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 around 8% in 2010 to about 5-5.5% a year during the forecast period. This would also be weaker than the average of around 7% in 2003-07. During the second half of the forecast period, we expect growth to be more balanced between external and domestic demand.

After declining in 2008-09, private consumption has recovered strongly, helped by exceptionally low real interest rates and a strong pick-up in credit growth. 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 0.5% in 2010. However, we expect the government to loosen 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 an estimated 26.5% in 2010. Growth is expected to moderate from 2011 owing to base effects and softer external and domestic demand growth. Nevertheless, these factors will be offset by some government spending on construction projects anticipated because of the 2011 election and companies' need to replace old machinery and equipment.

In 2009 a sharp fall in exports of goods and services was offset by an even larger contraction in imports, reflecting weak domestic demand. Owing to a rebound in domestic demand and only a moderate recovery in Turkey's main export markets (the EU and Russia), this trend was reversed in 2010. The foreign balance is therefore estimated to have reduced GDP growth by about 4 percentage points. We forecast this negative trend to continue, as we expect import growth to far exceed that for exports as domestic demand growth remains robust and demand in Turkey's main European markets is subdued, especially during the first half of the forecast period. However, the drag on GDP is forecast to a more moderate 1 percentage point in 2013-15.

Our GDP growth forecasts have downside risks attached that could be triggered if economic expansion does not moderate from 2010 levels. Stable economic growth requires Turkey to be able to finance a large current-account deficit and substantial external debt repayments. In 2010 foreign capital inflows fuelled strong domestic credit growth, which-combined with real lira appreciation, also driven by capital inflows-increased the current-account deficit (to an estimated 6.7% of GDP). Private-sector debt is relatively low at around 40% of GDP and capital inflows are expected to remain adequate. However, if private-sector debt levels continue to rise sharply 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 to, as it has done in the past, 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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