Cablegate: Is Turkey's Fiscal Policy Too Tight?

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

171449Z Oct 05

UNCLAS SECTION 01 OF 02 ANKARA 006292

SIPDIS

TREASURY FOR PLANTIER

SENSITIVE BUT UNCLASSIFIED

E.O. 12958: N/A
TAGS: EFIN TU
SUBJECT: IS TURKEY'S FISCAL POLICY TOO TIGHT?

1. (SBU) Summary: The very large size of Turkey's primary
fiscal surplus target -- 6.5 % of GDP for the last four
years -- has emerged as a key issue in discussions between
the IMF and Turkey. While the IMF seems to have prevailed
in its insistence on additional fiscal tightening in 2006,
there appear to be strong economic and political arguments
for greater flexibility. Given the importance of sustaining
and deepening the economic reform effort in Turkey, Post
recommends that Washington agencies take a close look at
this issue and discuss its implications with the IMF. End
Summary.

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IMF Tightening an Already-tight Fiscal Policy
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2. (SBU) Though frustrated in recent years over the IMF's
insistence on fiscal austerity, the GOT has bowed to the
Fund's requirement that it maintain a 6.5% of GDP primary
surplus (non-interest expenditures less revenues) budget
target. 2005 will be the fourth year the GOT has met or
come close to this target, which we understand represents
the tightest budget constraint of any IMF program, with the
possible exception of Jamaica.

3. (SBU) In recent weeks, the GOT quietly pressed the IMF
to reduce the target slightly for the 2006 budget, to around
6.25% of GDP. The Turks argued that this would take into
account the expected privatization of state companies (Turk
Telekom, Tupras and Erdemir) that currently contribute about
0.25% of GDP in net revenue. The IMF staff, however, has
insisted on the 6.5% target, so as to restrain domestic
demand and thereby moderate import growth that is
exacerbating Turkey's worrisome current account deficit. In
fact, maintaining the target despite the loss of state
company net revenue would represent an additional tightening
of fiscal policy in 2006.

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The Economic Counterargument
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4. (SBU) The IMF's belief that additional fiscal restraint
would help trim the current account deficit is not shared by
all local observers, many of whom believe that the growth in
the deficit is driven by strong inflows of short-term funds
attracted by high domestic interest rates rather than by
import growth. There is a particular risk of a surge in
inflows following the start of EU accession negotiations.
These observers allege the IMF is being doctrinaire in
sticking with the high primary surplus target and not
recognizing the progress Turkey has made in reducing its
vulnerability to shocks.

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The Political Counterargument
-----------------------------

5. (SBU) At the same time, the political cost of
implementing a very high level of budget austerity keeps
growing the longer the effort is maintained. This has
created pressures for populist responses that are
increasingly difficult for the AK Government to resist,
especially as it continues to pursue unpopular political
reforms linked to EU accession (including vis a vis Cyprus).
One senior bank economist told us that even a symbolic
relaxation of the budget target (like that suggested by the
GOT) could create the political space the GOT needs to
sustain economic reforms over a longer period. Factually
true or not, many Turks believe that that the benefits of
Turkey's post-crisis economic success have not been felt by
the man on the street. Given the GOT's need to show results
ordinary Turks will appreciate, some flexibility on fiscal
austerity -- or at least no tightening -- might enable the
GOT to sustain controversial reforms, including extremely
unpopular structural reforms and privatizations.

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Comment
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6. (SBU) Although the GOT may be acquiescing to the Fund's
demands under deadline pressure (the Constitution requires
that budget parameters be set by October 17), the economic
argument for increased tightening is not entirely clear. At
the same time a calculation that did not let the GOT off the
fiscal hook but allowed the Government to show that good
efforts are rewarded has a strong political logic. Post
recommends that Washington may want to explore these issues
in greater detail with the IMF and IMF board.
MCELDOWNEY

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