The question of whether the Euro can be described as a "success" or "failure" at this relatively early stage cannot be answered as a simple binomial outcome or with reference simply to one hurdle.  It depends largely upon what factors one considers important criteria to fulfill, and the weighting on a relative basis one prescribes to such criteria.

Generally, it is submitted that one should look at the influence of the currency, both within and outside of Euroland, the broader economic statistics within Euroland, Euroland's external economic influence, and the changes to the underlying financial system.

Without a doubt, Euroland and the creation of the Euro has marked a watershed for the international monetary system.  The impact of the Euro has clearly not been confined to the economies of its member states.  It has left its mark on the framework conditions for investment and trade between Euroland and the rest of the world.

The new common currency has created a stable setting for Euroland/external economic relations and the second largest economy and financial market after the US.

Monetary union has eliminated the remaining FX risks between the participating countries.  Exchange rate volatility, which has repeatedly distorted competitiveness in the corporate sector, has become a thing of the past.

Greater certainty will be provided for trade and long term investment so that hedging costs are significantly reduced.

Although the USD will maintain its key position in the global economy, the Euro has advanced to become the second major currency in the world.

Euroland

As can be seen from the figures Euroland in terms of population, market size and percentage of global GDP is a close second to the US.  In addition, the Euro area of exports of goods and services represents 19% of world exports compared to 15% from the US and 9% from Japan.

Currency Analysis

The importance of the Euro as a currency on the global stage must be examined having regard to the seven factors listed.

(i)             Financing currency:

n          33% of worldwide money market activity (US$ = 47.5%)

n          26% of international debt-narrow measure (debt issued in a currency different to that of the borrowers) which was 7% higher than the total share of Euro legacy currencies as at the end of 1998

n          34% of international debt-broad measure (denominated in home currency and targeted to the international financial markets)

Reasons for growth include:

n          increased liquidity

n          increased M&A activity

n          diversification of debt by several emerging market countries in favour of the Euro

n          efficient/competitive cost of funds versus USD

n          larger pool of investors (removal of 80/20 rule)

(ii)   Investment currency:

Before making the fundamental investment decision, potential buyers will demand a high level of transparency, liquidity and stability both at the macro (economic) and micro (instrument specific) level.

In addition, return hurdles must be met or potentially seen to be met.

In this regard, investors will look at the relative productivity developments in each geographic region.  This is one of the main reasons for the (until recently) poorer performance of the Euro versus the USD (ie. sustained productivity differentials - although this was indeed the case for the rest of the world versus the US).

On the micro level, investors need to have comfort about liquidity (and being able to liquidate) as well as a sufficient degree of price transparency.

As an investment currency, it is worthwhile investigating international banking data and the portfolio construction of international fund managers.  In relation to international banking assets, these include loans, other debt securities and foreign equities.

n          Euro share of international banking assets was 22% as at 9/00 which represents a 6% increase since the start of Stage 3.

n          The estimated share of Euro in the portfolio allocation of international fund managers was 32% for bonds (US$ = 47%) and 25% for equities (US$ = 50%).

(iii)      FX Markets:

As a pricing and quotation currency, the Euro does not play a role comparable to the US$ at a global level when one considers:

n          trading volumes

n          bid/offer spreads

n          transaction costs

n          other market practices

(iv)   Settlement and invoicing (transaction/currency):

The US$ is the predominant currency for the settlement of foreign trade and the only one in extensive use as a "vehicle currency" (ie non US trades).

The US$ role as the prime reserve and transaction currency carries great advantages for the US economy.  It gives the US the power and ability other countries do not have to finance its external deficits in its own money.

It is suggested the longer term dynamic implication of monetary union on invoicing habits is of greater relevance to the importance of the Euro in the future global currency system than it statistical one-off effects.  For many countries, Euroland is or will become the most important trading partner.

(v)        Reserve Currency:

Monetary union has consequences for central bank reserve management worldwide.  A distinction must be made between the repercussions on reserve maintenance by ECB and member banks and by those of non-EU countries.  A large proportion of the currency reserves of USD held by the EU central banks were prompted by their mutual intervention commitments within the framework of EMS.  These compulsory interventions are no longer necessary.  Moreover, the maximum intervention commitments of the ECB within EMS will be restricted to a degree which does not jeopardise monetary stability in the Euro area.

