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Euro won’t replace dollar as reserve currency for now

By Naween A Mangi

KARACHI: It is only in the long term that the euro will become attractive as a reserve currency because so far it has not rivaled the US dollar as an international reserve asset, Dr Ross Masood, an eminent scholar said here Wednesday at a workshop on “Euro in the Market; Its Political and Economic Impact” organized by the Area Study for Europe, University of Karachi, in collaboration with the Hanns Seidel Foundation, Islamabad.

“When the European Central Bank came into operation in 1999 and in 2002 the euro was launched, most felt that important shifts would occur in the reserves of central banks,” he said. “They did occur relative to the Deutsche Mark but the belief that the euro will rival and surpass the dollar as a leading reserve asset has not come to pass.”

Dr Masood addressed the issue of “The International Role of the Euro: Whether the Euro will become a Reserve Currency or a Vehicle Currency.”

He said the dollar had the built-in advantage of more than 40 percent of the world’s business transactions being conducted in the US currency.

In order to displace the dollar as a reserve currency, the euro will have to have stability and value, be used widely in international transactions, precipitate significant portfolio shifts and, be pegged against by other countries currencies, Dr Masood said. Currently, 64 percent of the world’s reserves are held in dollars, 25 percent in euro-area currencies and, six percent in the Japanese yen, he said. Many anticipate that the euro’s share could rise to 40 percent.

The international role of any currency is determined by the size of the economy backing the currency, the economic policy of the country or countries and the efficiency of the financial markets. In assessing the impact of the euro as an international currency, he said that from the indicator of size, it can be concluded that the euro should assume the role of a leading international currency since the GDP of the EU amounts to 5,800 billion euros compared to 7,600 billion euros for the US. “But size is not enough,” Dr Masood said. “Economic policy is critical in ensuring the stability and credibility of the currency.” That means monetary policy decisions of the European Central Bank should be seen as independent of politics, monetary policy should be transparent, decisions should be implemented efficiently and quickly and, member governments should ensure fiscal discipline, he added.

As far as financial markets are concerned, which is the third factor determining the global role of a currency, Dr Masood said that the EU has traditionally lagged behind the US and even the UK. “This is on account of segmentation and the reluctance to introduce innovative new products,” he said. However, today European financial markets are undergoing rapid development since the single currency has given impetus to financial markets and removed the foreign exchange risk of transactions. Still, skeptics say the EU will not be an optimal currency area because of diversified economies and the fact that full convergence has not taken place. Critics also say that fixed exchange rate regimes do not, in modern day experience, last for more than five years. And Europe’s markets cannot be compared with Wall Street in terms of either size or liquidity.

Economic conditions in the European Union, the incorporation in the union of three weak economies in the form of Italy, Portugal and Greece, the uncertainty created by the Asian currency crisis and the continued economic boom in the US are the major reasons for the downfall of the euro, according to Hafsa Abbasy, visiting faculty member of SZABIST. “The only way the euro can take foothold is to replace the dollar even partially as a reserve currency in the world,” she said.

Abbasy, who spoke on “The Introduction of the Euro: The Political Motivation”, said the dollar remains the major international medium of exchange because of a weak, fumbling euro. The enhancement of cross-border transactions and the increase of prestige as owners of a reserve currency were the major reasons behind the introduction of the euro, she said. “The euro is the basic ingredient in the recipe of the EU,” Abbasy said. The monetary reserves of the EU amount to $6.5 trillion.

Riaz Raziuddin, director of research at the State Bank of Pakistan, spoke on the “Impact of Euro on the Functioning of the Money Markets in Europe: The New Operating Environment for Setting Euro Area’s Interest Rates.” He said that before the introduction of the euro, expectations were that short-term interest rates would converge, cross-border transactions would increase, short term debt issues would increase, repurchase transactions would become more important, and there would be an increase in integration, competition and efficiency. Post-euro efficiency, as measured by the bid-ask spread, improved as the spread declined from 14.4 to 8.5 basis points and as cross-border transactions increased from $650 billion in 1998 to $900 billion in 1999, Raziuddin said. He also said that in comparison with unsecured business, the increasing importance of the repo market was slower.

Meantime, the issue of commercial paper and derivative instruments increased tremendously, although treasury bill issues did not. Additionally, the expectation that the market would become very competitive has not come to bear, although movement in that direction is evident, he said.

Hamidullah Khan, former ambassador, presented a paper written by Batoor Khan on “The Impact of the Euro on Small and Medium Sized Enterprises in Austria and the UK.” He said that although it is not yet clear whether the EU is an optimal currency area, it is a feasible currency area. He also said that small firms in the EU, especially in the UK and Austria have been able to benefit greatly from monetary union in terms of new opportunities for exports, supplies and, investment. With lower transaction costs, small businesses are able to enter new markets more easily, he said. Khan presented data, which showed that there are four million firms in the UK, 90 percent of which can be classified as small businesses with less than 50 employees. These companies account for 45 percent of employment in the UK. In Austria, 23,700 new small and medium enterprises were set up in 2000, 50 percent in the services and tourism sectors. In the EU as a whole, SMEs account for 68 million jobs as against 35 million from large firms.

On January 4, 1999, the euro was introduced as a single currency for the 11 countries of the eurozone. The collective income of the countries of the European Union accounts for 15 percent of the world’s GDP and has a total population of 292 million.

Dr Andreas Rieck, resident representative of the Hanns Siedel Foundation, said that although the introduction of the euro is an economic measure, its political significant is great. He said that the economic advantages are clear but that there are also economic risks involved, which is why the German economy was seen as taking too much risk in coming together with weaker economies. “We had anticipated it would bring inflation and squander our savings,” he said. “But unexpectedly, the German economy has been lagging and has been supported by the single currency.”

Earlier, Prof Dr Naveed Ahmed Tahir, director, Area Study Centre for Europe presented the welcome address and M. B. Naqvi made the concluding remarks.

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