TURKEY AND IMF ANNOUNCE BROAD AGREEMENT ON A NEW

UNCLAS SECTION 01 OF 03 ANKARA 006947 SIPDIS SENSITIVE TREASURY FOR INTERNATIONAL AFFAIRS - MMILLS AND RADKINS NSC FOR BRYZA AND MCKIBBEN E.O. 12958: N/A TAGS: EFIN ECON PGOV TU SUBJECT: TURKEY AND IMF ANNOUNCE BROAD AGREEMENT ON A NEW PROGRAM REF: A. ANKARA 6835 ¶B. ANKARA 6700 ¶C. ANKARA 6594 ¶1. (SBU) Summary: The IMF and the Turkish Government have announced agreement on the broad outlines of a new three-year program. Though final details will need to be wrapped up before a Letter of Intent can be signed, and an IMF board vote will not take place until January, the GOT and IMF succeeded in reaching sufficient agreement to make a joint announcement prior to the critical EU Council decision on the start of Turkey's EU accession negotiations later this week. The $10 billion dollar program is at the low range of what markets expected: Turkey will be a significant net payer to the IMF during the three-year program period such that the program will allow the IMF to gradually reduce its exposure to Turkey. Though the GOT was slow to decide it needed the program and slow to take the measures required, agreement on a new program is an important milestone in the gradual stabilization of the Turkish economy. The program is projected to help Turkey achieve single-digit inflation and greatly reduce its vulnerability to problems rolling over its large short-term debt. The program is not a panacea, however, and Turkey is likely to continue its bumpy economic ride for some time. End Summary. IMF and GOT Announce Agreement... -------------- ¶2. (SBU) At a joint press conference early December 14, the IMF mission chief and State Minister of Economy Babacan announced that the Government and the IMF mission had reached broad agreement on a new Standby Arrangement. The facility, covering 2005 through 2007, would allow credits up to about $10 billion. Though Babacan and IMF staff say they are close to agreement on the text of a Letter of Intent(LOI),we understand some issues remain to be finalized and the LOI will not be signed until after the EU Council meeting, perhaps several weeks afterwards. Formal approval at the IMF Board will not take place until January or February. Providing some Insurance Against EU-linked Market Turbulence -------------- -------------- ¶3. (SBU) As reported in reftels, GOT economic officials and IMF staff thought it prudent to reach sufficient agreement to be able to make a joint announcement on the broad outlines of a program prior to the EU Council decision. Though few observers place a high probability on the EU Council failing to give Turkey a date to begin accession negotiations, it is entirely possible that the elements of the EU decision may be politically difficult for Turkey to swallow, opening the way for market turmoil. By announcing the IMF agreement beforehand, both the GOT and IMF hope to limit whatever market damage could take place in an unfavorable EU scenario. A Long Time Coming -------------- ¶4. (SBU) The new agreement was a long time coming. After the a global sell-off in emerging market debt hit Turkey in April and May, private sector observers were unanimous that Turkey needed to seek a new IMF program, and should start negotiations as soon as possible. Central Bank Governor Serdengecti told us he had urged the GOT to seek a new program early so as to have it in hand before the uncertainty of the EU summit. Instead of heeding the business community or the Central Bank, the Government did not announce it had decided to pursue a new IMF program until August, reportedly because it took that long for Minister Babacan to convince the Prime Minister it was necessary. We understand that many cabinet ministers opposed seeking a new agreement, chafing under IMF strictures and failing to understand the Turkish state's continued dependence on markets' willingness to roll over its huge stock of short-term debt. IMF Pushes Through its Agenda -------------- ¶5. (SBU) Even after negotiations began in early September, it took the IMF three missions to reach agreement, with the GOT seeming very slow both to take needed measures and to reach agreement with the IMF on policies. In the end, the GOT largely bent to IMF demands: VAT rates were not cut; the banking law will be broadly what the IFI's wanted; the fiscally austere 6.5% primary surplus target will be maintained; 2004 fiscal "overperformance" is being saved rather than spent; and the tax administration is being restructured in the hope of broadening the tax base. The status