TURKEY: RESPONSE TO INFORMATION REQUEST IN ADVANCE

C O N F I D E N T I A L ANKARA 000339 SIPDIS STATE/EEB/OMA ALEX WHITTINGTON; TREASURY/IMB BILL MURDEN, WILBUR MONROE AND MARY BEASLEY E.O. 12958: DECL: 03/04/2019 TAGS: ECON EFIN TU SUBJECT: TURKEY: RESPONSE TO INFORMATION REQUEST IN ADVANCE OF G-20 MEETINGS REF: A. SECSTATE 17502 ¶B. ANKARA 334 ¶C. ANKARA 313 ¶D. ANKARA 297 ¶E. ANKARA 281 ¶F. ANKARA 250 ¶G. ANKARA 205 ¶H. ANKARA 201 ¶I. ANKARA 195 ¶J. ANKARA 118 ¶K. 08 ANKARA 2180 ¶L. 08 ANKARA 2087 ¶M. 08 ANKARA 1014 Classified By: Economic counselor Dale Eppler for reasons 1.4 b, d ¶1. (C) Responses to reftel A questions for Turkey follow below. As requested, electronic copies of reftels B-M (referred to below) will be sent to recipients listed in reftel A. Summary of Key Issues Stimulus: What has been proposed thus far? What more is being considered? Is there capacity to implement current and potential future measures? Answer: As reported Ankara 313, the GOT passed a so-called Crisis Response package on February 18. However, the package consists mainly of measures that had been under consideration since before the crisis hit Turkey, and provides little in the way of direct stimulus (cost will be about USD $1.5 billion, or 0.24% of GDP). The GOT has increased spending sharply in recent months, but this is attributable more to front-loaded budget spending in advance of March elections than additional spending to stimulate the economy. There is limited capacity to undertake fiscal stimulus. The GOT faces declining revenues and likely will have to revise the 2009 budget and reduce spending. The IMF is strongly of the opinion that the GOT should not increase spending to avoid crowding the private sector out of credit markets, and any significant stimulus package would complicate Turkey,s negotiations with the IMF on a new Stand By Agreement. See 08 Ankara 2180 and Ankara 250. Financial Sector: What has been the approach to resolving bad assets: ring fencing, injection of capital, nationalization? Answer: The GOT has not yet seen significant volumes of bad assets. Turkish banks entered the crisis without any exposure to mortgage derivatives or other impaired assets. Non-performing loans, however, have increased sharply in recent months, and banks have tightened lending. Banks, non-bank financial institutions, and the corporate sector are all drawing in and shrinking their balance sheets. We have not seen any signs of nationalization or ring fencing. On regulation: what changes, national or supranational reforms are being implemented or considered? Answer: The Central Bank and Bank Regulatory Agency have taken some actions to increase foreign exchange liquidity, the most acute problem in Turkish financial markets. The Central Bank also announced new rules for providing emergency liquidity to banks, although no bank appears to be in need of such help at this time. Real Economy: Have sensitive and vulnerable sectors been identified and protected? If so, by what means? Have governments commented on WTO commitments? What is the tenor of government and public discussion regarding protectionism? Answer: The government has identified six "critical" sectors and is planning tailored rescue packages for each, but the plans have not been announced. These are: automotive, maritime, contracting/construction, tourism, iron and steel, and textiles. The crisis response to date has consisted mostly of extending existing tax breaks and investment incentives, but there is some expectation that the sectoral packages may provide such things as reduced electricity costs or consumer tax discounts. The government has not formally commented on WTO commitments but has privately stated that it intends to honor its treaty obligations. There have been individual calls for protectionism from the private sector, but no overt GOT discussion of raising tariffs. See Ankara 118 (automotive sector) and 08 Ankara 2087 (protectionism) Social/Labor Impact: What steps have been taken to address an increase in unemployment? Have governments extended or provided new benefits to assist the unemployed? How is this being funded? What is the level of public protest related to the economic crisis and government response? Answer: As noted above, the February Crisis Response package (Ankara 313) contained some measures to extend current temporary employment subsidies. There has not been any significant public protest in Turkey about the economic crisis or government response, though Turks cite unemployment as their major economic concern. There have been frequent complaints from business groups about the lack of government response. See also 08 Ankara 1014, Ankara 250 and Ankara ¶297. Dimension of the Crisis: What are the concerns regarding scope and duration of the current economic situation? What are views on the impact on emerging markets? What is the exposure of cross-border financial