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WASHINGTON (Reuters) - The International Monetary Fund called on Turkey to tighten its monetary and fiscal policies to reduce its external imbalances, which have been exacerbated by capital outflows from emerging markets.
"The market reappraisal of advanced economies' monetary policies has exposed Turkey's main vulnerability — its external imbalance," the IMF said after a mission visit to Turkey.
"In this context and with gross external financing needs projected to remain high over the next few years, a weakening or a reversal of capital flows present a major challenge for the Turkish economy," the Fund said in a statement on Friday.
The IMF said Turkey's current account deficit should widen to 7 percent of its gross domestic product this year and stay that way in 2014, in part due to more gold imports. And inflation should remain above the target of 5 percent this year and next, exacerbated by the depreciation in Turkey's lira.
Turkey has been among the most high-profile victims of the shift in global capital prompted by signals the Federal Reserve would rein in its ultra-easy monetary policy. The lira gained sharply when the U.S. central bank surprised markets in September by holding fire on an actual cut in bond-buying.
Turkey's central bank governor, Erdem Basci, said last week the lira's fall had worsened the outlook for inflation. He said the bank would implement additional monetary tightening in its complex money market operations if there were risks of price growth getting out of control.
Basci said the lira, which hit its weakest level ever against the dollar on September 5, was unjustifiably weak, and said inflation would be higher than the bank's previous forecast - an argument for more action.
The Fed's decision to hold off on tapering gave Basci some breathing space but economists are skeptical of whether the lira's 15 percent fall since February is at an end given the pressure of global flows and Turkey's huge current account deficit.
The IMF said tighter fiscal and monetary policy should reduce external financing requirements and inflation, which would decrease the likelihood of further capital outflows.
It also said Turkey should avoid selling its foreign exchange reserves as a substitute for monetary policy, and use the reserves only to address excessive volatility.
Turkey's central bank has sold more than $9 billion of its roughly $50 billion in readily available foreign currency reserves in the past three months, raising questions about its ability to resist another bout of currency volatility.
The IMF said Turkey's high domestic demand should lead to growth of 3.8 percent this year and 3.5 percent next year, assuming current macroeconomic policies stay in place. But growth driven mostly by demand is worsening the country's current account deficit and inflation, the IMF said.
The Fund urged Turkey to raise domestic savings and improve its business climate over the medium term to increase growth.
(Reporting by Anna Yukhananov; editing by Matthew Lewis)