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

UNCLAS SECTION 01 OF 02 ANKARA 002742 
 
SIPDIS 
 
TREASURY FOR INT'L AFFAIRS - CPLANTIER AND MNUGENT 
NSC FOR MCKIBBEN 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN TU
SUBJECT: SHARP SELL-OFF IN TURKISH MARKETS 
 
 
THIS CABLE HAS BEEN COORDINATED WITH CONGEN ISTANBUL. 
 
1.(SBU) Summary:  A decline in Turkey's financial markets 
turned into a rout Friday, May 12 and continued May 15. 
Driven by a combination of global and local factors, 
investors -- especially foreign investors -- reached a 
tipping point and reduced their Turkish positions. 
Neither the Government nor the Central Bank has any easy 
tools with which to stop the slide, but at this stage a 
2001-style crisis seems only a remote possibility.  End 
Summary. 
 
-------------------------------- 
Market Decline Turns into a Rout 
-------------------------------- 
 
¶2.  (U)  During the first four months of 2006, Turkish 
financial markets continued to go their bullish way, with 
equities continuing to rise as the lira accompanied the 
dollar's gradual fall against the euro.  In May, however, 
sentiment cooled due for a variety of global and local 
reasons.  On Friday, May 12, the gradual decline turned 
into a rout given increasingly unfavorable global market 
conditions and more and more market-unfriendly local and 
regional news flow.  Though there was no single event 
that triggered the sell-off, a series of concerns finally 
reached a tipping point. 
 
¶3.  (U)  On Friday, the IMKB 100 stock market index fell 
3.99%, the exchange rate dropped 4.5% against a Euro- 
dollar basket and the yield on the benchmark bond rose to 
14.51%, the highest rate so far in 2006.  For the week 
the IMKB was off 6.13%, the exchange rate had fallen 6.6% 
and the yield rose from 14.13% to 14.51%.  The lira 
closed at 1.3976 to the dollar -- an eighteen month low - 
- and 1.8032 to the euro.  New Central Bank Governor 
Durmus Yilmaz, attempted Friday to reassure markets by 
reaffirming the Bank'scommitted to the floating exchange 
rate regime.  He also said the higher-than-expected April 
inflation numbers had not altered the Bank's medium-term 
inflation projections.  The Governor said the Bank was 
watching market developments closely.  This statement was 
sufficient to cause markets to pause in their fall and 
even pull back a bit. 
 
¶4. (U) On Monday, however, following an overnight sell- 
off in Asian markets, the free fall continued with the 
IMKB 100 down an additional 3.45% to 40,519.89 at 2:35 
local time, the exchange rate down to 1.46 to the dollar 
and 1.86 to the Euro.  The benchmark yield rose to 
14.82%. 
 
----------------------- 
Causes Local and Global 
----------------------- 
 
¶5.  (U)  First among the global factors were signs of the 
long-expected weakness in Emerging Markets as a result of 
tightening monetary policy in the U.S., Europe and Japan. 
This tightness particularly affects Turkey, since many 
international investors in Turkish markets do so by means 
of "carry trades," i.e. borrowing in low-interest 
currencies like the yen and investing in high-yielding 
Turkish assets.  An HSBC trader told May 13 that 
investors were not renewing the normally-popular yen-lira 
carry trades. 
 
¶6.  (SBU)  Over the previous days and weeks, a variety of 
local and regional factors combined to make market 
participants increasingly anxious.  Among the 
longstanding worries were high oil prices that exacerbate 
Turkey's widening current account deficit; concerns about 
regional tension (especially vis-a-vis Iran); and 
increasingly acrimonious domestic political wrangling 
with more and more talk of early elections.  Early 
elections are considered a negative for markets since 
they bring with them the possibility that the market- 
unfriendly Nationalist Party (MHP) would enter parliament 
and possibly even form a coalition government with the AK 
Party. 
 
¶7.  (SBU)  On more purely economic issues, markets were 
surprised by unexpectedly high April inflation numbers, 
which wrong footed the Central Bank: Only days beforehand 
the Monetary Policy Committee, chaired for the first time 
by newly-appointed Governor Yilmaz, cut rates a quarter 
point.  With the prospect of the Bank facing greater-than- 
foreseen difficulties getting close to the 5% year-end 
target, inflation expectations and interest rates blipped 
upwards. 
 
¶8.  (SBU)  President Sezer's May 10 veto of Social 
Security Reform legislation further rattled markets. 
Although the President's veto is likely to be overridden 
by parliament, it created new uncertainties that the 
reform would not be implemented in a way as to bring the 
social security system's red ink under control.  The 
reform is also crucial for the IMF program. 
----------------- 
Uncertain Outlook 
----------------- 
¶9.  (SBU)  Some observers welcome a limited market slide 
as a healthy corrective to what they see as excessive 
investor enthusiasm.  They also believe a weaker lira 
will give exporters a competitiveness boost, particularly 
for exports to Europe.  On the other hand, if the 
downturn marks the beginning of a sustained fall in 
Turkish markets, neither the government nor the Central 
Bank have easy access to tools that can stop the slide. 
 
¶10.  (SBU)  Though the Central Bank could intervene to 
support the lira, this would run counter to the Bank's 
longstanding claims that its interventions are primarily 
intended to build up foreign exchange reserves.  The Bank 
had long warned investors it would not facilitate their 
exit from the market (i.e. buy lira in a correction). 
The Bank could, however, raise interest rates, which 
could send a signal of renewed inflation-fighting zeal 
and would help Turkish yields become attractive again. 
 
¶11.  (SBU)  Quickly wrapping-up an agreement with the 
visiting IMF mission on a new Letter of Intent without 
the customary drama could also give markets a shot in the 
arm.  The more the Government can do in the way of strong 
fiscal and structural measures in this IMF review to show 
a renewed commitment to the reform track the more it is 
likely to help markets.  Likewise, the sooner parliament 
overrides Sezer's veto of the social security legislation 
the better. 
 
--------------- 
Crisis Unlikely 
--------------- 
 
¶12.  (SBU)  The sharp fall with seemingly no buyers of 
lira assets is the worst correction since at least the 
spring of 2004.  Though worrisome, it has some way to go 
before it gets into crisis territory.   Even if it does, 
Turkey's much-improved fundamentals, including a 
strengthened fiscal situation a better-capitalized 
banking sector and improved public sector debt ratios 
suggest the likelihood of a full-blown financial crisis a 
la 2001 is remote. 
 
Wilson