INTRODUCTION OF EURO AS COMMON CURRENCY
RAMA SHUKLA SHUKL A (PG) SHRUTI KALANTRI (PG) JIGAR MODY (MMS) SHASHANK GAIKWAD GAIKWAD (MMS) VIVEK CHOTHANI (MMS) SUMIT POPHARI (MMS)
INDEX INTRODUCTION EURO V/S V/S DOLLAR DOL LAR EFFECTS OF EURO EURO CRISIS EURO AS COMMON CURRENCY IN EURO ZONE
INDEX INTRODUCTION EURO V/S V/S DOLLAR DOL LAR EFFECTS OF EURO EURO CRISIS EURO AS COMMON CURRENCY IN EURO ZONE
INTRODUCTION TO EURO The euro (sign: €; code: EUR) is the official currency of the euro zone: 17 of the 27 member states of the European Union.
The euro zone consists of Austria, Belgium, Cyprus,
Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands , Portugal, Slovakia, Slovenia, and Spain. It is consequently used daily by some 332 million European Europeans. s. Additionally, Additionally, over 175 million people worldwide use currencies which are pegged to the euro, including more than 150 million people in Africa.
CANDLE STICK PRESENTATION OF EURO
EURO ZONE Based on International Monetary Fund estimates of 2008 GDP and purchasing power parity among the various currencies, the euro zone is the second largest economy in the world. •
The euro is the second largest reserve currency as well as the second most traded currency in the world after the United States dollar. As of July 2011, with nearly € nearly €890 890 billion in circulation, the euro has the highest combined value of banknotes and coins in circulation in the world, having surpassed the U.S. dollar •
This chart shows the value of the euro (before 1999 as a basket of the 11 legacy currencies) against the US dollar.
Evolution of EURO Birth of the European Monetary System The economic crisis of the 1970s that led to the first plans for a single currency. The system of fixed exchange rates pegged to the US dollar was abandoned. The system immediately came under pressure from the strong dollar, causing problems for some of the weaker European economies.
Plaza Accord In the 1980s the dollar strengthened dramatically. US interest rates were very high. In 1986 the world's leading industrial countries agreed to act and lower the value of the dollar. The deal was struck at New York's Plaza hotel.
ECB AND ERM CRISIS Maastricht Treaty In 1991 the 15 members of the European Union, meeting in the Dutch town of Maastricht, agreed to set up a single currency as part of a drive towards Economic and Monetary Union. There were strict criteria for joining, including targets for inflation, interest rates and budget deficits. A European Central Bank was established to set interest rates. Britain and Denmark opted out of these plans. ERM crisis The Exchange Rate Mechanism - established in 1979 was used to keep the value of European currencies stable. But fears that voters might reject the Maastricht treaty led currency speculators to target the weaker currencies. In September 1992 the UK and other EU countries were forced to devalue.
SUCCESS ACHIEVED BY EURO CURRENCY •
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Integration of money markets
Convergence of long term market interest rates Single monetary policy
CHALLENGES FACED BY EURO •
Need to raise the economic growth
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Enlarging the euro area
EURO V/S DOLLAR •
Euros and dollars are one of the most influential global currencies in this modern era. Both of these currencies play a very significant role in defining the shape of global economics and finance. Though, the dollar was already established as the world’s most stable and important currency before the advent of euro but right at this moment, both of these currencies seem to go parallel in their value and worth
DIFFERNCE BETWEEN EURO AND DOLLAR EURO •
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It is used in european states of european union It is second largest trading currency in the world European central bank governs euro currency Euro does not have stamping power
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It is used in united states of america It is the first largest currency which is been traded in the world Federal reserve bank governs dollar Dollar has a stamping power of american economy on the world wide fiscal scenario
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Recently euro is appreciating in the value against dollar Interest rates for euro prescribed by european central bank is 1% Euro is used for maintaining reserves of banks in euro zone
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Vice-versa Interest rates for dollar prescribed by federal reserve bank is 0% But dollars are used by world bank for maintaining reserves
Effects Of EURO On Business IN EURO ZONE
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The single currency benefits business in many ways, in addition to cutting costs and risk. It encourages investments and brings more certainty to business planning – thus allowing businesses to be more effective overall. More Cross-Border Trade
A direct benefit of the euro is that, within the euro area, there is no need for businesses to work in different currencies. A company can buy and sell throughout this area, paying and being paid in euro. Previously, when doing business in another EU Member State, a company would need to take account of the risk of fluctuating exchange rates
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This meant either export prices were higher, or companies were discouraged from exporting within the single market. This risk has now gone, as have the costs associated with exchanging different currencies. Before the euro, these exchange costs were estimated at €20 to 25 billion per year in the EU much of it incurred as companies transferred goods, people and capital around Europe. With the euro, these costs have disappeared in the euro area, and this money is now available for more productive investment. With no exchange risks and costs, cross-border trade within the euro area is encouraged. Not only can companies sell into a much larger ‘home market’, but they can also find new suppliers offering better services or lower costs – a development that is helped by the growth of e-commerce over the internet. Trade within the euro area is estimated to have increased between 4% and 10% since the introduction of the single currency.
