TURKEY: IMF DEAL REQUIRES POLITICAL DECISION

C O N F I D E N T I A L ANKARA 000153

SIPDIS

EEB/IFD/OMA FOR ANDREW SNOW
TREASURY FOR FRANCISCO PARODI

E.O. 12958: DECL: 01/30/2019
TAGS: EFIN ECON TU
SUBJECT: TURKEY: IMF DEAL REQUIRES POLITICAL DECISION

REF: A. ANKARA 122

B. ANKARA 85

C. ANKARA 68

Classified By: Econ Counselor Dale Eppler for reasons 1.4(b,d)


1. (C) Summary: When the GOT and IMF suspended negotiations
on January 26, they were apart on key issues such as the type
and quality of spending cuts, the terms of a fiscal rule,
reduction of disbursements to municipalities, and the need to
beef up taxation and enforcement. While the GOT has said
publicly that the break is for 10 days, Treasury Minister
Simsek has privately told the Fund that it should not send a
Mission back to Turkey until they are ready to conclude an
agreement. IMF Deputy Resident Rep Lombardo said the GOT has
to make a political decision on what it is willing to commit
to, and put those commitments in the letter of intent with
measurable performance goals. He thought a letter of intent
could be signed before March elections. The two sides are
"in the ballpark" on the amount of adjustment needed and the
size of an agreement. There still is no firm agreement on
how funds would be passed through to the real sector, with
doubts about whether the credit channel is open. End
summary.


2. (SBU) The GOT and IMF announced January 26 that they were
temporarily suspending talks after nearly three weeks of
negotiations. The GOT said publicly there would be 10-day
break in talks, while both sides reviewed and discussed
structural issues and possible changes to fiscal policy. On
January 28, Prime Minister Erdogan and Treasury Minister
Simsek traveled to the World Economic Forum in Davos,
Switzerland and held two lengthy meetings with IMF Deputy
Managing Director John Lipsky (reportedly, the meetings began
at midnight and ran until 3 AM). Press reports quoted the
Prime Minister afterwards as saying he liked Lipsky,s
approach and hoped an agreement would be reached, but also it
would not be "the end of the world" if Turkey did not sign a
deal with the IMF. Markets have taken this break in stride,
amid widespread expectation that a deal ultimately will be
signed. Analyst opinion is mainly divided over whether the
deal would be concluded before or after March 29 municipal
elections.

What,s Still on the Table?
--------------


3. (C) Prior to the January 26 suspension, our understanding
was that the talks were bogged down over several key issues:

-- The Quality of Spending Cuts -- Against the IMF,s express
request, the GOT had made cuts almost exclusively in
investment spending, and had indicated that it would cut
investment spending further if the Fund demanded additional
spending cuts. The Fund wanted the GOT to reverse those
investment cuts (arguing they only postpone needed
investments and don,t fix institutionalized overspending)
and instead wanted cuts in spending that the GOT said were
politically unacceptable, e.g., capping civil service wage
increases, reducing municipal spending, and taxing pension
income of retirees under age 60.

-- Medium term fiscal controls -- After the GOT released its
2008 budget performance report, showing that Turkey had
missed its primary fiscal target for the third year in a row,
the IMF had begun to stiffen its position on reforms needed
to improve Turkey,s fiscal performance in the medium term,
such as reforming tax administration, increasing auditing,
and cracking down on informal employment. The Fund wanted a
very credible program to convince investors that the targets
were real. The GOT objected to being penalized for actions
under the prior Stand-By Agreement, and Turkish Treasury had
not been able to get agreement from the Finance Ministry on
tax administration reforms.

-- Designing the Fiscal Rule -- One key component of the
medium term fiscal plan is creating a binding fiscal rule for
Turkey. The IMF hosted a workshop in December with
international experts who spoke about how fiscal rules work
in other countries, but the GOT had not yet made a proposal
for a Turkish fiscal rule, and had not yet decided on touchy
design elements such as enforceability and whether to create
an independent agency.

-- How to get IMF funds to the private sector -- both sides
agreed that the Turkish corporate sector will need access to
foreign exchange for debt payments in 2009. But there are
doubts on both sides whether the banking sector can act as
the conduit, because they are reluctant to lend in current
economic conditions.


4. (C) Davide Lombardo, IMF Deputy Resident Representative,
told Econoff January 30 that it "was not and is not" his
impression that the GOT is delaying a deal until after the
March 29 municipal elections. However, the GOT must make a
political decision on what it is willing to commit to, and
those commitments must be outlined with measurable goals in
the letter of intent. Lombardo said that it is increasingly
clear that 2009 will be a difficult year and that GOT debt
levels will increase. The IMF wants to see structural
reforms and fiscal adjustments for the short to medium term
that will convince investors that 2009 is a short-term hiccup
and not the beginning of a reversal of Turkey's commitment to
fiscal responsibility and reform. The IMF and GOT appear to
be apart on the terms of a fiscal rule, reduction of
disbursements to municipalities, and the need to beef up
taxation and enforcement. They are "in the ballpark" on the
amount of adjustment needed and the size of a deal. The Fund
believes any new agreement must last at least two budget
cycles, to allow the GOT time to show improvements and ensure
that debt reduction continues.


5. (C) There still was no firm agreement on how funds would
be passed through to the real sector. Lombardo said the
preferred GOT mechanism would be to give the money to the
Treasury Ministry, which would deposit it in the Central Bank
and use it to make debt payments. Theoretically, this would
reduce GOT borrowing and free up foreign exchange held by
banks for use by the corporate sector to make debt payments
and fund operations. But there are still doubts about the
willingness of banks to lend in the current grim economic
environment. If this credit channel is blocked in whole or
part, both sides have to consider how else to get money to
the businesses that need it. (Note: In conversations with
banks, banking regulators, and business people, we hear
disparate views on the current willingness of banks to make
business loans. End note.)


6. (C) Lombardo said that the IMF Mission is willing to
return in February with additional structural experts.
However, Treasury Minister Simsek had privately made clear
that the Mission should not return until they are ready to
close an agreement. Simsek wants both sides to make progress
"remotely" before another trip is planned.

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

Jeffrey