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Euro: Currency of future

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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 world’s 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 world’s 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 dollar’s role as world currency. It enabled the US to borrow without limit in its own currency making it world’s 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 won’t 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 policies.

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 country’s 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 many.

 

United States and European Union relative economic size and use of currencies

(Per cent)

.

US

EU

Share of world GDP, 1996

20.7

20.4

Share of world exports, 1996

15.2

14.7

Use of currencies in World trade 1995

51

31

International bond offerings Sep 1997

45.9

41.9

Developing country debt, end of 1996

50.2

15.8

Global foreign exchange reserves, end of 1996

63.7 19.5

Foreign exchange transactions, April 1995

11.5 25.0

Source IMF, World Economic Outlook database, and Annual Report, 1997 (cited Journal of the IBP).

 


 

Impact of Euro on growth of economies

Regions 2000 2001 2002 2003 2010
EMU Countries 0.2 0.9 1.0 1.1 2.9
Non-European, G-7 Countries -0.1 0.0 0.0 0.1 0.1
Other Industrialized Countries -0.1 0.1 0.1 0.0 0.2
Developing Countries 0.0 0.1 0.2 0.2 0.3

 



Composition of non-industrial country reserves at end of 1996

Currency

Developing
Countries

%

Global Total

%

US Dollar 531.9 71.5 1041.5 68.6
Japanese Yen 60.8 8.2 105.3 6.9
Core EU 101 13.6 303.6 20
German Mark 87.1 11.7 246.1 16.2
French franc 10.1 1.4 23.2 1.5
Dutch guilder 3.8 0.5 5.1 0.3
British Pound 36.4 4.9 52.1 3.4
Swiss franc 1.39 1.9 15.4 1
Total 744 100 1517.8 100

Source: 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.