VZCZCXRO2986
RR RUEHDA
DE RUEHAK #3370/01 1600457
ZNR UUUUU ZZH
R 090457Z JUN 06
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC 6401
INFO RUEATRS/DEPT OF TREASURY WASHDC
RHEHAAA/NSC WASHDC
RUEHIT/AMCONSUL ISTANBUL 0758
RUEHDA/AMCONSUL ADANA 0848
RUEHBS/USEU BRUSSELS

UNCLAS SECTION 01 OF 03 ANKARA 003370 
 
SIPDIS 
 
TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER 
DEPARTMENT PASS EXIMBANK 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN TU
SUBJECT: CENTRAL BANK STRENGTHENS CREDIBILITY WITH BOLD RATE 
HIKE 
 
Ref: A) Ankara 3033;  B) Ankara 3104 
 
1.(SBU) Summary:  By raising its policy interest rates 1.75% 
when markets were expecting a much more modest increase, the 
Turkish Central Bank has taken a step towards restoring some 
of the credibility it had lost since the appointment of a 
new Governor and since the global sell-off hit Turkish 
markets.  Higher-than-expected inflation data for two months 
in a row have substantially altered the inflation outlook 
for 2006.  Unless the market sell-off  deepens, the effect 
on Turkey's debt situation and on the banking sector seems 
manageable and there is no evidence yet of serious problems 
in the banking or corporate sectors.  End Summary. 
 
--------------------------------------------- -------------- 
High Inflation Numbers Prompt Extraordinary Central Bank 
Meeting 
--------------------------------------------- -------------- 
 
¶2. (SBU) Following the announcement late Friday, June 2, for 
the second month in a row, of higher-than-expected inflation 
data, the Central Bank announced it would hold an 
extraordinary meeting of its interest-rate setting Monetary 
Policy Committee on Wednesday, June 7.  The consumer price 
index rose 1.9% in May, bringing the increase over the past 
twelve months to 9.86%, well above 2005 inflation and 
virtually precluding Turkey will achieve its 5% 2006 
inflation target.  (Separately, a Central Bank survey 
released June 8 found that end of year inflation 
expectations had increased to 8.82%)  After the inflation 
data was announced on June 2, the Central Bank declined for 
logistical reasons to follow the IMF's counsel to hold its 
meeting on the weekend to moderate the anticipated market 
reaction to the inflation news.  Between the inflation data 
and a resumption of selling in global markets, Turkish 
financial markets resumed their bearish trend:  the exchange 
rate reached 2 lira to the Euro and was over 1.584 lira per 
dollar on Tuesday, before easing slightly on Wednesday.  By 
Wednesday's close the stock exchange index had fallen 3% 
from Friday's close.   The continued slide on Wednesday came 
despite Minister Babacan's attempt to put Turkey's situation 
in perspective by reaffirming the Government's commitment to 
structural reforms and by trying to get markets to focus on 
macroeconomic fundamentals.   The yield on the benchmark 
bond, which started the year at 13.85% reached 18.46% on 
Monday but eased back to 18.03 % at the close on Wednesday. 
 
--------------------------------------------- ---- 
Markets Favorably Surprised by Scale of Rate Hike 
--------------------------------------------- ---- 
 
¶3. (SBU) After the markets closed on Wednesday, the Bank 
announced that the MPC had decided to raise rates 1.75%, 
lifting its borrowing rate from 13.25% to 15% and its 
lending rate from  16.25 % to 18 %.  With analysts having 
predicted an increase between 50 and 100 basis points, the 
Bank successfully surprised the markets with the boldness of 
its move.  Market commentary was uniformly positive, marking 
a 180-degree shift in commentary on the Central Bank.  Many 
analysts believe the Bank has succeeded in getting ahead of 
the curve, whereas they had been critical both in public and 
in private conversations over the tepidness of the Central 
Bank's response to the past month's sell-off.   The Bank's 
accompanying statement suggests that by raising rates so 
sharply at one go, it hopes it would not have to continue 
raising rates, though that will depend on future inflation 
data releases. 
 
------------------------------ 
Impact Centers on Exchange Rate 
------------------------------- 
 
¶4. (SBU) The currency market seems to have been the 
principal beneficiary of the improved mood in the market. 
The stock exchange continued to sell off on Thursday (down 
3.73%), demonstrating that global markets are the principal 
driver of Turkish markets.  Equities were driven down by a 
powerful bearishness in global markets and the fact that the 
higher borrowing costs implied by the rate hike are a 
negative for corporate profits.  Likewise, the yield on the 
benchmark government bond did not improve with the news and 
closed at 18.03% on Thursday.  The exchange rate, however, 
started to appreciate in night trading Wednesday night after 
 
ANKARA 00003370  002 OF 003 
 
 
the Central Bank announcement and did not follow the equity 
market down on Thursday, ending the day at 1.55 to the 
dollar at the close of trading. 
 
