Cablegate: Current Account Deficit Concerns: Mitigating

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

011445Z Oct 04





E.O. 12958: N/A


B. ANKARA 5637

1. (Sbu) Summary: As Turkey's current account deficit
continues to grow, several analysts have recently outlined
some mitigating factors that could reduce the danger of a
disruptive correction. These factors include: Durables
import growth is unlikely to continue to surge; short-term
portfolio investors have shown a willingness to maintain
their positions during sell-offs; and there are signs of
growing Foreign Direct Investment. Despite these mitigating
factors, other analysts point out the possibility of a bad
scenario arising from good news on EU accession: short-term
portfolio flows would continue to increase, inflating the
currency and exacerbating the current account deficit. Even
in this scenario, however, no analyst in Turkey believes
there is a serious risk of a "maxi-devaluation" as some
external analysts have suggested. End Summary.

2. (Sbu) Economic analysts tend to see the single greatest
financial risk to the Turkish economy over the coming year or
two as the risk that the build-up in the current account
deficit could lead to a sudden, disruptive market correction
in which the Turkish lira falls precipitously and short-term
portfolio investors head for the exits. In recent weeks,
however, several analysts have mentioned factors that
mitigate against this scenario, or at least would limit the
extent of the disruption.

Consumer Goods Import Surge Mainly Autos:

3. (Sbu) Both Memduh Akcay, Director of Foreign Economic
Relations at the Turkish Treasury, and Mehmet Simsek of
Merrill Lynch/London, told econoffs that they believe the
surge in durable imports is unlikely to continue at the same
pace. Akcay pointed out that when durables (especially cars)
are excluded from consumer goods imports, this category of
imports has hardly grown at all in 2004. Note: Economists'
worries about import growth focus on consumer goods imports,
on the theory that capital goods imports--which grew 76% in
the first seven months of 2004 compared to the same period in
2003--are a proxy for investment. Unlike these two
fast-growing categories, intermediate goods imports have
shown only modest growth. If one assumes the boom in car
sales is likely to taper off (see below), Akcay's point is
that the growth in consumer goods imports should not be a
cause for worry. End Note. In a similar, if less specific
vein, IMF resrep told Econoffs that the IMF's GOT
interlocutors view the current account deficit as largely
self-correcting, perhaps for the reason espoused by Akcay.
He added that IMF staff believe the GOT officials are at
least partially right about the self-correcting nature of the
current account deficit, but are considerably less sanguine.

4. (Sbu) Central Bank data suggests Akcay may be right: for
the first seven months of 2004, motor vehicle and vehicle
parts imports grew 173 percent, increasing by $3.8 billion,
roughly equating to the $3.99 billion increase in total
consumer goods imports. With tax incentives on turning in
old cars to buy new ones now halved, and due to expire by
year-end, Akcay went on, the auto sales growth should slow
down. Simsek of Merrill Lynch, a more independent analyst
than Akcay, made a similar point, noting that much of the
demand for durable goods is pent-up demand from the crisis
and immediate post-crisis period, and consumers rarely buy
more than one car or refrigerator every few years, such that
the growth is likely to taper off. Indeed, Auto Association
data shows some tapering off, with monthly domestic auto
sales having peaked in April and declining each month
thereafter. In July, domestic retail car sales fell 7.2%
while sales of imported vehicles fell 11.3%. Trade balance
data for August, released by the State Statistical Institute
on September 30, seem to confirm the trend, with vehicle and
parts imports further declining 20% month-on-month, though
some of this decline could be attributable to seasonal
factors. Simsek added, however, that another scenario cannot
be excluded: if a continued fall in interest rates makes
durable purchases affordable to a broader group of consumers
the durables growth could continue.

