Euro impact on developing countries by Shan Saeed

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February 11, 2002 Monday Ziqa’ad 27, 1422





Euro’s impact on developing countries



By Shan Saeed


JANUARY 1, 2002 was the day which marked the switch over of the euro from a “virtual currency” used by bankers and financiers to real notes and coinage to be used by millions of people. Indeed, the 12-member Euro-zone is a study in diversity.

For more than three decades, Europeans wanted to devise some sort of single currency which could be used all over the Europe. The original proposal set out in the 1972 Werner report foresaw the monetary union by 1980 but its implementation was delayed by the 1970 oil shock and the world-wide move to float exchange rates.

Fifteen billion banknotes in 7-denominations and 50 billion in eight denominations coins have been shipped to banks and retail outlets in December 2001 and January 2002. More recently, a single currency has been seen as a necessary element in order to complete the European Union’s single market. Without such a reform, exchange rate fluctuations and the costs and inefficiencies, the trading between different currencies create major barriers between cross-border trade and investment within the Europe. The decisions to complete the single market, with the signing of the single European Act in 1986, lent a new force to the belief, long held by many Europeans, that a closely-integrated group of economies would have much more to gain from the lack of exchange rate fluctuations than from occasional exchange rate realignments.

However, the Maastricht treaty signed in February 1992 was the document which in the eyes of the European public was the first to define the criteria, needed by Europeans countries to join the (European Monetary Union (EMU). The most important of these was the convergence criteria. It is related to inflation, to public expenditure and to government borrowing in each of the countries. The Maastricht treaty supplemented by the Treaty of Rome, proved to be highly controversial in a number of member’s states. The new currency was christened as the Euro in Madrid (SPAIN) in 1996.

Europe’s impending reaction of a monetary union with a single currency—the Euro—, is the most important change in the global economy well into this century. Perhaps people around the world will remember four things about the present century: Princess Diana’s death, France’s soccer triumph, September 11 or (9/11) and the last but not the least, emergence of a powerful currency named “EURO”. Euro is the a currency that will give tough competition to the US dollar in the foreseeable future and will replace the French franc, German Mark, Italian Lira, Spanish pesetas and other currencies soon. The Euro is also not just another new currency. It has special characteristics which will affect both domestic international users. It will have a more lasting impact than virtually any other economic event, such as the re-emergence of Japan as a powerhouse or the extension of NAFTA throughout the South America. According to Mr Jeffrey E. Garten, Dean of the Yale University, Euro could pose a serious challenge to America’s economic supremacy.

The new economic club would have three categories of members including powerhouses of the global economy the United States of America, the EU and the Japan. At present, the world currency market is dominated by trading between main currency pairs: dollar/mark, dollar/yen and Mark/yen. Euro will become a leading currency very soon, making to a greater degree of symmetry between the major international monetary systems. Clearly, the value of the euro will strongly affect the value of other Europe currencies outside of the EMU including those of the Eastern Europe and many be the former Soviet Union.

Japanese experts say the euro has a good chance to emerge though perhaps quickly as a credible alternative to the dollar investment target. Private Japanese investors as well as the nation central bank may well shift some holding out of the US treasuries into bonds dominated in euros. Or it may place major portion of their reserves in Euros. Already, China has announced that out of $200 billion of her reserves, some portion will be cushion in for euro. Other countries are following the same pattern. Middle East countries are also pondering over to convert some of their reserves in Euro that might be equivalent to $150 billion. America may lose part of the $10 billion to $30 billion it gets annually in (Seigniorage) — the use of dollars by foreigners in their own countries. That’s like a free loan, every year to Washington, which does not have to pay interest on the money.

Euro brings both opportunities and threats for the world’s financial market. There is a mixed feeling about euro. The euro will go down as one of the most ambitious experiments in the EMU but it is by no means the first. In 1863, Napoleon III made a bid to extend French influence in Europe with the creation of the Latin Monetary Union. The EMU may be the greatest European project to come along since 1648 [the peace of Westphalia]. It could foster quasi-unified economy larger than America’s worth $9.6 trillion potentially. There is no doubt that the new Europe is a potential heavy weight. The 15 members of the EU together issue 35 per cent of the world debt securities, compared with 38 per cent for the United States. But the Greenback is now used more than twice as much as all the EU currencies as a portion of global reserves. This imbalance suggests that the euro will quickly elbow its way into banks worldwide. Especially since the European Central Bank — a Bundesbank clone will likely to make the euro sturdy. As a study by economist at Credit Suisse First Boston puts it, “One might well find that, once euro notes and coins re-introduced into circulation, internal and external holders and hoarders of national notes and coins will seek to rebuild their balances in euros quite rapidly.”

Ever since September 11 tragedy, global economy has gone deep into recession and it will take some time to come out of red. However, the investor enthusiasm is awe-struck and bullish. A gall-up poll conducted by Merrill Lynch illustrated that 45 per cent investors feel bullish or optimistic about European equities. On a 12-month view, 72 per cent said they are bullish for the region despite the US economy is in recession. The survey of fund managers who control $800 billion reflects that the Euro will be a strong currency. Meanwhile, 78 per cent of those surveyed said they did not expect the exchange rate between the Euro and the dollar to be more volatile than the Deutsche Mark-dollar rate has been in the past.

