CURRENT ACCOUNT CONTINUES TO SWELL

UNCLAS SECTION 01 OF 02 ISTANBUL 001393

SIPDIS

SENSITIVE

DEPARTMENT FOR EB/OMA AND EUR/SE
TREASURY FOR CPLANTIER

E.O. 12958: N/A
TAGS: ETRD ECON EFIN TU
SUBJECT: CURRENT ACCOUNT CONTINUES TO SWELL

REF: ANKARA 4530

This message is sensitive but unclassified-- not for internet
distribution. This message was coordinated with Embassy
Ankara.


1. (SBU) Summary: Turkey's current account deficit set a new
record in June, reaching 2.35 billion USD, for a year-to-date
total of 13.7 billion USD and a cumulative total of 19.3
billion USD over the last 12 months. The result slightly
exceeded market expectations, but was not a surprise, as
Turkey's foreign trade deficit for June (announced earlier
this month) had also set a record at 4 billion USD. Istanbul
analysts see little difficulty in financing the imbalances in
the short term (indeed strong inflows over the first six
months of the year enabled the Central Bank of Turkey to
build up its reserves significantly),but they warn that the
growing imbalance is the key risk factor hanging over the
Turkish economy. They also see little prospect for
improvement in the near future: exports are beginning to
weaken slightly (initial figures show only a 1.1 percent
increase in July exports and declines in many categories),
and tourism revenues have not met expectations. Most
analysts thus predict that this year's current account
deficit will reach 5.7 percent or more of GDP, and they
expect it to remain over 5 percent next year. End Summary.


2. (SBU) A Growing Issue: With exports at 5.8 billion USD and
imports of 9.8 billion USD, the 4 billion USD June trade
deficit was in line with market expectations, but still
highlighted a worrying trend in which the 12-month increase
in exports (9.7 percent) has remained below that of imports
(16.3 percent). Subsequently, July figures released by the
Turkish Chamber of Exporters (TIM) showed exports slowing
further, with an increase in July of only 1.1 percent from
July 2004. Current account figures released on August 9 also
showed a widening gap, with the June deficit at an all time
high of 2.35 billion USD, slightly above the market consensus
estimate of 2.1 billion. For the first six months of the
year, the current account gap grew 38.7 percent to 13.7
billion USD (exceeding the originally projected figure for
the year and nearing the current official projection of 15.4
billion USD). The 12-month cumulative deficit also set a
record, reaching 19.3 billion USD. Analysts pointed to
disappointing tourism receipts as part of the reason for the
shortfall: while tourist arrivals increased both in June and
in the first six months of the year (26 and 27 percent
respectively),tourism income failed to keep pace, rising
only 13 percent in June and 16 percent for the six month
period. (Note: Turkey's tourism boom has largely centered in
cheap package holidays; analysts estimated last week that the
average tourist spends only 650 USD in country over the
course of a week-long holiday. End Note.) As a result of
these trends, most Istanbul analysts see a current account
deficit of 5.7 percent or more for the year, with the gap
remaining over 5 percent in 2006.


3. (SBU) Ready Financing: Though they call attention to the
quality of its financing, which has traditionally been
through short-term flows of portfolio investment (hot money),
analysts see little problem for Turkey in financing the
current account gap in the short term. Recent experience
supports their view. Financial inflows in the first half of
the year totaled 16.9 billion USD (excluding the net errors
and omissions discussed below),enabling the Central Bank of
Turkey to increase its reserves by some 6.6 billion USD.
Portfolio investments grew 50 percent (to 6 billion USD),and
financing provided by the banking and non-financial sector
also grew, standing at 5.6 billion USD and 5.7 billion USD
respectively. In June alone, Turkey had an inflow of 4.9
billion USD. Also indicative is the continued growth in "net
errors and omissions", which was 2.7 billion USD in June (5.9
billion USD year-to-date). Most analysts believe this money
is "under the mattress" money that has either been parked
overseas or otherwise outside the official economy. Some
also ascribe part of it to cash coming into the system from
border trade, which is typically conducted on a
cash-and-carry basis. Whatever the source, it has played a
role in supporting the lira, which has reached new heights
even as the trade imbalances have swelled. One Central Bank
contact told Embassy's Senior Economist that while the bank
does not have an official view, he finds it intriguing that
the "net errors and omissions item" has not zeroed itself out
over time, as has historically been the case, but instead has
been in only one direction since 2003 (into Turkey). In
addition to cross border trade (which he reminded us occurs
with Iran and Syria as well as Iraq),he suggested it may
stem from ineffective accounting for capital inflows into
Turkey (since most transactions are accounted for in London).
Finally, he said, tourism accounting is also problematic, so
that some tourism revenues may be captured through the
figure.


4. (SBU) A Risk: Despite their perception that the gap can be
financed in the short term, Istanbul analysts nonetheless
view Turkey's current account deficit as the key risk factor
facing Turkey's economy, a view the IMF increasingly shares
(reftel). Together with the short terms flows through which
it is financed, Baturalp Candemir of EFG Securities sees the
gap raising the volatility of the foreign exchange market.
He also sees an absence of policy instruments available to
the government, given the already high level of Turkey's
primary surplus under the IMF program. Only the currency
remains as an adjustment tool, he wrote in a recent note to
investors. Other observers similarly see the need for a
correction in the real exchange rate, given the slowdown in
export growth and continued rise in imports. They are not
sure this will occur, however, given the continued strong
interest of foreigners in Turkish assets. As Candemir told
us recently, he has spent the last several months seeking to
convince his firms' clients to reduce their Turkish lira
exposure, thus far unsuccessfully. Funds have money to
place, he commented ruefully, and he said he had
underestimated the extent to which Turkey would continue to
attract interest even as the local news flow became less
positive.


5. (SBU) Comment: Most observers here remain confident that
the growing current account deficit can be successfully
financed. This is based in part on the fact that after a
long absence, Turkey finally has the prospect of large flows
of FDI. Recent banking deals (Yapi Kredi Bank (in part),
Disbank, and TEB were purchased by foreigners) and
privatization of a number of state enterprises (including
Turk Telecom) should all bring significant foreign capital
into the country. It is also predicated on a continued
favorable international climate for emerging markets,
generally, and on the absence of any Turkish development that
sparks investor flight, whether domestic or international.
Certainly, investors' threshold for bad news seems to have
risen significantly in recent years, and investors have
either shrugged it off or seen it as a buying opportunity.
Analysts here stress, however, that this underlying
complacency is based on Turkey's EU anchor and the October 3
start of negotiations. If serious doubts arise about that,
many bets are likely off. The larger problem for the Turkish
economy is that continued financing of the deficit through
foreign speculative capital will prevent the adjustments in
the exchange rate that would help correct it by making
exports more competitive and imports more expensive.
Turkey's real sector may thus continue to find itself
squeezed by a strong lira. End Comment.
SMITH