* IMF sees long-term growth trend of 4 percent
* Current account deficit seen at 7.5 pct in 2012
* Central bank should maintain cautious stance
* Tighter budget structure needed
(Adds details, background, quotes)
By Seltem Iyigun and Seda Sezer
ISTANBUL, Oct 8 (Reuters) - Turkey is on track to return toits long-term growth path after a soft landing this year but itswide current account deficit leaves it vulnerable to volatileforeign capital flows, the International Monetary Fund said onMonday.
Turkey, Europe's fastest-growing economy last year withgrowth of 8.5 percent, is expected to expand at a "more measuredpace" of 3 percent in 2012 despite weak growth in the EuropeanUnion, its main trading partner, the IMF said.
"The conditions for a resumption in domestic demand growthare in place, with unemployment at a ten-year low, relativelyhealthy private sector balance sheets, and more supportivemacroeconomic policies," it said in the concluding statement ofits mission to Turkey under Article IV, a compulsory assessmentundergone annually in every member country.
"Beyond 2012, the economy is in a good position to return toits long-term trend growth rate of around 4 percent."
Turkey averaged 3.5 percent growth between 2007-2011,despite the global financial crisis. Household consumption andhigh private sector investment drove last year's expansion.
But weakening domestic demand has slowed growth this year.Deputy Prime Minister Ali Babacan said last month the economywould grow 3 percent this year, missing a 4 percent target.
Tighter monetary policy in the last quarter of 2011 and thestart of 2012 helped steer Turkey into a soft landing, narrowingits large current account deficit and bringing down inflation.
The IMF expected the current account deficit to narrow to7.5 percent of GDP this year but warned it remained a concern,with Turkey's external financing needs set to remain high.
"The unstable global financial environment presents a majorrisk as it could lead to a reversal in capital flows and forcethe economy into a sharp adjustment," the Fund said.
"There is also a risk that the easing of monetary policy inthe advanced economies might be conducive to a resurgence ofexcessive credit growth in Turkey ... bringing to a halt - andeven reversing - the unwinding of imbalances."
Turkey's current account gap fell 31 percent year-on-year to$34.46 billion in the first seven months of 2012. Thegovernment's year-end target is $65.4 billion.
CAUTIOUS MONETARY POLICY
The central bank cut its overnight lending rate for thefirst time in seven months at its last monthly policy meeting inSeptember, and hinted it could do more to try to cushion theslowdown in economic growth.
Governor Erdem Basci said last month that he was "slowlyloosening the brakes" but was cautious about easing policy toofar and widening the current account deficit.
"In the period ahead, the monetary policy stance needs toremain cautious and forward-looking, mindful of the impact thatthe resumption in domestic demand-led growth may have oninflation and wage formation," the IMF said.
Prime Minister Tayyip Erdogan has said he would like to seereal interest rates of zero percent, and has lashed out at whathe called an "interest rate lobby" of investors pressing forhigher rates that could stifle Turkey's growth.
The IMF said the central bank should maintain a positivereal interest rate policy given still-high inflation. Annualinflation, around 9.2 percent in September, remains above thecentral bank's year-end target of 5 percent.
Tax and energy price increases are also set to pushinflation higher in the short term, although the underlyinglonger-term trend is for less pressure on prices, with coreinflation indicators falling last month.
SUPPORTIVE OF RATINGS UPGRADE
The IMF said it was important that the government'smedium-term fiscal plan for 2013-15 sets strengthening thebudget structure as a key aim. It also said the authoritiesshould seek to deliver a sizeable increase in the primarysurplus.
Turkish economy officials said in recent weeks the countrywould miss its year-end budget deficit target of 1.5 percent ofnational output by one percentage point, as tax revenuesdecline.
Late in August, Fitch Ratings said it may upgrade Turkey'slong-term rating to 'BBB-' from 'BB+' if it makes progresstowards its potential growth rate, trims inflation to its targetand narrows the current account gap.
"These more supportive IMF comments, plus a realistic set ofassumptions in the 2013 budget and medium program, could yetjust leverage the rating agencies to finally upgrade Turkey toinvestment grade," wrote Timothy Ash, head of emerging marketsresearch at Standard Bank in London.
In the past the Turkish government relied on IMF loans tomeet financial shortfalls, but it has managed to do without theaid since 2008. Erdogan said in September that Turkey will clearits remaining $1.3 billion of debt to the fund by next April.
(Writing by Nick Tattersall and Daren Butler; Editing byAnthony Barker)
Keywords: TURKEY IMF/STATEMENT