ECONOMIC PARTNERSHIP COMMISSION SCENESETTER

C O N F I D E N T I A L ANKARA 000688

SIPDIS

SIPDIS

FROM AMBASSADOR WILSON FOR EEB A/S DAN SULLIVAN AND DOC U/S
CHRIS PADILLA

E.O. 12958: DECL: 04/10/2018
TAGS: ECON PREL TU
SUBJECT: ECONOMIC PARTNERSHIP COMMISSION SCENESETTER

Classified By: Ambassador Ross Wilson for reasons 1.4 B and D


1. (C) The EPC has added balance to a bilateral relationship
that has been heavily weighted to political and security
cooperation. At the start of last year's EPC meeting,
Turkey's economy was in its sixth year of strong growth, the
government was steering a steady course, and the business
climate was vibrant, but bilateral relations and security
cooperation were nearing a low point. This year, our
bilateral relations and security cooperation are in much
better shape, but the Turkish government has been weakened
politically, while almost all of Turkey's economic indicators
are turning negative. Our message to the Turks in this
situation needs to be one of continuity. USG support for
Turkey is one important constant in an uncertain world.
Businesses and investors also reward continuity, and
continuation of the strong economic policies of the past six
years is the best way for Turkey to position itself to ride
out the current global economic uncertainties -- and its
domestic instability as well.

The Honeymoon is Over
--------------


2. (C) The first AKP government was singularly successful
following an orthodox economic agenda with six "anchors":
fiscal discipline and debt reduction; support for the Central
Bank's anti-inflation program; following the IMF program;
making progress on EU accession; structural reforms; and
privatizations. These anchors -- and a favorable
international financial environment -- contributed to the
surge in foreign investment in Turkey since 2002.


3. (C) The second AKP government took office August 29 after
a huge election win, taking 47% of the popular vote. In its
first 100 days, it loosened several of these anchors.
Investors and business groups were expecting the new AKP
government to finally move forward on structural reforms,
particularly Social Security, Labor Markets and Tax
Administration reforms, but the government did almost nothing
on the economic front. The GOT did finally submit the
revised Social Security bill to the parliament, but it was
immediately referred to a sub-committee and failed to
advance. Instead, the government spent its election mandate
pursuing domestic political goals: broad constitutional
reforms that have yet to materialize, and achieving passage
of only a vaguely worded constitutional amendment that might
allow some girls with headscarves to attend universities, if
the changes survive legal challenges.


4. (C) Turkey is paying a price for this exclusive focus on
domestic politics. In the fourth quarter of 2007, businesses
began curtailing hiring and stopping capital investment due
to a slowdown in domestic business activity. At the same
time, the international financial environment began to turn
negative for Turkey. Banks sharply curtailed lending and
investors began re-assessing risk, particularly those in high
current account deficit emerging markets like Turkey.
Foreign investors began pulling capital out in January. The
Istanbul Stock Exchange (ISE),on which 72% of shares are
held by foreigners, fell 25% in the first quarter, and the
Turkish lira fell nearly 10%. Slowing growth in export
markets began to hurt Turkish companies at home. Turkish
private companies have relied heavily on low-interest foreign
borrowing (they had approximately USD 52 billion in foreign
currency-denominated loans outstanding at the end of the
year, much of it unhedged). As the credit crisis began to
take hold, Turkish companies began having problems borrowing
abroad or getting their existing loans refinanced at
affordable rates.


5. (SBU) In February, in a rare show of unity, several
Turkish business groups united in an appeal to the government
to focus on the economy and move quickly forward on reforms
that were of high interest to business. This seemed to have
had an effect. GOT officials met with business leaders and
announced some provisions of some reform bills, such as a 5%
reduction in social security premiums in the draft Labor
Markets Reform. The Social Security Reform was finally
brought to the floor of the parliament for a vote. Then the
tsunami hit.

SIPDIS

Wide-ranging Effects of the Party Closure Case
-------------- --------------


6. (C) The party closure case filed by Turkish prosecutors on
March 14 against the ruling AK Party and 71 of its senior

members has had a negative effect politically and
economically. The case is likely to drag on for months.
There is no timeframe within which the Constitutional Court
must make a decision.


