UPDATE 2-Turkey predicts brief economic impact from graft probe
* Finance minister says growth may slow in Q1
* Fitch says prolonged crisis could hit creditworthiness
* Pressure on central bank to hike rates
By Seda Sezer
ISTANBUL, Jan 7 (Reuters) - Uncertainty caused by Turkey's corruption scandal could hit economic growth in the near term, Finance Minister Mehmet Simsek said on Tuesday, while ratings agency Fitch warned that a prolonged crisis could weaken the country's creditworthiness.
A wide-ranging graft investigation, cast by Prime Minister Tayyip Erdogan as a plot to undermine his government, is shaking investor confidence in Turkey when the lira is languishing around record lows, inflation rising and growth slowing.
"We are facing a significant challenge in the political arena but we think this will not be long-lived," Simsek said in an interview on CNN Turk television.
"There could be a slowdown to some extent in the first quarter. But according to our base scenario, I believe that as uncertainty lessens and the environment calms...growth could still be around 4 percent (this year)."
Erdogan's ruling AK Party has built its reputation on its record for economic management and an avowed commitment to fight corruption. The scandal, which exploded on Dec. 17 with the detention of businessmen close to the government and the sons of three cabinet ministers, risks damaging him in the run-up to local and presidential elections this year.
Fitch said that while the crisis had no immediate impact on its 'BBB-' sovereign rating for Turkey, prolonged uncertainty could prove more damaging.
"If the corruption scandal drags on, it could weaken the government and undermine its ability to take timely policy measures that would maintain economic stability," it said.
It noted that tensions between the government and judiciary had strained institutions in Turkey. Erdogan has cast the corruption investigations as an attempted "judicial coup" by forces seeking to undermine his government, and hundreds of police officers have been removed from their posts.
"These factors are not incompatible with a 'BBB-' rating, but they have the capacity to weaken sovereign creditworthiness," Fitch said in its statement.
PRESSURE ON CENTRAL BANK
The economic and political pressures caused by the scandal may delay for many more months a tightening of monetary policy that would stabilise inflation and stop the lira from plumbing record lows.
Across Turkish financial markets, there is a near-consensus that short-term interest rates need to be a lot higher - as much as 3 or 4 percentage points higher, some traders say - to be sure of relieving pressure on the sliding currency.
But the central bank has been reluctant to raise its main interest rates for fear of slowing growth ahead of elections.
Simsek said Turkey was taking measures to keep domestic demand at reasonable levels without the need for interest rate hikes, supporting the central bank's current monetary stance.
"The central bank, banking watchdog, finance ministry and treasury got together, we limited loan growth with capital adequacy ratios and macro prudential measures, without resorting to rate hikes," he said.
The Turkish lira has been under intense pressure since the U.S. Federal Reserve announced it will begin winding down, or tapering, its $85 billion-a-month money-printing programme, and Turkey's high-level corruption probe has added to that pressure.
Emerging markets in general are seeing foreign investment pull back, and Turkey is among the most vulnerable with its huge current account deficit and reliance on external financing.
"With market perceptions of political risk showing no sign of abating, the central bank will remain under pressure to raise interest rates, even while the authorities aim to maintain growth at 4 percent in 2014," Fitch said.
It said macroprudential measures had so far not been enough to narrow the current account deficit, which at around 7 percent of national output is Turkey's main economic weakness, or inflation, running well above the central bank's 5 percent target.
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