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

301615Z Oct 03

UNCLAS SECTION 01 OF 03 ANKARA 006780 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EB/IFD, AND EUR/SE 
TREASURY FOR OASIA - JLEICHTER AND MMILLS 
NSC FOR MCKIBBEN AND BRYZA 
 
 
E.O. 12958: N/A 
TAGS: ECON EFIN TU
SUBJECT: THE LIRA'S OCTOBER DECLINE 
 
 
REF: A. ANKARA 6554 
     ¶B. ANKARA 6623 
 
 
 ¶1. (Sbu) Summary:  After a long rally, Turkish markets have 
turned down over the past two weeks, although there has been 
little in the way of high-profile, market-jolting bad news. 
Instead, the markets, especially the foreign exchange market, 
have turned around due to a combination of seasonal factors, 
foreign investors' profit-taking, and privatization process 
nervousness among other reasons. End Summary. 
 
 
Lira Stops Appreciating, then Falls: 
----------------------------------- 
 
 
¶2. (Sbu) Turkish markets sustained summer and early fall 
rally started to fizzle in early October: the lira had 
already begun to weaken from its September 23 peak of TL 
1.354 million per USD to TL 1.408 million on October 15. 
Strangely enough, the pressure on the lira accelerated after 
the GOT reached an agreement with Fund staff October 15 and 
submitted its budget to parliament October 17--events that 
should have cheered the markets. 
 
 
¶3. (Sbu)  The week of October 20 opened with what should have 
been the positive news of Finance Minister Unakitan's press 
conference on the just-submitted, fiscally-austere budget. 
Yet on October 20, the Central Bank, faced with sharply lower 
demand for TL, lowered its daily foreign exchange purchase 
auction amount from USD 120 million to USD 60 million as of 
October 21, and completely abandoned the FX purchases as of 
October 23. Nevertheless, the lira continued to fall, closing 
the week on October 24 at TL 1.486 million and diving Monday 
and during the half-day Tuesday, October 28 to TL 1.520 
million, a five-month low.  After the October 29 holiday, the 
lira came back on Thursday, October 30 to TL 1,498 million, 
however, Central Bank officials told econoff they did not 
expect a resumption of the lira rally. 
 
 
¶4. (Sbu) The late summer nominal appreciation of the lira 
against the dollar had exaggerated the lira's overall 
appreciation: on a trade-weighted basis the lira's movement 
was less pronounced because the dollar fell against the euro 
during this period.  By contrast, the late October fall in 
the lira/dollar rate was mirrored in the lira/euro rate and 
nothing to do with dollar/euro movements. 
 
 
Why the Fall? 
------------ 
 
 
¶5. (Sbu) The fall in the lira is particularly interesting 
given that the markets had made it past a series of 
potentially-frightening political events without the feared 
outcomes materializing: the Dehap court case, the IMF mission 
visit, the signing of the U.S. Financial Agreement, and 
parliamentary authorization of a deployment to Iraq all 
turned out the way the markets wanted. Moreover, Standard and 
Poors announced it had moved the outlook for Turkey from 
negative to stable last week.  So, why the fall now? 
 
 
¶6. (Sbu) A confluence of factors seems to have reversed 
sentiment on the lira.  First, the lira was probably 
overvalued.  The currency had been appreciating in nominal 
terms since the spring despite an inflation rate far above 
that of Turkey's trading partners--in other words the lira's 
value had skyrocketed in real terms.  Central Bank officials 
told econoffs they had been surprised at the height of the 
lira's peak.  Second, the lira often starts to weaken in the 
fall, as the summer tourism season with its FX inflows comes 
to an end.  Market participants and central bank officials 
also say that there has been a significant movement by 
foreign players out of Turkish lira, reportedly to book their 
profits. 
 
