Accordingly,  we predict that aggregate demand conditions would not restrain inflation for a while. In this context, our revised medium-term forecasts are based on a disinflationary output gap – albeit narrower than envisaged in the previous Report. As I mentioned earlier in my speech, the tightness in credit conditions tend to attenuate with the effect of easing global liquidity conditions and improving risk appetites. The healthy state of the Turkish banking system is conducive for a rapid recovery in credit volumes. In fact, credit markets have been increasingly supportive of domestic activity in the recent period. Accordingly, the first quarter of 2010 was marked by the increasingly benign outlook for credit markets (Figure 30). Consumer loans have continued to recover while commercial loans have accelerated. Credit extended to small- and medium-sized enterprises has also begun to recover after a long period of stagnation, indicating the support of easy monetary conditions on economic activity (Figure 31). Assuming that external finance conditions continue to ease steadily and that the fiscal stance does not crowd out domestic funding, we expect that credit volumes would continue to expand in the forthcoming period. However, expectations that unemployment rates will remain at high levels for a long period, and ongoing problems in the global economy are still potential factors that might restrain credit expansion.
In this respect, as implied by the fiscal rule, it is assumed that the fiscal space created by the stronger than expected economic activity leading to better than expected performance in budget revenues since the second half of 2009, would be used mostly to reduce the government debt stock; therefore, the goals set out in the MTP be implemented through institutional and structural improvements in 2011 and onwards. In other words, it is assumed that tax adjustments would be consistent with the inflation targets and automatic pricing mechanisms throughout the forecast horizon. Accordingly, it is envisaged that the rising debt-to-GDP ratios would gradually reverse course starting in 2011, and hence the risk premium would not display any significant changes throughout the forecast horizon. Against this background, assuming that liquidity measures are normalized gradually over the short term and that policy rates are kept constant at current levels for some time followed by limited increases starting in the last quarter of 2010, with policy rates staying at single digits throughout the three-year forecast horizon, the medium-term forecasts suggest that, with 70 percent probability, inflation will be between 7.2 and 9.6 percent with a mid-point of 8.4 percent at end-2010, and between 3.6 and 7.2 percent with a mid-point of 5.4 percent by the end of 2011. Furthermore, inflation is expected to decline to 5.0 percent by the end of 2012 (Figure 34). Despite the upward revision in the output gap, it is expected that the economic recovery would be gradual.