TOUGH TIMES AT TURKEY'S CENTRAL BANK

C O N F I D E N T I A L ANKARA 003104 SIPDIS SENSITIVE SIPDIS TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER AND MNUGENT E.O. 12958: DECL: 03/22/2016 TAGS: EFIN PGOV TU SUBJECT: TOUGH TIMES AT TURKEY'S CENTRAL BANK REF: ANKARA 3033 Classified By: Econ Counselor Tom Goldberger. Reasons 1.4 b and d. ¶1. (C) Summary. Experts agree that the challenge of bringing Turkey's inflation rate down from last year's 8% to normal OECD levels will be far harder than the success over the last four years reducing it from 70% to 8%. Thus, longtime central banker Dormus Yilmaz took the helm of Turkey's Central Bank on April 18 at what would have been one of the most challenging times for monetary policy since the Bank's independence in 2001 even if were not also a period of market turbulence unseen since the financial crisis. Yilmaz is widely seen as lacking the charisma, confidence, and fierce independence of his predecessor, Sureyya Serdengecti, who was appointed by the previous government and had no scruples about defending the bank and its hard-earned independence. Although this impression was not contradicted in a meeting with the Ambassador, the new Governor reassuringly appears to recognize the uphill battle he faces in establishing his and the Bank's credibility with the government and the public. Time will tell if he is up to the work and the challenge, but the learning curve both for the Bank and for markets could be steep. End Summary. -------------- CUTTING INFLATION BECOMES MORE COMPLICATED -------------- ¶2. (SBU) Monetary policy, which had, in a sense, been on autopilot as interest rates and inflation fell in tandem over the past four years (table) is reemerging as a key variable in Turkey's macroeconomic balance. According to the IMF's local representative, the just-ended Fund Mission concluded that the 2006 year-end inflation target of 5% will likely be missed, largely due to increasing world energy prices. This could threaten the credibility of the Central Bank's new "explicit inflation targeting" regime at the same time as pressures in global financial markets and on the domestic political front heat up with 2007 presidential and parliamentary elections approaching. ¶3. (SBU) Taking office in the aftermath of a politicized nomination fight that pitted the more liberal Islamist AKP government against statist-minded President Sezer, Yilmaz entered the game with a built-in credibility deficit. Although respected as a long-time senior Central Banker, he was clearly neither the government's nor markets' first choice. As was also apparent in a private May 24 getting-to-know-you session with Ambassador, he is seen as lacking the charisma, drive, and confidence of Serdengecti, who was an articulate defender of the Bank's independence and integrity. -------------- -------------- NEW GOVERNOR SAYS THE RIGHT THINGS, BUT SEEMS NERVOUS -------------- -------------- ¶4. (SBU) Meeting the Ambassador, Yilmaz said all the right things, stressing his commitment to the existing inflation targeting monetary framework, the preeminence of price stability, and the Bank's "arms-length" relationship with political authorities. He recognized that the Bank needed to earn the confidence of the government, public, and markets. Nevertheless, he seemed nervous and uncertain about how to do this. He understood that decisions of the Bank's decision-making Monetary Policy Committee (MPC) would be determined by economic developments and data and that his main task was explaining those decisions -) and any deviations from targets -) to markets and the public. -------------- UNSETTLED LOCAL POLITICS COMPLICATE THE JOB -------------- ¶5. (SBU) The increase in local political tensions following the May 17 assassination of a senior judge will not make the Governor's job any easier. Yilmaz said he was relatively unconcerned by the market correction since mid-May and that the Bank had the financial reserves and tools it needed to deal with this and more. He seemed more worried by the potential pressures from local politics, including pressures that could affect the government's commitment to tight fiscal policy as 2007 elections approach (see reftel for more discussion of these risks). ¶6. (SBU) For markets, the Governor's true test will be in demonstrating his readiness to raise interest rates as needed to counter inflationary trends. The first MPC meeting chaired by Yilmaz on April 27 was a disaster in this respect as its vote to continue rate cuts was contradicted by a data release the next day showing higher than expected inflation. This cost Yilmaz credibility and added to market suspicion that as the AKP government's appointee he was biased towrd lowering rates. Market watchers saw the MC's May 24 meeting as an opportunity to recover credibility. In the event, the MPC decided to leave the rate unchanged but "signal" an upward bias. A London-based contact told us this validated her impression that the CBT did not have the gumption for decisive action. Worried by Yilmaz's apparent deference to Minister Babacan in a May 15 press conference with the IMF, she was also unimpressed by a May 24 CBT statement that affirmed the Bank's sole responsibility for exchange market interventions. Some -- including the IMF rep -- had interpreted the statement as Yilmaz's first attempt to stand up to PM Erdogan, who had said in a party speech the day before that neither the government nor the CBT were considering intervention. -------------- COMMENT -------------- ¶7. (SBU) When former Senator Phil Gramm visited Ankara last January, he remarked that things that take a long time to make (e.g., Central Bank credibility) are easily broken. That is not yet the case for the CBT, but it does seem clear that the biggest economic issues going forward will be monetary. The government, as the IMF rep also reports, seems committed to the IMF program and its strengthened fiscal targets. The program's major structural reforms are also pretty much done. Thus, if something is going to go awry, it will most likely be on the monetary side. The true nature of the Central Bank under its new leadership remains unclear. It may we be, as is often the case, that Yilmaz will grow into the job and find his pace after early missteps. He has the intellectual capability, and his readiness to contradict the PM's statement may show some underlying fortitude. Time will tell. -------------- Inflation and Interest Rate Trends -------------- Consumer Benchmark CBT Price Gov't Overnight Inflation Bond Rate -------------- 2000 39.0 42.1 199.0 2001 68.5 92.9 59.0 2002 29.7 64.9 44.0 2003 18.4 46.1 26.0 2004 9.3 24.7 18.0 2005 7.7 16.3 13.5 2006* 5.0 13.7 13.3 2007* 4.0 ? ? *Inflation: CBT target Govt Bond: end April Mkt Rate: current Visit Ankara's Classified Web Site at http://www.state.sgov.gov/p/eur/ankara/ WILSON