Central Bank Governor Appointed and Social Security

UNCLAS SECTION 01 OF 02 ANKARA 002183

SIPDIS

TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: EFIN TU
SUBJECT: Central Bank Governor Appointed and Social Security
Legislation Passed

Ref: Ankara 2049 and Previous

1.(SBU) Summary: On April 18, President Sezer approved the
nomination of a new Central Bank Governor, ending months of
speculation and uncertainty. The new Governor is a well-
regarded career central banker, though his reputed ties to
the ruling Justice and Development Party (AKP) raise
concerns about Central Bank independence. On April 19,
Parliament finally succeeded in passing the long-awaited,
IFI-supported social security reform legislation, despite an
opposition boycott of the proceedings. These two
achievements pave the way for another IMF review and perhaps
a change in Turkey's credit rating. The economic outlook
for 2006 remains favorable, with risks principally in the
domestic political arena. End Summary.

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Central Bank Governor Appointment Resolves Uncertainty
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2. (SBU) On April 18, President Sezer's office announced
that he had approved the Government's nomination of Durmus
Yilmaz to be Central Bank Governor. The appointment
resolves months of frenzied speculation in the press and
fretting by market analysts about who the new Central Bank
Governor would be. The speculation was exacerbated by the
Government's messy handling of the process and the rejection
by President Sezer of the Government's nomination of the CEO
of an Islamic Bank to be Governor.


3. (SBU) In the end, the GOT and Sezer agreed on 26-year
Central Bank veteran Durmus Yilmaz. Yilmaz was a member of
the Bank board and of its interest-rate setting Monetary
Policy Committee. Current and former Central Bank employees
tell us he is well-liked and well-regarded within the Bank.
He has good relations with former Governor Serdengecti but
he is also reputed to have ties to FonMin Gul from their
studies in the UK in the early 1980's. Sezer's approval of
Yilmaz disproves speculation that a Sezer would reject any
candidate with a headscarved wife, since Yilmaz' wife wears
a headscarf. Most market analysts were positive about the
appointment, citing Yilmaz' long experience, although a
Goldman Sachs analyst said the appointment raised questions
about Central Bank independence.

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Social Security Legislation (Finally) Passes
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4. (SBU) On April 19 Parliament passed the long-awaited and
highly controversial social security reform legislation.
The legislation will institute universal health insurance,
but will also gradually reduce the deficits of the state-
funded pension system, by raising retirement ages and
adjusting pension formulas. This legislation has long been
the single most important structural reform under the IMF
program and delays in its passage have put the program on
hold (reftel). In the end, the AKP Government succeeded in
overcoming opposition delaying tactics only by using an
extraordinary, expedited procedure, causing the opposition
People's Republican Party(CHP) to boycott the proceedings.
The passage of the law despite CHP and violent street
protests (which were dispersed by police gunfire in Ankara),
shows that the AKP has the discipline and parliamentary
majority to make hard reform decisions when it wants to.




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IMF Mission and Possible Rating Upgrade
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5. (SBU) In public comments April 20, both Economy Minister
Babacan and IMF Resrep Hugh Bredenkamp said they expected an
IMF mission to come to Turkey very soon, now that the social
security legislation has been passed. Though the mission
will still need to deal with the GOT's decision to cut Value-
added tax rates for the textile sector, the IMF and GOT are
expected to find a way forward, allowing the third review to
go to the IMF board and the accompanying loan tranche to be
disbursed.


6. (SBU) The market-friendly news also reopens the

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possibility that the rating agencies will upgrade Turkey's
sovereign credit rating. At the beginning of the year,
Fitch had implied it would upgrade Turkey once the social
security legislation was passed. S&P was also thought to be
considering an upgrade. Moody's, on the other hand, has
tended to adjust its ratings much less frequently, and
Turkey analyst Kristin Lindow played down the likelihood of
a change on April 20.

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Positive Outlook for 2006
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7. (SBU) With markets reassured by the Central Bank
appointment and the expected return of the IMF mission, the
outlook for the remainder of 2006 is mostly positive. Most
analysts expect continued strong GDP growth in 2005,
exceeding the 5% target. While the Central Bank is expected
to have its work cut out for it in achieving the ambitious
5% inflation target, most analysts expect it will at least
come close. Foreign Direct Investment, which is badly-
needed to provide long-term financing to Turkey's large
current account deficit, not to mention to bring jobs and
technology transfer, is expected to remain at the high level
Turkey experienced in 2005. With installment payments on
2005 acquisitions still flowing in, and several new deals
announced in 2006, total FDI is expected to be roughly
comparable to last year's $9.6 billion. The Turkish state
is also much less vulnerable to problems rolling over its
debt, with yearend 2005 Net Public Debt to GDP below 60%.
Stubbornly high unemployment remains a problem, since
Turkey's economy is not creating jobs as quickly as the
growth in the potential labor pool.

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But Risks Remain
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8. (SBU) Though the current outlook for the economy is quite
positive, Turkey is vulnerable to sudden shifts in market
sentiment. Though unlikely to lead to a full-blown crisis,
a sharp shift could be disruptive, leading to a sharp
recession, for example. One risk remains Turkey's large and
growing current account deficit, which surpassed 6% of GDP
in 2005 and is likely to be slightly larger in 2006.
Turkey's dependence on short-term portfolio investment to
finance the current account deficit means a sudden shift in
sentiment could be damaging, though in recent years
investors have tended to wait out market corrections.


9. (SBU) Perhaps the greatest area of risk to the economy
and market confidence arises from the political arena. With
elections due in 2007, Turkish politicians are already in
election mode, with the attendant risks of populist
pandering on economic policies. Tensions between the AKP
Government and the secularist establishment have increased
recently, increasing the possibility of a politically-
disruptive clash that would unnerve businessmen and
financial market investors. In addition, markets are very
sensitive to instability in Turkey's volatile region or to
tensions between Turkey and the EU.

Wilson