IMF REVIEW TEAM ON TURKEY'S STATUS

C O N F I D E N T I A L ANKARA 002586

SIPDIS

SIPDIS

TREASURY FOR INTERNATIONAL AFFAIRS - JROSE
ANKARA PASS TO ADANA

E.O. 12958: DECL: 10/18/2017
TAGS: EFIN PGOV TU
SUBJECT: IMF REVIEW TEAM ON TURKEY'S STATUS

Classified By: Ambassador Ross Wilson for reasons 1.4(b) and (d)


1. (C) Summary: On October 15, Ambassador hosted G7
ambassadors for a readout by IMF Turkey Desk Chief Lorenzo
Giorgianni and new IMF Resident Representative Hossein
Samiei. The IMF team expressed concern about a lack of focus
on economic policy by the government since the July election
and confusion over roles in the new economic team. Spending
is off track and Turkey will miss its 6.5 percent primary
fiscal surplus target by a wide margin. The team pressed the
government on the need for social security, energy, tax
administration, and labor market reforms, but did not have a
clear idea yet what the government,s priorities would be, or
how the government sees its IMF relationship after the
current program expires in May 2008. End Summary.


2. (C) IMF Mission Team Leader Lorenzo Giorgianni outlined
his impressions from the Mission,s ongoing meetings that are
its first since the July election. The government appears
focused on political issues and is not taking advantage of
its honeymoon period to push forward needed economic reforms.
The new GOT economic team appears unsure who is in charge of
which issues, while it is trying to finalize the 2008 budget
and move forward on reforms that will be expensive and
unpopular.


3. (C) Economic growth has softened to five percent.
Giorgianni believes that more effective policies could push
this up to seven percent per year. (The GOT estimates 5.5
percent growth in 2008.) Stubbornly high inflation (seven
percent versus four percent target),high interest rates, and
an appreciating lira are drags on growth. Hitting the four
percent target will require very strong fiscal discipline or
continued high interest rates. Spending is far off track and
Giorgianni was not sure if the new government remained
committed to maintaining fiscal discipline. Turkey will miss
its 6.5 percent of GNP primary fiscal target this year due to
both excessive spending and poor revenue collection. It will
likely achieve only 4 percent in 2007, and it will drop the
target to 5.5 percent for 2008.


4. (C) The economic team of the first AKP government, led by
Economy Minister Babacan, was stronger and more cohesive than
its successor. State Minister for Economy Ekren leads the
new team with Treasury Minister Simsek and Finance Minister
Unakitan. Roles and responsibilities, so far, do not seem to
be clearly defined. We noted that Simsek is a relative
newcomer to politics, and that he will have a difficult time
replacing Babacan and his close relationship with the Prime
Minister.


5. (C) On October 17, the AKP will present its 2008 budget
submission, which will be a first test of commitment to
continued reform and fiscal prudence. Giorgianni said that
they had raised four priority reforms with the government:
the Social Security reform package; energy sector
privatization and deregulation; tax administration; and labor
market reform.


6. (C) The Social Security reform package has been revised to
meet Constitutional Court objections. It is ready to be
submitted to the Parliament, but the Mission was unable to
get a timetable from the government for its actual
submission.


7. (C) Turkey is facing a severe energy crisis, with
electricity demand outstripping supply. Electricity prices
have been frozen for five years, giving no incentive for new
investment. Municipalities do not pay the state distribution
company for their electricity, producing billions in losses.
The GOT knows that it needs private sector investment to
build capacity to meet this looming shortage, but fears the
political backlash of raising rates sharply. The GOT also
knows any reform must include a mechanism to force municipal
and provincial entities to pay their bills to other state
entities. The IMF supports proceeding with long-delayed
privatizations and selling distribution and production
facilities together.


8. (C) Revenue collection is perennially weak. During the
elections many taxpayers took a tax holiday, knowing that no
one was likely to come after them. To reduce marginal tax
rates while increasing collections is another expensive but
necessary reform.


9. (C) Turkey's labor markets are costly and uncompetitive.
Employers pay 39-45 percent of every formal sector salary in
taxes--the highest level in the OECD. The result is that
many companies turn to informal employees to fill out their
labor pools. Companies that strictly follow the rules do so
at a higher cost than their competitors. Reforms in this
area will be expensive, as they will reduce revenue initially
but over time will reduce both unemployment and informality.


10. (C) In visits last week to Istanbul, the IMF heard pleas
from investment banks and corporate leaders for continuing
IMF involvement in Turkey. Giorgianni noted that the
government has not indicated whether it wanted to continue
its IMF relationship or in what capacity. The options range
from a continuation of the current stand-by program to a
post-program monitoring relationship. Giorgianni said he
thought Turkey might be interested in a newly-proposed Rapid
Access Line program, in which countries with good economic
progress would have an open credit line with the IMF that
they could draw on immediately if needed. That program has
not yet been approved by the IMF board.


11. (C) Comment: Giorgianni asked whether we see the same
lack of coordination and focus on economic issues. In our
view, the GOT is focused on political priorities, including
international issues like the PKK and the Armenian Genocide
resolution, that not only push economic concerns to the side
but also make engagement with an international institution
like the IMF more difficult politically. We also discussed
linkages between the IMF program and EU accession, where
political issues like Cyprus and Section 301 similarly
threaten to push economic reforms to the back burner.
Treasury Minister Simsek is very smart, but politically
inexperienced. He will have difficulty filling the shoes of
former Economy Minister Babacan, who has spent years in
politics and enjoys a very close relationship with the Prime
Minister.


12. (C) In a pull-aside, Giorgianni said that it was possible
the Mission would not be able to reach agreement with the
government this week, and that the Mission would continue
after the Bank and Fund Annual meetings in Washington. We
indicated our willingness to meet and discuss events again if
he thought it useful. End comment.

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WILSON