 
¶7. (Sbu) Several domestic developments appear to have 
unsettled market participants.  First among these was a press 
report that the Government was drafting a new decree to 
"protect the Turkish lira," which would discourage domestic 
transactions denominated in foreign exchange.  Though Economy 
Minister Babacan later denied that this represented a 
tightening of the foreign exchange control regime, markets 
were understandably negative on the idea.  Also, early last 
week there were a several ministers made comments about 
Turkey not needing the USD 8.5 billion loan from the U.S., 
making markets nervous about the status of the assistance. 
On privatization, though the bids on parastatals Tupras and 
Tekel reportedly took place October 24, the Privatization 
Authority made the market nervous by saying it would not 
announce who bid until the week of November 1, adding to 
doubts about the real status of the bids, particularly on the 
oil refiner Tupras.  Finally, worries about the status of the 
U.S. loan and yet another "reception crisis" between the 
President and the Ak Party Government over the wearing of 
headscarves at the Independence Day reception, further 
undermined market confidence. 
 
 
¶8. (Sbu) In a meeting October 30, Central Bank officials 
explained to econoffs that the prospect of a repayment plan 
for Imar Bank depositors has also weighed on the foreign 
exchange market.  According to these officials, the Central 
Bank succeeded in convincing the GOT to pay only TL 10 
billion rather than TL 15 billion per depositor as a first 
instalment.  Since half of the Imar Bank deposits had been in 
foreign exchange, the payment to depositors entirely in TL 
was likely to result in massive conversions back to foreign 
exchange, a prospect that weighed on the lira.  The Central 
Bankers also told econoffs that there were market rumors of 
an impending Treasury debt swap that would be indexed to 
foreign exchange, leaving banks with open positions that the 
banks would have to close by selling lira.  The Central 
Bankers' analysis about the Imar Bank would tend to be 
confirmed by the appreciation of the lira October 30, after 
the repayment plan--at the lesser amount--was announced.  The 
passing of the headscarf "reception crisis" may also have 
helped market sentiment. 
 
 
¶9. (Sbu) There is also beginning to be increased concern 
about balance of payments issues and the prospects for the 
Current Account deficit.  In recent months, there has been 
little discussion about BOP concerns, in part due to the 
buoyancy of exports and the apparently positive trends in the 
overall economy.  In a speech October 16, however, former 
Economy Minister Kemal Dervis warned about the Current 
Account deficit.  On October 27, the Central Bank announced 
August BOP numbers, showing that the twelve-month rolling 
Current Account deficit rose to USD 4.3 billion at the end of 
August, and that the Current Account deficit for the year was 
projected to reach USD 7.7 billion, or about 3.1 percent of 
GDP.  Some analysts are beginning to express concern about 
the Current Account deficit.  On the other hand, an IMF 
official told econoff October 20 that the Fund did not have 
particular concerns about the outlook for the Current 
Account, given the GOT's access to financing and the floating 
exchange rate regime. Central Bank Markets Department 
officials articulated a similar view, expressing confidence 
that the floating exchange rate regime acts as an automatic 
stabilizer. 
 
 
Milder Correction in Debt Market: 
-------------------------------- 
 
 
¶10. (Sbu) The sharpest movements were in the foreign exchange 
and equity markets, but the debt market was not immune. 
Though on October 17 the benchmark bond was still trading at 
29.74 percent, near its post-crisis low, during the week of 
October 20-24 it rose to 31.58 and by the close October 28 it 
closed at 32.12 percent.  In the October 30 post-holiday 
uptick, the benchmark closed at 31.70.  It is noteworthy that 
the domestic debt market bore up better than the currency and 
equity markets, despite large redemptions the week of October 
20-24.  Central Bank officials agreed that this disconnect 
between the debt and FX markets demonstrated that foreigners 
moving out of lira instruments were a key factor in the fall 
of the lira, since the domestic debt market is less 
influenced by foreign investors. 
 
 
Comment: 
------- 
 
 
¶11. (Sbu) It is too soon to tell whether the fall in the lira 
represents a sustained change of direction, which could lead 
to concerns about overshooting and problems on the inflation 
and debt fronts.  For now, it should at least have the 
positive effect of muting pressures on the Central Bank from 
politicians and business people to do something about the 
strong lira.  Though the weaker lira could make it harder for 
Turkey to make its 2003 inflation target, Central Bank 
officials told econoffs there might not be too big an impact, 
at least in 2003. According to these officials business 
people have not been quick to pass through exchange rate 
fluctuations into their prices, reducing the correlation 
between exchange rate movements and inflation.  If there is 
an effect, these officials expect it to hit with a lag, 
causing inflation in early 2004. 
 
 
 
 
 
 
 
 
 
 
EDELMAN