Cablegate: Electricity Price Issue Holding Up Imf Program

DE RUEHAK #0685/01 0851441
R 261441Z MAR 07





E.O. 12958: N/A


1. (SBU) Summary: The IMF mission left Ankara March 21
without reaching agreement on the terms of the Sixth Review.
Both sides, however, were at pains to explain that agreement
was reached in every area but one: what to do about the
fiscal impact of constant electricity prices charged by
state-owned energy companies, despite higher fuel costs. The
two sides are working to reach agreement through cost cuts
since the Government seems determined not to raise
electricity prices before elections. Agreement was reached
on spending cuts to make up for overspending in 2006 and
subsequent populist measures that could hurt 2007 fiscal
balances. The Government persuaded IMF staff that it was
unrealistic to try to submit pass social security reform
legislation before the elections. End Summary.

IMF Leaves Without a Deal

2. (SBU) Following the more collegial Article IV discussions
(reftel) the IMF Mission embarked on negotiations on the
Sixth Review under its Standby Program. Ultimately, the Fund
mission finally left town March 21 without having reached
agreement with the authorities -- a relatively rare
occurrence for IMF missions here. In the absence of an
agreement, the customary press conference was not held, but
both sides issued public statements to the effect that broad
agreement had been reached in all areas except state energy
company finances. Minister Babacan followed up with an
appearance before the press March 22. We met with IMF and
Turkish Treasury officials to get a fuller picture.

Compensating Fiscal Measures

3. (SBU) Thanks largely to one-off revenues, in 2006 the
Government overperformed on the centerpiece primary surplus
target of 6.5% of GDP. On the spending side, however, the
Government violated its agreement with the Fund not to spend
any of the overperformance and exceeded explicit spending
caps. To compensate for this overspending, it was agreed
that 0.3% of GDP of spending cuts would be enacted in 2007.
The outlook for 2007 performance has also been clouded by a
series of measures, opposed by the IMF, such as expanding the
number of provinces eligible for investment incentives,
increasing pension payments more than projected, and cutting
special consumption taxes on vehicles. Another 0.3% of GDP
in cuts was therefore agreed by the two sides to bring
projected fiscal balances back in line with the 2007 budget.
The cuts are to expected to be spread across the budget,
however, the public investment budget is likely to take the
biggest hit.

Health Care Spending Still Problematic

4. (SBU) As during all recent IMF reviews, Fund staff was
concerned about controlling the growth of health spending.
The IMF's fear is that spending will exceed the 2007 budgeted
allocation due to insufficient controls. In the end, an
understanding was reached after a 14-hour overnight meeting
with four ministers including the Health Minister Recep
Akdag. On the one hand, the Government, including the Health
Minister personally, committed not to exceed the budget. To
give credibility to this commitment, additional work is being
done on mechanisms to better control spending by hospitals.
Among these are monitoring of individual invoices submitted
by hospitals to the Social Security Administration,
instituting partial reimbursement to hospitals when they go
over hospital-specific spending limits, auditing 5-10% of
bills submitted, and keeping bonus payments to doctors at the
2006 level.

State Energy Company Finances

5. (SBU) Beyond the central government, achievement of the
overall public sector's primary surplus target could be
threatened by financial weakness at state energy companies,
particularly the electricity distribution company TEDAS and
the gas company BOTAS. The root of these companies'
financial problems is the Government's refusal to raise

ANKARA 00000685 002 OF 003

electricity prices which have remained constant since 2002
despite a doubling of world oil prices. Although Babacan
and some other minsiters agreed in principle to electricity
price increases in November, the politics of increasing
electricity prices in an election year have trumped other
considerations. In the end, this was the only area in which
the mission and the Government could not reach agreement.
Discussions are continuing, with the IMF pushing both for
electricity price increases and for a structural fix to take
pricing decisions out of the hands of politicians, by passing
a law with an automatic formula. In the short run, however,
Babacan stated publicly that the Government will not agree to
price increases, and will seek to make up for the state
company's financial weakness through spending cuts or
efficiencies, which the IMF told us they may have to accept,
at least until after the elections. If cuts at the companies
themselves are insufficient, the IMF will demand cuts
elsewhere in the public sector.

Social Security Reform Postponed

6. (SBU) Following the Constitutional Court's invalidation of
the Social Security reform law, the Government had announced
it would submit revised legislation by July 1. When the IMF
mission came, however, the Government argued that trying to
push through legislation by July 1 was unrealistic and ran
the risk that parliamentarians -- even from the ruling party
-- would water down the reform under electoral pressure.
There is also a very narrow window in which the legislation
could be considered: parliament will be entirely focused on
presidential elections from April 15 to May 15, after which
parliamentarians will be distracted by upcoming parliamentary
elections, widely expected to be called earlier than

7. (SBU) In the end, the IMF team was persuaded by the
Government's argument. The IMF believes the Government is
committed to the reform since they have passed it twice. The
Government's plan is to issue a new white paper, with several
options that come close to achieving the savings in the
original plan but still have a good chance of being
acceptable to the Constitutional Court. After consultation
with labor unions and other stakeholders, the Government
would submit legislation, but only after elections.

Other Structural Reforms

8. (SBU) The IMF was frustrated with the Government's
decision to privatize Halk Bank in two stages, with a
minority share IPO first, since the goal of privatization is
to move control to the private sector rather than just raise
money. IMF officials told us that the outside advisors had
recommended a block sale up front as the preferred option.
The one advantage of the IPO-first strategy that the IMF
acknowledged was that it would set a market price for Halk
Bank, thereby undermining critics who might claim that the
Government was selling Halk at a fire sale price.

9. (SBU) President Sezer's veto of the second stage of the
personal income tax reform was because of a clause on tobacco
and alcohol taxes that was of no importance to the IMF. The
Government has removed the offending clause and will
reportedly re-submit the legislation in the coming week or

10. (SBU) The IMF's Financial Sector Assessment team was also
in Ankara to wrap up its work. The FSAP is expected to go to
the board along with the Article IV document, either
simultaneous to the Sixth Review or sooner, if the Sixth
Review document is not ready. A Turkish Treasury official
told us there were no significant concerns about the banking
sector raised in the FSAP and the IMF officials did not
mention it. This tracks with a widespread view that the
banking sector has strengthened considerably over the last
two or three years.

Board Vote in May?

11. (SBU) The plan now is for a Letter of Intent Signature in
early May and a board vote in late May. Given the necessity
of Government follow-up actions and the track record, we
would be inclined to bet this will slip a bit, especially in

ANKARA 00000685 003 OF 003

the context of presidential elections. In the end, however,
the IMF and the Government both have a big stake in keeping
the program alive.

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