"Hot Money" Is Really Lukewarm:

5. (Sbu) Another potential cushion against a steep fall in
markets is the behavior of short-term foreign portfolio
investors. Baturalp Candemir of HC Istanbul said that in the
April-May sell-off, foreign investors did not try to
completely liquidate their positions in Turkish lira assets,
preferring to maintain a large portion of their holdings and
hope that markets would come back. According to Candemir,
investors simply did not want to incur large losses in a
rapidly falling--and illiquid--market when there was a
reasonable chance that Turkish bonds and bills would come
back up in price. For this reason Candemir does not expect a
market correction to turn into a rout under all but the most
extreme circumstances. Ann Wyman of Citigroup's London
office made a similar point: the investors who have pulled
out during sell-offs are the ones who have lost money in
Turkey. Even people who were holding Turkish assets in the
crisis made money if they held their positions rather than

Signs of Foreign Direct Investment:

5. (Sbu) A third factor that would mitigate against an
alarmist current account deficit scenario would be an
increase in Foreign Direct Investment. Though FDI continues
to be far below Turkey's potential or the flows for
comparator countries--there are signs of an increase from
previous years. Central Bank balance of payments data show
FDI of $1.3 billion for the first seven months of 2004,
compared to $344 million for the first seven months of 2004.
There is also considerable anecdotal evidence of corporate
plans to expand capacity, particuarly with GDP growth now
expected to reach something on the order of 10 percent for
2004, and remain strong in 2005.

6. (Sbu) Though it may not be traditional FDI--in the sense
of foreign corporate equity investment in Turkey--there is
another line in the capital account suggesting there has been
a surge of long-term capital flowing into Turkey's private
sector. Both Kubilay Cinemre of Garanti Bank and Emin Ozturk
of Bender Securities, drew econoffs' attention to the surge
in non-bank private sector long-term borrowings in the
balance of payments statistics. This category jumped from a
negative $155 in the first seven months of 2003 to a positive
$3.13 billion in the first seven months of 2004. Ozturk and
Cinemre both felt this was an indicator of Turkish companies
borrowing offshore to finance investments. (Note: Other
Istanbul bank contacts pointed out that the Turkish tax code
makes it attractive for Turkish banks to use offshore
subsidiaries to lend to Turkish borrowers. The risk
associated with foreign borrowing by Turkish corporates was
not addressed by Ozturk and Cinemre. If the increase in this
line item represents local corporates taking on additional
foreign exchange risk through external borrowing, this would
be an increase in vulnerability. If on the other hand,
Turkish corporates foreign exposure is hedged through a
stream of exports or through hedging instruments, then it is
less of a concern. End note.)

How Good News Could Lead to a Bad Scenario:

7. (Sbu) Though the factors cited above may cushion the risk
of a sharp correction, some economists see a danger that
these factors could be offset by "too much" good news. Both
Emin Ozturk and a visiting Fed economist laid out a scenario
in which good news on the EU accession front, and possibly
the IMF negotiations, leads to a surge in short-term
portfolio investment, essentially the "convergence play" on
EU accession. Under this scenario, this increased flow would
exacerbate the overvaluation of the lira, causing even more
consumer goods imports, and leading to an even more dramatic
build-up in the current account deficit. Under this
scenario, the correction, when it comes, would be that much
more violent. But even in this scenario, Ozturk doubted
there would be a depreciation as steep as 40 or 50%, and he
thought such a correction would be manageable. None of the
four Istanbul analysts at a recent roundtable discussion with
econoffs, nor any other local analyst post is aware of,
disagrees with Ozturk on this. In other words, they do not
subscribe to the "maxi-devaluation" scenario suggested by a
Moody's analyst and at least one U.S.-based emerging market

8. (Sbu) Comment: The behavior of markets over the past year,
and comments by investment advisors like Wyman, give
credibility to Ozturk's scenario, in that foreign emerging
market investors simply cannot afford to be out of a market
like Turkey's high-yielding lira-denominated bonds, unless
they expect a major crisis leading to default. In a sense,
this is the flip side of Baturalp Candemir's observation
about short-term investors not running for the exits in a
correction. These investors' bias towards towards staying in
could exacerbate the overvaluation/import surge problem.


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