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

101559Z Mar 05

UNCLAS SECTION 01 OF 04 ANKARA 001318 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR INTERNATIONAL AFFARIS - ASHAH AND CPLANTIER 
NSC FOR BRYZA AND MCKIBBEN 
 
E.O. 12958: N/A 
TAGS: EFIN ECON TU
SUBJECT: HIGH CURRENT ACCOUNT DEFICIT IN 2004; REVIVED 
CONCERNS ABOUT 2005 
 
 
This cable was coordinated with Congen Istanbul. 
 
¶1. (SBU) Summary:  Final 2004 data put Turkey,s current 
account deficit at $15.4 billion or 5.2% of GDP, Turkey's 
highest such deficit in memory.  There are two views of the 
sustainability of deficits of this magnitude: optimists say 
that financing by private sector actors (roughly half of 
total financing) is long-term, mitigating the risks of a 
sharp outflow.  Pessimists point to the continued large 
reliance on reversible, short-term portfolio investment.   In 
any case, most analysts expect a slowdown in the rate of 
economic growth and a consequent slowing of import growth to 
shrink the size of the deficit in 2005.  However, an 
appreciating lira and recent surge in portfolio 
inflows--apparently including from large international funds 
that are not savvy about Turkish risk--are reviving analysts' 
worries.  End Summary. 
 
---------------------------------------- 
Imports Keep Growing Faster than Exports: 
---------------------------------------- 
 
¶2. (SBU) Despite some signs that the torrid growth of the 
economy, especially in the durable goods sector, was 
beginning to moderate, December and January trade data 
continued a pattern whereby imports grew faster than exports, 
resulting in large monthly trade deficits.  For December, 
imports totaled $9.6 billion and exports $6.6 billion, 
yielding a trade deficit of $3 billion--by far the largest 
monthly trade deficit of the year.  For all of 2004, imports 
(on a FOB basis) were $90.7 billion, exports $66.9 billion 
and the trade deficit $23.8 billion.  The year-on-year growth 
from 2003 dramatically demonstrates both strong growth in the 
economy and Turkey,s increasing integration into the global 
economy: exports grew 31% and imports grew 39% compared to 
2003 data.  Total exports plus imports totalled about 64% of 
GNP, versus about 49% in 2003. 
 
¶3. (SBU) Central Bank data show that so-called "suitcase 
trade" registered a slight decrease in 2004, from $3.95 
billion in 2003 to $3.88 billion.  The suitcase trade 
consists of  purchases by visitors (i.e. Turkish exports), 
many of them from the former Soviet Union,  on short-term 
shopping trips.  This seems to have been triggered by new 
policies of the CIS countries restricting the suitcase trade, 
although bombings in central Istanbul may have played a role. 
 
-------------------------------------------- 
Tourism Boom partially offsets Trade Deficit: 
-------------------------------------------- 
 
¶4. (SBU) Turkey normally runs trade deficits and offsets 
these deficits in part with a positive services balance, 
largely deriving from tourism.  Despite fears that the 
November 2003 Istanbul bombings or the war in Iraq would 
deter tourists in 2004, gross tourism receipts in the balance 
of payments rose 20% to $15.9 billion.  Tourist arrivals 
increased from approximately 19.8 million in 2003 to about 
24.6 million in 2004--a 25% increase. The remaining item in 
the current account--income--is typically a negative number 
because of Turkey's large external interest payments:  about 
$4.6 billion in 2003 and $4.4 billion in 2004.  The overall 
balance of the income account in 2004 was a negative $5.5 
billion. 
 
¶5. (SBU) Including tourism and remitted earnings, the 2004 
balance of payments showed a current account deficit near the 
high end of what analysts had been predicting in recent 
months.  For the year, the current account deficit reached 
$15.4 billion or about 5.2% of GDP.  The deficit nearly 
doubled from 2003, when it was only $8.0 billion, and 
represents the highest deficit in memory, higher than in 
2000, the year that produced the financial crisis, when the 
CA deficit was 4.8% of GDP.  The increase in the current 
account can be attributed to the increase in the trade 
deficit which was roughly the same amount. 
 
