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

171525Z Mar 04

UNCLAS SECTION 01 OF 03 ANKARA 001607 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EUR/SE, EB/IFD 
TREASURY FOR OASIA - JLEICHTER AND MMILLS 
NSC FOR MBRYZA AND TMCKIBBEN 
 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV TU
SUBJECT: AGREEMENT WITH IMF ON DRAFT LETTER OF INTENT, 
CENTRAL BANK CUTS RATES 
 
 
REF: A. ANKARA 1319 
     ¶B. ANKARA 1578 
 
 
¶1. (Sbu) Summary: Deputy ResRep confirmed to Econoffs that 
the IMF and GOT have reached agreement on a draft letter of 
intent (LOI), with only minor follow-up steps needed for the 
GOT to sign the actual LOI.  Not coincidentally, on March 17 
the Central Bank cut overnight interest rates by 2 percentage 
points.  Two-thirds of the fiscal gap was filled from 
expenditure reduction and one-third from increased excise tax 
revenues on tobacco, alcohol, petroleum products, and 
liquified petroleum gas.  After much discussion, natural gas 
and electricity taxes and prices were not increased.  The 
Deputy ResRep admitted the quality of the fiscal adjustment 
was not good, but said there were few near-term alternatives 
to the measures taken.  The GOT has also committed to 
promulgate bankruptcy regulations, appoint the head of a 
commission to study the Imar Bank failure, and take steps 
towards state bank privatization.  The IMF program will have 
only three more reviews, each with a $660 million 
disbursement, with the final board vote scheduled for January 
¶2005.  The GOT seems increasingly open to an IMF role after 
¶2004. End Summary. 
 
 
Agreement Reached on a Draft LOI: 
-------------------------------- 
 
 
¶2. (Sbu) In a March 16 meeting, IMF Deputy Resident 
Representative Christoph Klingen confirmed press reports that 
the recently-departed Seventh Review Mission had reached 
agreement with the GOT on a draft LOI.  As with past reviews, 
Klingen said there were some follow-up actions the GOT needed 
to take before they could finalize the LOI, but that these 
were not major. 
 
 
¶3. (Sbu)  Klingen specified that, other than some minor 
procedural actions, the GOT needed to take three steps before 
the Seventh Review could go to the IMF Board: appoint the 
head of a commission to study the Imar Bank collapse, a 
longstanding IMF demand; withdraw capital from state-owned 
Ziraat Bank, and, depending on the structure of the planned 
Halk Bank-Pamuk Bank merger, from Halk Bank; and promulgate 
regulations implementing the new bankruptcy law passed by 
parliament in February. 
 
 
End-game of the Fiscal Gap Saga: 
------------------------------- 
 
 
¶4. (Sbu) After months of complex negotiations over measures 
to close the fiscal gap, the Fund and GOT finally agreed to a 
package with two-thirds of the gap made up from the 
expenditure side and one-third from increased revenues.  As 
previously reported, the gap was opened by a combination of 
shortfalls in 2003 and the Prime Minister's decision to 
increase the minimum wage and pension payments.  Klingen 
specified that the Fund stuck with its estimate of a TL 7 
Quadrillion (about 1.75% of GDP) gap, declining to get into a 
debate over the appropriateness of its estimate. Klingen said 
the GOT still did not have final 2003 data for the entities 
outside the Central Government.  For the Central Government 
the 5 percent primary surplus target had been slightly 
exceeded, but when final numbers are available for the 
Consolidated Public Sector the Fund expects a primary surplus 
of 6.2 percent of GDP, a slight shortfall from the 6.5 
percent target. 
 
 
¶5. (Sbu) On the spending side, the gap-filling measures 
totalled TL 4.4 Quadrillion, according to Klingen, with TL 
3.9 Quadrillion from the 13 percent across-the-board cut in 
discretionary spending, and TL 500 Trillion in earmarked 
spending from the Special Revenue accounts.  Klingen said 
these accounts, which are being brought on-budget by the 
Public Financial Management on Control Law, consist largely 
of university and other school expenditures, drawing on 
earmarked school fees. 
 
 
¶6. (Sbu) On the revenue side, Klingen shed light on the 
ever-changing and sometimes contradictory press reports.  In 
the end, the package includes increased tax revenues from 
tobacco products, petroleum products, alcohol, and liquid 
petroleum gas.  In recent weeks, Energy Minister Guler had 
repeatedly denied press reports that natural gas and 
electricity prices would be increased, and Klingen confirmed 
that natural gas and electricity were not in the final 
package.  He said the Fund had advocated inreased excise 
taxes on natural gas.  In the end, Klingen said the GOT had 
pushed for only raising taxes on Liquified Petroleum Gas 
(LPG), because LPG prices had fallen 25 percent on 
international markets such that the GOT could more easily 
assess higher taxes.  He said the IMF had reluctantly agreed, 
subject to review in six months.  Klingen pointed out 
however, that the budget assumed natural gas  prices would 
rise over the course of 2004 in line with projected wholesale 
price inflation, so the GOT may need to raise gas prices 
later in the year. 
 
