up credibility. Current Account Deficit: -------------- ¶6. (Sbu) Serdengecti asserted that the public discussion of the current account deficit reflected past experience and an inability to fully comprehend the implications of a floating exchange rate regime. To support the case that it,s a real float, he pointed out that the Central Bank had not been in the foreign currency market for five months. If people complain about the risk of the current account deficit, "We answer they should buy more dollars, but they don,t want to," the Governor said. ¶7. (Sbu) Serdengecti also confirmed press reports that the bank was considering resuming its foreign exchange purchase auctions. These purchases would help the Bank build reserves, which he admitted were not high enough given Turkey,s large foreign debt service requirements in coming years. Other than reserve building, he said the Central Bank reserved the right to intervene if markets are too volatile, in which case they may buy large quantities on a single day. Serdengecti acknowledged and agreed with the IMF,s point that the Bank should make its intervention policy more transparent and said it would do so. Iraq Debt: -------------- ¶8. (Sbu) Econ/C raised the issue of the Central Bank,s holding of Iraq debt and pointed out the importance of debt forgiveness to ensure Iraq,s stability. The Governor said the Bank would have a problem with debt forgiveness, claiming that Turkey, a poor country, could not afford debt forgiveness, even for a very good cause. He said that if the Central Bank did forgive the debt, the Government would have to compensate it for the loss, and in a context of tight fiscal policy it would be difficult for the Government to do so. While expressing sympathy for the Iraqi people, he noted that Iraq, unlike Turkey, had significant oil resources. While open to a rescheduling or "doing something about interest," he opposed forgiveness. Comment: -------------- ¶9. (Sbu) We raised the Iraqi debt issue with Serdengecti since most of Turkey,s Iraq debt is held by the Central Bank. However, it will be the Turkish government, not the independent Central Bank, that will need to make the policy call on Iraq debt, with an eye to more than economic considerations. Serdengecti deserves tremendous credit for having preserved Central Bank independence and for bringing down inflation. Although there are risks, the move to explicit targeting of inflation will be jewel in the crown of his successful campaign to transition Turkey to a more "normal", low-inflation economy. Baghdad minimize considered. EDELMAN