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

071736Z May 04

UNCLAS SECTION 01 OF 02 ANKARA 002599 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EUR/SE, AND EB/IFD/OMA 
TREASURY FOR OASIA - MMILLS AND RADKINS 
NSC FOR BRYZA AND MCKIBBEN 
 
 
E.O. 12958: N/A 
TAGS: EFIN ECON TU
SUBJECT: CONTINUED SELL-OFF IN TURKISH MARKETS 
 
 
REF: A. ANKARA 2456 
     ¶B. ANKARA 2359 
 
 
¶1. (Sbu) Summary: The sell-off continued in Turkish markets 
this week, with bursts of nervous selling Thursday and Friday 
driving the lira to new lows for the year.  A bad week for 
global emerging markets was exacerbated in the Turkish case 
by increased tension between the Government and the military 
over legislation to make it easier for students from 
religious schools to enter university.  Though interest rates 
continue to rise, they remain manageable for the Turkish 
Treasury.  After the markets closed Friday, the Central Bank 
announced a worse-than-expected February Current Account 
deficit of $2.066 billion.  End Summary. 
 
 
¶2. (Sbu) Turkish Financial markets had another bad, but not 
disastrous, week.  The market volatility that began with the 
April 24 Cyprus referendum and the moved-up expectations of a 
U.S. interest rate hike continued this week, and was helped 
along both by global market and local developments. 
According to analysts and the Central Bank Governor, the main 
global market trend depressing Turkish markets was the 
negativity in the global market in emerging market bonds, 
driven by the drumbeat of information out of the U.S. raising 
fears of a Fed rate hike sooner rather than later: the Fed 
statement earlier this week followed by lower than expected 
applications for unemployment compensation on Thursday and 
higher than expected non-farm payrolls on Friday. 
 
 
¶3. (Sbu) Local developments hardly helped the markets' mood. 
Even though the inflation data for April announced Monday, 
showed that 12-month CPI was already, at 10.18 percent, below 
the year-end target of 12 percent, Citigroup Istanbul's 
economist Olgay Bukkayali told econoff that markets seemed to 
focus more on the surprisingly sharp month-on-month jump in 
agricultural prices and in the Wholesale Price Index.  The 
month-on-month WPI jump was worse than expected at 2.65 
percent, although the 12 month change in the WPI was still 
only 8.91 percent.  Consequently, Monday was a bad day in the 
markets, with the Lira weakening from TL 1.420 at Friday's 
close to TL 1.458 at the close. 
 
 
¶4. (Sbu) On Wednesday, Prime Minister Erdogan publicly 
floated the idea of reducing Turkey's crucial primary surplus 
target of 6.5 percent of GDP in 2005.  Though certainly a 
negative for markets, the markets did not react sharply, 
perhaps because Central Bank Governor Serdengecti had earlier 
in the day implied Turkey needed a continued IMF role next 
year.  Markets were also focused on the U.S. unemployment 
application and non-farm payroll data on Thursday and Friday, 
respectively. 
 
 
¶5. (Sbu) Most rattling of all, however, was the sudden uptick 
in tension between the GOT and the military over the GOT's 
moving ahead on legislation that would make it easier for 
graduates of Imam Hatip high schools, which focus on 
religious education, to enter university.  Though the 
political dimension of these developments is being reported 
septel, the military's issuance of a strong warning statement 
late Thursday clearly unsettled the markets. A worried 
Central Bank Governor Sureyya Serdengecti told Econcouns 
Thursday evening that he had taken the unusual step of urging 
GOT ministers to withdraw the legislation to avoid market 
problems.  He feared  that Friday would be a bad day if 
tensions were not defused.  Sure enough, in early morning 
trading Friday the equity market fell sharply and the TL fell 
from 1.463 mm to the USD at Thursday's close to TL 1.480 
before stabilizing somewhat.  Near the end of the day, the 
sell-off again took on a head of steam such that the TL ended 
the day breaking the TL 1.5 barrier, reaching TL 1.51 mm per 
USD in after-hours trading. The IMKB 100 stock index ended 
the day 3.5 percent down, at 17,001.97. Today's sell-off 
happened in a context of very low transaction volumes, 
suggesting that most investors are still on the sidelines, 
even though those that are in the market are selling rather 
than buying. 
 
 
¶6. (Sbu) The government securities market was not immune to 
the sell-off: The benchmark May 10, 2005 bond ended the week 
yielding 26.25 percent compared to 24.46 at the close last 
Friday.  As these numbers suggest, the sell-off in government 
securities was not as dramatic as in the thinner and more 
volatile equity and foreign exchange markets.  The tendency 
of Turkish banks, who dominate the government securities 
market, to buy to support the value of their portfolios, 
combined with reports that foreign holders of longer-dated TL 
assets are still holding on to them, may explain this more 
limited impact on fixed income markets. 
¶7. (Sbu) In all three markets, however, the difference a 
month has brought is quite striking.  One month ago, the TL 
was at 1.335 mm to the dollar and 1.615 mm to the Euro (vs 
1.796 mm at the close May 7), the benchmark interest rate was 
only 21.91 percent and the stock market was around 20,000. 
Much as the market was in one of Turkey's "virtuous circles" 
for much of the past year, in the last month it has returned 
to a "vicious circle" pattern.  During the virtuous circle 
period, the appreciation of the currency helps reduce 
inflation, causing interest rates to fall, and investors to 
keep betting on the currency rising and interest rates 
falling. During the vicious circle period, the momentum is in 
reverse. Not only, as several Istanbul analysts have 
explained to econoff, do investors "stop-loss" positions 
exacerbate the fall as they are forced to unwind their 
positions when the lira hits certain levels, but the fall in 
Turkish Eurobond prices generates margin calls on Turkish 
banks' external borrowings collateralized by Eurobonds. 
Huseyin Kelezoglu of HC Istanbul, who explained the latter 
phenomenon to econoff, said the fall in Turkish Eurobond 
prices also exacerbates Turkish banks' already significant 
open foreign exchange positions, i.e. the banks 
FX-deonominated liabilities exceed their FX-denominated 
assets.  When the Eurobonds, which are FX-denominated assets 
fall in price, the banks have to sell more TL and buy FX to 
avoid going over exposure limits monitored by the bank 
regulators.  This adds to the market pressure on the lira, 
exacerbating its fall. 
 
 
¶8. (Sbu) If all this were not enough, after the markets 
closed Friday, the Central Bank announced a 
worse-than-expected Current Account Deficit for February of 
$2.066 billion.  (Markets were expecting $1.532 billion). 
The Current Account 
Deficit announcement, and the unresolved Imam Hatip 
situation, set the stage for difficult market conditions on 
Monday.  Some analysts, including Kelezoglu, believe the 
Central Bank could intervene to prevent excess volatility in 
the foreign exchange market.  Unlike the Central Bank's 
several interventions to break the speed of the Lira's 
appreciation over  the past year, intervening to support a 
falling lira will decrease rather than increase the Central 
Bank's foreign exchange reserves. 
 
 
¶9. (Sbu) Despite the continued sell-off, it is important to 
note that the markets are nowhere near a crisis.  The Turkish 
Treasury is not expected to have any difficulty rolling over 
its debt in the coming months.  Because of the substantial 
fall in inflation and interest rates in the first quarter of 
2004, current interest rate levels are already well below the 
projected average interest rate for the year of 29 percent, 
on which the Treasury's borrowing program and the GOT's 
budget are based. Moreover, the Treasury borrowed heavily 
from the domestic market in the first three months of the 
year, when conditions were favorable, given it some room for 
maneuver for the remainder of the year. 
 
 
 
 
EDELMAN