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Borrowing, Better Planning, More Investment
Before the euro, volatile interest rates meant unpredictable costs. With the euro, inflation has come down to a low and stable level, which also means low and stable interest rates. Firms can borrow more and more cheaply and can invest more confidently in the long term.
Better Access To Capital The euro gives a large boost to the integration of financial markets across the euro area. Investors, such as banks, are no longer limited to local markets. Capital can flow more easily because exchange rate risks have disappeared and because financial market rules are being progressively harmonised – allowing investors to move capital to those parts of the euro area where it can be used most effectively.
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Energy and Environment(Facts)
The EU depends on imports for more than 50% of its energy needs. Net dependence on energy imports as a percentage of total consumption, EU-27 (2007) was 53.1 % To reduce this dependence and protect the environment, the EU is striving to use energy more efficiently and use more renewable sources. The EU has set a target of generating 20% of its electricity from renewable sources such as wind, the sun, water, geothermal plants and biomass by 2010.
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International Trade
The euro is a strong international currency backed by the commitment of the euro-area Member States and the firm and visible management of monetary policy by the European Central Bank. The euro area is also a large and open trading bloc. This makes doing business in euro an attractive proposition for other trading nations, which can access a large market using one currency. Euro-area companies also benefit because they can export and import in the global economy while paying, and being paid, in euro – reducing the risk of losses caused by global currency fluctuations.
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Trade (Facts) With just 7% of the world’s population, the EU's trade with the rest of the world accounts for around 20% of global exports and imports. The EU is the world’s biggest exporter and the second-biggest importer. Around two thirds of EU countries’ total trade is done with other EU countries. The United States is the EU’s most important trading partner, followed by China. In 2005, the EU accounted for 18.1% of world exports and 18.9% of imports.
Effects Of EURO On Consumer IN EURO ZONE •
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There are multiple opportunities for EU citizens and consumers to benefit from the euro. These arise because the euro and its political framework, the Economic and Monetary Union, offer lower costs, stable prices, more transparency and economic stability. Some of these consumer benefits are direct, such as easier-tocompare prices while shopping; others are indirect, such as the long-term benefits economic stability brings to interest repayments on a bank loan for a new car. In both cases, the opportunities the single currency offers are wide ranging, covering not only everyday transactions, but also employment opportunities and European citizens’ quality of life.
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Consumer Benefits(Facts)
Percentage of EU citizens who believe that their country has benefited or not from being a member of the EU, autumn 1996 to autumn 2009
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Year
Benefited
Not benefited
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1996
42
36
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1997
44
35
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1998
49
31
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2006
54
34
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2007
58
29
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2008
56
31
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2009
57
31
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A more Competitive Market The euro brings price transparency to the single market. Consumers can easily compare prices across borders and find the most advantageous price for a product or service – especially in the internet era – whether it is a pair of trousers or a high-end home cinema system. This is because increased price transparency has the effect of increasing competition between shops and suppliers, keeping downward pressure on prices in the euro area. Stable Prices
The euro has brought inflation down to a low and stable level. In the 1970s and ‘80s many EU countries had very high inflation rates, some of 20% and more. Inflation fell as they started preparing for the euro and, since its introduction, has remained around 2% in the euro area. Price stability means that ordinary citizens’ purchasing power and the value of their savings are better protected, which helps make the future more certain.
