UPDATE 2-Turkey set to resume growth path but faces risks -IMF

* 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 to its long-term growth path after a soft landing this year but its wide current account deficit leaves it vulnerable to volatile foreign capital flows, the International Monetary Fund said on Monday.

Turkey, Europe's fastest-growing economy last year with growth of 8.5 percent, is expected to expand at a "more measured pace" of 3 percent in 2012 despite weak growth in the European Union, its main trading partner, the IMF said.

"The conditions for a resumption in domestic demand growth are in place, with unemployment at a ten-year low, relatively healthy private sector balance sheets, and more supportive macroeconomic policies," it said in the concluding statement of its mission to Turkey under Article IV, a compulsory assessment undergone annually in every member country.

"Beyond 2012, the economy is in a good position to return to its 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 and high 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 economy would grow 3 percent this year, missing a 4 percent target.

Tighter monetary policy in the last quarter of 2011 and the start of 2012 helped steer Turkey into a soft landing, narrowing its large current account deficit and bringing down inflation.

The IMF expected the current account deficit to narrow to 7.5 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 major risk as it could lead to a reversal in capital flows and force the economy into a sharp adjustment," the Fund said.

"There is also a risk that the easing of monetary policy in the advanced economies might be conducive to a resurgence of excessive credit growth in Turkey ... bringing to a halt - and even 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. The government's year-end target is $65.4 billion.


The central bank cut its overnight lending rate for the first time in seven months at its last monthly policy meeting in September, and hinted it could do more to try to cushion the slowdown in economic growth.

Governor Erdem Basci said last month that he was "slowly loosening the brakes" but was cautious about easing policy too far and widening the current account deficit.

"In the period ahead, the monetary policy stance needs to remain cautious and forward-looking, mindful of the impact that the resumption in domestic demand-led growth may have on inflation and wage formation," the IMF said.

Prime Minister Tayyip Erdogan has said he would like to see real interest rates of zero percent, and has lashed out at what he called an "interest rate lobby" of investors pressing for higher rates that could stifle Turkey's growth.

The IMF said the central bank should maintain a positive real interest rate policy given still-high inflation. Annual inflation, around 9.2 percent in September, remains above the central bank's year-end target of 5 percent.

Tax and energy price increases are also set to push inflation higher in the short term, although the underlying longer-term trend is for less pressure on prices, with core inflation indicators falling last month.


The IMF said it was important that the government's medium-term fiscal plan for 2013-15 sets strengthening the budget structure as a key aim. It also said the authorities should seek to deliver a sizeable increase in the primary surplus.

Turkish economy officials said in recent weeks the country would miss its year-end budget deficit target of 1.5 percent of national output by one percentage point, as tax revenues decline.

Late in August, Fitch Ratings said it may upgrade Turkey's long-term rating to 'BBB-' from 'BB+' if it makes progress towards its potential growth rate, trims inflation to its target and narrows the current account gap.

"These more supportive IMF comments, plus a realistic set of assumptions in the 2013 budget and medium program, could yet just leverage the rating agencies to finally upgrade Turkey to investment grade," wrote Timothy Ash, head of emerging markets research at Standard Bank in London.

In the past the Turkish government relied on IMF loans to meet financial shortfalls, but it has managed to do without the aid since 2008. Erdogan said in September that Turkey will clear its remaining $1.3 billion of debt to the fund by next April.

(Writing by Nick Tattersall and Daren Butler; Editing by Anthony Barker)

((daren.butler@thomsonreuters.com)(+90-212-350 7122)(Reuters Messaging: daren.butler.thomsonreuters.com@reuters.net))