--------------------------- 
Underwhelming Growth in FDI: 
--------------------------- 
 
¶6. (SBU) Overall, the capital account provided more than 
ample financing of the current account deficit.  The capital 
account, combined with positive errors and omissions, led to 
reserve accumulation of $4.3 billion.  The increase in 
reserves brought gross Central Bank reserves to $ 37.6 
billion as of December 31, 2004, or about 111% of short-term 
external debt.  Several of the capital account line items, 
however, saw significant movements, not all of which are 
fully understood by local analysts.  Most disappointing was 
the very modest growth in foreign direct investment, despite 
the low base and Turkey,s breakneck (estimated at 8.3%) 
economic growth rate in 2004.  Net FDI rose only from about 
$900 million to $1.7 billion.  A closer look suggests this is 
even less impressive: about half of the $2.6 billion of gross 
FDI was investment in real estate, following a 2003 change in 
local law to allow foreigners to buy property. 
 
---------------------- 
Portfolio Inflows Soar: 
---------------------- 
 
¶7. (SBU) The most striking change in the capital account was 
the surge in portfolio inflows, which more than doubled from 
approximately $4 billion in 2003 to $9.2 billion in 2004. 
Most of this money went into debt securities, and most of 
this into government securities.  This is the proverbial "hot 
money" that analysts worry could quickly reverse direction, 
disrupting Turkey,s thin financial markets. According to the 
Central Bank of Turkey, foreign holdings of TL and FX 
denominated Turkish debt increased $7 billion in 2004.  So 
far in 2005, the money continues to flow in, at an even 
faster pace, as investors buy into Turkey as a quasi EU 
convergence story, following the December 17 EU Council 
decision to begin accession talks with Turkey.  Analysts 
believe the inflows are increasingly coming from large 
international investment funds that have little specific 
knowledge about Turkey.  High real  returns on lira 
instruments, investors, belief that a new IMF program will 
be approved, and global liquidity all contribute to the 
continued strong flow. In January 2005 such flows totalled $4 
billion versus only $672 million in November 2004. 
 
--------------------------------------------- ------- 
The debate over increased Private Sector Liabilities: 
--------------------------------------------- ------- 
 
¶8. (SBU) The "Other Investment" category of the capital 
account has shown significant, and not fully understood, 
shifts from 2003 to 2004.  Overall liabilities increased by 
$10 billion, contributing a significant source of financing 
to the BOP.  Rising imports led to an increase in net trade 
credits, from $2.2 billion in 2003 to $4.1 billion in 2004. 
On the other hand, Turkey,s $3.5 billion in net repayments 
to the IMF weighed on the balance of payments in 2004, the 
first year in which Turkey was a substantial net payer to the 
Fund.  More striking, and more commented upon, was the 
increase in bank and other private sector liabilities: bank 
liabilities shot up from $2.8 billion in 2003 to $6.2 
billion, and "other sectors" liabilities soared from $3.1 
billion in 2003 to $9.4 billion in 2004.  This "other sector" 
liability increase began to be much discussed in late summer 
and early fall, with several analysts and government 
officials asserting that the increase was a positive 
development, since it was largely long-term corporate 
borrowing from abroad to be used to finance expanded capacity 
in Turkey. As such, these analysts made the argument that it 
was akin to FDI in being a more stable source of financing. 
 
---------------------------- 
Errors and Omissions Decline: 
---------------------------- 
 
¶9. (SBU) Net errors and omissions, which had been very 
substantial in 2003 at $5 billion, fell to $2.9  billion in 
¶2004.  Though neither Central Bank officials nor private 
economists ever were completely sure what explained the large 
errors and omissions in 2003, the consensus view was that it 
represented some combination of reverse currency substitution 
(i.e. Turks moving foreign exchange-denominated assets into 
lira assets), flows of dollars from Iraq, and data capture 
problems in the methodology used by the Central Bank to track 
balance of payments data.  Note: No local analyst that 
econoffs have met subscribed to the theory put forward by 
Michael Rubin in a recent article in Middle East Quarterly, 
that the large errors and omissions represents Islamist money 
arranged for by AK Party officials. End Note. 
 
