Fundamentally, Turkey remains one of the favourite macroeconomic stories in the emerging Europe region. While Turkey will face a sharp economic contraction in 2009, we contend that its strong banking system, relatively low leverage ratios, large domestic market and pro-reform government will better enable the economy to take advantage of the improvement in foreign investor risk appetite and stabilisation of international credit markets. Moreover, we maintain that the trough of the recession is already behind us, with the pace of contraction expected to moderate significantly through H209.

In political news, Turkish Prime Minister Tayyip Erdogan's May 1 cabinet shuffle is a strong indication of his government's commitment to market reforms. The elevation of Ali Babacan to an enlarged economy portfolio, in particular, signals a broad continuation of economic policies. While we still believe fiscal policy will be expansionary in 2009 and 2010, we hold that core policy foci, including economic liberalisation in the long term, remain on the cards.

Turkey remains one of the world’s largest arms importers and has the second-largest armed forces in the North Atlantic Treaty Organization (NATO). The size of its army and arms expenditure is unlikely to change in the near future. However, Turkey’s defence budget and number of troops are likely to fall in the coming years, owing to the combined effects of a weakened economy, EU pressures and shifts in the nature of threats to the country. The country’s defence industry is small, but is likely to grow and improve. Its export industry is also likely to increase over time as local design and production leads to the development of competitive products.

We believe that momentum is building towards some form of political settlement in Turkey's longstanding conflict with the terrorist Kurdistan Worker's Party (PKK). That said, we stress that a quick resolution is not part of our core scenario and highlight several key risks which suggest that recent moves toward conciliation remain tentative at best. Efforts to end the long-standing conflict between the terrorist Kurdistan Worker's Party (PKK) and the Turkish government appear to be slowly gaining momentum.