TURKEY: RESPONSE TO INFORMATION GATHERING REQUEST:

C O N F I D E N T I A L ANKARA 001898

SIPDIS

EEB FOR DAS NELSON, EEB/OMA FOR MARLENE SAKAUE, ALEX
WHITTINGTON
TREASURY/IMB FOR BULL MURDEN, WILBUR MONROE AND CAROL CARNES

E.O. 12958: DECL: 10/31/2018
TAGS: EFIN ECON TU
SUBJECT: TURKEY: RESPONSE TO INFORMATION GATHERING REQUEST:
SUMMIT ON FINANCIAL MARKETS AND THE WORLD ECONOMY

REF: A. SECSTATE 114420

B. ANKARA 1872

C. ANKARA 1864

D. ANKARA 1855

Classified By: Economic Counselor Dale Eppler for reasons 1.4 b, d

Turkey's Key Objectives and Priorities/Desired Outcomes
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1. (C) The GOT has not yet publicly offered any ideas on
reform of Bretton Woods institutions. GOT contacts say that
they are awaiting the Summit agenda before meeting to discuss
Turkey,s position on the specific agenda items. The Prime
Minister and Treasury Minister have publicly said that
Turkey,s 2001-02 banking reforms insulated Turkey from being
directly affected by the crisis, and they may offer their
experience to other G-20 members. Privately, the Treasury
Ministry has indicated its view that the outcome of the
Summit should be a coordinating mechanism in the G-20, using
an improved IMF as its implementing organization. The crisis
has macroeconomic imbalances at its core and these need to be
addressed through better coordination. The G-20 is an
inclusive platform for this coordination. The IMF should be
the G-20 coordination implementing organization, but the IMF
toolkit will need to expand, and it will need to do a much
better job of surveillance of developed countries and on a
multilateral basis (e.g., US-China). There are transparency,
governance, funding and other issues at the IMF that may also
need to be addressed. (Note: Treasury's views have not yet
been presented to the Prime Minister, who will have the final
say. End note.)


2. (C) The GOT is approaching the Summit as an opportunity to
confirm their self-image as a regional power with assured
access to the world stage. They already point to their
recent election to the UN Security Council as evidence of
their heightened status. GOT Summit positions also will be
colored by the domestic politics surrounding future GOT )
IMF relations. The last IMF Standby Agreement ended in May.
The IMF is not popular with the Turkish public, and the Prime
Minister, a longtime opponent of the IMF, sees political
victory in March 2009 local elections and vindication of his
economic policies in Turkey,s ability to get through the
financial crisis without another IMF program. In response to
business sector requests that the GOT sign a new Standby
Agreement with the IMF, the Prime Minister said October 26
that &during a crisis, we will not bury our future in
darkness by bowing to the demands of the IMF.8 The major
point of contention is IMF fiscal constraints. The GOT wants
the IMF at most to set general, overall financial targets and
give the GOT maximum flexibility in budget, fiscal policy and
spending matters.

Key Turkish Concerns/Reform Recommendations
-------------- --------------


3. (C) The GOT has not proposed any changes to the global
financial system. The GOT is likely to emphasize national
sovereignty and responsibility in its positions, and seek
opportunities to discuss Turkey,s extensive 2001-02 banking
reforms as an example of the sort of national leadership that
could have prevented the crisis.

Key Concerns
--------------


4. (C) Turkey,s two primary concerns are maintaining access
to foreign capital and avoiding FX liquidity problems. While
there are no immediate liquidity problems, Turkey faces
potentially serious foreign exchange problems in coming
months. The Central Bank estimates that USD $14 billion
(net) left Turkey in the first three weeks of October, much
of that carry trade investments that unwound. FX is in demand
and large FX debt payments coming in the next few months
promise to keep FX demand high. The Central Bank,s reserves
are about $77 billion gross, and $58 billion net, less than
foreign investment in Turkish bonds ($23 billion) and
equities (approximately $50 billion). The lira depreciated
about 37% against the dollar from October 1 to October 24.
Thus far, there has not been any indication that Turks are
moving out of lira and into FX. On the contrary, the latest
data indicates that Turks continued to sell FX as the lira
depreciated in October.

5. (SBU) Turkey is highly dependent on imported capital )
its capital needs have been estimated at USD $100 to 145

billion over the next 12 months. The Current Account Deficit
is expected to be about 7% of GDP this year, or about USD $51
billion. The Turkish private sector has about USD 80 billion
in foreign currency debt outstanding (USD 100 billion in
2009). This debt will be difficult to rollover in the
current environment. Banks, while not highly leveraged, will
still face difficulties renewing their external credit lines,
and the domestic banking sector does not have the resources
to substitute for the low-interest financing Turkish
companies have received offshore. The banking sector is
well-capitalized but it still faces credit risk (as its
formerly credit worthy borrowers see their export orders
vanish),FX risk (from borrowing abroad and lending at home)
and maturity mismatch problems as interest rates rise.
Key Concerns for Prime Minister Erdogan
--------------


6. (C) The Prime Minister will welcome being included in this
select grouping, and will see this as reinforcement that
Turkey under his leadership is being recognized as a key
regional power. His attention will be focused in part on how
the Summit plays to domestic Turkish audiences, in light of
nationwide local elections scheduled for March 2009. He also
will be looking for opportunities to tell the world how his
government,s banking reforms, financial policies and
economic management have allowed Turkey to avoid being
directly affected by the crisis.