Europe-wide capital markets will emerge for the first time, offering colossal cross border opportunities for borrowing and investing. This united capital market will rival that of the United States. The economy of the EU is 22 per cent larger than that of the United States. Its population is 370 million, 112 million more than in the USA. The EU accounts for 21 per cent of the world excluding trade within the EU, versus 18 per cent for the US. Moreover, the EU has a higher saving rate than the USA and runs a smaller current account surplus with the rest of the world, allowing it to export capital. the potential strength of the united European market is a further evidenced by the fact that while the USA capital market is a $17.6 trillion market, the current size of the fragmented European capital market is already $16 trillion. The Euro area, therefore, has the making of one of the world’s principal capital zones.

Why should developing countries care about the European integration and creation of Euro? The Asian Development bank asserts that a Europe with one currency will be very strong and more in demand. The crisis in ASEAN countries in 1997-1998 gives ample proof that dollar dominated economies are in great danger. Argentina is one country to cite. The 1998 Indonesian currency Rupiah was pegged with dollar. This proved to be a big mistake. Basically any nation has three monetary choices: pegged rates, unified currency or (currency board) or a float. In Indonesia not only did it encourage foreign currency borrowing but also the pegged exchange rate also prevented central banks from raising interest rates to curb an explosion in domestic credit. Economy overheated, sucking in more imports. Ninety per cent of the economy was dollar- dominated.

Above all, though Argentina is worth watching because it is a classic case of what economists call, “the curse of resources”. A century ago, thanks to beef, Argentina was a rich nation and granted itself the sort of social-welfare systems that rich nations can afford. In 1990s, sustained by a stable currency and growing world trade, the country had a chance to build a truly modern economy. It blew it. Argentina, says an emerging — markets specialist on the Wall Street has a “European style welfare state in a third world economy”.

Most developing countries have hinted at de-linking their currencies from the dollar and opting for the Euro after taking into the account the allied advantages and disadvantages. The advent of the Euro in the World financial markets could provide an attractive alternative to the weaker economies, notably those that could hardly match the global strength of the dollar and its two-pronged negative impact of the foreign trade.

Mr Owais Kalia, a foreign exchange giving his opinion about the future of euro especially in the context of Pakistan’s economy said that it may be an effective check on the excessive speculative trend, dominating in the money market. With the gap between inter-bank and kerb rates/open market narrowing down signs a positive change for the economy. Speculative trade has damaged Pakistan’s economy enormously. Speculation, due to over-dollarization will be narrowed down to a great extent with the arrival of Euro.

Mr Zafar Aziz Osmani, a senior executive in one of the leading banks said the de-link could provide the much needed psychological boost to the falling Rupee as well as the economy. The deposit base of the Euro will be around $100 billion in the embryonic phase. It could inflate to any highs taking the changes happening around the globe.

Developing countries can foresee three key areas in which the Euro will be advantageous to them. Firstly, it is rapidly becoming currency in which world trade is conducted and invoiced. Most of the multinationals around Asia are switching over from dollar to euro. Companies like the Philips and the Siemens have already announced their intentions to switch their accounting to the Euro and some major European countries have already informed their suppliers and price lists in euro. This is a huge development that is going to affect the economies heavily relying on US dollar.

* Secondly, developing countries predict that the euros credibility, allied to large and very liquid financial market will attract foreign investment. Asian investors and issuers simply can’t ignore the Euro market. This offers good chance for firms to move into the market and raise money with Euro bonds. The EU governments simply won’t be able to keep up with the demand coming from this growth. A gap will be formed in the market and this will be filled by corporates. Many Japanese experts predict that Japanese investors will move their money out of the USA soon. Japanese companies with huge investment in Europe will shift their focus and ponder over their strategy to work out the ways and means to get the practical benefits of the Euro, as transaction costs are reduced and currency exchange risks eliminated.

* Thirdly, euros development will increasingly confer on it the status of an international reserve currency. Central banks worldwide seeking greater diversification in their currency portfolios are looking into it and have already made plans to make euro as an attractive alternative to the dollar and the yen. The Gold prices fluctuating and not being consistent, central bankers around the world have little choices but to switch their reserves in Euro. George Soros the author of Alchemy of Finance predicted an outflow of $500 Billion from the dollar deposits to the Euro and expected that it could lead weaker dollar in the months to come.

According to the survey conducted by the local financial analysts and research houses, euro will have a global deposit base of 40% as compared to 29 per cent of the US dollar and its share in the world trade will be 32 per cent as compared to 23 per cent of the US dollars. Says Gary S. Becker, Nobel Laureate and an economist at Chicago University: “Euro will be strong and in great demand not only in Asia but also in Africa and Latin America. But it remains to be seen that Euro should be tested at more than one front in order to reduce the risk of collapse”.

Commenting on the current situation, Owais Kalia said that so far 12 countries have joined Euro single currency while the reaming three including Britain, Denmark and Sweden are still to make a decision. The most important among them is the UK whose decisions to join or not the euro will make a great difference in Euro status because obviously the prime object of euro is to being a strong rival against dollar. The success of the Euro could be a role model for the economies especially in Asian countries currently trapped in financial turmoil.

There is a more important reason for developing countries to pay attention to the EMU: its emergence shows that a large part of the western world is finally getting both the economies and, with luck the politics right. The EMUnomies is textbook simple. Increased competition is good, protectionism is bad. Mobility of capital and labour is good, hindrance is bad. Less government intervention is better than big government and more transparency is better than less. A truly integrated Europe would hold great promise not only for itself but also for the rest of the world. The result. A euro that will genuinely compete with the dollar as a reserve currency, and a united Europe that could in a decade’s time develop into more than a junior partner for the United States.

The physical introduction of the euros will bring a big change in the hearts and minds of consumers and bankers. My bet is that over the next few years we will see at least half a dozen cross border transactions in the financial services industry.

(The writer is an IBA graduate, working in a foreign bank.)