These are weird days. These are the days where there is a high possibility that it is not logical to say what comes to your mind first. These are the days where the possibility that nothing is as it seems must be considered; because these are not some of the days we are accustomed to. In such days, there is no option other than starting over. It is necessary to develop bit by bit a new approach pertaining to how things work. This is what must be done for economics as well. We have never seen such an economic crisis before. Treatment starts when the patient accepts that he is sick. In economics, the starting point for acknowledging what is new is accepting that we are in a period the dynamics of which we are not accustomed to. Starting point for finding the remedy is seeking a new remedy. For economics, the way to seek the remedy starts with carrying out a strict archeological research. Today, let us see how we export, so that we can understand better the dynamics that appreciate the Turkish lira as well as what firms do nowadays. Question of the day reads in the title: What does a person importing with cash do with the cash at hand?

Last week we took a look at the appreciation of Turkish lira in this context. In terms of foreign exchange market we have underlined a difference unique to the ongoing economic recession period:  This was not the first time that Turkish lira appreciated. However, lira, which used to be demanded due to foreign exchange abundance, was now and for the first time being demanded the steep fall in foreign exchange demand due to the tightening of exports. Lira's appreciation did not imply that we have returned the past; it signaled a new development.

We are in a new equilibrium point in economic recession process. It is wise to acknowledge well the dynamics of this new equilibrium characterized by lower production, lower employment, lower exports and lower imports. Why? Because, it seems that we will remain in this equilibrium point for at least two years. It is wise to try to understand the dynamics of economic recession.

Have you checked the latest study of TEPAV policy analyst Ozan Acar on trade finance? The study is basically a part of the project carried out for the World Bank. The study involves a nice figure which indicates that almost 50 percent of Turkey's imports are paid to exporters in cash. The share of payment in cash method was not this high; it gradually evolved to this level in the recent period (Figure 1). It is possible to derive five conclusions from this. First, banks to not step in much in the process of import finance. It is either foreign banks decline the commitments of Turkish banks or Turkish firms do not involve the banks in the import finance process as banks offer services at higher costs. Which option is valid? We need to observe. However, figures suggest that Turkish imports are financed through payment in cash with an increasing ratio since 2005. This is the first point.

Figure 1: Share of payment in cash in methods of payments for imports (%, 1998-2009 January -June)

Source: TEPAV

Let us ask one question before switching to the second point. How are the import transactions, recoded to be carried out with payment in cash, financed? First, firms might be using import credit. However, share of import credits in total credits extended by banking sector is almost zero. Second, firms might be using some proportion of the operating capital credit they receive to finance imports. We do not know the share of imports financed through this method yet. Third, that import payments are mostly made via cash might be forcing firms or partners to keep foreign exchange. Interviews made within the scope of the World Bank project indicate that firms' internal financing facilities are of importance in financing imports.

Upon these assessments, let us switch to the second point. Since transactions are mostly not realized through banks, since a bank does not step in to make the import payment, it seems that we must have firms that hold cash. The firm will have cash at hand so that it can directly make the payment.

This takes us to the third point and to the title question. "What does a firm that holds cash to import does in the climate of economic recession?" This question has two parts. First, the firm has an operating capital in foreign exchange terms. Using the foreign exchange it holds in cash, the firm directly imports a part of production inputs. Then, combining the inputs, the firm produces a commodity. Then, the firm sells the commodity and receives cash in return. Just like the way Uncle Karl successfully explained the money-commodity-money circle. Therefore, the production circle starts with the foreign exchange in cash the firm holds. In the second stage, climate of economic recession which spans the following production circle is observed. In that case, the firm has to do what is normal. What is normal? Waiting rather than preferring not to buy production input with the cash it holds.

Then, fourth point steps in directly. In this new production period where the firm cancels all or majority of its activities, can it be imagined that it does not make the payments? No, it cannot. So, what does the firm which holds foreign exchange reserves due to the fall in import demand do? What does a firm which holds some proportion of its operating capital in foreign exchange do? It naturally sells foreign exchange to make the payments. Then what happens? As you sell foreign exchange to pay liabilities in Turkish lira terms, Turkish lira appreciates day by day.

Fifth point is: What is the way to transfer operating capital to the coming period without putting it in effect in the production circle? After all, if you spend your operating capital, you destroy the funds necessary to initiate growth in the future. The best way to transfer operating capital saved to meet import demand to the coming period is investing it in financial instruments and earning interest profits. And the best way to this in the current climate is to switch to Turkish lira.

In a system where imports are financed with cash-based methods, fall in import demand has the potential to appreciate Turkish lira through more than one channel. For those who think that the crisis is about to end:  We do not think so.

This commentary was published in Referans daily on 04.08.2009