¶5. (SBU) Before the MPC meeting, some analysts had suggested 
the Bank might also intervene in foreign exchange markets. 
By taking no action in foreign exchange markets, the Bank 
implicitly reaffirmed its stated commitment to the floating 
exchange rate regime.   Yet in his remarks on Thursday 
Central Bank Governor pointed out that the Bank can always 
exercise its authority to curb the volatility in the 
currency market, implying he was leaving the door open to 
the possibility of intervention.  Some analysts believe the 
Bank may yet intervene to brake the fall in the exchange 
rate but is waiting until the State Deposit Insurance Fund 
completes its large sales of foreign exchange from the 
proceeds of its sales of companies seized from the owners of 
failed banks, especially Telsim, the cell phone company 
formerly owned by the Uzan group.  The head of the SDIF 
raised eyebrows in recent days by talking about his large 
foreign exchange sales, although a Central Bank official 
told us not to make too much of this,  saying SDIF, like all 
state institutions, had given the Central Bank prior notice. 
 
--------------------------------------------- 
Striking a Blow for Central Bank Independence 
--------------------------------------------- 
 
¶6. (SBU) The large increase in rates, in addition to 
signaling determination to rein in inflationary pressures, 
is also being interpreting as a reassertion of Central Bank 
independence.   With the selection process of the new 
Governor having raised concerns about bank independence, 
Governor Yilmaz seems keen to stand up to the Government. 
We are hearing rumors of frictions with the Prime Minister. 
Moreover, in a speech June 8, the Governor called for fiscal 
policies to be in line with the program - apparently a 
warning against the Government succumbing to its occasional 
bouts of fiscal populism.  Yilmaz also cited the importance 
of the IMF and EU anchors to the Turkish economy, a point 
the government has chosen to frame in a way that is more in 
tune with domestic political priorities (emphasizing that 
it's the Government's - not the IMF's program). 
 
¶7. (SBU) Though Yilmaz' muscle-flexing is encouraging, the 
Bank has not yet fully recovered its credibility or 
reputation for independence.   The news of the rate hike 
drowned out a market-unfriendly development at the Bank - 
the appointment to the Monetary Policy Committee of Bank 
board member Ibrahim Turhan.  When Turhan's name was bruited 
as a possible Vice-Governor in March, the Turkish press 
uncovered his anti-free market, anti-IMF writings in an 
Islamist journal.  Yilmaz participated in the June 7 MPC 
meeting, along with the two recently-appointed, and less 
controversial new Vice-Governors. 
 
-------------------------------------------- 
Sell-Off Yet to Impact other Vulnerabilities 
-------------------------------------------- 
 
¶8. (SBU) The past month's sell off in Turkish markets has 
yet to show signs of having a serious impact on Turkey's key 
areas of macroeconomic vulnerability. The fall in the 
exchange rate came as a welcome relief to the export and 
tourism sectors, though few economists expect much of a 
short-run boost to exports.  The most recent tourism numbers 
show the numbers broadly in line with last year's record 
number of visitors, putting to rest earlier fears of a sharp 
fall in tourism revenues. 
 
¶9. (SBU) Curtailed inflows of portfolio investment, which 
would normally raise concerns about financing Turkey's large 
and growing current account deficit, coincide with very 
positive news flow on foreign direct investment.  With many 
of last year's mega-deals being paid for in installments, 
the pre-correction outlook for FDI was at least on a par 
with last year's strong $ 9.6 billion inflow.  Some recent 
announcements have led the IMF Resrep, for example, to state 
publicly that FDI could reach $20 billion for the year.  In 
a meeting June 2, Treasury Under Secretary Canakci predicted 
a similar level and noted that the increase in FDI 
compensated for the expected increase in the current account 
deficit. 
 
ANKARA 00003370  003 OF 003 
 
 
 
¶10. (SBU) Canakci also told us he is quite confident about 
Treasury's debt situation, saying that even if market 
conditions caused Treasury to only roll over 55 to 60% of 
maturing debt, Treasury could still finance itself.   He 
also pointed out that the IMF's insistence the Government 
save any above-projection revenues helps Treasury's cash 
position, as do strong receipts from privatizations and SDIF 
asset sales. 
 
¶11. (SBU) Though it may be too early to tell, there is no 
sign yet that the banking sector has been hurt in any 
significant way by the sell off.  Canakci told us the bank 
regulatory agency (BRSA) has not reported any problems.  The 
impact on the corporate sector is much less clear, however, 
since some Turkish corporates have been hurt by the effect 
of a weaker lira on their large borrowings in foreign 
exchange. 
 
Wilson