Cablegate: Istanbul Bankers Praise Akp Economic Reforms

VZCZCXRO3751
PP RUEHDA
DE RUEHIT #1846/01 2830721
ZNR UUUUU ZZH
P 100721Z OCT 06
FM AMCONSUL ISTANBUL
TO RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHC/SECSTATE WASHDC PRIORITY 6084
INFO RUEHAK/AMEMBASSY ANKARA PRIORITY 5660
RUEHDA/AMCONSUL ADANA PRIORITY 2259

UNCLAS SECTION 01 OF 03 ISTANBUL 001846

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EUR/SE AND EB/IFD
TREASURY FOR INTERNATIONAL AFFAIRS - JROSE

E.O. 12958: N/A
TAGS: ECON EFIN TU
SUBJECT: ISTANBUL BANKERS PRAISE AKP ECONOMIC REFORMS

REF: ANKARA 5849

Sensitive But Unclassified, Please Protect Accordingly. Not
for Internet Distribution.

1. (SBU) Summary. We met three Istanbul-based bankers with
visiting Turkey desk officer to discuss economic performance,
trends and political risk. All three thought that the AKP
government had done a good job implementing IMF-backed
reforms, but felt that the AKP economic team lacked depth and
had been unable to formulate a long-term economic strategy of
its own. The current account deficit and the effect of
political risk on the economy were primary concerns, but both
were seen as manageable in the short to medium term. End
Summary.

Enormous Progress Despite a Weak Team
-------------------------------------

2. (SBU) Baturalp Candemir of EFG Securities told us that
despite personally disagreeing with the AKP on virtually
every social issue, he felt that AKP had made enormous
progress on both economic and political reforms an assessment
echoed by Steve Bideshi of Citigroup and Idil Dagdalen of
Bender Securities. Candemir explained that he is much less
pessimistic than he was only two years ago. He is no longer
concerned about the possibility of a debt crisis because the
structural reforms of the past several years have shielded
the economy, particularly the banking sector, from external
shocks. Bidishi agreed, noting that Citigroup's internal
projections give a 65% chance that the economic situation
will remain the same over an 18 month horizon. This factors
in the early November EU 'report card' as well as upcoming
presidential and parliamentary elections and contrasts with
2005 projections that gave a 70% chance for stability.

3. (SBU) Candemir cited three broad areas of improvement
during the AKP government: fiscal policy, changes to the
social security system and the situation with regard to the
EU. Candemir argued that the AKP government has not only
established better fiscal policy but also created a public
recognition of the need to "pay for" budgetary outlays that
was lacking in the past. Additionally changes to the social
security system have limited the deficit in that system to
approximately 4.5% of GDP, heading off a projected increase
in the deficit. He expects that figure to remain constant
for the next two to three years and then to gradually
decrease to 2-3% of GDP over the subsequent decade. Finally,
he argued that worries over the Cyprus ports issue
notwithstanding, relations with the EU were clearly better
than five years ago.

4. (SBU)In a complaint voiced by all three bankers, Candemir
complained that the AKP government lacked a long-term
economic vision and cannot strategize. Candemir and Bideshi
argued that recent reforms were simply the result of
mechanically implementing IMF and World Bank recommendations,
an overly simplistic assertion in our view and one that
government officials would vehemently deny. Dagdalen
conceded that point, but argued that it was better to have no
economic vision than a "bad" economic vision and that lack of
a competing economic philosophy made it easier for the
current government to implement reforms than it might for a
government controlled by the "statist dinosaurs" of the
opposition CHP. Comment: We would frame the issue
differently -- the AKP may not have a well-thought out
long-term economic strategy of its own, but it clearly has
free-market, pro-reform instincts that stand in sharp
contrast to the reflexive statist impulses that are the norm
within other political parties and the upper reaches of the
secular establishment. (See reftel) The government has gone
beyond the IMF's minimum requirements and shown real
political courage on privatization, foreign investment and in
going after the owners of failed banks. End Comment.

