Over the medium term, implementation of the ambitious structural reform agenda is critical to raising Turkey’s potential growth, the IMF said on December 5 (Friday) in a staff report for the 2014 article IV consultation. The report was prepared in November and released on Friday.

Policies should focus on rebalancing the economy, reducing the external deficit by boosting savings rather than decreasing investment, and lowering inflation to preserve competitiveness, IMF staff said.

The macroeconomic policy mix should focus on bringing down the external imbalance, lowering inflation to reduce vulnerabilities and preserve competitiveness; the preferred adjustment is through higher domestic savings to preserve investment, according to the report. Staff advises tighter fiscal and monetary policies in the near term to achieve higher domestic savings and lower inflation, while using macroprudential policies to preserve financial sector resilience.

Without a change in policies, medium-term economic performance is likely to be weaker than in the recent past, according to the IMF, which says on current policies and national saving rates, staff has revised annual medium-term growth to about 3.5%. The lower growth rate is expected to contain inflation and the deterioration of the current account, although both will remain elevated at about 6%, the IMF said.

The IMF identifies capital flow reversal as the main risk to the Turkish economy, saying that a sharp decrease in inflows would result in a large compression of absorption to close the external deficit and lead to a recession. Lower than anticipated growth in Europe would hurt demand in Turkey’s main export market, the IMF said, adding that the economic spillovers to Turkey from conflicts in Syria and Iraq have negatively impacted exports. The effects of tensions between Ukraine and Russia have thus far been limited, but if they were to lead to generalized risk aversion in financial markets, the impact could become significant, according to the IMF staff. A sharp increase in oil prices would have an immediate pronounced effect on Turkey’s import bill, further widening the external gap, the Fund warned.