Growth in Turkey is expected to be below potential over the next couple of years, the International Monetary Fund (IMF) said in a report issued on November 2.

After expanding by 4% last year, Turkish economy is set to post a growth of 3.3% in 2016, the fund said in the November issue of its Regional Economic Issues: Central, Eastern, and Southeastern Europe, report. Growth will further weaken to 3% next year. Both estimates were unchanged from the IMF's published in October.

Last month, the Turkish government slashed its GDP growth forecast for 2016 to 3.2% from a previous 4.5%. The growth estimate for 2017 was lowered to 4.4% from 5%.

This year's slower growth reflects adverse external shocks, alongside the negative impact of the credit slowdown, real effective exchange rate appreciation, and weakness in consumer and investor confidence amidst heightened political uncertainty, the IMF said. “In 2017, growth is projected to remain below potential as the one-off factors pushing growth in 2016 dissipate, and headwinds from eroded business confidence further weigh on investment.”

The fund expects the real domestic demand growth to accelerate to 4.9% this year from 4.2% in 2015 only to slow to 2.9% in 2017. The real private consumption growth will pick up to 6.4% in 2016 from last year’s 4.8% but it will weaken to 3.6% next year, according to the report.

The IMF recommends that policies in Turkey should aim at using the favourable external conditions to build buffers and address external imbalances, reducing inflation, and addressing long-lasting structural weaknesses. “Over the medium term, additional tightening may be needed, if external imbalances persist and inflation remains high. For Turkey, structural reforms should focus on increasing private saving rates and improving the business climate.”

According to the fund, inflationary pressures are likely to stay elevated amid carryover effects from last year’s depreciation and monetary easing. The IMF’s inflation projections for 2016 and 2017 are 8.4% and 8.2%, respectively.

“In the CESEE economies appear generally compressed, which leaves countries exposed to the risk of an abrupt correction. Countries with a relatively high leverage or with financing needs are more vulnerable to an abrupt shift in market sentiment. This is particularly relevant for Turkey, given a large negative net international investment position and sizeable external financing needs,” the IMF warned.