As a reserve currency, the Euro share of total world foreign reserves is comparable to that of its legacy currencies.

(vi)      Anchor Currency

Plays some role in the exchange rate regime of 56 countries outside the Euro area which however, on the whole account for only 4% of world GDP + 17% of Euro area GDP.

Bonds

As at the end of 2000, the Euro government debt securities market comprised around 93% of its US counterpart.

The result of introduction of the Euro has been to open up an attractive financial market for investors offering a serious and equivalent to the US$.  Higher liquidity, a non/low inflationary environment and less volatility as a result of lower susceptibility to exchange rate disturbances has put the European bond market more sharply into focus.  The absence of exchange rate risks means interest spread differentials of the EU members reflects only creditworthiness and liquidity.

Unfortunately there is still no uniform established yield curve.

This is a reflection of the lack of uniform credit quality, liquidity issuance patterns and that historically, bonds were issued largely to meet the needs of the specific domestic customer base and that the importance of national institutional structures has not yet been fully eliminated.

Corporate bonds have been the big winner with sharp increase in issuance levels.

This has been fuelled by demand from institutional investors.

Demand will continue to be generated by factors such as:

n          Investor outperformance:
Prior to monetary union, European investors, predominantly fixed interest investors generated higher returns through currency plays.  As the ability to outperform through this method has disappeared, investors have needed to diversity into credit products and equities.

n          Pension fund deficit:
The largest single risk to European sovereign spreads, in the absence of asymmetric economic shock is the extent of unfunded pension liability across the EMU regions.
Governments aware of this situation are encouraging a shift towards increased private sector provision of pensions.  More households will save to supplement state pensions.

n          Demographics:
There will be a massive increase in the elderly population of Europe over time.  The trend in retirements in Europe will have a rising impact after 2002 which will prompt investors to seek higher yields.  In general, during their earning years, savers may seek higher returns in the equity market but on retirement, many prefer to purchase annuities.

n          Removal of 80/20 rule
Regulatory constraints based on currency for insurance companies necessarily disappear.
All intra-EMU currency restrictions on insurance companies and pension funds investment becomes irrelevant.
[80/20 rule requires 80% of assets to be in the same currency as liabilities.]

Equities

The proportion of European stocks owned by private investors has grown from 10% to nearer 40% over the past five years.  Gross issuance of international equity by Euro area companies was almost doubled in 2001 compared with the previous two year period to $199 billion.

European pension funds (at $2.75 trillion) in 1999, up from $1.68 trillion five years ago and expected to climb to $4 trillion by 2004 are increasing asset allocations to equities.  The estimated equity allocation increased from 19 to 29% over the past four years helped by the removal of some restrictions on equity investment in the Euro area.

Investors in European equity markets must now build strategies with a pan-European perspective as prices increasingly reflect risk factors specific to industrial sectors as opposed to the individual currencies.

It is fair to say though that perhaps the introduction of the common currency has been felt more on the economic factors that drive share prices and less on the structure of the trading of the same securities.

There has been surprisingly slow progress in bridging the gaps between existing equity trading platforms in the Euro area in order to facilitate the future development of a truly pan-European equity environment.

Some complexities integrating historically independent markets, driven by local interests still remain.  In order to allow equity markets to reach their full potential, liquidity must grow and transaction costs must be reduced.  Thus, market consolidation should be inevitable but will remain difficult until post trade costs are reduced by consolidating the clearing and settlement systems.  (ie. Cross border transactions remain quite expensive given the number of organisations involved.)

Impact on Trade & Investment

A major question that arises with the advent of the Euro is its effect on trading and investments between Australia and Euroland.

Factors such as the development of exchange rates, the cyclical performance in the two regions as well as the remaining barriers to trade and trade relations with the rest of the world certainly play a more significant role overall than MU and the Euro could conceivably do.  In the long run, however, the Euro will leave its mark on economic relations by paving the way for more stable relations, by creating easier access to the European goods and services markets and by facilitating the financing of trade and investment activities.

Corporates in Australia will need to reconsider their business strategies in Europe in order to guarantee they can compete in the more dynamic environment.

