Benefits that are expected to surface from trading in Euro are primarily offshoots
of reduced transaction cost
By AGHA ABDUL HAKEEM
(MBA) IBA (Jamshoro)
Apr 24 - 30,2000
No country can survive in isolation from rest of the world;
international trade has proved to be solid bond between countries integrating them in
interdependent society. Money is one of initial inventions of civilized man. Concept of
value took many shapes from barter to currency and man saw evolution towards modernity.
Refinement of concept of value and exchange power brought with it different monetary
systems for international trade. From Bimetallism to Bretton wood system there lies a
story of success of International trade. Deviating from concept of using currency as
source of exchange some people came up with idea of concurrently using currency for
economic benefit of group of countries at large. EMU (European Monetary Union) is
brainchild of those people.
Land mark agreement known as "Maastricht Treaty" (1991) paved
the way for introduction of common currency "Euro". In pursuance with treaty
common currency unit has been adopted in January 1999, it needs to be clarified that
"Euro" notes and coins would be launched in January 2002, when currency notes of
EMU member countries would cease to circulate.
"EMU new economic giants"
Rise of Euro has given birth to new economic superpower, threatening
supremacy of U.S and Japan. According to December 1997 figures, the Euro zone produces
worlds 18% GDP, 20% exports and 16% imports. US on other hand accounted for 22% GDP,
16% exports and 19% imports. The share of Japan in worlds GDP is 11%, in exports 16%
and their imports is 7% of the world. There has been a clear rise in share of EMU
countries in world trade from figure of 1996 and earlier as given in table: 1
"Euro for europe"
We must remember that primary reason for formation of EMU and its
policy instruments like "Euro" is to benefit member countries, any implications
to rest of the world are peripheral to cause of EMU. Lets see to what extent Euro benefits
member countries and in process rest of the world.
In initial years as the member states are likely to see only a 0.2%
increase in growth. But with the passage of time, product market liberalization coupled
with the efficiency gains arising due to single currency, will lead to a rise in total
factor productivity in the long-run and it is estimated that by year 2010 the total growth
of EMU will increase by 3%. Due to stable currency, a stable economy, reduced transaction
cost and transparency, efficiency gains from economies of scale Euro-Zone countries would
be impinging hard on their main competitors (Non-European G-7 Countries) cutting their
growth by 0.1% in 2001 though they would also be beneficiaries in long run and would grow
by 0.1% by 2010, thanks to launching of Euro.
Benefits to EMU countries
1) Lower transaction cost: As Euro would be accepted widely
transaction cost related to conversion of currencies and interest rate spread would be
checked, benefiting traders and tourists and improving efficiency of European economies.
2) Exchange rate certainty: Would result in Transparent pricing,
as economic agents would have to process less and simple information for pricing purpose.
Combined with lower transaction cost and existence of a single market, investment
decisions are expected to improve both in terms of quality (better investment decisions)
and quantity. To simplify it further exchange rate volatility can induce uncertainty about
selling price in future resulting into investment in sub-optimal avenues.
3) Price stability: Euro is offshoot of Maastricht treaty, which
lays down the criteria for countries to accomplish before joining EMU. Criteria is:
(a) Inflation to be no more than 1.5 % points above
the levels of three best performing Countries.
(b) Long term interest rates no higher than 2
percentage points above those of the best three countries.
(c) A low budget deficit measured against a reference
level of 3% of GDP.
(d) Overall public/government debt below or falling
towards, a reference level of 60% of GDP.
Criteria suggested would bring uniformity in policies of EMU countries,
as a result price would stabilize across the zone. Price stability and resulting stable
interest rates would bring with it a better environment for economic decision making,
portfolio investment would increase.
4) A reserve currency: Some portion of international trade would
be denominated in Euro, this would further reduce exchange rate risk for EMU countries.
US has enjoyed huge benefits from dollars role as world currency.
It enabled the US to borrow without limit in its own currency making it worlds
biggest debtor and to continue to run huge current account deficit. Euro is expected to
give a run for money to US.
Cost of monetary union
Loss of independent monetary policy: European System of Central
Banks (ESCB) would be responsible for the formulation and implementation of common
monetary policy, exchange rate and reserve management policies, and the maintenance of a
properly functioning payment system, individual countries would no longer maintain
respective monetary policies. It is quite possible that a unique problem might hit a
country requiring monetary policy adjustments, in that eventuality member countries
wont have any option with them. This risk is real as labour mobility among the
member countries is low and wages are rigid, coupled with no indication of fiscal
redistribution at Pan-European level, all this necessitate to have different monetary
Implications of Euro for Pakistan
European Union is one of largest trading partners of Pakistan
accounting for 21.74% of our exports and 13.1% of imports. A gauge for measuring magnitude
and severity of impact on economy by launch of Euro is combination of quantum of bilateral
trade/country is having with EU and degree of trade elasticity of countrys economic
growth. If we have more trade (exports) with EMU countries, we would be beneficiaries
otherwise bet would be lost.
Benefits that are expected to surface from trading in Euro are
primarily offshoots of reduced transaction cost. From foreign trade point of view
countries have to indulge in buying and selling of currencies of trading partner and their
own. Before EMU introduction EU countries were trading in local currencies, if Pakistan
had to trade with Italy, were required to purchase lira, while transacting with France,
franc were required and so on. Apart from that if borrowings were arranged from EU
countries, separate interest rates of local countries were applied. As a net result
transaction cost of trading increased with increase in trade. With Euro in use trading
countries would be required to arrange for Euro (if importing) and would be well placed to
take decision about borrowing from EU member countries.
With introduction of Euro as common currency thus breaking of last
barrier in virtual free trade, EU countries are expected to experience new heights in
economic growth. With people getting option to pay in Euro for goods made in no matter
what countries of Euro zone without having to deal with intricacies and uncertainties of
exchange rate fluctuations, demand for goods and services would surge giving a rise to
production and growth. Talking purely from economic point of view an increase in income of
people leads to greater import of items, this is what we are hoping for, an increase of
import of textile, sports goods and other commodities from Pakistan.
Drawback: we will have to compete with producers from whole of
Euro zone, earlier producers in countries with different exchange rates and some other
distortions where dealt in individual fashion. Now Euro has made EU a single market where
competing producers in any country of Euro Zone will have to be surpassed in order to
strike a deal within Euro Zone.
If we want to reap benefit of creation of Euro we will have to increase and diversify
our trade with Euro zone countries. Export analysis clearly reveal dominant role of US in
our foreign trade, with exports to US increasing from 11.5% FY88-89 to 20.5% of our total
exports in FY97-98 as compared to a fall of exports to EMU from 17.9% in 88-89 to 13.1% of
our total exports in 97-98. With such a scenario gains from Euro trading would not be too
United States and European Union
relative economic size and use of currencies
Share of world GDP, 1996
Share of world exports, 1996
Use of currencies in World trade 1995
International bond offerings Sep 1997
Developing country debt, end of 1996
Global foreign exchange reserves, end of 1996
Foreign exchange transactions, April 1995
Source IMF, World
Economic Outlook database, and Annual Report, 1997 (cited Journal of the IBP).
Impact of Euro on growth of
Composition of non-industrial country reserves at end of 1996
US Treasury Bulletin, IMF and BIS estimates (Cited Journal of the lBP)
Prospects for Euro as official reserve currency for other countries are
bright due to volume of trade size of economy etc.