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Easier, Safer, and Cheaper Borrowing
Low inflation and stable prices are a key aim of the management of the euro-area economy. Because the European Central Bank acts to keep inflation low, interest rates are also lower. This means consumer loans are cheaper and future repayments are more predictable, so ordinary citizens can borrow more easily and cheaply, for example to pay for holidays or to buy a house. Mortgage rates have fallen from around 8%-14% in the early 1980s to an average of 5% now in the euro area, saving a borrower with a €100 000 outstanding loan between €170 and €750 a month on interest payments.
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More Growth and Jobs
In a single market with a single currency, doing business across borders is cheaper for companies as they no longer need to include the risk of currency fluctuations into their prices nor to pay exchange costs. Previously, these costs amounted to around €20 to 25 billion annually within the European Union. Today, they have disappeared in the euro area. This helps release capital to invest in expanding and growing business and employing more workers, thereby benefiting jobseekers and their families. Since the euro was introduced in 1999, more than 10 million new jobs have been created in the euro area, compared with only 1.5 million in the previous seven years.
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Employment(Facts)
Over the past 50 years, employment in agriculture and industry has fallen, while more and more people now have a job in the service sector. Percentage of workforce employed in agriculture, industry and services, EU-27 (1998 and 2009) 1998
2009
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Services
64.7
66.7
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Industry
27.5
27.7
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Agriculture 7.8
5.6
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More Public Investment
It is not only citizens and business which benefit from cheaper loans: government borrowing is also less expensive, as interest payments on national debt are lower. The money saved can therefore either be used for investment in new infrastructure, or to boost research spending for jobs and growth, or for improving welfare and pension systems, or to reduce the tax burden – depending on a Member State’s priorities.
Single Financial markets •
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Financial markets deal with the flow of capital and are vital to an open market economy because an efficient financial market provides for better use of capital. The introduction of the euro in 1999 provided major impetus to the integration of financial markets in Europe, thus making them more efficient and competitive, and reducing the costs of cross-border money transfers in euro. Measuring the EU’s economy With 12 new member countries joining since 2004, the EU’s GDP— output of goods and services — is now bigger than that of the US: GDP (€11 785 474.9, 2009)
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Use As Reserve Currency(Facts)
Since its introduction, the euro has been the second most widely held international reserve currency after the U.S. dollar. The share of the euro as a reserve currency has increased from 17.9% in 1999 to 26.5% in 2008, at the expense of the U.S. dollar (its share fell from 70.9% to 64.0% in the same timeframe) and the Yen (it fell from 6.4% to 3.3%) The euro remains underweight as a reserve currency in advanced economies while overweight in emerging and developing economies: according to the International Monetary Fund the total of euro held as a reserve in the world at the end of 2008 was equal to USD 1.1 trillion or €850 billion, with a share of 22% of all currency reserves in advanced economies, but a total of 31% of all currency reserves in emerging and developing economies.
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Bigger is More Efficient The more integrated financial markets are, the more efficient the allocation of capital is because investments opportunities and competition are also greater, and capital can move around to where it can be used most efficiently. The introduction of the euro in 1999 proved to be a powerful catalyst to the integration of financial markets and the creation of a much larger, more efficient single financial market, which brings many economic benefits:
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A single financial market allows individual citizens and companies to invest throughout the euro area to obtain the best return on their savings. It creates opportunities to borrow from across the euro area, seeking out the lowest cost for their loan. Investors can also spread risks more widely.
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The costs of financial intermediation, such as bank charges, are lower. In the euro area there are more banks and investment funds and thus there is more competition between them. Lower costs encourage more capital flows.
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More capital is available to borrowers at a lower cost because there are more sources of capital. This makes the money they borrow cheaper and better tailored to the needs of the borrower.
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Because borrowing is cheaper this makes more capital available for further lending. This encourages citizens and companies to borrow more to invest – which creates more economic growth and more employment, and benefits the EU economy as a whole.
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Building The Single Financial Market
The single currency was a key step towards the creation of the single financial market. Its introduction immediately removed some obstacles to free capital flows – namely the costs associated with exchanging different currencies. Previously, these costs were a barrier to cross-border investments – today they no longer exist in the euro area. Since the introduction of the euro, cross-border bank deposits have increased, the yields on government bonds have converged, and the interest rates on retail loans, taken out by individual citizens, have also converged.