Impact of the Financial Market Crisis on the Financial Sector
-------------- --------------


7. (SBU) As discussed above, Turkey faces a potential FX
liquidity problem in coming months. This is mainly the
result of heavy FX borrowing by the Turkish private sector in
recent years (about $100 billion),taking advantage of low
interest rates offshore and, until October, the strong lira.



8. (SBU) The Turkish private sector will bear the brunt of
the financial crisis. The corporate sector will have
difficulty rolling over its offshore credit lines. Most
Turkish production relies on imported inputs, and the recent
lira depreciation will increase costs of production. At the
same time, Turkey,s major export markets (Europe, Russia
and the GCC) are all slowing down, making it more difficult
to export even though Turkish goods are more price
competitive with a depreciated lira.


9. (SBU) This weakening of the corporate sector,s financial
health threatens to undermine Turkey,s well capitalized
banks, which face increasing credit and FX risks as well as
maturity mismatch problems if interest rates increase. Seven
banks account for 79% of Turkish banking assets. While
Turkish banks are only lightly leveraged by international
standards, they still rely on foreign credit lines, and
several of these major banks face large FX debt rollovers in
coming months. A failure to rollover these credits or other
financial problem at one of these major banks could easily
provoke a systemic crisis.

GOT Actions Taken to Address the Financial Crisis
-------------- --------------


10. (SBU ) While assuring the public that the crisis will not
affect the Turkish financial sector because of the 2001-02
banking reforms, the GOT is proposing several measures to
deal with the secondary effects of the crisis. To deal with
declining exports, the GOT says it will propose a new
incentives package for exporters who expand to new markets.
The GOT also is proposing a tax amnesty for offshore funds,
allowing Turks to repatriate some of the estimated USD 100
billion they hold offshore over a three month period with no
questions asked. The GOT also plans to restart a commercial
loan guarantee mechanism and will do away with the 10%
withholding tax on domestic investments. The Finance Minister
recently rejected business calls for increasing Turkey,s
bank deposit insurance (currently YTL 50,000, approximately
$29,000),but there is an ongoing effort in the Parliament to
give the GOT the discretionary authority to increase deposit
insurance if necessary.

11. (SBU) The Central Bank has taken several actions to try
to head off a liquidity problem. On October 9, it entered
the interbank FX market as a broker and effectively took on
counterparty risk. On October 22, it doubled the amount of FX
that banks could borrow directly from the Central Bank on a
short term (up to two week) basis, to $10.8 billion. These



loans are priced higher than prevailing rates on the
interbank market. The Central Bank restarted daily FX
auctions the same day but then cancelled them on October 28
because FX liquidity conditions had improved.

Current Economic Situation/Near-Term Outlook
-------------- --------------


12. (SBU) Turkey,s GDP growth is highly dependent on
exports, the majority of which go to the EU (51%). With
Europe going into recession and other key markets (Russia and
the GCC) slowing down, GDP growth projections are being
slashed. 2008 GDP now is expected to be around 2.5-3%,
versus a 4-4.5% growth expectation just a few months ago.
The GOT seems to be in denial about this, with the 2009
budget based on rosy 4% GDP growth (private estimates range
from 1.9 to 2.5%, with risks to the downside) and 7.5%
inflation (private estimates are rising in response to the
recent lira devaluation).

12. (SBU) 2009 promises to be an even more difficult year if
the crisis continues. In addition to $100 billion in private
sector FX debt, the GOT will need to make USD $11.6 billion
in foreign debt payments, its largest FX debt payment level
of the next five years. This will be offset somewhat by the
sharp drop in energy prices, as Turkey,s Current Account
Deficit (CAD) is essentially equal to its energy imports.
While natural gas prices are tied to long-term contracts, the
drop in oil prices will reduce Turkey,s external financing
needs (analysts are estimating the 2009 CAD will fall to USD
$32-40 billion).

13. (SBU) Investment is very likely to slow substantially,
but no one seems to be sure yet by how much. The GOT,s
ambitious privatization program is likely to be hard hit.
Two recently completed privatization deals have come
unraveled after banks withheld promised financing for the
deals.

Visit Ankara's Classified Web Site at
http://www.intelink.sgov.gov/wiki/Portal:Turk ey

WILSON