Boston, MA -- (SBWIRE) -- 07/30/2013 -- We expect domestic demand to stage a modest recovery in 2013 and 2014, and economic growth to accelerate following a sharp decline in 2012. However, a loss of investor confidence following recent social unrest and global financial market turmoil will slow capital inflows and cap the potential of Turkey's credit driven growth model. With relatively healthy budget and debt dynamics, the government is in a position to provide a more pronounced fiscal boost to the economy if needed, although we expect fiscal discipline to remain high up on the government's agenda, with monetary policy playing a more active role in boosting growth.

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Turkey's external imbalances will widen again in 2013, as domestic demand improves and export growth slows. This implies the country's external rebalancing process, which was impressive in 2012, will take a breather this year. Moreover, Turkey will rely on short-term foreign capital inflows to cover the sizeable current account shortfall, leaving it prone to reversals in risk sentiment and financing crises.

Recent protests have highlighted the fact that major political challenges still face the country over the medium term. In particular, the government will struggle to secure a multi-party consensus on the process of writing a new constitution, and the ruling Justice and Development Party will face growing and more vocal public opposition, with the potential for further unrest. Moreover, Turkey faces a challenging foreign policy environment amid heightened regional tensions as the government attempts to cement its role as an economic and political power in the region.

Major Forecast Changes

We have revised down our 2013 and 2014 real GDP forecasts for Turkey on the back of weakening leading indicators. We now expect growth of 3.0% and 4.2% in 2013 and 2014 respectively, compared to our previous forecasts of 4.0% and 4.7%. Nevertheless, if the Turkish authorities are able to weather the rebalancing process and challenging external financing environment over the next few quarters, the country's long-term growth story remains an attractive one.

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