IMF FIGHTING GOT'S POST-BOARD VOTE POPULISM, AGAIN

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 003033 SIPDIS SENSITIVE TREASURY FOR INTERNATIONAL AFFAIRS - MMILLS AND CPLANTIER NSC FOR BRYZA AND MCKIBBEN E.O. 12958: DECL: 03/24/2009 TAGS: EFIN PGOV TU SUBJECT: IMF FIGHTING GOT'S POST-BOARD VOTE POPULISM, AGAIN REF: A. ANKARA 2975 ¶B. ANKARA 2972 Classified By: Ambassador Eric S. Edelman for reasons 1.4(b) and (d). ¶1. (C) Summary: In yet another case of proposing populist measures shortly after a board vote, in contravention of its commitments to the IMF, the GOT proposed legislation in mid-May that would soften repayment terms and penalties for missed social security premia payments. IMF pressure (and perhaps worries about Turkey's eroding EU "anchor"),led to a partial retreat, but the draft legislation still contains unacceptable measures, including an amnesty for participants in VAT fraud and targeted tax breaks. A distressed IMF Resrep is no longer giving his interlocutors the benefit of the doubt, and has concluded that an influential group of leading politicians, led by Finance Minister Unakitan and apparently including the Prime Minister, simply does not agree with and is actively opposed to the need to avoid one-off exemptions and amnesties. End Summary. Populist Measures (Again) Right After IMF Board Vote -------------- -------------- ¶2. (SBU) As it has more than once before, the GOT proposed populist tax and incentive measures that violate agreements with the IMF within days of the May 11 IMF board approval of a new $10 billion three-year stand-by program. The absence of consultation and the violation of commitments in the Letter of Intent (LOI) were blatant. The IMF board approved the new program on May 11. On May 18, with the ink hardly dry, news broke that a parliamentary commission was preparing legislation, with GOT assent, that would reschedule on concessional terms past-due premia owed to the social security system. (The IMF Resrep told us it is not clear whether these parliament-generated provisions were truly the idea of the MP's or in fact inspired by GOT Ministers. Either way, the GOT went along with the proposal.) When asked by a reporter if the provisions accorded with the IMF program, Finance Minister Unakitan replied, "Let the IMF think about it." ¶3. (C) Indeed, the IMF did think about it, and rather quickly, as Deputy Managing Director Krueger shot off a letter that Minister Babacan told the Ambassador was "sharply-worded." In a meeting May 26, the IMF Resrep told us that when they first got wind of the new law, GOT officials misleadingly and incorrectly told them that it contained nothing that had not been already discussed with the Fund or that was out of line with the program. When IMF staff learned the true substance, this was most emphatically not the case, leaving the IMF disgusted both with the substance and the absence of consultation. The legislation directly contravenes a continuing performance criterion prohibiting amnesties of public receivables, with a very specific definition. As to the process, the GOT once again sprung populist measures on the IMF right after a board vote. GOT Backs Off, but Only Part Way -------------- ¶4. (C) Following the IMF objections (and Chancellor Schroeder's call for snap elections that could bring the CDU, which opposes Turkey's EU membership, to power in Germany) Labor Minister Basesioglu announced on May 24 that the controversial restructuring of social security premia was being removed from the legislation. However, the Resrep confirmed that objectionable provisions remained. Although the government backed off the concessional rescheduling of back premia and reduced interest rates for non-compliance, the legislation was opaque and clearly included at least one other provision that violated the "no amnesty" and "no special tax breaks" performance criteria. One of these is a sort of "amnesty of an amnesty:" people who benefited from the 2003 "tax peace" amnesty but have failed to honor even their reduced obligations would no longer have to pay the penalizing interest rates required for non-compliers. In addition, the new law would provide tax breaks to former professional soccer players (which GOT officials told the IMF was an "anti-terrorism" measure targeted at eastern provinces.) There also appears to be a measure that would indemnify individuals who aided in VAT fraud, but did not personally or directly benefit -- as Unakitan is alleged in the press and by CHP politicians to have done when he was a director of al-Baraka Bank. When the IMF objected to the remaining amnesty-like provisions, GOT officials, as they have done with previous populist incidents, have said removing all of the provisions is not politically feasible. ¶5. (SBU) Rather than hold off on the first review mission until the GOT completely eliminates the objectionable provisions, the Fund has decided it makes more sense to bring the mission here to help sort through this complex legislation and try to hash it out