Trade

The most important aspect for closer trade links between Australia and Europe will result from the positive economic forces set free by the Euro in Europe itself.  Australian firms will be able to enter one coherent market, free of the impediments to internal trade with an impressive growth potential.  Australian corporates will be able to effect all the financial transactions in the entire Euroland area in only one currency which will clearly offer ample scope for streamlining their treasury activities.

In addition, considerable cost savings can be achieved by exploiting synergy effects in distribution networks and export financing activities.

A word of caution.  At the same time, competition between firms within Euroland will increase, making it harder to operate in the area.  Corporates will need to evaluate and weigh the demands of the more competitive European markets against the benefits of easier trade facilitated by one currency.  It should be noted that European companies may wish to exploit their growing competitiveness outside Euroland and compete directly with Australian corporates in third markets (eg Asia).

The EU member states not initially participating in the Euro (Denmark, Sweden and the UK) should not be ignored.  As competitive pressures spill over into the non-participating countries rather swiftly adjustments in market and industry structures similar to those inside Euroland have occurred for these countries as well.  Consequently, Australian companies engaged in trade primarily with the non-participating states will not be spared the structural impact of the Euro.

Regardless of whether an Australian firm has already established a presence in the EU or whether it is planning to enter, the Euro will greatly enhance sales and procurement possibilities, as currency related obstacles to the mobility of goods, services and factors within the EMU area will vanish.  The twelve union members will also serve as access points to the entire EU and the emerging markets of Central and Eastern Europe.

Selecting a business location, be it from the perspective of established firms or of entrant firms will be facilitated by EMU.  As considerations related to exchange rate risk no longer matter for the choice of the right business location, enterprises in future will be able to concentrate on the core decision parameters related to the specific demands of their company such as production costs, staff qualifications, proximity of primary select markets and infrastructure.  Most importantly, there will no longer be a reason to maintain more than one principal business location in Euroland only for the sake of protecting the company against erratic exchange rate movements and high currency related transaction costs. 

Australian firms should consider that pricing policies many have to be revised in the face of increasing competition.  In the Monetary Union, cross border arbitrage will largely undermine strategies of price differentiation.  At the same time, factor input prices will be under pressure, too, rendering the EMU sector cheaper.

Nevertheless, prices will not be identical across the EMU area.  The same is true of wage costs.  Differences in taxation will continue to prevail (eg national VAT rates between15% and 25%).  Furthermore, there are many different national norms and customer preferences.  In order to meet the pressure on profit margins, companies engaged across Euroland may find alternative strategies such as greater product differentiation.

Issues for Business

n          Preparation is key with the main issues to consider revolving around:

-        strategic business decisions

-        operational

-        financial

n          Whilst the Euro market clearly opens up opportunities via greater transparency afforded, liquidity and standardisation, it also creates threats from increased competition, particularly in terms of scale and conversely the level of transparency demanded.

Concluding Remarks

In its formative stages, there were always going to be questions asked about the potential success of the Euro being hindered or mitigated by the ability of European countries to efficiently form a nation state without fiscal adjustment mechanisms, and a perceived low mobility of labour.

This however neglects a number of structural reforms in Europe that were commenced nearly a decade ago (1993 EED established a single European market).

So how does the Euro overall "report card" read.

Overall, the Euro role in originating and capitalising trends across the spectrum of financial markets has been uneven.  It is probably fair to say that the impact has been more pronounced for fixed income, and in particular credit markets than anywhere else.  In terms of currency, the Euro has performed as expected in the near term particularly given the relative strengths and output of competing economies.  As far as the equity markets go, there is still room to improve.

The critical mass achieved by full integration has led to greater liquidity and transparency which in turn, has led to a more efficient allocation of capital.  This process could be further improved by the removal of inconsistent intra-Euroland legal, regulatory and institutional infrastructures, some of which are motivated by local interests and national historical experiences.

Most importantly though, as the internal economic strength and success of the Euro area grows, so the importance of the Euro as a global currency also grows.

Translated, this means:

Given such a young age, the Euro is showing achievements across subjects at a different rate.  Nonetheless, one thing is certain, further significant potential has already been tangibly demonstrated through results to date and it would be difficult to believe that given such accomplishments, the Euro will not be anything but a success story over time.

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