of the IFI's ill-starred attempts to move forward on state bank privatization is less clear, though we understand the GOT, working with the World Bank, will need to develop a new, more ambitious state bank privatization strategy in the first quarter of 2005. Eleventh Hour Negotiations on Social Security Reform -------------- -------------- ¶6. (SBU) In the end, the most difficult issue proved to be the reform of the social security system. Though the Prime Minister has reportedly agreed to long-term numerical targets to reduce the huge social security system deficits (4.5% of GDP),the devil was in the details. IMF and World Bank officials spent much of the past few days dealing with the danger that the Labor Ministry would use less conservative assumptions about the number of participants, economic growth and inflation, so as to reduce the severity of the parametric changes (such as reducing pension benefits, or pushing back retirement ages). IFI officials are now reasonably confident the GOT understands it will have to use conservative assumptions, and the LOI will not be signed until the social security law is submitted to parliament. $10 Billion Facility Allows Gradual Reduction in IMF exposure.. -------------- -------------- ¶7. (SBU) The IMF's $10 Billion facility means that Turkey will be a net payer to the IMF, but will avoid a spike in repayments from the earlier IMF program. Whereas without a Fund program, the Turkish state would probably not have been able to make the huge payments required, with the new program--and some smoothing out of the repayment profile under the old program--Turkey's net payments to the IMF will be more gradual and therefore manageable. Total outstandings to the IMF are now projected to go from about $20.7 billion at the end of 2004 to about $9.6 billion at the end of 2007 and falling thereafter to only $600 million by the end of ¶2010. Though the GOT had been pushing for a larger facility, and the markets were expecting a bigger number, the GOT seems to have accepted an amount towards the low end of the range of possible financing. Under strong pressure from the IMF board not to grant too large a loan, the IMF staff seems to have convinced the GOT, in part by a degree of front-loading of the disbursements: the program envisions 5 disbursements in 2005, 4 in 2006, and 3 in 2007. Nor have markets reacted negatively to the lower-than-expected size of the loan: the Turkish lira strengthened against both the dollar and euro and interest rates came down slightly, though stock prices eased after a strong rally on the 13th. And Sets the Stage for a Further Stabilization of the Economy... -------------- -------------- ¶8. (SBU) More broadly, Turkey's remarkable progress since the 2001 crisis in stabilizing its economy has a better chance of continuing under IMF-provided financial breathing room combined with policy oversight. With IMF support, the independent central bank is widely-credited with bringing Turkey's inflation rate to its lowest level in 30 years and most observers expect single-digit inflation in 2005. The fiscal austerity in the IMF program is projected to produce a gradual but crucial fall in Net Debt to GNP from around 70% at the end of 2003 to 60% at the end of 2007. This ratio remains sensitive to exchange rate movements, and Turkey will continue to have to roll over about 90% of its traded domestic debt as it comes due, but the program offers the hope that Turkey can slowly but surely grow out of the debt trap. But the Bumpy Ride is Likely to Continue -------------- ¶9. (SBU) Though the new IMF agreement is a major step towards economic stabilization, Turkey's wild economic ride is probably not over. As with EU-related reforms, the GOT is better at passing laws and approving big-picture policy frameworks than it is at effective implementation. Moreover, the new program's significant structural reform agenda (social security, state bank privatization) runs directly counter to powerful local interests (state bank managers and public sector employees). A World Bank official, for example, told us he believes the toughest work is still to come. Guven Sak, the independent member of the Central Bank's monetary policy committee told us he expects the GOT to have a harder and harder time with implementation, as public weariness with seemingly never-ending austerity grows, and as elections (due by 2007) approach. Finally, though the GOT has made major strides in taking ownership of reforms, the GOT still seems to lack a strong long-term reformist vision. EDELMAN