 
¶7. (Sbu) Klingen explained that the revenue increase from 
tobacco derives from price increases rather than a higher tax 
rate.  The additional revenue from tobacco products is 
expected to be about TL 1.1 Quadrillion.  He said that with 
most of the end price to the consumer deriving from VAT and 
other excise taxes on tobacco products, a price increase has 
a significant tax collection impact.  Klingen confirmed that 
the Fund's initial idea of increasing tax rates had led to 
GOT fears that state-owned Tekel might be hurt if its private 
competitors did not fully pass on the tax increases to 
customers.  The GOT solved the problem by "talking to" the 
private companies and getting them to raise their prices. 
Klingen admitted this was not an ideal approach but was one 
of the compromises the Fund went along with.  Klingen added 
that the IMF insisted that in August, any end-user price 
increase will come from increasing excise taxes rather than 
prices. 
 
 
 
 
Quality of Fiscal Adjustment: 
---------------------------- 
 
 
¶8. (Sbu) Klingen admitted that the quality of the fiscal 
adjustment was "not good."  He argued that the GOT decision 
to raise the minimum wage and pension payments had left few 
good options in the short run.  Over a longer time horizon, 
the Fund was working on improving tax collection.  Klingen 
said the GOT is also due to have a Public Expenditure Review 
under its IFI programs.  Though normally conducted by the 
World Bank, the IMF felt the review should not wait and is 
taking the lead on an initial review in the coming months, 
followed by a fuller World Bank-led review later in the year. 
 
 
 
 
Banking Issues: 
-------------- 
 
 
¶9. (Sbu) Klingen said the LOI specifies an ambitious schedule 
for the revisions to the Banking Act, calling for the 
introduction to parliament before the summer recess.  The 
changes would provide for better coordination between off- 
and on-site bank inspection, immunities for BRSA and SDIF 
staff for their official acts, and a tightening of the "fit 
and proper" criteria for bank owners.  Klingen said the Fund 
now has more faith in BRSA Chairman Bilgin.  The new SDIF 
leadership seems to be moving in the right direction, but 
Klingen said that the Fund's Bank experts have doubts about 
the SDIF leaders' competence. Regarding the continued 
attempts of failed bank owners to come back into the banking 
system, Klingen said IMF M.D. Kohler had warned Prime 
Minister Erdogan about the Demir Bank case, and that the 
delay in the Court of Accounts' decision on Demir may be a 
positive sign.  Klingen said the Fund is monitoring Cukurova 
Group, who might try to play newly-separated BRSA and SDIF 
off against each other. 
 
 
¶10. (Sbu) Klingen said the Bankruptcy legislation was a 
longstanding IMF requirement and that bankers had fought a 
provision spelling out the mechanism for a pre-packaged 
bankruptcy feature facilitating out-of-court settlements. 
The bankers believed that if the law got too specific about 
the mechanism it would undermine banks' leverage in debt 
workouts.  According to Klingen, having lost the battle over 
the legislation, bankers might try a rearguard action on the 
implementing regulations, hence the IMF's requirement that 
the regulations be announced before the IMF Board vote. 
 
 
Fewer IMF Reviews: 
----------------- 
 
 
¶11. (Sbu) With the schedule of reviews pushed back by the 
delays in the Fifth, Sixth and Seventh Reviews, the IMF and 
GOT agreed to shrink the number of reviews remaining under 
the existing Standby.  Instead of five, there will be three 
more reviews, with each releasing a $660 million--rather than 
$500 million--disbursement.  Klingen said the final review 
would be negotiated in December but would not go to the Board 
until January 2005. 
 
 
Post-program IMF role: 
--------------------- 
 
 
¶12. (Sbu) Klingen said the GOT is showing increasing signs of 
accepting an IMF role beyond the end of the Standby.  At a 
minimum, IMF rules require a post-program monitoring 
arrangement for countries having borrowed over 100 percent of 
their quota.  In Turkey's case, Klingen said the Board would 
probably require three or four reviews a year under such an 
arrangement.  One step up from such post-program monitoring 
would be a Precautionary Standby.  Klingen said Babacan has 
said the GOT will take a decision in mid-year. 
 
 
Central Bank Cuts Rates: 
----------------------- 
 
 
¶13. (Sbu) Undoubtedly because of the agreement with the IMF, 
the Central Bank announced a 200 basis point rate cut March 
¶17.  The Central Bank's press release said nothing about the 
IMF, but highlighted the importance of fiscal policy 
complementing monetary policy, and even sounded a 
Greenspanesque note favoring spending-side cuts over tax 
increases.   Many private analysts have been saying for some 
time that a rate cut is overdue based on fundamentals, and 
the markets had clearly priced in the cut: rates on 
government securities hardly budged after the Central Bank 
announcement. The timing, coupled with Governor Serdengecti's 
frequent private comments to econoffs about the need to 
maintain pressure on the Government over fiscal policy and 
the IMF program, suggests the Bank waited for agreement on a 
LOI to announce the cut. 
 
 
EDELMAN