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

011445Z Oct 04

UNCLAS SECTION 01 OF 03 ANKARA 005668 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR E, EUR/SE, AND EB/IFD/OMA 
TREASURY FOR IA - MMILLS AND RADKINS 
NSC FOR MBRYZA AND TMCKIBBEN 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV TU
SUBJECT: CURRENT ACCOUNT DEFICIT CONCERNS: MITIGATING 
FACTORS AND A BAD SCENARIO 
 
REF: A. ISTANBUL 1371 
 
     ¶B. ANKARA 5637 
 
 ¶1. (Sbu) Summary: As Turkey's current account deficit 
continues to grow, several analysts have recently outlined 
some mitigating factors that could reduce the danger of a 
disruptive correction. These factors include:  Durables 
import growth is unlikely to continue to surge; short-term 
portfolio investors have shown a willingness to maintain 
their positions during sell-offs;  and there are signs of 
growing Foreign Direct Investment.  Despite these mitigating 
factors, other analysts point out the possibility of a bad 
scenario arising from good news on EU accession: short-term 
portfolio flows would continue to increase, inflating the 
currency and exacerbating the current account deficit.  Even 
in this scenario, however, no analyst in Turkey believes 
there is a serious risk of a "maxi-devaluation" as some 
external analysts have suggested. End Summary. 
 
¶2. (Sbu) Economic analysts tend to see the single greatest 
financial risk to the Turkish economy over the coming year or 
two as the risk that the build-up in the current account 
deficit could lead to a sudden, disruptive market correction 
in which the Turkish lira falls precipitously and short-term 
portfolio investors head for the exits.  In recent weeks, 
however, several analysts have mentioned factors that 
mitigate against this scenario, or at least would limit the 
extent of the disruption. 
 
Consumer Goods Import Surge Mainly Autos: 
---------------------------------------- 
 
¶3. (Sbu) Both Memduh Akcay, Director of Foreign Economic 
Relations at the Turkish Treasury, and Mehmet Simsek of 
Merrill Lynch/London, told econoffs that they believe the 
surge in durable imports is unlikely to continue at the same 
pace.  Akcay pointed out that when durables (especially cars) 
are excluded from consumer goods imports, this category of 
imports has hardly grown at all in 2004.  Note: Economists' 
worries about import growth focus on consumer goods imports, 
on the theory that capital goods imports--which grew 76% in 
the first seven months of 2004 compared to the same period in 
2003--are a proxy for investment. Unlike these two 
fast-growing categories, intermediate goods imports have 
shown only modest growth.  If one assumes the boom in car 
sales is likely to taper off (see below), Akcay's point is 
that the growth in consumer goods imports should not be a 
cause for worry.  End Note. In a similar, if less specific 
vein, IMF resrep told Econoffs that the IMF's GOT 
interlocutors view the current account deficit as largely 
self-correcting, perhaps for the reason espoused by Akcay. 
He added that IMF staff believe the GOT officials are at 
least partially right about the self-correcting nature of the 
current account deficit, but are considerably less sanguine. 
 
¶4. (Sbu) Central Bank data suggests Akcay may be right: for 
the first seven months of 2004, motor vehicle and vehicle 
parts imports grew 173 percent, increasing by $3.8 billion, 
roughly equating to the $3.99 billion increase in total 
consumer goods imports.  With tax incentives on turning in 
old cars to buy new ones now halved, and due to expire by 
year-end, Akcay went on, the auto sales growth should slow 
down.  Simsek of Merrill Lynch, a more independent analyst 
than Akcay, made a similar point, noting that much of the 
demand for durable goods is pent-up demand from the crisis 
and immediate post-crisis period, and consumers rarely buy 
more than one car or refrigerator every few years, such that 
the growth is likely to taper off.  Indeed, Auto Association 
data shows some tapering off, with monthly domestic auto 
sales having peaked in April and declining each month 
thereafter. In July, domestic retail car sales fell 7.2% 
while sales of imported vehicles fell 11.3%. Trade balance 
data for August, released by the State Statistical Institute 
on September 30, seem to confirm the trend, with vehicle and 
parts imports further declining 20% month-on-month, though 
some of this decline could be attributable to seasonal 
factors.  Simsek added, however, that another scenario cannot 
be excluded: if a continued fall in interest rates makes 
durable purchases affordable to a broader group of consumers 
the durables growth could continue. 
 
