TURKISH CYPRIOT BUSINESS; ISOLATION OR

UNCLAS SECTION 01 OF 04 NICOSIA 000146 SIPDIS SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON PGOV PREL CY SUBJECT: TURKISH CYPRIOT BUSINESS; ISOLATION OR SELF-ISOLATION? REF: NICOSIA 980 ¶1. (SBU) For decades, maintaining the global (except for Turkey) non-recognition of the "TRNC" has been among the ROC's top foreign policy goals. This, of course, is the inverse of a key objective of the "TRNC;" to achieve even incremental international recognition for its "institutions." There is no doubt that the GOC has largely succeeded in preventing foreign recognition of the "TRNC," with the result, Turkish Cypriot (T/C) businessmen claim, of significantly higher costs of doing business and loss of trade and investment opportunities for their companies. The GOC counters that any obstacles are the result of T/C "self-isolation"- since GOC policy allows any T/C full access to ROC facilities and institutions. This cable examines the degree to which T/C business operations are hampered due to the recognition-related policies of both the GOC and the "TRNC." We conclude that, while T/C businesses could, in some circumstances, expand if it took full advantage of its status as ROC citizens, the practical and political difficulties of doing so would not be worth the marginal increase in business income. End Summary and Introduction. What Creates "Isolation?" -------------- ¶2. (U) T/C businesses argue that due to the ROC-inspired "embargoes," they are unable to utilize "TRNC" ports for trade or travel with nations other than Turkey, unable to negotiate bilateral trade agreements, and cannot participate in state-level international conferences or conventions. These conditions cause tariffs and transport fees to be higher than in competing economies and make it difficult to form international business linkages. Further, the lack of access to international financial institutions and programs reduces T/C competitiveness. ¶3. (U) The ROC officially views T/Cs as full citizens of the Republic (leaving aside the varying definitions of who is or is not a Turkish Cypriot.) While T/C voting rights are suspended unless they live in the south, these "citizens" have the right to passports, government health and pension programs, and access to GOC institutions and facilities. Therefore, when the subject of "isolation" of the "TRNC" is raised, GOC officials respond that T/Cs are not isolated; rather,the institutions of the "illegal" state are prevented from behaving as if they represent any part of Cyprus. If T/C businessmen do not wish to utilize GOC institutions, this is their own, "self-isolating" choice. Ports: Theory and Practice -------------- ¶4. (SBU) For example, T/Cs are permitted to import/export through GOC ports. They can even register their companies in the south and these legal entities can trade through GOC facilities on the same terms as G/Cs and G/C-owned companies. This means zero duties on goods imported from the EU and with tariff rates at the GOC rate on imports from third countries. No VAT on imports is payable except at point-of-sale (and therefore, for T/Cs operating in the north, no VAT payable to the GOC.) Exports are treated as GOC-origin goods so long as they are produced or substantially-transformed on-island. ¶5. (SBU) A shipping container shipped through Limassol costs at least US$350 (and as much as $1500) less than shipping to Famagusta (the main T/C cargo port) via Mersin, Turkey. Observers report that the port of Famagusta "is of early 1960s design whilst equipment is from the early 1970s" and "it cannot be economically expanded." Nevertheless, almost no T/C trade is conducted through GOC ports. This is due primarily to northern trade union and "government" polices that strongly discourage such activity in the belief that it would abet a slow economic absorption of the north's economy into the ROC. T/C "officials" and business also express concern that GOC policies and practices could change at a moment's notice with potential big losses for companies that had become dependent on working through the ROC. As one T/C businessman told us, "how could I ever allow my business to be liable to blackmail from a government that owes me no allegiance and which is actively seeking the destruction of my country?" Another T/C businessman told us that utilizing GOC ports would be "unethical," even though his expenses are such that he must charge his customers 25 percent more for goods he imports than is charged for the same products in the southern part of the island. Tourism NICOSIA 00000146 002 OF 004 -------------- ¶6. (SBU) Similarly, T/C hoteliers and others involved in the tourism sector complain that the lack of direct flights into north Cyprus' Ercan airport is a significant barrier to increased tourism due to the higher cost of flights to the north compared to flights to the south (although the price difference is typically not more than US$50 for a flight from London,) and the fact that all flights must stop in Turkey before arriving at Ercan airport (adding 2-3 hours to total travel time.) When asked why the T/C tourism industry doesn't promote travel to Larnaca airport (not more than a one-two hour drive from north Cyprus' major tourist destinations,) T/C businessmen said it was out of concern that the ROC might eventually close the crossing points, that tourists don't want to deal with crossing points when they go on holiday, and that the "TRNC authorities" would not allow advertising travel via the ROC. Access to Credit, But at a Price -------------- ¶7. (SBU) T/C businessmen have difficulty finding access to credit at globally competitive rates. Also, some modern financial services are not offered by local banks. While it is theoretically possible for T/Cs to use banks in the ROC, in practice these banks will not finance transactions for companies in the north. This is (officially) because they cannot assure their collateral on any property in the north and because they do not trust "courts" in the north to be objective if a disagreement arose with borrowers (and the GOC does not recognize the authority of T/C courts in any case.) Of course, the GOC would strongly object to any loans made that somehow utilized "G/C owned" land in the north (75 - 85 percent of total land there) and the the Central Bank would most likely apply a very high risk-rating to all loans G/C banks made in the north given these factors. As a practical matter, no G/C bank would even consider making loans to businesses located in the north due to the political cost of such action. ¶8. (SBU) The 18 local and six foreign (Turkish) banks operating in the "TRNC" are hamstrung by the same uncertain status of G/C-owned land in the north and, therefore, either refuse to accept such land as collateral entirely (in the case of Turkish bank branches,) require additional collateral, or apply a steep discount to the collateral value (in the case of T/C-owned banks.) The small size of T/C banks and questionable legal status of the "TRNC" has resulted in T/C bank's access to capital being restricted to sources in the north. This also is manifested in their limited correspondent banking relationships which typically do not include any credit facilities. Cost of communication between banks is also higher than typical for most banks because the international inter-bank communication system, SWIFT, denies northern Cyprus its own country code, something granted almost exclusively to "states." This all raises the cost of funds and operating expenses for T/C banks which they, accordingly, pass on to their customers through high lending rates. Thus, while T/C businesses can theoretically borrow in the south, as a practical matter no G/C bank will lend to them based on assets or business located in the north. Banks in the north have restrained lending capacity, further restricted by lack of acceptable collateral and high expenses; all resulting in high fees and poor credit access for the T/C borrower. Green Line Trade Limited -------------- ¶9. (SBU) Total bilateral trade across the Green Line reached about US$7 million in 2007. The number of transactions per month is typically about two dozen undertaken by about 15 companies with volumes highly volatile and dependent upon what crops are being harvested and the world price for these commodities. The majority of the transactions are for building materials, fruit and vegetables, and irrigation fittings. Trade is significantly hampered by: -The reluctance of retail stores on either side to offer products that are clearly produced by the other community due to concern about political blowback. There has been some limited success selling "no-name" bulk goods including soap and toilet paper. Further reducing T/C ability to export to the south is T/C reluctance to apply EU standards to their manufacturing, labeling and packaging. As one foreign consultant told us, "it's taken a long time to convice the T/Cs that standards are not a G/C plot." NICOSIA 00000146 003 OF 004 -Concern that becoming dependent on supplies from the other side would present unacceptable supply disruption risk. A G/C cheese manufacturer cannot source raw milk in the south sufficient to meet demand for his product. When asked why he doesn't buy milk from T/C dairies (assuming T/C compliance with EU dairy standards),he said that he would not take the risk of a) one side or the other changing the rules so that the milk couldn't cross, b) lack of confidence that the T/Cs could trace the source of any problems in case of contamination and, c) concern that his competitors or some future G/C government would label him a "traitor" for buying milk from animals which "grew fat on occupied G/C land." -The business risk that any transaction could be stopped for political reasons. For example, transactions for the sale of T/C-grown citrus and potatoes have at times been stopped by the "TRNC government" because they were concerned that the goods would be exported by the G/C buyers out of Limassol and sold as "Cypriot" agricultural products. The fact that an orange is highly fungible was less important to the T/C "officials" than the perceived risk that such a transaction might be used by the G/Cs to "prove" that the "TRNC" is not economically isolated. -G/C travel agents refuse to book hotels in the north although there clearly would be added revenue for them for tourists wishing to visit crusader castles or casinos unavailable in the south. It is not illegal for them to make such bookings so long as the hotel is not on "G/C-owned" land. -Although the Cypriot Chamber of Commerce and Industry has offered to help T/C truck drivers to obtain ROC commercial driver's licenses allowing them to do business on both sides of the line, the T/C drivers have refused, following the "TRNC government" line that their "TRNC" commercial licenses meet EU requirements and therefore should be sufficient. The GOC does accept the regular drivers licenses issued by the "TRNC." Limited Foreign Investment -------------- ¶10. (SBU) Because of the question of working with an unrecognized state and the issues related to land ownership, very little foreign direct investment finds its way north of the Green Line. The exception, other than Turkey, comes from a few Israeli real estate developers and individual British citizens buying property because of the relatively low prices. Lack of international finance, strong vested intersts, and the small market size further limit the attractiveness of "north Cyprus" to foreign investors. Even franchises typically refuse to grant franchise/distribution agreements directly to T/Cs due to these concerns and potential disruption to their operations in the south, working instead through their Turkish franchise holders who may then sub-franchise north Cyprus to a T/C. By not having direct links with franchises and brand owners, T/C businesses are effectively kept out of the global supply chain and lack effective communication with many global markets. There have been no instances in which G/Cs and T/Cs cooperate on a franchise or distributorship covering the entire island although this should be possible in theory. ¶11. (SBU) Comment: If T/C businesses chose to try and operate purely on the basis of reducing costs or increasing exports, they would be able to somewhat increase their sales and margins assuming no change in relevant GOC policies. However, "officials" in the north have no incentive to diminish their own authority and so can be expected to continue to put roadblocks in the way of transactions that are designed to bypass "TRNC" institutions. Furthermore, we believe, the Turkish authorities would strongly object to activity seen as strengthening GOC control over northern Cyprus' trade. This all reflects one of the most striking aspects of the problems in Cyprus: politics completely trumps business interests here, even when both sides could come out ahead financially. ¶12. (SBU) Comment continued: The result is an economy in the north that has high costs, low productivity, and is poorly integrated into the global trading and financial regime. T/C businesses have come to depend on subsidies for many operations, damaging competitiveness and transparency. They often use "isolation" as an excuse for not dealing with business problems, including facing the impracticality of operating a modern, competitive and self-sustaining economic infrastructure for a "TRNC" population of about 200,000 with a 2007 "GDP" (PPP basis) of about US$4.5 billion - about the NICOSIA 00000146 004 OF 004 same as the US GDP contribution of Albany, Georgia. The dependence on Turkish financial aid (and concomitant Turkish influence and increasing domination of the business sector) is only enhanced by current GOC policies that in practice, if not entirely in theory, isolate the T/C business community. As we are constantly told by members of the T/C business community, "we just want to do business the way everyone else does." But it has been a long time since they have done "normal" business. SCHLICHER