institutions? Have any proposals been put forward to assist such markets and institutions? Answer: The crisis is hitting Turkey primarily through the trade channel, with exports to the EU and Russia down sharply. This is having a follow-on effect in the real economy and will eventually cause some deterioration in Turkish bank balance sheets. There is significant concern about how long the crisis will last and that Turkey,s export-led growth model has left its economy dependent on recovery in foreign markets. Turkish banks have very little foreign exposure. The non-bank financial sector, however, borrowed heavily in foreign currency in recent years, and faces a repayment bulge in 2009 of around $100 billion. Depending on how much of that debt can be rolled over, there could be FX liquidity problems later in the year. As noted above, the Central Bank and Bank Regulatory Agency have taken measures to increase FX liquidity. A new IMF Stand By Agreement, however, would provide a much greater degree of confidence and relieve FX liquidity concerns. Role of the G-20: How is the G-20 process viewed? What is the level of support for the process? How is the G-20 process seen in terms of other multilateral processes and global economic architecture? Answer: The G-20 process is very important for Turkey and the GOT is devoting significant assets, personnel, and brain power to the process. Turkey sees the G-20 as a way for it to gain its rightful place on the world financial stage. See Ankara 334 for GOT views on the process and its positions going into the London Summit. Specific Questions: ¶I. Objectives for the London Summit: ¶A. In the run up to the London Summit, what are the issues of greatest importance to the host government? Answer: See Ankara 334 ("Turkish Expectations for London Summit"). The GOT is focusing its attention on working groups 3 and 4, addressing the role of the IMF and MDBs. Turkey is a major borrower from the World Bank, and becomes a recipient of EBRD funding for the first time this year. It also has been ONE of the IMF's largest borrowers for the past nine years, and is negotiating a new Stand By Agreement with the Fund. ¶B. Based on public comments made by host government officials, what are the country's likely objectives for the summit? Answer: The GOT has not made any public comments about the Summit. From private conversations (as reported Ankara 334), the GOT wants to see substantive announcements at the London Summit that increase public confidence that the crisis is being managed. They believe lack of international coordination was a major contributor to the crisis and a necessary part of any recovery. It wants to see greater emerging market participation in the IMF, and to keep multilateral development banks focused on middle income countries like Turkey. ¶C. Are there desired outcomes that officials have identified publicly? Answer: Not publicly. ¶D. Based on public information, what recommendations or reforms might the host government suggest? For example, is the host government proposing changes to international financial architecture, reform of international financial institutions, or advocating the creation of new international bodies? Is the host government proposing additional regulation of financial products or institutions, making changes to existing regulatory standards, or advocating new best practices? The GOT has not made any public pronouncements on this. GOT private views on reforms and positions were reported in Ankara 334. II. Impacts of the Global Financial Crisis: ¶E. What are the host government's greatest financial market concerns (providing more liquidity to financial institutions, dealing with bad assets, injecting fresh capital, improving housing markets, guaranteeing deposits, making trade finance available, etc.)? Answer: Providing sufficient foreign exchange for the private sector to settle its FX-denominated debts this year is the most acute concern. It also wants to ensure that credit remains available to small and medium sized enterprises. ¶F. What are the most important impacts on the host country's financial sector (what specific financial institutions have failed, which ones have had liquidity/solvency problems, has domestic lending to the corporate sector been affected, etc.)? Answer: The Turkish banking sector started the crisis with a low level of non-performing loans and excellent capital adequacy ratios. Turkish banks now are in defensive mode, shrinking their balance sheets, buying GOT bonds, calling loans early to collect or renegotiate terms, and generally hoping to weather the storm. So far, most business owners we have talked to are frustrated with the conservative stance taken by their lenders. We are not hearing about problems getting financing. It is more expensive and offered on a short-term basis, but it is available. ¶G. What initiatives has the government taken in response to the financial crisis (has the government rescued financial institutions, provided capital injections or credit lines, changed its deposit insurance guarantees, provided interbank guarantees, established asset purchase programs, trade finance, etc.)