TURKEY-IMF: IS IT ANY DIFFERENT THIS TIME?

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 000812 SIPDIS TREASURY FOR INTERNATIONAL AFFAIRS - DLOEVINGER, MMILLS AND CPLANTIER NSC FOR BRYZA AND MCKIBBEN E.O. 12958: DECL: 02/11/2010 TAGS: EFIN TU SUBJECT: TURKEY-IMF: IS IT ANY DIFFERENT THIS TIME? REF: A. ANKARA 606 ¶B. ANKARA 686 Classified By: Ambassador Eric S. Edelman. Reasons 1.4(b) and (d). ¶1. (C) Summary: Although the IMF has gone public with its serious concerns about a new regional investment incentives law, markets are betting that the IMF and Turkish government will find a way to paper over their differences and work things out, as they have several times over the past three years during contentious reviews of the 2002-05 stand-by program. The local Fund staff, however, tells us that this time is different: IMF management is not prepared to accept "one-off" spending cuts to compensate for the enhanced incentives and will instead make a new program conditional ON withdrawal of the draft law or permanent new measures that would be at least as painful as retracting the law. Whether the IMF will be able to FOLLOW through with this tough position is open to question, but given its difficulty communicating its seriousness to the Turks and markets, the Fund is likely to look to the U.S. and other leading members for support. End Summary. -------------- IMF Goes Public... -------------- ¶2. (SBU) Following the Prime Minister's decision to formally submit a new regional investment incentives law to Parliament (refs),public comments by Resident Representative Hugh Bredenkamp about the Fund's concerns over the fiscal cost of the law prompted only a slow and mild reaction from markets. ON February 9, the day after Bredenkamp's initial comments were published in the Financial Times, the stock market fell 2.62%, coming off recent record highs. The currency market was more neutral, as the lira weakened slightly against the euro and appreciated slightly against the dollar to 1.3284 NTL per dollar. At the same time, the interest rate ON the benchmark bond continued to improve, falling from 17.95% to 17.68%. (In the first ten days of February the interest rate ON the benchmark fell from 19.32% to 17.68%.) ON February 10, after Bredenkamp appeared ON local financial television news programs, markets sold off, but not sharply: the lira fell a bit more to 1.3391 to the dollar, the equity market eased 0.80% and interest rates ON what had been the benchmark bond came back up to 17.94% (the benchmark bond changed February 10, and the new benchmark closed at 17.74%). In sum, after a nearly unbroken rally since the START of the year, these mild falls amounted to little more than mere profit-taking, not a dramatic sell-off driven by serious concerns about the IMF anchor. -------------- And Tells us It's Different This time... -------------- ¶3. (C) ON February 10, Bredenkamp told EconCouns that he was frustrated by the GOT's decision to go ahead with submitting the incentives law to parliament. But he was even more frustrated by the difficulty he said he was having in conveying the seriousness of the IMF's concerns. He said there was a qualitative difference in the negotiating dynamic this time from the frequent delays and disputes over individual reviews under the old program. The difference this time, according to Bredenkamp, is that the IMF is not willing to undermine a new program before it begins with "one-off" compensatory measures such as a cuts in investment spending. Instead, the IMF would insist ON compensatory measures that would be just as painful as retracting the draft law. He said it was not the Fund's intention to spook markets by going public. ON the other hand, there was an issue of transparency with which Turkish Treasury apparently agreed. -------------- Analysts Unmoved -------------- ¶4. (SBU) Market analysts in some cases showed concern over news of increased problems with the IMF, but mostly they are betting that the GOT will work out its problems with the IMF. Saruhan Dogan, Finansbank chief economist, said markets were confident that the GOT would resolve the problem with the IMF soon. Deutsche Bank's Tevfik Aksoy said in his daily review that in the past two years there had been a similar pattern of problems between the GOT and the IMF ON the issues like pensions, public servant salaries, amnesties and subsidies, but each time they were resolved in the end. Matthew Vogel of Barclays Capital opined that the problem will be resolved, but said markets should keeping an eye ON Erdogan,s spending plans. Citigroup,s Olgay Buyukkayali wrote that any market dip caused by the IMF news was a "buying opportunity." Some analysts, however, are beginning to sound a more worried tone, notably Bender's Emin Ozturk and Baturalp Candemir of HC Istanbul. Ediz Tolga, of Lehman Brothers, has been sounding the alarm about the current account deficit for some time, though ON the IMF problem, his only comment was that it might delay further rate cuts by the Central Bank. Erdal Saglam, a leading economic journalist, wrote in his February 10 column that there was a growing bitterness in ties between Turkey and the IMF. The IMF, he wrote, continues to send "warnings" to the GOT. According to Saglam, IMF relations deteriorated as result of AKP attempts to increase populist spending. -------------- Government Posturing -------------- ¶5. (SBU) Responding to the increasing concern, but not showing any flexibility ON the incentives law, Finance Minister Unakitan said in a press conference February 10 the GOT was determined to implement sound fiscal policies with or without the IMF and that it would not initiate any spending without compensatory financing. Unakitan also underlined that from the GOT perspective there was not any problem with the IMF. Unakitan noted that budget appropriations could be reallocated, or there could be new financing (a market economist commented that the GOT may announce another special consumption tax hike). ON February 10 and 11, Deputy PM Sener said the tax administration reform and new banking law had been submitted to the Council of Ministers and would go to parliament shortly (two of the three "prior actions" for a new program.) -------------- Central Bank Cuts Rates Less Than Expected -------------- ¶6. (SBU) The Turkish Central Bank's decision to cut its overnight borrowing rate by 50 basis points ON February 9 instead of the 100 bps it had previously signaled to markets was interpreted as a sign of the bank's concern over a possible impasse. Most market analysts agreed that a rate cut was necessary and inevitable given that market rates which had floated below the CBT rate recently. But several analysts said that by cutting by only 50 basis points, from 17% to 16.5%, the CBT was putting some pressure ON the GOT. A Central Bank Markets Department official confirmed this interpretation to us, saying the Bank had only cut 50 basis points because it was worried about the situation. In its press statement, the CBT said it based its rate cut decision on the medium-term prospects for disinflation, yet reiterated that fiscal discipline and reform progress remain the key pillars of disinflation in medium/long term. The CBT also stated that a significant delay in the reform process, a permanent slow-down in productivity increases, and an increase in domestic demand could change the bank's disinflation views. -------------- Comment -------------- ¶7. (SBU) The blase market reaction confirms a pattern: with the increasing stabilization of Turkey's economy, and more and more portfolio investors betting ON Turkey as a "quasi-EU convergence play," markets only pressure the GOT when it looks like problems with the IMF are at a breaking point. Markets' experience is that the Fund and the GOT always work things out, and this undermines the credibility of IMF intentions to be "tough." As we reported this fall, one long-time Turkey-watcher at a U.S. bank told us the investors who have lost money in Turkey are the ones who pull out in a correction, creating a powerful bias towards staying in the market. ¶8. (C) With the markets applying no pressure, and the Central Bank less than it used to, the Turkish government will likely be encouraged to stick to its guns. This leaves the question of whether or not the IMF is really serious this time about insisting ON the credibility of the fiscal framework, which is, as Bredenkamp pointed out, one of the main objectives of the new program. With Turkish government economic technocrats its only allies, the IMF is likely to look to G-7 governments to put bilateral pressure ON the Turks. Post recommends that the U.S. Government encourage the IMF to stick to its guns. EDELMAN