5. (SBU) All three bankers agreed that the AKP economic team
lacks depth and that Economy Minister Babacan was
overstretched by his additional responsibilities with the EU.
Bidishi argued that Babacan, who is "outstanding," needs to
more visibly support Central Bank Governor Durmus Yilmaz who
has had a difficult first few months in office. Bidishi felt
that both Yilmaz and Finance Minister Unakitan were hard
workers, but noted that
Unakitan does not "present well" particularly with
international audiences. Candemir argued that the economic
administration had grown overconfident and was taking credit
for several years of strong economic growth that were more a

ISTANBUL 00001846 002 OF 003

reflection of global conditions in emerging markets and IMF
reforms than AKP economic policy per se. Candemir also noted
that the AKP policy team does not trust career bureaucrats -
who tend to be vehemently secular. In the same vein,
Dagdalen noted the AKP government is unable or unwilling to
call upon technocrats in the way the Ecevit government did
with Kemal Dervis in 2000. She argued they will not pull in
outsiders even at the mid-levels and that this has
exacerbated the lack of economic expertise at the top.

Inflation, Interest Rates, Investment and the Current Account
Deficit
--------------------------------------------- ---------

6. (SBU) We asked how long it would take for interest rates
to go down and how this had affected consumer credit.
Bidishi thought that interest rates were unlikely to go down
before mid-2007 and then only if inflation was under control.
The rate of credit expansion has reduced. In particular car
sales have decreased due to higher interest rates, however
export sales benefited from the weaker lira leaving a net
neutral effect on the auto industry. Bidishi noted that even
during the spring volatility Turks did not sell lira to buy
dollars. There was a cashing out effect as Turks sold
dollars to benefit from favorable rates, but unlike in
previous years there was no massive shift from lira to
dollars as the lira fell. We asked whether the lira had
rebounded to the point where it was overvalued. All three
thought that the lira would eventually stabilize at 1.55 to
the dollar (slightly weaker than current rates.)

7. (SBU) We asked how the government could best deal with the
current account deficit. Candemir argued that if the lira
stabilized at 1.55 and growth held at 6% the current account
deficit would fall to manageable levels within four to five
years. Dagdalen argued that the current account deficit -
presently approximately $30 billion or 8% of GDP - is "too
big to ignore." Turkey's manufacturing sector uses a large
amount of imported inputs, so increasing exports alone will
not significantly reduce the current account deficit.
Foreign direct investment has helped to finance the deficit,
but she argued this is not sustainable.

8. (SBU) Foreign investment in Turkey can be divided into
three broad categories: foreign direct investment,
experienced (with Turkey) financial investors and financial
investors without significant experience in Turkish markets.
Candemir noted that foreign direct invstment was largely
unaffected by the exchange rae volatility earlier in the
year. He was surpried when deals went through without
suspensions o even demands for price concessions citing
Petro Ofisi and Vakifbank. We noted that FDI remains
elatively low given the size of Turkey's economy de to
investor concerns regarding inflation and crruption.
Candemir argued that FDI was understatd in official figures
because companies registered transfers as intracompany
lending rather than FDI as an inflation shield and tax hedge.
Bidishitold us that Citigroup views Turkey as a good plac
to invest. Explaining that it was important toview
investments in context, Bidishi argued that Turkey had a more
open financial sector and thus more opportunity tha
n China, Russia, India or Brazil.

9. (SBU) Experienced financial investors expect liquidity to
evaporate when problems occur that affect Turkish markets.
Candemir and Dagdalen expect experienced financial investors
to return fairly quickly. Inexperienced financial investors
were attracted to the market when the EU opened accession
negotiations. Many of these investors were caught off-guard
by the spring liquidity crunch, and were badly hurt (with
some investors losing 30 %.) Although some of these
investors have remained in the market, Dagdalen expects most
of them to cash out after recouping some portion of their
losses. Candemir expects it will be hard to re-attract these
investors, particularly at the aggressive levels of 2005 and
the first four months of 2006.

Conclusion and Comment
----------------------

10. (SBU) Despite political and social misgivings, even our
normally skeptical financial markets observers give credit to
the current government for economic reform. We tend to
agree, noting that the AKP government's commitment to
free-market, pro-business policies and hold on the
Parliamentary majority have enabled the implementation of
IMF-backed reforms. These reforms, combined with generally

ISTANBUL 00001846 003 OF 003

positive trends in the emerging markets, have fueled three
years of strong growth.
OUDKIRK

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