Cablegate: Turkey's Economy: Some Positive Signs, but Little

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

161434Z May 03





E.O. 12958: N/A


1. (SBU) Summary: The rapid end of the Iraq war, prospect
of U.S. and IMF money, and a global emerging market rally
have combined to boost the Turkish currency and reduce
interest rates substantially in recent weeks. Meanwhile,
exports and industrial production continue to rise, while
inflationary expectations have fallen, increasing the
prospects for Turkey meeting its 2003 growth and inflation
targets. On the other hand, conversations with foreign
investment bankers and local business executives reveal
little confidence in the GOT's ability to build on these
positive trends and to manage the economy effectively in the
year ahead. The bottom line: although the mood is more
buoyant than two months ago, investors realize the
fundamentals have not changed and thus remain reluctant to
look beyond the next several months. End Summary

2. (SBU) Although they have weakened slightly in the past
few days, Turkish markets have staged a huge rally in the
past seven weeks. From their March 25 lows, the lira has
strengthened from TL 1.750 million/dollar to TL 1.485
million/dollar, and yields on the benchmark t-bill have
fallen from 73.5 percent to just over 50 percent. Investment
bankers (we have spoken this week to Goldman Sachs,
Deutschbank, Merrill Lynch, HCIstanbul, ING Barings, and
several of their clients) attribute this rally to a
combination of positive developments: the rapid, successful
conclusion of the Iraq war (with relatively limited impact on
Turkey's economy), the prospect of significant U.S. financial
assistance, completion of the Fourth Review under the IMF
program, and the post-war global rally in emerging markets,
as investor risk appetite has returned. Central Bank Markets
Department General Manager Akil Ozcay told us May 14 that two
internal factors also played a role: the shift by Turkish
depositors of about 7 percent ($3 billion) of their foreign
exchange deposits to lira deposits at the time the lira
reached its low (i.e., a significant bet on the lira); and,
related to that, some shift from dollars to lira as people
made payments under Turkey's "tax peace" program. (Note; Of
course, some of the lira's rally against the dollar reflects
the dollar's global weakness. End note)

3. (SBU) The real economy also has shown signs of
improvement (reftel), although not as dramatic as in
financial markets. Industrial production rose 5.6 percent in
March (year-on-year), above expectations, and 7.5 percent for
the quarter. Exports increased 27.5 percent in March (and 27
percent for the first quarter), and the Exporters Association
estimates strong growth for April as well. March's sharp
(44.8 percent) rise in imports suggests growing domestic
demand, though it is also raising concerns about the size of
Turkey's current account deficit this year. In the past
week, State Minister for Trade Kursad Tuzmen has joined a
growing chorus of exporters warning that the lira's
appreciation is hurting their competitiveness. Oyak
Executive VP Ergun Okur told us May 14 that the company was
now losing money on some auto exports because of the lira's

4. (SBU) The Central Bank's latest inflationary expectations
survey also came in positive, as expectations for year-end
CPI fell from 28 to 26.6 percent. Central Bank officials,
along with Treasury U/S Ibrahim Canakci, remain hopeful that
they can still hit the 20 percent CPI target for the year,
though they acknowledge they will miss the 17 percent WPI
target. The seasonal decline in agricultural prices,
combined with the strength of the lira, lower oil prices, and
declining expectations, should all help keep inflation in
check in the months ahead.

5. (SBU) That is the good news. The bad news is that, based
on our conversations with local business executives and
several groups of foreign investment banks in the past week,
there is little optimism that the government will be able to
build on recent positive developments. As Deutschbank
economist Marco Annunziato put it, "the recent confluence of
events gives Turkey a great opportunity to begin a virtuous
economic cycle, but we have been struck in our conversations
by the complete lack of confidence (in Istanbul) in this
government's ability to take advantage of the opportunity."
Turkish Young Businessmen's Association Ankara Chairman Murat
Sarayli said Turkish companies are still reluctant to invest
(other than those involved in exports) because they cannot
plan beyond the next 3-6 months.

6. (SBU) Investment banker contacts note that the government
continues to move slowly and half-heartedly to meet IMF
conditions, while intermittently offering populist measures
that undermine whatever credibility it has built up via the
reform measures it has taken. As a result, they say,
financial markets are likely to remain vulnerable to even
minor shocks, with little prospect of a long-term, steady
decline in interest rates of the sort that would reduce
concerns about debt sustainability. They predict that, in
the next few months, investors will begin to focus on
Turkey's very large external debt repayment schedule for
2004, and will want to see strong evidence that the
government is faultlessly implementing its reform program.
The bottom line, therefore, is that, while the government has
been able to lengthen t-bill maturities to some extent, there
remains little appetite -- among both financial and
non-financial investors -- for medium and long-term investing.

7. (SBU) Comment: Three times in the past year, nominal
interest rates on t-bills have fallen to the 50 percent
level, only to rise again due to policy failings or political
developments (eg. the declining health of then-PM Ecevit last
year). Based on our latest conversations, our sense is that
investors almost expect a repeat of this pattern. One
foreign investment banker told us his company was making a
list of the "trigger points" that would cause markets to fall
again. Changing this mentality will require improved
economic policy performance (eg. surprising the markets by
quickly completing the Fifth Review) at a time when many fear
all the good news will encourage GOT complacency.


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