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Cablegate: The Lira's October Decline

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

301615Z Oct 03

UNCLAS SECTION 01 OF 03 ANKARA 006780

SIPDIS


SENSITIVE


STATE FOR E, EB/IFD, AND EUR/SE
TREASURY FOR OASIA - JLEICHTER AND MMILLS
NSC FOR MCKIBBEN AND BRYZA


E.O. 12958: N/A
TAGS: ECON EFIN TU
SUBJECT: THE LIRA'S OCTOBER DECLINE


REF: A. ANKARA 6554
B. ANKARA 6623


1. (Sbu) Summary: After a long rally, Turkish markets have
turned down over the past two weeks, although there has been
little in the way of high-profile, market-jolting bad news.
Instead, the markets, especially the foreign exchange market,
have turned around due to a combination of seasonal factors,
foreign investors' profit-taking, and privatization process
nervousness among other reasons. End Summary.


Lira Stops Appreciating, then Falls:
-----------------------------------


2. (Sbu) Turkish markets sustained summer and early fall
rally started to fizzle in early October: the lira had
already begun to weaken from its September 23 peak of TL
1.354 million per USD to TL 1.408 million on October 15.
Strangely enough, the pressure on the lira accelerated after
the GOT reached an agreement with Fund staff October 15 and
submitted its budget to parliament October 17--events that
should have cheered the markets.


3. (Sbu) The week of October 20 opened with what should have
been the positive news of Finance Minister Unakitan's press
conference on the just-submitted, fiscally-austere budget.
Yet on October 20, the Central Bank, faced with sharply lower
demand for TL, lowered its daily foreign exchange purchase
auction amount from USD 120 million to USD 60 million as of
October 21, and completely abandoned the FX purchases as of
October 23. Nevertheless, the lira continued to fall, closing
the week on October 24 at TL 1.486 million and diving Monday
and during the half-day Tuesday, October 28 to TL 1.520
million, a five-month low. After the October 29 holiday, the
lira came back on Thursday, October 30 to TL 1,498 million,
however, Central Bank officials told econoff they did not
expect a resumption of the lira rally.


4. (Sbu) The late summer nominal appreciation of the lira
against the dollar had exaggerated the lira's overall
appreciation: on a trade-weighted basis the lira's movement
was less pronounced because the dollar fell against the euro
during this period. By contrast, the late October fall in
the lira/dollar rate was mirrored in the lira/euro rate and
nothing to do with dollar/euro movements.


Why the Fall?
------------


5. (Sbu) The fall in the lira is particularly interesting
given that the markets had made it past a series of
potentially-frightening political events without the feared
outcomes materializing: the Dehap court case, the IMF mission
visit, the signing of the U.S. Financial Agreement, and
parliamentary authorization of a deployment to Iraq all
turned out the way the markets wanted. Moreover, Standard and
Poors announced it had moved the outlook for Turkey from
negative to stable last week. So, why the fall now?


6. (Sbu) A confluence of factors seems to have reversed
sentiment on the lira. First, the lira was probably
overvalued. The currency had been appreciating in nominal
terms since the spring despite an inflation rate far above
that of Turkey's trading partners--in other words the lira's
value had skyrocketed in real terms. Central Bank officials
told econoffs they had been surprised at the height of the
lira's peak. Second, the lira often starts to weaken in the
fall, as the summer tourism season with its FX inflows comes
to an end. Market participants and central bank officials
also say that there has been a significant movement by
foreign players out of Turkish lira, reportedly to book their
profits.