with the GOT. They believe the prospect of a failed mission is more likely to exert pressure than not sending a mission that the public did not know was about to come. The current plan is for the mission to come to Turkey late next week (around June 3 or 4). Lack of Ownership of Fiscal Philosophy: -------------- ¶6. (C) This last go-round, coming so soon after a similar case of the proposed and then watered-down regional tax incentive scheme, has convinced the IMF that Unakitan and Prime Minister Erdogan simply do not buy into the IMF's fiscal philosophy, i.e. that it is best to avoid exemptions and loopholes or to create incentives for non-payment of public sector receivables by granting amnesties. Unakitan has learned to mouth the IMF line, but his deeply-rooted instinct is to respond to political pressures by granting exemptions and amnesties. The Resrep did, however, contrast Unakitan's inability to come around to the IMF's way of thinking on exemptions and amnesties with the Finance Minister's turnaround on the need for large primary surpluses. Though Unakitan originally fought the IMF on primary surpluses, he eventually became convinced of their benefits. (Comment: We find even this purported conversion dubious, although he finds it useful to tout the line, especially with foreign investors.) Link to Corruption Allegations -------------- ¶7. (C) The allegations against Unakitan, which surface from time to time in the press, are that Al-Baraka helped Unakitan's son's company prepare fraudulent documents filed to obtain tax rebates on Value-Added Tax for exports that did not actually exist (so-called "fictitious exports"). One of the provisions in the newly-proposed legislation would eliminate any liability for intermediaries (such as banks) that facilitated this type of tax fraud. The Resrep specified that the provision was highly-targeted to avoid prosecution for the crime Unakitan is accused of. It is not out of the realm of possibility that the desire to include this provision was the driving motivation in proposing the new legislation, with the other provisions added as a smokescreen. IMF and Turkish Treasury Downplay Post-Referendum risk of Market Turbulence: -------------- ¶8. (SBU) Like Governor Serdengecti, the Resrep was not overly concerned about the risk that a French "no" vote on the proposed EU constitution would send Turkish markets into a tailspin. First, the markets should have largely priced in a no, even allowing for Turkish markets bias towards optimism. The risk is more how EU leaders will react and Turkish leaders will counter-react. Even so, with Turkey's much reduced vulnerabilities, the Resrep doubted there would be serious problems. ¶9. (SBU) Likewise, Turkish Treasury's Domestic Debt manager Volkan Taskin told econ specialist Treasury was not worried. To be prudent, Treasury will have increased its cash reserves to 9 billion lira ($6.5 billion) and do not have a challenging redemption schedule in the coming weeks. The next big redemption comes June 22 and is foreign exchange-denominated. Finally, they expect strong seasonal flows of foreign exchange into the market this time of year. GOT cave-ins to President Sezer on anti-Foreign Investment Issues -------------- ¶10. (SBU) The Resrep also lamented the GOT's cave-ins to President Sezer's recent vetoes of legislation that would have been encouraging to foreign investors. Sezer vetoed the provision in legislation regarding the Savings Deposit Insurance Fund's (SDIF) auctions of seized bank assets that would allow foreign buyers to become majority-owners of media properties. Rather than override the veto, the GOT aligned the legislation with Sezer's wishes. The Resrep was even more concerned about another GOT concession to Sezer, whereby purchasers of SDIF assets would be vulnerable to subsequent lawsuits, rather than being indemnified. Effect of Babacan Appointment Unclear -------------- ¶11. (C) IMF staff are not sure what to make of the Babacan appointment as lead EU negotiator. On the one hand, they wonder how he will be able to handle both jobs, although EU officials have asserted to IMF staff that the workload at Babacan's level will not be heavy in the early going. On the other hand, the IMF staff greatly prefers dealing with Babacan to most of the likely alternatives. The Resrep noted that the only minister who has evidenced to the Fund a similar understanding of economic matters was Foreign Minister Gul, who, however, tends to avoid getting involved in IMF issues. Comment -------------- ¶12. (SBU) The GOT's introduction of amnesty-like legislation without consultation and so soon after the board vote merely repeats the earlier pattern of GOT bait-and-switch with the IMF. The IMF's realization that Finance Minister Unakitan has not come around to accept the IMF's fiscal philosophy seems to be a new feature of the IMF-GOT dynamic. Unfortunately, this incident confirms that the new program will suffer from the same half-hearted ownership of the reform agenda as the last one. EDELMAN