VZCZCXRO0253
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHIT #0187/01 1080717
ZNR UUUUU ZZH
P 170717Z APR 08
FM AMCONSUL ISTANBUL
TO RUEHC/SECSTATE WASHDC PRIORITY 8044
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 ISTANBUL 000187 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR J.ROSE 
USDOC FOR 4200/ITA/MAC/EUR/PDYCK/CRUSNAK 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV TU
SUBJECT: ISTANBUL BANKERS PAINT PESSIMISTIC PICTURE 
 
REF: A. ANKARA 654 
     ¶B. ANKARA 642 
     ¶C. ANKARA 527 
     ¶D. ANKARA 473 
 
¶1.  (SBU) Summary.  Istanbul-based investment analysts 
describe a much more fragile picture than six months ago -- 
including stubborn inflation, a weakening lira, slowing 
growth and the possibility of an interest rate hike that 
would further hammer the real economy.  External factors, in 
particular the economic slow down in the United States and 
the tight global credit market, are most important but 
internal factors are making a bad situation worse.  Rumors of 
a policy shift at the Central Bank are becoming more 
prevalent as analysts see little choice but for the Central 
Bank to abandon the 4% inflation target in the face of 
expectations in the high single digits and an inflation rate 
that has stubbornly refused to converge over the past two 
years.  Privatizations and the $18 billion FDI target appear 
optimistic given market conditions with one analyst 
predicting significant FDI deceleration.  End summary. 
 
External Factors 
---------------- 
 
¶2. (SBU)  Turkey is highly dependant on international capital 
flows to finance its $52 billion current account deficit. 
The global credit crunch therefore hits Turkey harder than 
many other emerging markets.  EFG Istanbul Securities chief 
economist Baturalp Candemir argued that unless global credit 
markets suddenly improve, Turkey's monetary policy makers 
will have to choose between hiking interest rates, thereby 
sacrificing growth, and permitting further currency 
depreciation.  So far this year the lira is already down by 
approximately 15% against an equally weighted dollar-euro 
basket and Candemir believes the lira has further to fall. 
Comment: Given a net private sector foreign debt mismatch in 
the $50-70 billion  range (ref D) a significant decline in 
the lira's value would put pressure on Turkish companies that 
have borrowed abroad to take advantage of lower interest 
rates, but lack foreign currency earnings to back up the 
debt.  End Comment. 
 
¶3. (SBU)  Murat Gulkan, Deutsche Securities chief strategist, 
sees an increased probability of rate hikes both to maintain 
external financing and to signal Central Bank resolve should 
the Central Bank revise upward its 4% inflation target. 
Inflation is continuing to drift away from the 4% plus or 
minus 2 target, which all market observers agree will be 
impossible to meet again this year.  For the last two years, 
inflation expectations, although higher than the target, have 
consistently underestimated actual inflation.  If the market 
decides the target is not credible, forward looking inflation 
expectations could spiral upward quickly and getting 
expectations back under control would likely prove difficult, 
Gulkan explained.  If the Central Bank re-sets the inflation 
target at a higher level, an interest rate hike accompanying 
the announcement would telegraph the Central Bank's 
commitment to meet the new target "at any cost." 
 
¶4. (SBU)  Privatizations will also be relatively difficult 
this year (ref B).  Deutsche Securities is handling the Turk 
Telekom deal and it is proving to be a hard sell.  The 
Halkbank sale may be postponed due to unfavorable market 
conditions - "Why buy Halkbank at a share price higher than 
Citibank's?" Gulkan asked rhetorically, noting the IPO sale 
price was a psychological floor below which the GOT was 
unlikely to accept.  Electricity distribution sales will be 
broken up by region and although some regions are likely to 
attract strong local interest, other regions are much less 
attractive.  Candemir believes foreign direct investment is 
unlikely to meet the 2008 target of $18 billion given market 
conditions and sees $13-14 billion as a more realistic level. 
 He argues that FDI cannot be sustained at current levels and 
will decelerate to a sustainable annual range of $8-10 
billion now that mergers and acquisitions in the financial 
sector are complete and privatization is winding down. 
 
Internal Problems 
----------------- 
 
¶5. (SBU)  Candemir contrasted the current situation with the 
initial six to eight months of the first AKP government, when 
the economy was facing a serious debt crisis and the GOT made 
a number of important decisions in quick succession.  He 
argues current performance is lacking both on economic policy 
and on EU (political) reforms.  Noting the length of time it 
 
ISTANBUL 00000187  002 OF 002 
 
 
took for the GOT to announce a relatively straightforward 
electricity price increase last fall, he claims the economic 
decision making process is "clearly flawed" in comparison to 
the former government.  The most likely culprit is Cabinet 
composition, possibly exacerbated by overconfidence or lack 
of understanding of how serious the economic problems facing 
Turkey are on the part of the Prime Minister.  He notes the 
GOT's failure to carry through on any subject - political or 
economic - and argues the GOT appears to be "disorganized to 
the point of chaos."  (See Ankara 198 on this.) 
 
¶6. (SBU)  Additional reforms, including judicial reform, are 
necessary but will be seen as political retaliation in 
today's tense climate, Candemir noted.  The market would 
applaud a precautionary stand-by agreement with the IMF (ref 
A), but he doubts the IMF would be able to convince the GOT 
to take steps that it would not otherwise take on its own. 
The EU, while still playing a vocal role, has squandered good 
will and done lasting damage to the accession process by 
being perceived as biased against Turkey, argued Gulkan. 
 
¶7. (SBU)  Both Gulkan and Candemir echo the received wisdom 
in Istanbul financial circles - "Turkey's entrenched secular 
elite are complete economic illiterates, unable to comprehend 
either how global trends affect Turkey or how domestic 
Turkish politics are perceived by markets."  Gulkan argues 
the judiciary, with support from the military, prompted 
current political tensions by bringing a closure case against 
the ruling AKP but failed to anticipate how markets would 
react and lacks a clear idea of how to move forward.   For 
its part, the ruling party is constrained by unforgiving 
external circumstances and internal opponents who don't 
understand the nature of the problem.  Gulkan however sees a 
one in three chance the two sides will be able to work out 
some sort of compromise that could result in the AKP being 
cautioned rather than disbanded. 
 
Comment 
------- 
 
¶8. (SBU)  Candemir and Gulkan's analysis is significantly 
less positive than it was in the pre-sub prime melt-down 
environment.  Much of the problem is not of the GOT's making, 
and cannot be solved from Ankara, but some of it could have 
been headed off or reduced if the GOT had moved forward on 
its economic reform agenda at the start of the second AKP 
government.  When political tensions erupted in April 2007, 
the global credit environment was much more benign, 
international investors were focused on relative interest 
rate differentials and largely discounted early elections and 
related political turmoil.  The external environment is now 
much less forgiving and may force economic policy makers to 
make decisions, such as hiking interest rates or allowing the 
lira to weaken significantly, that would have a significant 
negative impact on the real economy. 
WIENER