7. (Sbu) Several domestic developments appear to have
unsettled market participants. First among these was a press
report that the Government was drafting a new decree to
"protect the Turkish lira," which would discourage domestic
transactions denominated in foreign exchange. Though Economy
Minister Babacan later denied that this represented a
tightening of the foreign exchange control regime, markets
were understandably negative on the idea. Also, early last
week there were a several ministers made comments about
Turkey not needing the USD 8.5 billion loan from the U.S.,
making markets nervous about the status of the assistance.
On privatization, though the bids on parastatals Tupras and
Tekel reportedly took place October 24, the Privatization
Authority made the market nervous by saying it would not
announce who bid until the week of November 1, adding to
doubts about the real status of the bids, particularly on the
oil refiner Tupras. Finally, worries about the status of the
U.S. loan and yet another "reception crisis" between the
President and the Ak Party Government over the wearing of
headscarves at the Independence Day reception, further
undermined market confidence.


8. (Sbu) In a meeting October 30, Central Bank officials
explained to econoffs that the prospect of a repayment plan
for Imar Bank depositors has also weighed on the foreign
exchange market. According to these officials, the Central
Bank succeeded in convincing the GOT to pay only TL 10
billion rather than TL 15 billion per depositor as a first
instalment. Since half of the Imar Bank deposits had been in
foreign exchange, the payment to depositors entirely in TL
was likely to result in massive conversions back to foreign
exchange, a prospect that weighed on the lira. The Central
Bankers also told econoffs that there were market rumors of
an impending Treasury debt swap that would be indexed to
foreign exchange, leaving banks with open positions that the
banks would have to close by selling lira. The Central
Bankers' analysis about the Imar Bank would tend to be
confirmed by the appreciation of the lira October 30, after
the repayment plan--at the lesser amount--was announced. The
passing of the headscarf "reception crisis" may also have
helped market sentiment.


9. (Sbu) There is also beginning to be increased concern
about balance of payments issues and the prospects for the
Current Account deficit. In recent months, there has been
little discussion about BOP concerns, in part due to the
buoyancy of exports and the apparently positive trends in the
overall economy. In a speech October 16, however, former
Economy Minister Kemal Dervis warned about the Current
Account deficit. On October 27, the Central Bank announced
August BOP numbers, showing that the twelve-month rolling
Current Account deficit rose to USD 4.3 billion at the end of
August, and that the Current Account deficit for the year was
projected to reach USD 7.7 billion, or about 3.1 percent of
GDP. Some analysts are beginning to express concern about
the Current Account deficit. On the other hand, an IMF
official told econoff October 20 that the Fund did not have
particular concerns about the outlook for the Current
Account, given the GOT's access to financing and the floating
exchange rate regime. Central Bank Markets Department
officials articulated a similar view, expressing confidence
that the floating exchange rate regime acts as an automatic
stabilizer.


Milder Correction in Debt Market:
--------------------------------


10. (Sbu) The sharpest movements were in the foreign exchange
and equity markets, but the debt market was not immune.
Though on October 17 the benchmark bond was still trading at
29.74 percent, near its post-crisis low, during the week of
October 20-24 it rose to 31.58 and by the close October 28 it
closed at 32.12 percent. In the October 30 post-holiday
uptick, the benchmark closed at 31.70. It is noteworthy that
the domestic debt market bore up better than the currency and
equity markets, despite large redemptions the week of October
20-24. Central Bank officials agreed that this disconnect
between the debt and FX markets demonstrated that foreigners
moving out of lira instruments were a key factor in the fall
of the lira, since the domestic debt market is less
influenced by foreign investors.


Comment:
-------


11. (Sbu) It is too soon to tell whether the fall in the lira
represents a sustained change of direction, which could lead
to concerns about overshooting and problems on the inflation
and debt fronts. For now, it should at least have the
positive effect of muting pressures on the Central Bank from
politicians and business people to do something about the
strong lira. Though the weaker lira could make it harder for
Turkey to make its 2003 inflation target, Central Bank
officials told econoffs there might not be too big an impact,
at least in 2003. According to these officials business
people have not been quick to pass through exchange rate
fluctuations into their prices, reducing the correlation
between exchange rate movements and inflation. If there is
an effect, these officials expect it to hit with a lag,
causing inflation in early 2004.


EDELMAN

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