"Hot Money" Is Really Lukewarm: 
------------------------------ 
 
¶5. (Sbu) Another potential cushion against a steep fall in 
markets is the behavior of short-term foreign portfolio 
investors.  Baturalp Candemir of HC Istanbul said that in the 
April-May sell-off, foreign investors did not try to 
completely liquidate their positions in Turkish lira assets, 
preferring to maintain a large portion of their holdings and 
hope that markets would come back.  According to Candemir, 
investors simply did not want to incur large losses in a 
rapidly falling--and illiquid--market when there was a 
reasonable chance that Turkish bonds and bills would come 
back up in price.  For this reason Candemir does not expect a 
market correction to turn into a rout under all but the most 
extreme circumstances.  Ann Wyman of Citigroup's London 
office made a similar point: the investors who have pulled 
out during sell-offs are the ones who have lost money in 
Turkey.  Even people who were holding Turkish assets in the 
crisis made money if they held their positions rather than 
selling. 
 
Signs of Foreign Direct Investment: 
---------------------------------- 
 
¶5. (Sbu) A third factor that would mitigate against an 
alarmist current account deficit scenario would be an 
increase in Foreign Direct Investment.  Though FDI continues 
to be far below Turkey's potential or the flows for 
comparator countries--there are signs of an increase from 
previous years.  Central Bank balance of payments data show 
FDI of $1.3 billion for the first seven months of 2004, 
compared to $344 million for the first seven months of 2004. 
There is also considerable anecdotal evidence of corporate 
plans to expand capacity, particuarly with GDP growth now 
expected to reach something on the order of 10 percent for 
2004, and remain strong in 2005. 
 
¶6. (Sbu)  Though it may not be traditional FDI--in the sense 
of foreign corporate equity investment in Turkey--there is 
another line in the capital account suggesting there has been 
a surge of long-term capital flowing into Turkey's private 
sector.  Both Kubilay Cinemre of Garanti Bank and Emin Ozturk 
of Bender Securities, drew econoffs' attention to the surge 
in non-bank private sector long-term borrowings in the 
balance of payments statistics.  This category jumped from a 
negative $155 in the first seven months of 2003 to a positive 
$3.13 billion in the first seven months of 2004.  Ozturk and 
Cinemre both felt this was an indicator of Turkish companies 
borrowing offshore to finance investments.  (Note: Other 
Istanbul bank contacts pointed out that the Turkish tax code 
makes it attractive for Turkish banks to use offshore 
subsidiaries to lend to Turkish borrowers.  The risk 
associated with foreign borrowing by Turkish corporates was 
not addressed by Ozturk and Cinemre.  If the increase in this 
line item represents local corporates taking on additional 
foreign exchange risk through external borrowing, this would 
be an increase in vulnerability. If on the other hand, 
Turkish corporates foreign exposure is hedged through a 
stream of exports or through hedging instruments, then it is 
less of a concern. End note.) 
 
 
How Good News Could Lead to a Bad Scenario: 
------------------------------------------ 
 
¶7. (Sbu) Though the factors cited above may cushion the risk 
of a sharp correction, some economists see a danger that 
these factors could be offset by "too much" good news. Both 
Emin Ozturk and a visiting Fed economist laid out a scenario 
in which good news on the EU accession front, and possibly 
the IMF negotiations, leads to a surge in short-term 
portfolio investment, essentially the "convergence play" on 
EU accession.  Under this scenario, this increased flow would 
exacerbate the overvaluation of the lira, causing even more 
consumer goods imports, and leading to an even more dramatic 
build-up in the current account deficit.  Under this 
scenario, the correction, when it comes, would be that much 
more violent.  But even in this scenario, Ozturk doubted 
there would be a depreciation as steep as  40 or 50%, and he 
thought such a correction would be manageable.  None of the 
four Istanbul analysts at a recent roundtable discussion with 
econoffs, nor any other local analyst post is aware of, 
disagrees with Ozturk on this. In other words, they do not 
subscribe to the "maxi-devaluation" scenario suggested by a 
Moody's analyst and at least one U.S.-based emerging market 
analyst. 
 
¶8. (Sbu) Comment: The behavior of markets over the past year, 
and comments by investment advisors like Wyman, give 
credibility to Ozturk's scenario, in that foreign emerging 
market investors simply cannot afford to be out of a market 
like Turkey's high-yielding lira-denominated bonds, unless 
they expect a major crisis leading to default.  In a sense, 
this is the flip side of Baturalp Candemir's observation 
about short-term investors not running for the exits in a 
correction.  These investors' bias towards towards staying in 
could exacerbate the overvaluation/import surge problem. 
 
 
 
EDELMAN