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The Single Euro Payments Area An important aspect of the single financial market is payments, which daily affect cross-border transactions of citizens and business. The costs of sending money in euro to another euro-area country have already been slashed by as much as 90% since the introduction of the euro and EU rules on cross-border euro payments in 2001.
The Single Euro Payments Area (SEPA), initially planned for 2010, is a further step in the same direction. An initiative of the European banking industry, it aims to further facilitate electronic payments across the euro area by making them as easy, safe and efficient as if they were done within one Member State and subject to identical charges. Citizens will benefit from faster and more secure transfers between bank accounts anywhere in the euro area, and will be able to use their bank debit card when shopping abroad as they would at home. The Commission has helped the development of SEPA by preparing the necessary legal framework in the form of a Directive on Payment Services.
Beginning of Crisis •
Started in – Oct 2009 in Greece
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Its immediate causes lie with the US crisis of 2007-09
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The result in Euro Zone was Sovereign debt crisis
PIIGS: Portugal, Italy, Ireland, Greece, Spain
What Happened •
Greece: Sharp Budget Deficit
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Large Government and External Debts in PIIGS
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Greece credit rating downgraded
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Interest rates surged on government bonds
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Need for external aid from EU and IMF
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The high debts and rising rate of interests was a matter of concern
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Sovereign-debt crisis boil over Financial panic in Europe Foreign banks lending was € 164 billion Debt to GDP ratio has been around 140 % January – February 2011, on a fiscal basis, the State Budget deficit was € 55million lower than the target set in the 2011 Budget for the first two months of the year standing at € 1,024 million compared to a target of € 1,076 million The 2011 State Budget deficit has grown – as expected – by 8.5% compared to the 2010
Portugal •
Budget deficit 9.3% of GDP
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Public debt 77% of GDP
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Common weaknesses with Greece: 1. Small economy 2. Competitiveness
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Total Debt of €198 billion
Spain •
Most at risk even now
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Dependence on foreign finance
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Public debt 53% of GDP
Reasons •
For rise in External Debts Increase Lower
in wage rates
exchange rate risk
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Weakening export competitiveness
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Weakening of tourism & shipping by 15%
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For rise in Internal Debts:
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Rising Unemployment: Lower tax returns, higher budget deficits
Slovenia’s Economy •
Europe Debt Crisis to Slow Slovenia’s Economic Recovery Further
Slovenia’s economic recovery is at risk from the euro region’s debt crisis because it hampers access to funding, according to the government’s forecasting institute.
EURO’s STATUS IN RECENT YEARS.. The Euro has experienced an incredibly volatile year of trading thus far in 2010—and the year is only half over. The European Central Bank had injected far less stimulus into its economy during the height of the 2008 Global Credit Crisis, and it appeared they may have positioned themselves for a stronger economic recovery. However, this bullish view of the Euro was destroyed beginning in November of 2009 when it became apparent that Greece and several other Euro Zone countries also known as PIIGS, were in severe danger of sovereign default. Suddenly, the talks changed from the Euro challenging the Dollar’s world reserve status to whether the Euro Zone would even survive.
AFTER EFFECTS OF RECENT CRISIS.. In late May the European Central Bank and International Monetary Fund finally stepped in with an official bailout package for Greece and any other struggling Euro Zone countries. This served to reassure investors since it was now virtually impossible for any of these countries to default in the short-term and a strong rally in the Euro ensued. This rally has pushed the Euro off its multi-year lows of 1.1875 to a HI of 1.3194 in 2 months.
RECENT DEVELOPMENTS… In order to qualify for bailout funds, they adopted very strict austerity measures, which meant they were forced to cut deficits immediately. Federal reserve in United States is talking about looser monetary policy, and you have the ECB talking about tighter monetary policy. This is causing a possible further widening in the interest rate spread between these two countries. Federal Reserve currently has interest rates held at near 0%, while the European Central Bank has interest rates set at 1%, if this continues, this will increase the yield spread even further which could cause a massive depreciation of the U.S. Dollar versus the Euro over the next 6 months to 1 year.
