By Yeliz Candemir

ISTANBUL--Turkey's growth is projected to be below potential in 2016 and 2017, the International Monetary Fund said Friday, cautioning that the economy faces considerable downside risks.

"Following a strong performance in 2015, growth has slowed. The July failed coup attempt heightened the spectrum of political uncertainty, and Russian sanctions have also negatively affected confidence," the IMF said, in its concluding statement of the 2017 Article IV Consultation with Turkey

The IMF said Turkey's growth is projected at 2.7% in 2016 and 2.9% in 2017.

Turkish gross domestic product in July through September shrunk by 1.8% annually, the first contraction since 2009."Executive directors welcomed the Turkish economy's resilience in the face of severe and increasing challenges and the authorities' efforts to avoid an excessive slowdown in the near term," the IMF said. "At the same time, directors cautioned that 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," it added.

The IMF said the authorities should continue simplifying the monetary framework, keeping a broadly neutral monetary policy stance. "Monetary tightening could be required to limit excessive lira volatility and its spillovers to inflation," the IMF noted.

Turkey's annual inflation jumped to one-year high of 9.2% in January from 8.5% in December, the state statistics agency said Friday, reflecting higher prices for food and nonalcoholic beverages.

The Turkish lira has slumped 5% against the dollar since the start of the year after the currency lost one-fifth of its value per dollar last year.

With the currency under pressure since the state of emergency called in the aftermath of the failed coup attempt, the central bank has largely refrained from pushing for a rate increase, while the government has advocated for lower interest rates to boost economic growth.

Instead, the central bank recently announced a series of measures to support the currency by canceling its regular one-week repo auctions and forcing the banks to borrow at a higher cost through its late liquidity window facility, a move seen as a backdoor tightening by investors.

The central bank kept its one-week repo rate steady at 8% at its monetary policy committee meeting on Jan. 24. Instead, it raised its overnight lending rate to 9.25% from 8.5%, and held its borrowing rate at 7.25%. In addition, the central bank raised the late liquidity window lending rate to 11% from 10%.

The central bank raised its 2017 inflation forecast to 8% from 6.5% and its 2018 inflation forecast to 6% from 5%, Gov. Murat Cetinkaya said Tuesday.

He added that Turkey's central bank may tighten monetary policy more if necessary to control inflation.

"Simplifying of the monetary policy framework and rebuilding credibility by appropriate tightening of monetary policy are necessary steps toward reducing inflation," the IMF said.

The IMF said moderate fiscal loosening in 2017 is appropriate, but a credible medium-term consolidation plan is needed.

The IMF stressed that slow progress with structural reforms and heightened political and economic uncertainty are keeping the economy from reaching its full potential.

"Policies should aim at improving the investment climate and ensuring adequate public institutional capacity in thewake of the failed coup attempt," it said.

Write to Yeliz Candemir at yeliz.candemir@wsj.com

(END) Dow Jones Newswires

February 03, 2017 11:14 ET (16:14 GMT)

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