? Answer: As noted above, the Central Bank and Bank Regulatory Agency have taken some steps to make foreign exchange more available (see 08 Ankara 1864),including the Central Bank acting as a counterparty in the interbank lending market. The parliament gave the council of ministers the authority to raise the bank deposit guarantee (currently TL 37,000 or US$ 21,700),but the ministers have not used that authority. The GOT also has increased the amount of trade finance available from the Turkish Eximbank. III. The Broader Economic Crisis ¶H. What are the most important impacts on the host country's real economy? What steps has the host government taken to mitigate the effects of the crisis? Answer: As exports have fallen sharply in the past 5 months, the unemployment rate has increased sharply, particularly in the textiles, automotive and steel sectors. Official unemployment increased to 12.3%in November, and Turkey lost another 150,000 jobs in December alone, according to the Turkish Chamber of Commerce. These numbers are for the formal sector. Estimates for unemployment in the large informal sector are as high as 25%. The GOT,s response has been slow and uncoordinated (see Ankara 250, "Turkey,s Crisis Response: A Study in Inaction."). A 110-page Crisis Response package passed on February 18 failed to meet private sector expectations (see Ankara 313). Sector-specific assistance legislation is expected for the six "critical" sectors -- automotive, maritime, contracting/construction, tourism, iron and steel, and textiles -- but remains in the drafting stage. ¶I. What has been the impact on trade, trade finance, and employment in export-oriented sectors? Are there problems financing exports and/or imports? If so, in which sectors? How is the host government attempting to address these problems? Answer: Trade has taken a direct hit from the crisis. In January 2009, exports were down 25.7% from the previous January and imports were down 43.3%. The automotive industry has been especially hard hit, with automotive exports down 67%. There has not yet been any difficulty financing either exports or imports (especially as the trade balance narrows), but if an IMF deal does not come through soon, Turkish companies may face serious difficulties financing their extensive foreign obligations. The GOT has not yet formally addressed this problem, but it is expected that the sectoral packages may contain some eased terms of credit for exporters. ¶J. How has the crisis impacted the host government's outlook on trade and investment? Has there been a perceivable shift in how the government and population view the benefits of international trade? Are political pressures growing for protectionist policies? Are measures being taken or contemplated that would impose costs on other countries in an attempt to meet domestic needs (e.g., tariff hikes, import licensing or other trade restrictions on, or discrimination against, foreign investors)? Is the host government considering capital controls? On the other hand, is the host government considering easing investment restrictions in an effort to encourage foreign investment? Answer: The government is still very open to investment and has, if anything, been trying to make it easier for foreign firms to invest. Turkey's growth in recent years has been led by exports, and while this has made them vulnerable to the crisis there have not been many calls for a change in this export-led growth strategy. The emphasis in public discussion has been less on outright protectionism and more on making Turkish goods competitive with rivals (particularly China and India) and on "leveling the playing field" by having the government shoulder some labor and electricity costs (the latter among the world's highest). Turkey has imposed two new licensing requirements: 1) a requirement that all firms in the textile supply chain register with the nearest Turkish consulate or Embassy (a reaction to a similar scheme from China) and 2) new import documentation requirements for certain goods such as medical devices coming from outside of the EU Customs Union. This second set of requirements is part of an initiative that predated the crisis, but still imposes some hardship on non-EU exporters. The Ministry of HEALTH has also taken some actions in favor of local generic pharmaceutical companies at the expense of foreign firms. There has been no talk of capital controls. ¶K. Do financial sector/industry bailouts or stimulus packages have local preferences? Is the government acting to influence the value of its currency (for example, to improve export competitiveness)? Answer: There have not been any financial or industry