TURKEY: NO DEAL YET WITH IMF

C O N F I D E N T I A L ANKARA 002820

SIPDIS

SIPDIS

TREASURY FOR INTERNATIONAL AFFAIRS - PLANTIER AND NUGENT

E.O. 12958: DECL: 05/17/2011
TAGS: EFIN PGOV TU
SUBJECT: TURKEY: NO DEAL YET WITH IMF

REF: ANKARA 2742

Classified By: Economic Counselor Thomas Goldberger for reasons 1.4 (b)
and (d).


1. (C) Summary: The IMF has not yet agreed with Turkish
officials on key fiscal measures to compensate for spending
overruns that would allow the third review to go forward.
The IMF's key message is that global and local risks are
increasing, especially in the run-up to elections next year,
and policies need to be adjusted. U.S. support in delivering
these messages to senior Turkish leaders could be helpful.
End Summary.

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Sell-off Heightens Importance of IMF Mission
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2. (C) The IMF mission currently in Turkey coincided with the
sharp sell-off in Turkish financial markets (reftel). Though
markets came part way back on May 16 and 17, they are still
jittery and uncertain. Market analyst -- and Central Bank
Vice-Governor Basci -- tld us that a relatively quick
annoucement of agreement on a draft Letter of Intent
incorporating strong fiscal measures will help reassure
markets. Markets will also be looking to the May inflation
numbers that will be announced June 2 as a critical indicator
of the extent of inflationary pressures following
surprisingly high April inflation.

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No Deal Yet
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3. (C) In a meeting with the Ambassador May 17, the IMF
Mission Chief and Resrep said the sell-off may have helped
dampen the Government's complacency: they characterized
Babacan as less confident now than he was when they arrived
before the market correction. On the other hand, the IMF
officials said that the government had been hoping for a
correction and did not seem overly worried. The mission,
which is scheduled to leave Ankara by May 19, has not yet
reached agreement with the Government on key issues,
especially fiscal measures, and "we have our work cut out for
us." The missions are always down to the wire and often
leave with only broad agreement and plenty of homework for
the Government. Nevertheless, the Mission Chief did not rule
out the possibility that there would not be a sufficient
meeting of the minds to hold a joint press conference.

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Key Issues are Fiscal
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4. (C) The most critical issues are fiscal: the need to
compensate for spending overruns and the Government's failure
to comply with its commitment to save any above-projection
revenues. The spending overruns are centered in the health
ministry where increased patient access to care in public
hospitals has led to rising short-term costs, whereas the
cost savings inherent in the social security reform will be
realized over the long term. Even though Turkey spends much
less per patient than comparator countries the
above-projection rise in spending is hampering realization of
the program's fiscal targets.


5. (C) The Resrep said the Government had also failed to
comply with its commitment to save any revenue collected
above projections in the program. The IMF officials said
this commitment had been an important pillar of the last
review, since the IMF accepted the political reality that it
could not ask for more than a 6.5% headline primary surplus
target on the understanding that any excess collections would
be saved. This policy was considered important to help
control growth in the current account deficit and head off
potential overheating in the economy. The Mission Chief
added that the Governent had not, in fact, met the 6.5%
target in 2005 and had not yet "come clean" on the issue. The
Fund staff and Government also disagree on which inflows
should be considered financing items and which revenues. The
IMF officials said they have identified a set of compensating
measures which they feel are appropriate but have not yet
secured Government agreement to the package.

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Key Message: Risks are Increasing
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6. (C) The Mission Chief said the key message to senior
Government officials is that risks are likely to increase in
the coming months. With global market conditions shifting,
markets may take the opportunity to speculate against the
Government's commitment to strong policies, particularly in
the run-up to an election. Given this situation and the
possibility of the economy overheating, the Government needs
to strengthen its policies.


7. (C) A second message is that the Government needs to keep
pushing forward on structural policies -- especially social
security -- that will safeguard over the long term what has
been gained in recent years. Anything the Government can do
to encourage more investment other than short-term portfolio
investment will help. Having stabilized the macro situation,
the IMF believes the Government should focus more on micro
reforms such as labor market measures. Finally, the Resrep
underlined the importance of political leadership on
strengthening tax collection, to level the playing field for
business, and to allow the Government to gradually reduce tax
rates and allocate more funding to infrastructure. In
response to the Ambassador's question about how the United
States could support a quick agreement, they noted that U.S.
support could help reinforce these messages at high political
levels.

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Rough Start for Central Bank Governor
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8. (C) The Mission Chief lamented the new Central Bank
Governor's rocky start. After his controversial selection
process, Governor Yilmaz had suffered from the Monetary
Policy Committee's decision to cut interest rates just before
higher-than-expected inflation data were announced. The
Mission Chief said the Bank had misread consumer price trends
because their surveys do not include clothing, the prices of
which jumped in April. The Mission Chief questioned the
wisdom of the Bank's decision to suspend its daily foreign
exchange purchase auctions during the recent sell-off. Fund
staff believe this sends a signal of desperation. On a more
positive note, the Mission Chief said Yilmaz was better than
some of the alternatives: as a career central banker he seems
committed to continuing the monetary policy framework agreed
with the IMF.

Visit Ankara's Classified Web Site at
http://www.state.sgov.gov/p/eur/ankara/

WILSON