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Viewing cable 05ANKARA1559, CENTRAL BANK AND GLOBAL SELL-OFF STOP RALLY IN

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Reference ID Created Released Classification Origin
05ANKARA1559 2005-03-17 16:06 2011-08-24 01:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Ankara
This record is a partial extract of the original cable. The full text of the original cable is not available.

171606Z Mar 05
UNCLAS SECTION 01 OF 03 ANKARA 001559 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER AND ASHAH 
NSC FOR BRYZA AND MCKIBBEN 
 
E.O. 12958: N/A 
TAGS: EFIN TU
SUBJECT: CENTRAL BANK AND GLOBAL SELL-OFF STOP RALLY IN 
TURKISH FINANCIAL MARKETS 
 
REF: A. ANKARA 1318 
 
     B. ANKARA 1202 
 
This message has been coordinated with Congen Istanbul. 
 
1. (SBU) Summary: A global sell-off in emerging markets, 
coming on the heels of a Central Bank rate cut and 
intervention, have caused a correction in the sustained rally 
in Turkish financial markets.  The lira, which had hit its 
highest level in three years earlier this month, finally 
reversed course and has fallen back approximately 5% against 
the dollar in the last week.  On March 9, the Central Bank 
not only cut interest rates by one percent but also 
intervened in the foreign exchange market, buying $2.3 
billion of foreign exchange--its largest intervention since 
the 2001 financial crisis.  These two actions, combined with 
favorable inflation indicators, suggest the Central 
Bank--like other observers--is beginning to be more worried 
about the outsized inflows of portfolio investment 
artificially inflating the value of the lira, than it is 
about inflation.  This week's emerging market sell-off hit 
Turkey's currency and eurobonds slightly harder than other 
emerging markets. End Summary. 
 
------------------------------------ 
Emerging Market Sell-off Hits Turkey: 
------------------------------------ 
 
2. (SBU) A broad sell-off in emerging markets this 
week--triggered by increased yields on U.S. Treasuries and 
expectations of continuing increases--has reversed the long, 
strong rally in Turkish financial markets.  Emrah Eksi of the 
Central Bank Markets Department estimated this week's 
outflows at about $700 million.  The lira in particular, 
which hit a three-year high on March 3, and is widely 
considered to be seriously overvalued, finally reversed 
direction.  Before the Central Bank intervention March 9, the 
lira was trading below 1.26 to the dollar.  At the close of 
business March 17, by contrast, the lira was at 1.3238  to 
the dollar and 1.7722 to the Euro.  Though the Central Bank 
action merely stopped the lira's appreciation, generating 
only a slight pullback in the lira later that day and on 
March 10, the change in global markets beginning Monday, 
March 14 caused the substantial depreciation of the lira this 
week, with the biggest declines on Monday and Wednesday. 
 
3. (SBU) Though the sell-off has had a significant impact on 
equities--notably with a 4.58% fall in the IMKB 100 March 
16--the impact on the government securities market has been 
far less dramatic.  The interest rate on the benchmark bond 
closed March 17 at 16.54% only 73 basis points higher than 
the close on the day of the Bank's rate cut, which helped 
bring down all interest rates on all types of interest rates 
by reducing bank funding costs.  In addition to the help from 
the rate cut, the impact on domestic bond prices caused by 
the reversal of sentiment on emerging market debt seems to 
have been mitigated by the relatively tight supply of new 
lira-denominated issuances.  In the Eurobond market, by 
contrast, Turkish bonds fell more than other emerging market 
Eurobonds.  Emrah Eksi explained that the continued TL 
issuances by foreign banks, now up to a cumulative $4.3 
billion, which he said the banks are largely hedging by 
buying TL bonds, may explain the mild impact of the sell-off 
on TL interest rates.  In other words, these banks' issuances 
are creating demand for TL bonds, braking the fall of these 
bonds' prices in a correction. 
 
4. (SBU) The emerging market sell-off has hit Turkey harder 
than other markets.  Last week's Central Bank rate cut and 
intervention (see below) signalled that the Central Bank 
would try to brake the rapid rise of the lira.  More 
recently, at the same time as global sentiment shifted, the 
news flow has been market-unfriendly:  there have been 
continuing stories about problems in relations with both the 
EU and the US, both viewed as key external anchors by 
financial markets.  Finally, on the IMF program, not only has 
there been no progress, but there are signs of new problems 
and delays on some of the IMF conditions that had been 
considered relatively easy to do: the tax administration 
reform law and the banking law.  The tax administration 
reform law was sent back to a parliamentary sub-committee for 
further work (and further delay). The provisions of the 
banking law relating to the deposit insurance fund (the SDIF) 
having flexibility to temporarily keep a bank running after 
intervening, rather than always having to liquidate the bank, 
remains the principal dispute between the bank regulatory 
agency (BRSA) and the Treasury.  According to the press 
reports, this, too, will now have to be decided by Prime 
Minister Erdogan. 
 
