VZCZCXRO8625
PP RUEHDA
DE RUEHAK #6503/01 3310604
ZNR UUUUU ZZH
P 270604Z NOV 06
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC PRIORITY 0065
INFO RUEATRS/DEPT OF TREASURY WASHDC
RHEHAAA/NSC WASHDC
RUEHIT/AMCONSUL ISTANBUL 1687
RUEHDA/AMCONSUL ADANA 1370

UNCLAS SECTION 01 OF 02 ANKARA 006503 
 
SIPDIS 
 
TREASURY FOR INT'L AFFAIRS - JROSE AND MNUGENT 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN TU
SUBJECT: UPTICK IN NERVOUSNESS IN TURKISH MARKETS 
 
REF: ANKARA 6410 
 
This cable has been coordinated with Congen Istanbul. 
 
1.(SBU) Summary: In the run-up to key decisions on Turkey's EU 
accession, Turkish financial markets are showing signs of increased 
nervousness, with declines in the currency and equity markets in 
recent days. the uncertainty and constant headlines on the EU front, 
combined with thin, end-of-year trading and a heavy reliance on 
foreign investors, mean increased probability for bumpy weeks ahead. 
 2007 might be even more volatile, as investors seem more concerned 
with upcoming elections and regional instability. End Summary. 
 
--------------------------------------------- --- 
Modest Correction in Currency and Equity Markets 
--------------------------------------------- --- 
 
¶2. (SBU) Starting the week of November 13-17, Turkish financial 
markets, especially equities and foreign exchange, have been 
declining, albeit not precipitously.  The IMKB-100 which stood at 
39,627 on November 10, fell 3 percent that week and continued to be 
soft in recent days, closing at 38,077  Thanksgiving day. 
 
¶3. (SBU) Beginning this week, the lira is showing signs of weakness, 
a notable change from its generally stable or strengthening trend 
this autumn. At the close November 17, the lira was at 1.4369 to the 
dollar and 1.8364 to the Euro, but had fallen to 1.4774 to the 
dollar at the November 23 close and 1.9146 to the Euro.  The easing 
in the bond market has been less pronounced, with the yield on the 
benchmark August 13 2008 bond increasing from 20.76 November 10 to 
21.56% November 23. 
 
------------------------------- 
Contrary to Conventional Wisdom 
------------------------------- 
 
¶4. (SBU) The modest but tangible sell-off is notable because it is 
contrary to the conventional wisdom in several respects.  The news 
on the inflation front -- a key focus of investors since June -- has 
been in line with expectations over the last few weeks, culminating 
in the Monetary Policy Council's widely-expected decision November 
23 to hold rates steady for the fourth month in a row. The release 
of a survey of inflation expectations also came in broadly in line 
with market predictions, with twelve-month inflation projected at 7% 
and 24-month inflation projected at 5%.  The recent easing of oil 
prices should also be positive for the inflation outlook, and for 
Turkish risk in general since lower prices imply a lower current 
account deficit. 
 
----------------------------------- 
Turkey-specific Factors to the Fore 
----------------------------------- 
 
¶5. (SBU) The market softness represents a relatively infrequent 
disconnect from the tone in global Emerging Markets, with some other 
EM stock markets hitting records in recent days.  This suggests 
Turkey-specific factors have come to the fore, particularly domestic 
politics and regional instability. This fall we have seen more 
foreign investor delegations in Ankara than at any time in memory 
and they are asking far more questions about politics and elections 
than about the economy or EU outlook. Though market analysts have 
not focused much on Iraq, continuing bad news out of Iraq may be a 
factor, with more and more local contacts and pundits focusing on 
the implications for Turkey of worsening instability. 
 
------------------------------ 
Insouciance About EU Tensions? 
------------------------------ 
 
¶6. (SBU) The increasingly bleak news on the EU front in the run-up 
to the December 14-15 EU Council meeting might have been expected to 
produce this kind nervousness in Turkish markets.  Analysts and 
investors, however, have been insisting for monts that markets are 
not overly concerned about the EU problems, having fully priced in a 
freezing of several chapters but not a complete suspension of the 
accession process.  The relative insouciance about the "train wreck" 
scenario may be reflected in the continued deal flow in Foreign 
Direct Investment.     Recent tensions with the EU have been 
shrugged off by the likes of National Bank of Greece, Citigroup, GE 
Capital, and Alpha Bank of Greece, which announced its purchase of a 
stake in Alternatifbank on November 22.  Even on November 22, 
representatives of a major U.S. hedge fund told us that in two days 
of meetings in Istanbul and Ankara, the EU issue was barely 
discussed. 
 
¶7. (SBU) By November 23 and 24, however, analysts were starting to 
say markets would be more focused on EU developments in the coming 
 
ANKARA 00006503  002 OF 002 
 
 
days, perhaps because they have treated potential EU problems in the 
same way they have handled IMF frictions in recent years -- betting 
until the last minute that both sides will blink to avoid a complete 
rupture. As the "last minute" approaches, some may be losing their 
sang-froid. 
 
----------------------------- 
Foreign Investors Will be Key 
----------------------------- 
 
¶8. (SBU) If we are entering a period of volatility,  foreign 
investors' willingness to stay in the market will be key, much as in 
the May-June period.  Since they were burned by their 
asset-liability maturity mismatches in May and June, Turkish banks 
have tended to keep much smaller holdings of the long end of the 
yield curve -- i.e. the benchmark 18 month bond. This has caused 
yields to remain at world-beating levels: over 20% in nominal terms 
which translates to over 13% in real terms based on inflation 
expectations.  These yields have proven irresistible to 
international investors, still flush with liquidity that they have 
to invest, hence the steady stream of Turkey-bound investor 
delegations.  Non-resident holdings of domestic debt securities were 
at an all-time high at the end of October, totaling YTL 32.3 billion 
($22.3 billion). Likewise, two-thirds of the free float on the 
Istanbul stock exchange is held by non-residents. 
 
¶9. (SBU) In addition to Turkish banks' reticence about 
longer-maturity bonds, a more anxious view held by local investors 
is perceptible from the trends in bank deposits.  Whereas from 2002 
through early 2006 the ratio of lira deposits to foreign currency 
deposits was on the rise, since the May-June volatility the trend 
has reversed, and picked up in recent weeks. 
 
------------------------------------ 
Critical Period Through mid-December 
------------------------------------ 
 
¶10. (SBU) It is far from clear whether the softening will continue 
or how big a role the EU "noise" is playing.  The uncertainty and 
constant headlines on the EU front, combined with thin, end-of-year 
trading and a heavy reliance on foreign investors, mean increased 
probability for bumpy weeks ahead, at least until the EU Council 
reduces the EU uncertainties and investors reopen positions at the 
start of the new year. Still, 2007 promises to be even more 
volatile, with investors more concerned about Turkey's May 
Presidential elections and November parliamentary elections than 
they are about the EU. 
 
Wilson