ASPECTS OF EURO AS COMMON CURRENCY Judging the Success of the Euro The Euro project should be judged according to whether it achieves its long term aims
• (1) Sustained non-inflationary growth • (2) Lower long-term interest rates and higher rates of investment • (3) Lower unemployment • (4) Expansion of the EU single market
The Euro on its own in insufficient to achieve these – structural economic reforms in Europe are also required and many are taking place
Convergence Criteria – Joining the Euro Flexibly applied for original Euro members – but more strictly applied in the case of new member states
Inflation:
Government Finances
Interest Rates:
• Average inflation over previous year must not exceed by more than 1.5% that of the three lowest inflation countries • Budget deficit must not exceed 3% of GDP • Gross government debt must not exceed 60% of GDP • Average yield on govt bonds must not exceed by more than 2% bond yields of three lowest inflation countries
Exchange • Currency must have adhered to fluctuation margins of the ERM II in two previous years Rate Stability: without severe tension
Is the Euro an Optimal Currency Zone?
An optimal currency zone occurs when:
• (1) Countries have achieved real convergence • (2) They respond in similar ways to external economic shocks or macro policy changes • (3) They have sufficient flexibility in both their product markets and labour markets to deal with these shocks • High geographical mobility of labour • High occupational mobility of labour • Wage and price flexibility in factor markets • (4) Countries are prepared to use fiscal transfers to even out some of the regional economic imbalances within the European currency union
Optimal Currency Zones (2)
By most criteria, the current Euro Zone does not come close to an optimal currency zone! • The core group of EU countries are broadly similar (Germany + France + Netherlands + Belgium) • But peripheral countries have big structural differences • And there are barriers to the mobility of labour • Little wonder that tensions are rising in the Euro Area as recession bites
Tensions in the Euro Area (2) Riots and protests
Recession in Euro Area as a whole (-2% in 2009)
• Fears of deep cuts in real wages • Rising unemployment • Strong Euro making life very tough for exporters • Many peripheral Euro Area countries are struggling e.g. Greece, Ireland, Italy, Portugal and Spain • Huge divergence in competitiveness showing up in massive trade imbalances • But no chance of nominal exchange rate adjustment • So downward pressure on wages and jobs
Tensions in the Euro Area (1) Fiscal policy is coming under pressure:
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Bail outs for financial institutions But smaller EU states have little chance of doing this Cross-border contamination Downgrading of credit rating for several Euro Area countries including Spain and Greece • Makes it more expensive for companies and the government to finance borrowing • Think of consequences for investment and growth • What happens if one or more countries leave and devalue their way to an economic recovery?
Microeconomic Benefits of Entry (1) Potential Gains for consumers The Euro is important in realising some of the gains from a functioning single market
• Lower prices because of increased competition/ greater price transparency (this is more likely with easily transportable goods) • Reduction in the transactions costs of travelling within Europe (e.g. costs of currency exchange) • Easier to live and work in different EU countries
Microeconomic Benefits of UK Entry
(2) Potential gains for businesses
• Invoicing can be done with one currency • Lower transactions costs – some people argue that staying out of the Euro is equivalent to exporters facing a tariff when they trade inside the EU • Gains for the tourist industry in attracting overseas visitors • Businesses might be able to fund their capital investment at lower real interest rates
Microeconomic Disadvantages (1) Changeover Costs from joining the Euro:
• Costs of changing accounting systems • Menu Costs (vending machines, catalogues, franking machines, postage • Installation of new payments systems • Customer confusion (imperfect information)
(2) Higher prices
• Potential loss of consumer welfare if suppliers increase prices when converting from sterling to euro
(3) The vast majority of consumers will continue to buy locally – what matters more is the effectiveness of competition policy in targeting anticompetitive behaviour
Macroeconomic Case Against Entry (1) Entering the Euro means losing an instrument of policy adjustment • A “one-size fits all” monetary policy may work against a country if their cycle is not convergent with Euro Zone • Retaining the option of making an exchange rate adjustment is useful
(2) Fiscal Policy constraints • The EU Growth and Fiscal Stability Pact • Limits on government borrowing • But now largely ignored – especially with the effects of the credit crunch / fiscal bail-outs etc
