The euro's implications on local businesses

The introduction of the euro across Europe in a little over three months is expected to achieve the effect of evening out competition levels between the Eurozone and the United States. While Malta is still far from European Monetary Union membership, businesses carrying out business with companies in EMU countries will need to make adjustments to fit in with the massive changeover. What are the pros and cons for such local firms? The Malta Financial and Business Times takes a look.

While the launch of the euro has been much flaunted across both the current and prospective European Monetary Union members, the Maltese information dealers have been somewhat conspicuous for the lack of information being presented to business owners. With the inclusion of the EU's current applicant countries, the euro will represent a magnitude of trade, reserves and population size equal, if not greater than that of the US dollar.

However, Maltese businesses dealing with the EU must be prepared for European countries' usage, as of January next year of the euro, as the changeover requires a good deal of adaptation. Following is an abbreviated guide from a local perspective on managing the changeover.

Some consequences on Maltese companies
As Malta derives the great majority of its imports and exports from the European Union, the Maltese economy is closely tied to the Eurozone economies.

Firstly, the overall value of the euro is expected to influence the profitability of those local companies trading with companies from within the EMU. Within this scenario, a strong euro would benefit exporters while being detrimental to importers. On the other hand, a weak euro would benefit importers but hurt exporters.

However, the introduction of the euro will create a single market of over 300 million customers, which will inevitably create many new trading opportunities for Maltese firms, but it will also significantly increase competition.

Local companies will have to bear the cost of converting their prices, adjusting accounting procedures, and purchasing the relevant software upgrades. On the other hand, these firms will also save money on the numerous costs associated with operating in different foreign markets using different currencies.

Notably, the introduction of the euro will decrease the exchange risks of companies carrying out business with countries that have a relatively unstable former currencies. But the changeover will increase the exchange rate risk of firms operating from countries that previously had stable national currencies.

Another positive aspects of the introduction euro on Maltese companies are expected to include a distinct stabilising effect on the criteria of convergence.

The euro and international trade
The euro will fill three main voids in terms of international trade, namely: trade creation, trade diversion and trade invoicing.

Trade creation
Trade creation means creating additional trade by removing inefficiencies and currency risks involved in international trade. This role of trade creation; the most important role of a currency, will depend on the size of the Eurozone, the soundness of EU and member state's economic policies and on the completion of the Single Market. While the latter is progressing, albeit at a slow rate, and while at the moment the member states are pursuing sound policies, it is thought that the future nature of the Eurozone will be comprised of: the EU itself, the candidate countries, the Southern Mediterranean, and African countries in the CFA franc zone.

Depending on the success of the Euro, its area of influence might extend to the Russia and the rest of Africa. At present, experts see no role for the Euro in Latin America and cannot yet forecast a role in Asia.

Trade diversion
This aspect, much less important than trade creation, implies the diversion of trade from extra-EU trade to intra-EU trade. Factors which will tend towards this are:

• the increased competitiveness of the Euro area;
• the elimination of exchange-rate uncertainty;
• a reduction in the financing cost of firms; a greater market transparency.

Trade invoicing
Here there has, up to now not been as much of an effect as had been expected. Many EU Member States, e.g. Belgium, still prefer to invoice in US dollars.

The Euro in the financial markets
In principle, greater market size, higher liquidity, sophistication and a stable Euro attract foreign capital and reduce interest rates. The cost of borrowing thus falls. There is little doubt that the dollar has retained its dominant position in world financial markets. 50% of world holdings are in US dollars and in 85% of transactions the dollar is still used as a marker.

In debt management, the dominance of the dollar continues as well. This is due to:

• the liquidity of the dollar;
• the existence of dollar derivatives, such as options, futures, CDs (certificates of deposit) which allow for the substitution of hard cash in many transactions;
• the large size of the average US dollar investor.
Will the euro be able to equal this? Of course it can in time offer the same derivatives and achieve similar liquidity, but for the moment this is untested.

How applicant countries should deal with the euro
There are three main areas that should be of interest to applicant countries. Firstly, they will use it as an exchange rate anchor. Applicant countries can use it as a reserve currency. This point is further emphasised by the fact that the bulk of their trade is with Euro zone countries. Meanwhile, after accession new members will become Exchange Rate Mechanism 2 (ERM2) participants (with derogations).

Why the EURO has declined in value since its January 1999 launch
Many experts believe that it was launched at a level which, with hindsight, was too high. The US economy was unexpectedly strong in 1999-2000, at least in part on the back of the e-commerce bubble which was now burst.

Economic forecasts for the larger Euro zone countries were overly optimistic, oil prices are quoted in US dollars, which consequently increase of oil prices strengthened the dollar.

A number of political factors also intervened – the Kosovo crisis being the most important – and declarations about the Euro which caused speculative movement.

Investors, particularly institutional ones, started to test Euro-Dollar parities, part of the normal game of high finance. There was a certain amount of investor fatigue – after the wave of giant mergers and takeovers of the late '90; and in the really big ones in 1999-2000 it tended to be EU investment in the US which resulted in an outflow of funds from the Euro zone.

The Euro behaved unlike a normal currency. There was still more than one Central Bank (the central banks of Euro zone countries all had a role), while the European Central Bank had no credible track record and reputation. The Euro existed only on the bank accounts; there were no banknotes and coins, etc. so it remained a fiction for most people.

The ultimate test of a currency's viability is its capacity to ensure low inflation, and that is what the Euro is doing successfully.

Why candidate countries should not adopt the euro simultaneously with EU membership
It seems odd that while the rest of the acquis communautaire is not negotiable to candidates, the opposite seems to be the case for the Euro. Candidates are being discouraged from "Euroisation" that is the early and unilateral introduction of Euro. Why is this?

Prior to accession, the Copenhagen criteria (requirements for EU membership) are more important for candidates – the Maastricht criteria (requirements for European Monetary) can be introduced only after accession;

on entering the larger common market, the candidates will need flexible exchange rates to cushion them from the first shocks of entry;

prospective membership will most probably lead to an increase in capital inflows which may well lead to a rise in interest rates. Some of these high rates will be seen as speculative and lead to destabilising outflows.