-------------------------------- 
Large CA Deficit Raises Eyebrows: 
-------------------------------- 
 
¶10. (SBU) With the 2004 current account deficit coming in at 
the high end of expectations, and indications that the flow 
of short-term portfolio investment continues to increase in 
2005, analysts cannot discount the risk of a severe market 
disruption caused by a sudden reversal of these flows. In 
late 2003 and early 2004, a few analysts--notably the 
Economist Intelligence Unit and a Moody,s analyst--made dire 
predictions of that the increasing current account deficit 
would eventually lead to a reversal of portfolio flows and a 
crisis.  As this did not transpire, analysts tended to move 
current account worries to the back burner during the second 
half of 2004, particularly as the improved fundamentals have 
gradually reduced most of Turkey,s indicators of financial 
vulnerability.  Indeed, the formerly alarmist Moody,s 
upgraded Turkey,s outlook from stable to positive, despite 
the news of difficulties in concluding the IMF program. 
Analysts increasingly bought into Central Bank Governor 
Serdengecti,s mantra, that the floating exchange rate regime 
has built in automatic stabilizers, reducing the risk of a 
sharp market disruption.  Moreover, analysts believed that 
the expected moderation of economic growth in 2005--with some 
analysts predicting growth below the 5% program target--will 
lead to a leveling off of import growth and a moderating 
current account deficit as a percentage of GDP.  A gradual 
adjustment scenario seemed likely. 
 
------------------------------------------ 
Early 2005 data revive CA deficit concerns: 
------------------------------------------ 
 
¶11. (SBU) However, recent data releases have revived worries 
about the current account deficit, and the possibility of a 
less gradual adjustment scenario.  Though markets continue to 
be very bullish, there has been a notable shift in several 
analysts' views on the issue in the past few weeks, for a 
variety of reasons.  First, though it's still too early in 
the year to be sure, there are signs the slowdown may not be 
as weak as expected.  Recent releases on industrial 
production and capacity ulilization, for example, surprised 
analysts on the high side.  At the same time, the January 
balance of payments showed continuing growth in imports such 
that the current account deficit continued to grow. 
 
¶12. (SBU) Perhaps the most worrying trend, however, is the 
continuing appreciation of the lira, driven by 
stronger-than-ever short-term portfolio inflows.  There are 
widespread indications that a portion of the increased flows 
derive from investment funds that are new to the Turkish 
market, that have not lived through Turkey's history of ups 
and downs, and therefore may not fully appreciate the 
downside.  The January BOP data show portfolio investment 
inflows exceeding $4 billion, compared with $9.2 for all of 
¶2004.  With the lira now trading around 1.25 to the dollar, 
the nominal exchange rate is about where it was in September 
2001, and the real exchange rate has appreciated roughly by 
half from its post-crisis trough.  While the strong lira (and 
surprisingly favorable February inflation data) has reduced 
inflation concerns, it is reducing the probability of that 
import growth will slow.  Consequently, analysts are lowering 
the probability of a gradual adjustment scenario. 
 
¶13. (SBU) Finally, some analysts are beginning to think that 
even if growth slows, import growth may remain relatively 
high.  Given that the composition of imports is heavily 
concentrated in intermediate goods, rather than capital or 
consumption goods, these analysts wonder whether imports will 
slow in a slower-growth scenario.  Baturalp Candemir of HC 
Istanbul--who came close to the mark with a $14.5 billion CA 
deficit prediction at a period in 2004 when the consensus was 
$8-9 billion--predicts a CA deficit of $16 billion if GDP 
growth is 4%, and $18 billion if it is 6.5%.  If he's right, 
this implies a continued widening of the CA deficit in all 
growth scenarios except those at the bottom of the range of 
analysts' expectations. 
 
¶14. (U) 2004 BOP Highlights ($ billions): 
 
                                  2003          2004 
                                             ---- 
---- 
 
             Exports (fob)                   51.2 
66.9 
             Imports (fob)                   65.2 
90.7 
             Trade deficit                  (14.0) 
(23.8) 
             Services                        10.5 
12.8 
               o/w Tourism (net)             11.1 
13.4 
             Income (interest   transfers)   (4.5) 
(4.4) 
 
             Current Account Deficit         (8.0) 
(15.4) 
 
             Net FDI                          1.2 
1.7 
               o/w inward FDI                 1.7 
2.6 
             Net Portfolio Investment         2.6 
8.1 
             Other Investment                 3.3 
7.0 
               o/w non-bank liabilities       3.2 
9.5 
 
             Net Errors and Omissions         5.0 
3.0 
 
             Overall Balance                 (4.0) 
(4.3) 
EDELMAN