bailouts in Turkey in the past year. The recently passed Crisis Response package contains regional preferences for investment and employment in Turkey,s poorer southeast and eastern provinces. There is no indication that the GOT or Central Bank is trying to manipulate the value of the Turkish lira to improve Turkish competitiveness. The Central Bank's Monetary Policy Committee does consider the inflationary impact of lira depreciation when making interest rate decisions. IV. Near-term Outlook and Political/Foreign Policy Ramifications ¶L. How has the outlook for growth, inflation, the current account, exchange rates, and the budget deficit changed? What are the biggest economic challenges facing the host country in the coming months and year? How is this crisis expected to affect employment? Answer: Growth expectations have dropped sharply, with only the GOT expecting positive growth in 2009 (the IMF estimates -1.5%, and private forecasts range from -0.5 to -5%). Inflation is expected to drop sharply, a result not only of the economic slowdown but also from the sharp drop in energy prices. The Current Account Deficit, which was Turkey,s largest macroeconomic liability last year (at 5.8% of GDP), is expected to be sharply lower (estimated at around 2-3% of GDP) this year. Exchange rate forecasts depend on assumptions, particularly about whether there will be a new IMF Stand By Agreement and, if so, its size and timing. Unemployment has increased significantly, to 12.3% in November officially, and estimated to be around 25% in the large, informal economy. ¶M. What are the potential political ramifications for the host country? How might the crisis directly impact leadership? Is a change of government a possibility? What are the social and security ramifications of the crisis? Answer: While unemployment is a major issue for Turkish voters, the ruling Justice and Development Party (AKP) is unlikely to face a sustained leadership challenge as a result of the economic downturn, and may even strengthen its dominance of Turkish politics following March 29 local elections. The party is credited generally for competent economic management compared to previous governments and voters do not appear to be subscribing in large numbers to the economic platforms of parliamentary opposition parties. Most voters seem to agree with AKP's rhetoric that the GOT is not responsible for the economic woes ) all the problems come from outside. A recent IRI poll confirmed this fact. Recent protests against perceived inaction by the government to address unemployment have been isolated but, in some cases, dramatic and well-publicized, including a handful of reported suicides and suicide attempts, including ONE such attempt in front of the Prime Ministry. This suggests rising frustration among the Turkish public over the economy. See Ankara 281, 205, 201, and 195. ¶N. Has the host government criticized and/or become significantly more critical of the United States for its role in the crisis or for provisions in the U.S. economic stimulus package (such as the "Buy American" provision)? Answer: No, it has not. ¶O. How might the crisis affect host government foreign or security policy and U.S. interests? Answer: Most directly, the crisis will reduce GOT revenues and limit Turkey,s ability to finance activities of key interest to the USG, such as greater participation in operations in Afghanistan, peacekeeping, military exercises, weapons system procurements, etc. If the crisis is deep and prolonged, it could provoke a populist, nationalist and protectionist reaction that could hurt US economic and commercial interests. ¶P. How might the crisis impact the host government's ability and commitment to sustain foreign assistance levels? Answer: We do not expect a significant reduction in foreign assistance levels from the 2009 budget (in lira terms),but assistance spending may slow down later in the year if the drop in revenues is acute, and could be reduced if an amended budget bill is passed. The crisis will, however, make it harder to convince Turkey to increase its assistance in response to USG requests. Since the budget is in Turkish lira, the continued depreciation of the lira will result in a reduction in assistance in dollar terms. ¶Q. How might the crisis impact government support for global peacekeeping operations and commitments to NATO operations, e.g., in Afghanistan? Answer:Answer: We do not expect any reduction in current NATO-related international security commitments, including Turkey,s contributions to the International Security Assistance Force in Afghanistan. However, additional expenditures to support the increased levels of Turkish troop strength and military equipment for Afghanistan that the U.S. has been requesting Turkey to consider could be adversely affected. Visit Ankara's Classified Web Site at http://www.intelink.sgov.gov/wiki/Portal:Turk ey Jeffrey