7. (C) With the closure action hanging over it, the
government finds itself seriously weakened. As a result, the
government will be much less able to move forward on the
economic reform agenda, even as it finally realizes how
important those reforms are. It likely will be forced to
make more political compromises than before, as it did
recently when faced with union opposition to the Social
Security Reform. It will be more cautious and move more
slowly to avoid political problems, as it has been in recent
weeks, delaying public release of its Labor Market Reform
package while it informally consulted with unions about the
bill's contents.


8. (C) This behavior is unlikely to win over foreign
investors, who have grown increasingly negative about Turkish
economic fundamentals. The pain thus far has mainly been felt
by foreigners on the ISE, but the government also will pay a
price later in the year, as bids for privatizations come in
much lower than expected (e.g., the recent Ankara Gas
Distribution sale, with an estimated USD 2-3 billion sales
price that received only four bids, the highest being just
USD 1.6 billion). Energy privatizations may be particularly
hard hit by the closure case because the value of these
investments is heavily dependent on investor confidence that
the government will complete the energy market de-regulation
process.

What This Means for the EPC
--------------


9. (C) Our message to the Turks should be one of continuity
and support. The USG supports Turkey in its fight against
terrorism, in its bid to join the European Union, and in its
economic and political reform efforts. We understand that
global financial conditions are not the most favorable right
now for high current account deficit countries like Turkey
and the United States. Businesses and investors reward
continuity. Turkey can best position itself to weather the
current storm and benefit from the recovery by continuing
with the policies and reform process that have been so
successful the last six years. That will be more difficult
now, but it also is the direction that the AKP now appears to
want to go.


10. (C) This message of continuity is particularly important
regarding our Caspian Energy Strategy. For over a decade,
the U.S. and Turkey have worked together to open non-Russian
routes to market for Caspian oil and gas. We have had some
solid success. Oil is flowing through the Baku-Tblisi-Ceyhan
pipeline, and gas now flows through the Turkey-Greece
interconnector. But the priority now is natural gas, and gas
pipelines are much more complex than oil to put together. At
the same time, Turkey's role is changing, from one of transit
state and EU accession candidate to that of a major energy
consumer that has doubts whether the EU will ever accept it.
We need to emphasize to Turkey that the best way to ensure
their future energy supply and become an indespensible
partner for its neighbors is to continue to help us realize
the Caspian corridor. This means finding a practical
solution that meets Turkey's energy needs and resolves gas
transit issues. This will pay extra dividends when Iraqi gas
is available to flow into and through Turkey.


11. (C) The EPC Business Event on April 16 will provide a
good forum for emphasizing the continuity of USG support for
Turkey and of Turkey's economic policies. It also is an
opportunity to hear from businesses what holds them back from
doing more business in Turkey. We are likely to hear many of
the same complaints we have heard before, such as the lack of
transparency and predictability in the legal system (such as
the recent Constitutional Court decision blocking foreigners
from buying real estate),lack of IPR protection,
bureaucratic inefficiency, labor permits, and high employment
taxes and severance pay. The good news is that GOT has
several economic reform bills in draft that will address some
of these issues. The EPC is an opportune time to remind the
GOT what the business community's reform priorities are and
encourage them to resolve these concerns in upcoming
legislation where possible.


12. (C) The current economic difficulties also create
opportunities. The largest US trade mission ever to Turkey,
the Tradewinds Conference, will be taking place in Istanbul
the same week as the EPC. The electricity sector, including
a number of privatizations and the construction of Turkey's
first civilian nuclear power plant, will open up many
opportunities for US bidders and suppliers. Turkey remains
one of the biggest U.S. agricultural export markets in the
world. The Turks also are creating opportunities. For
example, their new R&D law appears to allow foreign companies
and universities to obtain GOT grants and tax exemptions for
research work carried out in Turkey. But no one in the
foreign business or university community seems to be aware of
it yet. You may want to draw them out on these points, and
then encourage them to publicize what should be an attractive
offer, particularly for companies and universities that
already have established Turkish connections or partners.


13. (C) The missing link in our relationship has been Turkish
investment in the United States. Particularly now with EU
accession a distant possibility, Turkish businesses are
becoming more interested in doing business with, and
investing in, the United States. As governments we can
promote this by emphasizing our shared values and the
continuity of our policy support, and then give businesses on
both sides the chance to network and seek opportunities. The
Commercial Service of USDOC recently initiated an "Invest in
America" program to encourage inward FDI, and we need to make
effective use of this as well.

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

WILSON