Cablegate: Central Bank Governor Stays Focused On Inflation

DE RUEHAK #2052/01 2221445
R 101445Z AUG 07






E.O. 12958: N/A
SUBJECT: Central Bank Governor Stays focused on Inflation

1. (SBU) Summary: The Central Bank of Turkey (CBRT) noted in its
recent inflation report that the Government should restrain spending
to help the CBRT meet its inflation target this year. CBRT Governor
Durmus Yilmaz affirmed this view to us, and noted that the CBRT has
not changed its stance despite the current global market volatility
and the expected impact of a bad harvest on food prices. Yilmaz
said external factors are the biggest threat to price stability and
said the CBRT was closely monitoring Turkey's current risks. End

2. (SBU) Central Bank Governor Durmus Yilmaz met with us on July 30.
The meeting coincided with ongoing global market turbulence as
global portfolio investors work to lower their risk profile by
pulling out of emerging markets. Governor Yilmaz said the CBRT is
fully aware of the local risks for Turkey as well as risks arising
from global developments. Yilmaz said that inflation is still
trending downward but any interest rate cut will have to wait until
he has data confirming this trend and the medium term inflation
outlook. The Central Bank currently keeps its simple annual policy
rate at 17.50% (19.12% on compound annual basis) with real interest
rates around 8-9%.

3. (SBU) In his public statements on July 27, the Governor said the
CBRT might increase the reserve requirement ratio for banks if it
perceived excessive credit expansion in the economy. Yilmaz said
CBRT was watching demand-side pressures very closely.

4. (SBU) Yilmaz noted that it was too early to relax on the
disinflation process in part because of increased government
spending before the July elections that constituted a risk to price
stability. Yilmaz also said that external risk factors now are of
more concern than domestic--and that the current "global credit
market problem" could be a major risk for Turkey. Since the CBRT
has no control over these factors, it is even more important for the
government to control spending and for the CBRT to be very cautious
in cutting interest rates.

5. (SBU) The Central Bank has been under attack from exporters and
some government figures because of the strength of the Turkish Lira.
Yilmaz said that the CBRT's policy is to bring inflation down and
keep it within its inflation targets. The appreciation of the lira
is a by-product of the CBRT's anti-inflation policies and increased
confidence in the economy. Yilmaz emphasized that the CBRT does not
target or set exchange rates. When asked whether the bank was
receiving any political pressure, the Governor said that the CBRT
had to listen to government concerns, but should not deviate from
its inflation targeting policy under pressure.

6. (SBU) Increased public spending before the elections caused
budget balances to deteriorate and may cause the primary surplus
ratio to go as low as 5% of GDP this year, versus the 6.5% annual
target. The Central Bank publicly recommended that the Government
introduce some spending measures to stay within budget limits. The
Governor said that there was sufficient coordination among state
agencies, especially between the Central Bank and the Treasury.
Treasury has non-voting representation and shares information at the
Monetary Policy Committee (MPC) meetings. There are also regular
market maker meetings held between banks, the Central Bank and the

7.(SBU) The Governor said inflation was showing a downward trend and
the bank estimated the year-end mid-point of the expected inflation
range to be 6% for 2007 under an assumption of easing in policy
rates in the last quarter. As a result of the hot weather
conditions and a poor harvest caused by the current drought,
unprocessed food prices remain a threat to prices for the remainder
of the year. The Central Bank carries out regular in-house surveys
and the recent July 10 survey was pointing to higher food prices.
The CBRT also expects a higher inflation reading for August and
September due to seasonal factors like increased school spending.

8. (SBU) Comment: Turkey has come a long way on the economic policy
front in the past six years, bringing inflation down from 70% per
year to around 9-10%. The move to a formal inflation targeting
regime in January 2006 commits the CBRT to reducing the annual
inflation rate to 3-4%. Governor Yilmaz is signaling that restraint
on government spending is a necessary, but not sufficient, condition
for interest rates to come down. Even if spending does moderate,
the CBRT may not cut rates until after it sees food and energy price
data. His willingness to call publicly for Government fiscal
restraint before he will consider an interest rate cut is a
noteworthy exercise of CBRT independence, given the intense
political pressure on the bank and the government to ease monetary
policy to avoid an overly-strong lira. The Governor believes that
the government plays a key role in shaping price expectations and

ANKARA 00002052 002 OF 002

any CBRT announcement regarding future measures will have an
immediate impact on wage/price setters. End Comment


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