Cablegate: Turkish Markets Fall Sharply On Eu Concerns

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

B. ANKARA 5187

1. (Sbu) Summary: No sooner had markets shown signs of
beginning an autumn rally, than the GOT,
ss handling of the adultery issue -- resulting in the
postponement of the penal code reform and negative
implications for Turkey,s EU accession prospects --
caused markets to fall sharply Friday, September 17 and
Monday, September 20. The stock market fell 4.3 % Friday,
and fell 3.5% more Monday morning, to return to the level
in late August, and the lira fell to its lowest level of
2004 against the dollar at TL 1.54 million. Interest
rates rose back to levels well above those prior to
the Central Bank,s September 8 rate cut. With a
heavy domestic debt redemption calendar this week,
the interest rate spike will cost the GOT millions
of dollars in additional interest payments. End Summary.

Adultery Issue,s Turn for the Worse Scares Markets:

2. (Sbu) The GOT,s moves since late August to amend the
Turkish penal code to criminalize adultery did not alarm
markets at first. Unlike with the Imam Hatip
controversy in the spring, markets reacted calmly since
the adultery issue was not perceived to be a significant
source of friction between the GOT and the military that
would threaten EU relations. By Thursday, September 16,
however, it became evident that a faction of the AKP
government and parliamentary group were determined to keep
the issue alive, and when the leadership got caught
up in the debate (ref a), markets started to take notice.
When the government pulled the reform draft, which
contained a range of legal reforms important for meeting
the EU's Copenhagen accession criteria, many investors
headed for the exits.

3. (Sbu) Market participants, concerns stem from the
implications of criminalizing adultery for Turkey,s EU
accession prospects. Over the course of last week,
several EU officials criticized the AK parliamentarians,
push to criminalize adultery. Key among these statements
was EU Enlargement Commissioner Verheugen's comments on
the need to pass the penal code reform before the EU
Commission report, expected October 6, in order to
comply with the Copenhagen criteria. More importantly,
however, markets were alarmed by the government's decision
to pull the draft penal code, which contained other legal
reforms considered key to a positive EU decision.

Erdogan,s Comments Spark a Sell-Off:

4. (U) On the 16th, the markets began to reverse their
previously positive tone: the stock market barely moved
but the lira retreated from 1.491 million per $ to 1.501
million, and the interest rate of the Government's
benchmark bond rose from 24.35 to 24.46.

5. (Sbu) In the middle of the day Friday, Prime Minister
Erdogan made public comments that greatly exacerbated
market worries, at the same time that the entire penal code
reform--considered an important factor for the October 6 EU
Commission report on Turkey and, ultimately, the December EU
decision on Turkey,s candidacy--was pulled. Erdogan took
a harsh, defensive tone, saying, "Let nobody try
to pressure Turkey by using the EU..." and "Nobody should
try to impose conditions on us concerning
the EU." The shelving of the penal code changes, with
parliament on recess until October 1, just five days before
the release of the EU Commission report, greatly added to
market worries that the GOT had allowed the debate over the
adultery issue to greatly reduce the odds of a favorable EU

6. (Sbu) In late afternoon trading Friday, the markets
pulled way back. The IMKB 100 stock exchange index fell 4.3%
on the day, to 20,779.75,a level last seen on September
3. The lira depreciated sharply to TL 1.521 million to the
dollar from 1.501 at the previous day's close. Interest
rates, which had finally come down a bit after the Central
Bank's September 8 rate cut (ref B), began to rise, with
the benchmark reaching 24.93 at Friday's close, up from
24.35 at Wednesday's close. Turkish Treasury's domestic
debt manager, Volkan Taskin, told us Friday
that rates between 24.9 and 25%, if sustained during the
week of September 20, would cost Treasury an additional
TL 800 trillion (about USD 530 million).

7. (Sbu) Though Erdogan and Gul tried to downplay the
problem over the weekend, and there are press reports that
Erdogan and Verheugen are to meet on Thursday, September 23
in Brussels, the markets fell in morning
trading Monday. The IMKB 100 stock index fell a further
3.5 % in the morning to 20,294 and the lira fell to a low
for the year at TL 1.54 million to the dollar. Of the
greatest importance, however, for the Turkish state's
fragile financial situation, interest rates spiked: trading
on the GOT's benchmark bond yielded interest rates of
27.10% in Monday morning trading over 170 basis points
above the level prior to the Central Bank's September 8
rate cut. The timing of the increase in rates is
particularly unfortunate: Treasury has a heavy calendar of
redemptions (TL 6.8 Quadrillion, or USD 4.53 billion) and
new borrowings this week.

Comment and Conclusion:

8. (Sbu) The market sell-off and the GOT difficulties in
dealing with the EU have raised market analysts' concerns,
but do not (yet) imply a crisis. Indeed most market
analysts, while concerned, continue to place a high
probability on a favorable--if conditional--response from
the EU in December. Citibank, for example, reiterated its
recommendation to investors to increase their holdings of
Turkish assets. Nevertheless, the reversal in
the markets demonsrates the potential for market volatility
in the run-up to the December EU summit. From a
broader perspective(ref A), the GOT,s handling of the
adultery issue seems to demonstrate that senior GOT
leadership is either unable or unwilling to avoid missteps
that risk serious damage to its EU accession strategy.


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