Turkey: Country Economic Forecast: 20 Feb 2012

Despite the global financial turmoil in H2, Turkey's economy is likely to have grown by well over 8% in 2011 as a whole. And while part of this reflects the carry-over of momentum from when global conditions were more helpful, even in Q4 industrial output rose by 3.6% on the quarter helped by a more competitive exchange rate. But while industry may still be holding up, the rest of the economy is probably slowing much more significantly, under pressure from sharp rises in both inflation and interest rates. And a major slowdown in growth, with subdued private demand, is essential if inflation is to fall back from over 10% currently to the 5% target on a sustained basis and the current account deficit is to shrink from 2011's massive US$77bn. If this can be achieved, then the medium-term outlook remains optimistic, with growth moving back to trend at about 5% in 2013. But the forecast is subject to considerable uncertainty. There is a risk that as the slowdown becomes more evident the central bank reacts by easing policy too soon or the government steps in with a substantial fiscal boost. Such actions would keep inflation high and undermine the credibility of macro policy. And the major risk from the Eurozone debt crisis is still present; just because Turkey has weathered the crisis well to date (including a sizeable TRY rally this year) does not mean it will continue to do so. It remains hard to see how Turkey, with its large need for external financing, would not be gravely affected if the crisis led to a partial freezing in capital flows.