TURKISH CENTRAL BANK GOVERNOR CALM BUT VIGILANT ON

C O N F I D E N T I A L ANKARA 001031 SIPDIS SIPDIS TREASURY FOR INTERNATIONAL AFFAIRS - JROSE E.O. 12958: DECL: 05/01/2012 TAGS: EFIN PGOV TU SUBJECT: TURKISH CENTRAL BANK GOVERNOR CALM BUT VIGILANT ON POLITICS AND MARKETS REF: ANKARA 1015 Classified By: Ambassador Ross Wilson for reasons 1.4(b) and (d). ¶1. (SBU) Summary: Meeting with Ambassador May 1, Central Bank Governor Durmus Yilmaz seemed calm but vigilant. While wary of the potential for political tension to hurt financial markets, the Bank found the Monday morning sell-off less severe than expected and had not intervened. Looking ahead, the Bank was cooperating closely with the Turkish Treasury. Yilmaz thought markets would calm down if the Constitutional Court invalidated last Friday's vote, thereby forcing early elections. He is also on the lookout for election-year government spending, possibly at the municipal level. Longer-term, Yilmaz said the IMF and EU anchors were useful and the next government will need to decide to maintain good policies with or without the IMF. Yilmaz said the best way the U.S. could help would be to continue to support "support the democratic process" in Turkey. End Summary. -------------- Monday Sell-off Less than Expected -------------- ¶2. (SBU) Central Bank Governor Durmus Yilmaz told the Ambassador that Monday morning's market sell-off, while appreciable, was less than the Bank had expected. He said Turkish credit default swaps fell 15-16 basis points and the benchmark bond never reached the low it hit during the May/June 2006 financial turmoil. He said some investors who had sold in the morning came back into the market later in the day. The Bank did not intervene in the foreign exchange market and Yilmaz reiterated the bank's commitment to the floating exchange rate regime. Yilmaz insisted the Bank only buys foreign exchange to build up its reserves or if it feels that the exchange rate is so far out of line with fundamentals that the Bank needs to intervene to smooth volatility. -------------- Preparing for Volatility -------------- ¶3. (SBU) The Bank recognizes it cannot control political developments but can only react to their impact on markets. The Bank is cooperating closely with the Turkish Treasury and has taken a close look at the Treasury's financing needs in the coming weeks. The Bank expects liquidity in the market to remain around the current 6 billion lira level until May 9 when a Treasury redemption and low rollover rate could drive liquidity to around 9 or 10 billion lira. Tax payments due shortly thereafter are expected to absorb the excess liquidity. -------------- Uncertainty Bad for Monetary Policy -------------- ¶4. (SBU) Without explicitly recommending early elections, Yilmaz said the sooner the political uncertainty is resolved the better it would be for monetary policy. As far as investors are concerned, Yilmaz said a Constitutional Court ruling that invalidates last Friday's vote will calm things down (because it will force early elections, a view widely-shared by market analysts). Aside from the immediate political problem, Yilmaz sees risks to inflation arising from the possibility of excessive government spending in an election year. In particular, he cited concerns that municipalities might be overspending, since the data on municipal spending only become available with a six-month lag. Yilmaz said that if the Bank observes fiscal indiscipline, it has a responsibility to point it out to the public since it undermines disinflation. -------------- Anchors are Useful -------------- ¶5. (SBU) Looking ahead to priorities for the next government, Yilmaz stressed that political stability and favorable policies have been the key to attracting investment. Noting how fiscal discipline has helped Turkey come to be in a much stronger position, he hopes that the next Government will think hard about how to set its policies. Sooner or later the current relationship between Turkey and the IMF will end, and Turkish leaders need to think about whether they can follow the same policies without the IMF. If they cannot, they need to keep the IMF playing a role. Longer-term, Yilmaz sees the EU as more important and stressed the importance of maintaining the two anchors. The Ambassador passed on investor concerns about the EU process slowing down, possibly influenced by the Friday night military statement. If that is so, Yilmaz said, "then we are back to square one." -------------- - The U.S. Should Support the Democratic Process -------------- - ¶6. (SBU) When the Ambassador asked how we could help, Yilmaz said "support the democratic process." The Ambassador said that is what we are doing. -------------- Comment -------------- ¶7. (SBU) Yilmaz has shown himself to be an independent Central Banker and not political. While naturally concerned about the potential for political tension to hurt markets, Yilmaz did not seem overly worried for the time being. Visit Ankara's Classified Web Site at http://www.state.sgov.gov/p/eur/ankara/ WILSON