Cablegate: Istanbul Economic Pessimism: "Muddling Through" As

This record is a partial extract of the original cable. The full text of the original cable is not available.





E.O. 12958: N/A


Sensitive but unclassified. Not for internet distribution.

1. (SBU) Summary: While not quite so pessimistic as they
were two weeks ago about Turkey's immediate economic
prospects, Istanbul financial analysts remain decidedly
gloomy about the country's mid-term future. All agree that
the Treasury seems to have next week's debt auction well in
hand. In the mid-term, however, there is consensus that 30
percent real interest rates are not sustainable, and will
shift for better or worse. Though an upside is "technically
possible," in the words of former Disbank Chairman Vural
Akisik, such an evolution would require government
credibility in the markets, currently a sorely lacking
commodity. Akisik and others stressed that at root (and
counterintuitively) the problem is not fiscal. Turkey today
enjoys the best economic fundamentals it has had in a decade.
But without unstinting government commitment to
half-heartedly accepted and long-delayed structural reforms,
interest rates will not come down to a sustainable level.
End Summary.

2. (SBU) Less short-term angst...: In a round of meetings
during the week of March 31 with visiting Ankara DCM, Ankara
Econ Counselor, and Istanbul Pol/Econ Chief, financial and
real sector interlocutors indicated that their concerns had
eased about the short-term sustainability of Turkey's debt.
All agreed that the Treasury should be able to roll over the
4.8 quadrillion TL in treasury bills that come due on April
9. Analysts point to several factors: most importantly, the
country's sentiment-driven markets, initally alarmed by a
perceived breach in U.S.-Turkish relations at a time the
country appeared increasingly isolated in Europe, have been
calmed by Secretary Powell's visit and the proposed 1 billion
USD assistance package. A range of technical factors also
provide a safety margin to the Treasury: tax collections in
March and April should provide some ready cash, while the
state banks (little used in recent auctions) can step in as
a last resort.

3. (SBU) ...but long-term gloom: Our interlocutors concurred,
however, that in the medium to long-term it is hard to be
hopeful. ING Barings Managing Director John McCarthy noted
that given the current situation, one is "stretched for
positive arguments" about Turkey's situation. With the
economy at a standstill, the country is coming to a "dark
time," he warned, and will have to seriously face up to the
structural issues it has long ducked, or face a crisis along
the lines of Mexico in the 1990s. Others were similarly
pessimistic--Bender analysts Murat Gulkan and Emin Ozturk see
"muddling through" as the best case scenario for Turkey, and
can see no scenario for growth in the mid-term. Ozturk noted
that there are few engines for growth this year (only exports
seem poised for a positive performance, while consumption,
public sector investment and tourism are all down), and a
business decision to draw down inventories (which accounted
for a large proportion of the growth in the fourth quarter of
2002) could cause the economy to contract.

4. (SBU) Positive fundamentals, but: Gulkan and Ozturk
stressed that at root the problem is not fiscal, given that
Turkey currently enjoys the best economic fundamentals it has
seen in a decade. Continued strong performance on the fiscal
side is a necessary but not sufficient condition for turning
the economy around. Instead, they argued, the government
must stop sending mixed signals to the markets and instead
push the reform program wholeheartedly. Former Disbank
Chairman Vural Akisik echoed this point, noting that Turkey's
macro base is better than it has been since 1994. Because of
that, observers believe the government can get through the
next months by "spending the ammunition" it has accumulated.
But to achieve a sustainable real interest rate (which Akisik
calculates at 35 percent), the government must have
credibility with the markets, something that is now almost
totally lacking. Reviewing the missed opportunities and
missteps that have characterized the last few months, Akisik
likened the situation to that of a husband who has cheated on
his wife and now even when guiltless must pay attention to
every nuance. In such a situation it is not enough that the
government get the main issues right--the details must be
perfect too.

5. (SBU) Captive audience: Many of our interlocutors concur
that ultimately a restructuring of Turkey's domestic debt--
either orderly or chaotic--is inevitable. They do not expect
it soon, however. Most believe that the government can
sustain the debt through 2003. Questions deepen for the
following years, and one leading international bank has
adjusted its baseline scenario to reflect a 2005 default as
the most likely outcome. HSBC General Manager Antika concurs
that restructuring is inevitable, but she (and the bank's
Treasurer) do not see it happening this year. Indeed, she
noted that HSBC's own interests militate against such a
development, in that they mirror (though to a lesser degree)
the predicament of the sector as a whole. With exposure to
Turkish debt both on its balance sheet and in collateral for
corporate loans, as HSBC's Treasurer told us, "we have an
interest in keeping the boat afloat, not in profiteering from
the situation." Other banks' situation is similar. Bender's
Ozturk and Gulkan stressed (as they have repeatedly in recent
months) that Turkish banks are captives of the system, and
are essentially prevented from cashing out, since a decision
by one bank to do so could bring the whole "house of cards"

6. (SBU) Restructuring: Intriguingly, however, we heard this
week our first hint that the banks themselves may be
receptive to some sort of controlled restructuring, in an
effort to escape the treadmill on which they find themselves.
Bank of New York Representative Neslihan Tombul told us on
April 3 that she has heard that at least two banks (Isbank
and Garanti) have sent feelers to the Treasury on the
subject. Beyond the costs a restructuring might impose,
depending on how it is formulated, she also sees benefits, in
that with longer-term securities banks have a more stable
balance sheet on which to operate.

7. (SBU) Comment: With reassurance on U.S.-Turkish ties
helping to soothe Turkish markets in the short term,
attention is again focused on the key imponderable of
government credibility. We see little sign that the
government will be able to recoup that commodity any time
soon. Given its missteps, each government move has been
closely scrutinized, and in many cases (as in the case of
recent nominations to the board of Halkbank and Ziraat Bank)
found wanting. Most Istanbul analysts remain decidedly
downbeat on the government economic team, expressing grudging
respect only for Finance Minister Unakitan. Only by reaching
outside the government for a "Dervis," in Gulkan and Ozturk's
view, can the government regain credibility. They (and we)
see this as an extremely remote possibility, however. End

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