VZCZCXRO4595
PP RUEHDA
DE RUEHAK #5396/01 2581431
ZNR UUUUU ZZH
P 151431Z SEP 06
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC PRIORITY 8729
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHGP/AMEMBASSY SINGAPORE PRIORITY 0076
INFO RUEHIT/AMCONSUL ISTANBUL PRIORITY 1284
RUEHDA/AMCONSUL ADANA PRIORITY 1108
RUEHBS/USEU BRUSSELS

UNCLAS SECTION 01 OF 02 ANKARA 005396 
 
SIPDIS 
 
TREASURY FOR U/S ADAMS 
STATE FOR A/S SULLIVAN 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN TU
 
SUBJECT: Turkey: Meetings with Turkish Delegation in Singapore 
 
REF: ANKARA 5092 and previous 
 
Sensitive But Unclassified.  Please handle accordingly. 
 
1.(SBU) Summary: Your meeting with Minister Babacan occurs as Turkey 
looks forward to an autumn of potentially rocky EU accession issues, 
pre-election domestic politics and question marks about inflation -- 
any of which could roil financial markets, as they did in the 
spring.  Turkey weathered the spring financial volatility, 
vindicating its overall policy framework.  Public finances continue 
to improve, the current account deficit, while large, can be 
financed, and growth is expected to slow only slightly this year. 
For now, inflation is the most significant macroeconomic issue.  End 
Summary. 
 
--------------------------------------- 
After a Quiet Summer, Autumn Challenges 
--------------------------------------- 
 
¶2. (SBU) This is a moment of transition for Babacan, Central Bank 
Governor Yilmaz and the Turkish economic team.  The spring emerging 
market sell-off scared them, but the fact that the market correction 
did not turn into a crisis also vindicated Turkey's overall policy 
framework.  After the Central Bank's missteps during the volatile 
period, the Bank's ultimate ability to stabilize the markets and the 
ensuing two months of relative calm have partially restored Governor 
Yilmaz' credibility.   Now Babacan and Yilmaz are focused on the 
remainder of 2006:  Babacan on avoiding a "train wreck" over Cyprus 
in Turkey's EU accession process and Yilmaz on returning the Turkish 
economy to its pre-correction disinflationary path. 
 
¶3. (SBU) Babacan, normally a relatively technocratic, 
under-the-political-radar minister, has run into a barrage of press 
criticism in recent weeks over his perceived inactivity as EU 
negotiator.  This criticism, and the looming EU deadline for Turkey 
to open its ports and airports to Greek Cypriot shipping and 
aviation, is likely to make him focus more on his EU negotiator job 
than on his macro policy responsibilities and the IMF program.  The 
current relatively benign macro environment and the absence of major 
bones of contention with the IMF are likely to reinforce this 
tendency.  Turkey has recovered well from the May-June fall in the 
exchange rate and spike in interest rates.  To date, there is little 
evidence that the correction has scarred either the banking system 
or the corporate sector, despite initial fears to the contrary. 
 
------------------------------------ 
Biggest Macro Issue is now Inflation 
------------------------------------ 
 
¶4. (SBU) Public finances continue to benefit from a combination of 
strong growth, a reduced interest bill, and cash receipts from 
privatizations and asset sales from intervened banks.  From January 
through August, 2006 the central government actually ran a slight 
overall surplus - not bad for a country which had a budget deficit 
of 14% of GDP only four years ago.  So far, there have been few 
signs of political spending in the run-up to elections though this 
remains a risk. 
 
¶5. (SBU) Turkey's debt ratios are much improved from even two years 
ago: net public sector debt of 56% at yearend 2005, versus 90% in 
¶2001.  After the spring volatility, however, interest rates never 
returned to their pre-correction levels and rose again (surpassing 
20%) during an early-September dip in the market.  Higher nominal 
rates reflect higher inflation expectations following the May-June 
fall in the exchange rate.  Nominal rates have also been nudged 
upwards by the Turkish Treasury's need for large-scale redemptions 
in September, as well as market concerns about the global outlook. 
Higher rates are still manageable; Turkish Treasury has a strong 
cash position and the declining trend in interest rates is likely to 
resume soon. 
 
¶6. (SBU) The resumption of nominal rates' declining trend will 
depend on a return to disinflation.  With the fall in the exchange 
rate and higher fuel prices working to keep inflation high, the 
annualized inflation rate returned to the low double digits in the 
summer months.  Markets are now hoping inflation will start coming 
down again in the fall, given the Central Bank's cautious stance. 
 
¶7. (SBU) In July, in the immediate aftermath of the fall in the 
exchange rate and the increase in interest rates, there was a 
consensus among economists that there would be a significant 
slowdown in economic growth in the second half of the year.  Private 
investment and interest-rate sensitive consumption -- autos, 
housing, consumer durables -- have been major drivers of Turkey's 
 
ANKARA 00005396  002 OF 002 
 
 
strong growth from 2002 through the first half of 2006.  The most 
recent data releases, however, suggest that the slowdown may not be 
as pronounced as previously thought and that growth is likely to 
surpass the 5% program target for the full year. 
 
¶8. (SBU) The balance of payments outlook for 2006 is mixed, with a 
current deficit probably surpassing 7% of GDP.  On top of a still 
weak trade account, tourism receipts now look slightly down this 
year, particularly following the recent spate of terrorist bombings. 
 Still, the current account deficit does not seem a serious concern 
in the near-term, as Turkey has ample financing for it: strong FDI 
flows are set to surpass last year's record $9.6 billion by $10 
billion or more and portfolio investors have returned. 
 
--------------------------------- 
Political and EU Wrangling Likely 
--------------------------------- 
 
¶9. (SBU) Even as the macro picture looks more comfortable, the same 
contentious domestic political atmosphere that helped drive 
investors away in May will continue to be a risk in the run-up to 
May 2007 presidential elections and parliamentary elections, which 
must be held by November 2007.  A sign of the underlying political 
seething was the bitter debate over Turkey's participation in UNIFIL 
that pitted the Kemalist secular establishment - led by President 
Sezer and the vocal leading opposition party -- against the AK Party 
Government. 
 
¶10. (SBU) Turkish participation in UNIFIL, along with the Rice-Gul 
announcement in July of the Shared Vision and Structured Strategic 
Dialogue, have helped U.S.-Turkish bilateral relations, despite the 
exceedingly poor USG image in Turkey, as reflected in  the German 
Marshall Fund's Transatlantic Trends and other recent surveys. 
Ongoing PKK terrorist violence continues to roil bilateral 
relations, and is topic number one domestically.  The recent naming 
of General (ret) Ralston as the U.S. special envoy to combat PKK 
terrorism has helped, but Turkey is still looking for concrete 
action against the PKK in Iraq. 
 
Wilson