--------------------------------------------- -------- 
Central Bank Rate Cut at the High End of Expectations: 
--------------------------------------------- -------- 
 
5. (SBU) The broader emerging market sell-off this week comes 
on the heels of decisive Central Bank actions last week.  At 
the market opening March 9, following the monthly meeting of 
the Monetary Policy Committee the evening before, the Central 
Bank announced a one percent cut in both its lending and 
borrowing rates.  Analysts had been predicting a cut of 
between 50 and 100 basis points with the market consensus 
around 80 basis points.  In making their predictions, some 
analysts had thought the Central Bank would keep the cut 
small in order to maintain pressure on the GOT to make more 
rapid progress in concluding a Letter of Intent with the IMF. 
 
 
6. (SBU) As previously reported, Central Bank Governor 
Serdengecti was quite concerned about the lack of movement on 
concluding a Letter of Intent with the IMF, and predicted the 
Monetary Policy Committee might publicly refer to this 
problem.  He also had told us he could be cutting interest 
rates more quickly if there were an IMF program in place.  In 
the event, the Monetary Policy Committee's statement 
accompanying the March 9 rate cut never referred to the IMF 
by name.  It did, however, refer to the need to structural 
reforms and fiscal discipline (i.e. the IMF program) in an 
apparent attempt to keep the pressure on the GOT. 
 
------------------------------- 
Followed by Big FX Intervention: 
------------------------------- 
 
7. (SBU) Markets had been expecting a Central Bank 
intervention in the foreign exchange market, given the 
continued appreciation of the lira, driven by strong inflows 
of portfolio investment since the beginning of the year.  The 
Central Bank has a track record of intervening to support the 
lira, but always at a level lower than the previous 
intervention, and always insisting it is only intervening 
because of "excessive volatility" and is committed to the 
floating exchange rate regime.  What has become increasingly 
clear to analysts is that what the Central Bank means is that 
it will not allow the lira to appreciate too quickly, 
particularly when the appreciation is driven by short-term 
portfolio flows. 
 
8. (SBU) Shortly after the rate cut announcement, later in 
the morning on March 9, the Central Bank began intervening, 
buying foreign exchange.  In the end, the Central Bank bought 
a whopping $2.3 billion in foreign exchange on March 9, in 
addition to the $45 million it has been buying every day 
since mid-December through foreign exchange purchase 
auctions.  By contrast, the Bank's last intervention, in late 
January, was for $1.3 billion. 
 
--------------------------------------------- --------------- 
Central Bank Actions Suggest a Shift in the Balance of Risks: 
--------------------------------------------- --------------- 
 
9. (SBU) The higher-than-expected rate cut--despite the 
absence of progress with the IMF--combined with the huge 
intervention suggests a shift in the Central Bank's judgment 
of the balance of risks.  By continuing to aggressively cut 
rates--January and December rate cuts were also higher than 
expected--the Bank seems to be indicating it is less and less 
concerned about inflationary pressures.  Two recent data 
releases would appear to justify this lessened concern about 
meeting the 8% inflation target for 2005.  February 
inflation, coming in below analysts' expectations at 0.02% 
for CPI and 0.11 for PPI, were powerful indicators that the 
Bank's disinflation policies are working.  When the February 
numbers were announced, there were even articles discussing 
the possibility of a looming deflation--unheard of in Turkey. 
 
 
10. (SBU) Instead of worrrying overmuch about inflation, the 
Bank seems to have shifted to worrying more about foreign 
portfolio investment inflows artificially inflating the lira 
and exacerbating imbalances in the balance of payments.  With 
the 2004 current account deficit at the high end of 
expectations, and no sign yet that it will abate in 2005, the 
Bank has reason to worry. As noted in ref A, in January 
alone, the portfolio investment inflows were $4 billion, 
equivalent to 43% of the full-year 2004 inflows. 
 
11 (SBU) The correction is healthy: it reduced, albeit 
slightly, the overvaluation of the lira, and may have 
dampened portfolio investors' irrational exuberance.  That it 
did so without causing interest rates to spike is 
particularly fortuitous.  If the portfolio inflows 
resume--with some analysts saying the correction allows 
investors to re-enter the market--the shift in the balance of 
risks away from inflation to the current account and exchange 
rate is likely to continue. 
 
 
EDELMAN