* Rating upgrade considered if external risks reduced
* C/a deficit adjustment seen slower in 2013 (Adds quotes, details, background)
ISTANBUL Oct 30 Ratings agency Moody's said on Tuesday that a history of political friction between secular and religious elements of Turkish society remains a credit challenge for the country.
In a statement, Moody's also said it could consider upgrading Turkey if the government makes further progress in reducing its current account deficit, increasing foreign exchange reserves or reducing private sector external borrowing.
The statement came a day after the Turkish police fired tear gas and water cannon to disperse thousands of secularists at a banned rally on the country's republic day.
"Turkey's resilience to economic, financial and political vulnerabilities has strengthened considerably in recent years... Nonetheless, there are some noteworthy areas of political risk in Turkey, some of which stem from secular-religious tensions, others from longstanding regional and ethnic conflicts," Moody's said.
Moody's upgraded Turkey in June to Ba1, one notch below investment grade, and maintained a positive outlook, citing improvement in public finances.
Turkey's current positive outlook would likely be moved to stable if progress on managing external risks were reversed or public finances deteriorate, Moody's said.
The agency said it expects Turkey's large current account deficit, seen as its main economic vulnerability, to "remain relatively high at 7.8 percent and 7.4 percent of gross domestic product (GDP) in 2012 and 2013 respectively," Moody's said.
It forecast real GDP growth to slow in 2012 to three percent, from 8.5 percent in 2011.
"Although the market takes any rating-agency related news flow positively these days with the investment grade expectations, these conditions are not easy to achieve in the short term," wrote Ozgur Altug, chief economist at BGC Partners.
"Therefore, we think that it is unlikely to see an investment grade rating upgrade from Moody's in the short term."
Rival ratings agency Fitch said early in October it will hold a conference on Turkey's credit outlook in Istanbul on Nov. 8. It too currently rates Turkey one notch below investment grade at BB+ with a stable outlook.
After Turkey's central bank kept monetary policy tight over the end of 2011 and the start of 2012, Turkey's current account deficit fell to $36.1 billion in the first eight months of 2011, down 33 percent from a year earlier. The gap reached 10 percent of GDP at the end of 2011. (Writing by Seltem Iyigun; Editing by Ruth Pitchford)