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Cablegate: Istanbul Bankers Paint Pessimistic Picture

VZCZCXRO0253
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHIT #0187/01 1080717
ZNR UUUUU ZZH
P 170717Z APR 08
FM AMCONSUL ISTANBUL
TO RUEHC/SECSTATE WASHDC PRIORITY 8044
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 ISTANBUL 000187

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR J.ROSE
USDOC FOR 4200/ITA/MAC/EUR/PDYCK/CRUSNAK

E.O. 12958: N/A
TAGS: EFIN ECON PGOV TU
SUBJECT: ISTANBUL BANKERS PAINT PESSIMISTIC PICTURE

REF: A. ANKARA 654
B. ANKARA 642
C. ANKARA 527
D. ANKARA 473

1. (SBU) Summary. Istanbul-based investment analysts
describe a much more fragile picture than six months ago --
including stubborn inflation, a weakening lira, slowing
growth and the possibility of an interest rate hike that
would further hammer the real economy. External factors, in
particular the economic slow down in the United States and
the tight global credit market, are most important but
internal factors are making a bad situation worse. Rumors of
a policy shift at the Central Bank are becoming more
prevalent as analysts see little choice but for the Central
Bank to abandon the 4% inflation target in the face of
expectations in the high single digits and an inflation rate
that has stubbornly refused to converge over the past two
years. Privatizations and the $18 billion FDI target appear
optimistic given market conditions with one analyst
predicting significant FDI deceleration. End summary.

External Factors
----------------

2. (SBU) Turkey is highly dependant on international capital
flows to finance its $52 billion current account deficit.
The global credit crunch therefore hits Turkey harder than
many other emerging markets. EFG Istanbul Securities chief
economist Baturalp Candemir argued that unless global credit
markets suddenly improve, Turkey's monetary policy makers
will have to choose between hiking interest rates, thereby
sacrificing growth, and permitting further currency
depreciation. So far this year the lira is already down by
approximately 15% against an equally weighted dollar-euro
basket and Candemir believes the lira has further to fall.
Comment: Given a net private sector foreign debt mismatch in
the $50-70 billion range (ref D) a significant decline in
the lira's value would put pressure on Turkish companies that
have borrowed abroad to take advantage of lower interest
rates, but lack foreign currency earnings to back up the
debt. End Comment.

3. (SBU) Murat Gulkan, Deutsche Securities chief strategist,
sees an increased probability of rate hikes both to maintain
external financing and to signal Central Bank resolve should
the Central Bank revise upward its 4% inflation target.
Inflation is continuing to drift away from the 4% plus or
minus 2 target, which all market observers agree will be
impossible to meet again this year. For the last two years,
inflation expectations, although higher than the target, have
consistently underestimated actual inflation. If the market
decides the target is not credible, forward looking inflation
expectations could spiral upward quickly and getting
expectations back under control would likely prove difficult,
Gulkan explained. If the Central Bank re-sets the inflation
target at a higher level, an interest rate hike accompanying
the announcement would telegraph the Central Bank's
commitment to meet the new target "at any cost."

4. (SBU) Privatizations will also be relatively difficult
this year (ref B). Deutsche Securities is handling the Turk
Telekom deal and it is proving to be a hard sell. The
Halkbank sale may be postponed due to unfavorable market
conditions - "Why buy Halkbank at a share price higher than
Citibank's?" Gulkan asked rhetorically, noting the IPO sale
price was a psychological floor below which the GOT was
unlikely to accept. Electricity distribution sales will be
broken up by region and although some regions are likely to
attract strong local interest, other regions are much less
attractive. Candemir believes foreign direct investment is
unlikely to meet the 2008 target of $18 billion given market
conditions and sees $13-14 billion as a more realistic level.
He argues that FDI cannot be sustained at current levels and
will decelerate to a sustainable annual range of $8-10
billion now that mergers and acquisitions in the financial
sector are complete and privatization is winding down.

Internal Problems
-----------------

5. (SBU) Candemir contrasted the current situation with the
initial six to eight months of the first AKP government, when
the economy was facing a serious debt crisis and the GOT made
a number of important decisions in quick succession. He
argues current performance is lacking both on economic policy
and on EU (political) reforms. Noting the length of time it

ISTANBUL 00000187 002 OF 002


took for the GOT to announce a relatively straightforward
electricity price increase last fall, he claims the economic
decision making process is "clearly flawed" in comparison to
the former government. The most likely culprit is Cabinet
composition, possibly exacerbated by overconfidence or lack
of understanding of how serious the economic problems facing
Turkey are on the part of the Prime Minister. He notes the
GOT's failure to carry through on any subject - political or
economic - and argues the GOT appears to be "disorganized to
the point of chaos." (See Ankara 198 on this.)

6. (SBU) Additional reforms, including judicial reform, are
necessary but will be seen as political retaliation in
today's tense climate, Candemir noted. The market would
applaud a precautionary stand-by agreement with the IMF (ref
A), but he doubts the IMF would be able to convince the GOT
to take steps that it would not otherwise take on its own.
The EU, while still playing a vocal role, has squandered good
will and done lasting damage to the accession process by
being perceived as biased against Turkey, argued Gulkan.

7. (SBU) Both Gulkan and Candemir echo the received wisdom
in Istanbul financial circles - "Turkey's entrenched secular
elite are complete economic illiterates, unable to comprehend
either how global trends affect Turkey or how domestic
Turkish politics are perceived by markets." Gulkan argues
the judiciary, with support from the military, prompted
current political tensions by bringing a closure case against
the ruling AKP but failed to anticipate how markets would
react and lacks a clear idea of how to move forward. For
its part, the ruling party is constrained by unforgiving
external circumstances and internal opponents who don't
understand the nature of the problem. Gulkan however sees a
one in three chance the two sides will be able to work out
some sort of compromise that could result in the AKP being
cautioned rather than disbanded.

Comment
-------

8. (SBU) Candemir and Gulkan's analysis is significantly
less positive than it was in the pre-sub prime melt-down
environment. Much of the problem is not of the GOT's making,
and cannot be solved from Ankara, but some of it could have
been headed off or reduced if the GOT had moved forward on
its economic reform agenda at the start of the second AKP
government. When political tensions erupted in April 2007,
the global credit environment was much more benign,
international investors were focused on relative interest
rate differentials and largely discounted early elections and
related political turmoil. The external environment is now
much less forgiving and may force economic policy makers to
make decisions, such as hiking interest rates or allowing the
lira to weaken significantly, that would have a significant
negative impact on the real economy.
WIENER

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