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Cablegate: Turkey and Imf Announce Broad Agreement On a New

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 6700
C. ANKARA 6594

1. (SBU) Summary: The IMF and the Turkish Government have
announced agreement on the broad outlines of a new three-year
program. Though final details will need to be wrapped up
before a Letter of Intent can be signed, and an IMF board
vote will not take place until January, the GOT and IMF
succeeded in reaching sufficient agreement to make a joint
announcement prior to the critical EU Council decision on the
start of Turkey's EU accession negotiations later this week.
The $10 billion dollar program is at the low range of what
markets expected: Turkey will be a significant net payer to
the IMF during the three-year program period such that the
program will allow the IMF to gradually reduce its exposure
to Turkey. Though the GOT was slow to decide it needed the
program and slow to take the measures required, agreement on
a new program is an important milestone in the gradual
stabilization of the Turkish economy. The program is
projected to help Turkey achieve single-digit inflation and
greatly reduce its vulnerability to problems rolling over its
large short-term debt. The program is not a panacea,
however, and Turkey is likely to continue its bumpy economic
ride for some time. End Summary.

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IMF and GOT Announce Agreement...

2. (SBU) At a joint press conference early December 14, the
IMF mission chief and State Minister of Economy Babacan
announced that the Government and the IMF mission had reached
broad agreement on a new Standby Arrangement. The facility,
covering 2005 through 2007, would allow credits up to about
$10 billion. Though Babacan and IMF staff say they are close
to agreement on the text of a Letter of Intent(LOI), we
understand some issues remain to be finalized and the LOI
will not be signed until after the EU Council meeting,
perhaps several weeks afterwards. Formal approval at the IMF
Board will not take place until January or February.

Providing some Insurance Against EU-linked Market Turbulence
--------------------------------------------- ---------------

3. (SBU) As reported in reftels, GOT economic officials and
IMF staff thought it prudent to reach sufficient agreement to
be able to make a joint announcement on the broad outlines of
a program prior to the EU Council decision. Though few
observers place a high probability on the EU Council failing
to give Turkey a date to begin accession negotiations, it is
entirely possible that the elements of the EU decision may be
politically difficult for Turkey to swallow, opening the way
for market turmoil. By announcing the IMF agreement
beforehand, both the GOT and IMF hope to limit whatever
market damage could take place in an unfavorable EU scenario.

A Long Time Coming

4. (SBU) The new agreement was a long time coming. After
the a global sell-off in emerging market debt hit Turkey in
April and May, private sector observers were unanimous that
Turkey needed to seek a new IMF program, and should start
negotiations as soon as possible. Central Bank Governor
Serdengecti told us he had urged the GOT to seek a new
program early so as to have it in hand before the uncertainty
of the EU summit. Instead of heeding the business community
or the Central Bank, the Government did not announce it had
decided to pursue a new IMF program until August, reportedly
because it took that long for Minister Babacan to convince
the Prime Minister it was necessary. We understand that many
cabinet ministers opposed seeking a new agreement, chafing
under IMF strictures and failing to understand the Turkish
state's continued dependence on markets' willingness to roll
over its huge stock of short-term debt.

IMF Pushes Through its Agenda

5. (SBU) Even after negotiations began in early September,
it took the IMF three missions to reach agreement, with the
GOT seeming very slow both to take needed measures and to
reach agreement with the IMF on policies. In the end, the
GOT largely bent to IMF demands: VAT rates were not cut; the
banking law will be broadly what the IFI's wanted; the
fiscally austere 6.5% primary surplus target will be
maintained; 2004 fiscal "overperformance" is being saved
rather than spent; and the tax administration is being
restructured in the hope of broadening the tax base. The
status of the IFI's ill-starred attempts to move forward on
state bank privatization is less clear, though we understand
the GOT, working with the World Bank, will need to develop a
new, more ambitious state bank privatization strategy in the
first quarter of 2005.

Eleventh Hour Negotiations on Social Security Reform
--------------------------------------------- -------

6. (SBU) In the end, the most difficult issue proved to be
the reform of the social security system. Though the Prime
Minister has reportedly agreed to long-term numerical targets
to reduce the huge social security system deficits (4.5% of
GDP), the devil was in the details. IMF and World Bank
officials spent much of the past few days dealing with the
danger that the Labor Ministry would use less conservative
assumptions about the number of participants, economic growth
and inflation, so as to reduce the severity of the parametric
changes (such as reducing pension benefits, or pushing back
retirement ages). IFI officials are now reasonably confident
the GOT understands it will have to use conservative
assumptions, and the LOI will not be signed until the social
security law is submitted to parliament.

$10 Billion Facility Allows Gradual Reduction in IMF
--------------------------------------------- ----------------

7. (SBU) The IMF's $10 Billion facility means that Turkey
will be a net payer to the IMF, but will avoid a spike in
repayments from the earlier IMF program. Whereas without a
Fund program, the Turkish state would probably not have been
able to make the huge payments required, with the new
program--and some smoothing out of the repayment profile
under the old program--Turkey's net payments to the IMF will
be more gradual and therefore manageable. Total outstandings
to the IMF are now projected to go from about $20.7 billion
at the end of 2004 to about $9.6 billion at the end of 2007
and falling thereafter to only $600 million by the end of
2010. Though the GOT had been pushing for a larger facility,
and the markets were expecting a bigger number, the GOT seems
to have accepted an amount towards the low end of the range
of possible financing. Under strong pressure from the IMF
board not to grant too large a loan, the IMF staff seems to
have convinced the GOT, in part by a degree of front-loading
of the disbursements: the program envisions 5 disbursements
in 2005, 4 in 2006, and 3 in 2007. Nor have markets reacted
negatively to the lower-than-expected size of the loan: the
Turkish lira strengthened against both the dollar and euro
and interest rates came down slightly, though stock prices
eased after a strong rally on the 13th.

And Sets the Stage for a Further Stabilization of the
--------------------------------------------- ----------------

8. (SBU) More broadly, Turkey's remarkable progress since the
2001 crisis in stabilizing its economy has a better chance of
continuing under IMF-provided financial breathing room
combined with policy oversight. With IMF support, the
independent central bank is widely-credited with bringing
Turkey's inflation rate to its lowest level in 30 years and
most observers expect single-digit inflation in 2005. The
fiscal austerity in the IMF program is projected to produce a
gradual but crucial fall in Net Debt to GNP from around 70%
at the end of 2003 to 60% at the end of 2007. This ratio
remains sensitive to exchange rate movements, and Turkey will
continue to have to roll over about 90% of its traded
domestic debt as it comes due, but the program offers the
hope that Turkey can slowly but surely grow out of the debt

But the Bumpy Ride is Likely to Continue

9. (SBU) Though the new IMF agreement is a major step towards
economic stabilization, Turkey's wild economic ride is
probably not over. As with EU-related reforms, the GOT is
better at passing laws and approving big-picture policy
frameworks than it is at effective implementation. Moreover,
the new program's significant structural reform agenda
(social security, state bank privatization) runs directly
counter to powerful local interests (state bank managers and
public sector employees). A World Bank official, for
example, told us he believes the toughest work is still to
come. Guven Sak, the independent member of the Central
Bank's monetary policy committee told us he expects the GOT
to have a harder and harder time with implementation, as
public weariness with seemingly never-ending austerity grows,
and as elections (due by 2007) approach. Finally, though the
GOT has made major strides in taking ownership of reforms,
the GOT still seems to lack a strong long-term reformist

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