Following the 2008-09 recession, economic activity rebounded in Turkey in 2010, reflecting some base effects but also strong domestic demand growth driven by low real interest rates, strong capital inflows and a rapid acceleration in bank credit growth. We expect the pace of growth to be more moderate in 2011-15, slowing from 8.9% in 2010 to about 4.5-5% a year in 2011-12 and 5-5.5% during the remainder of the forecast period. During the second half of the forecast period, we expect growth to be more balanced between external and domestic demand.

Although unemployment is expected to remain above pre-crisis levels and wage growth is likely to be moderate in real terms, employment growth and still low interest rates (even taking account of our forecast that the Central Bank raises them in 2011-12) are expected to continue to support household spending growth, which we forecast will average 5-5.5% a year in 2011-15.

In 2010 the government curbed public spending, resulting in a sharp deceleration in government consumption growth from 7.8% in 2009 to an estimated 2% in 2010. However, we expect that the government has loosened the purse strings to some extent in the first half of 2011, pushing up public consumption growth to 5% for the whole year. In 2012-15 we forecast a moderate deceleration to 4-4.5% per year as the government tightens fiscal policy moderately.

After a collapse in 2008-09, gross fixed investment rebounded by 29.9% in 2010. We forecast that growth will moderate from 2011 owing to base effects and softer external and domestic demand growth, but will remain strong at about 8% in 2012-15.

As we expect robust domestic demand to drive import growth and demand in Turkey's main European markets to remain subdued, especially during the first half of the forecast period, the foreign balance is forecast to reduce GDP growth by 4-4.5 percentage points in 2011 and by 2-2.5 percentage points in 2012. The impact is forecast to remain negative during 2013-15 but at a more moderate 1-1.5 percentage points.

There are substantial risks to our projections, on the upside for 2011-12, but on the downside for the second half of the forecast period. If the Central Bank's monetary policy fails to moderate credit expansion, GDP growth is likely to be substantially stronger than we expect in the next two years. However, continued above-trend economic growth would exacerbate Turkey's imbalances posing risks to stable growth in the second half of the forecast period. If private-sector debt levels continue to rise sharply (by OECD standards they are relatively low at present, at around 50% of GDP) and the current-account deficit is not reduced in two to three years, a decline in global liquidity could cause severe problems, including an abrupt fall in the value of the lira leading, as it has done in the past, to higher inflation and a sharp tightening of monetary policy followed by a rapid slowdown in economic activity, with possible private-sector debt-servicing difficulties.

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