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The International Monetary Fund has warned of a cocktail of risks threatening the Turkish economy as it called on the country’s central bank to raise rates to protect the tumbling lira.

In findings from its latest annual report on the Turkish economy, the Washington-based fund said the country was exposed to a series of external vulnerabilities while inflation had soared and growth has fallen to its worst quarterly level since the financial crisis.

The IMF is forecasting GDP growth will fall “below potential” at 2.9 per cent this year having dropped to 2.6 per cent in 2016.

The economy faces “considerable downside risks—with high inflation, external imbalances, and substantial reliance on external financing continuing to generate vulnerabilities—while dealing with complex geopolitical and security challenges” said the Fund.

With the lira having weakened to its worst on record against the dollar last month, the IMF urged the Turkish central bank to continue tightening monetary policy in order to “address sharp lira depreciation, contain high and rising inflation, and counteract intensifying external pressures”.

Inflation hit a 12-month high in January on the back of the falling exchange rate and has not hit the central bank’s target of 5 per cent since 2011. The IMF forecasts average inflation will peak at 8 per cent this year before falling back to 7.3 per cent in 2020.

Turkey’s conservative government has cautioned against tighter monetary policy however, calling on the central bank (CBRT) to keep policy stimulative in order to raise growth.

Last month, the CBRT opted to hike its overnight lending rate rather than its benchmark policy lever, with analysts noting policymakers were moving towards adopting a more flexible interest rate “corridor” to control monetary conditions.

But the IMF urged for simplicity in the rate-setting framework to “improve communications and enhance monetary policy transmission and credibility”.

Turkey’s government has also ramped up spending in a bid to support growth, a move welcomed by the IMF in the short-term. However the Fund pushed for “a tighter fiscal stance” over the medium-term to bring down inflation and restore investor confidence in its public finances.

“The overarching priority of rebalancing the economy through policies aimed at increasing domestic savings and raising potential growth, while ensuring strong and credible public institutions and policy frameworks that are clearly communicated”, said the Fund.

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