The Euro what's it all about?

On January 1, 2002 the Euro became a tangible reality after existing in electronic mode for 3 years. But how will the new currency fare against the US dollar and what exactly are the implications for the Middle east?

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By  Massoud Derhally Published  February 21, 2002

|~||~||~|The changeover by 11 European currencies to a single currency will certainly have repercussions outside the European Union. The impact of the euro on non-EU countries, whether from a trading, economic, or financial aspect will be determined by how strong and close of a relationship a non-EU country has with a EU country.

The Euro actually came into being 3 years ago on January 1, 1999. But then as opposed to now, it was a currency in electronic mode. Today, some 300 million plus Europeans share a common single currency after exchanging their francs, liras, guilders and pesetas for the euro.
In the run up to the convergence of 11 European currencies, a great deal of speculation surrounded the new currency. Many industry analysts forecast that the German Deutsche mark, and to a lesser extent, the French franc, would determine what path the new currency would take. Since entering the international currency market though, the Euro has traded well below its 1999 debut price of $1.17, at times as low as $0.88.

So what exactly are the implications of this new currency for businesses and the Middle East region? Businesses in the Middle East and in the Gulf in particular have traditionally transacted in the US dollar and central banks have large denominations of their reserves in American dollars. Many Middle East countries have established trade relations with Europe and some make up part of the 12 Mediterranean partner countries with close ties to the euro-zone.

In the Middle East, and more specifically in the Gulf, where foreign banks have the largest presence, ABN AMRO had been advertising the arrival of the Euro long before the actual notes entered the market on 1 January 2002. ABN AMRO the Dutch bank started its operations in the Middle East in 1942 when it was the first bank in Saudi Arabia and issued the first currency, behaving much like the central bank on behalf of the government.
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Today, ABN AMRO has a large operation in Saudi Arabia, UAE and to a lesser extent Lebanon and until recently Bahrain. With the strong level of trade between European countries and the Middle East and the multinational companies it services in the Gulf, the bank has had to adapt its operational strategy in line with what is taking place in Europe. The change, according to ABN AMRO’s UAE country manager, Tom Zwaan, was not that difficult. “If you look at the introduction of the Euro, the real change-over was three years ago on January 1, 1999. That is when we had to be ready to account for everything in dual currencies and that was a tremendous event,” says Zwaan. “Since then it has been riding that three year transition period. January 1, 2002 was about switching of the button and getting rid off 12 currencies and changing over. From our perspective, the real hype was 3 years ago.”

Unlike European countries, whose lives are directly affected by the replacement of national currencies, the issue facing Middle East businesses is slightly more different. While tourists and business travelers to 11 European countries no longer have to exchange currency more than once as price transparency is enhanced with a uniform currency, for businesses involved in importing and exporting, the picture may be a bit different.

Most of the flows will be from imports into this part of the world and companies here will benefit from a better price transparency is one advantage believes Zwaan. It will be easier to compare price quotes from exporters in different Euro zone countries. Another benefit is the elimination of currency volatility, as you no longer have to deal with the individual fluctuations of 11 currencies. “Importers will benefit in the first place but another potential benefit can be in debt capital markets where companies can now issue debt in a much larger Euro denominated bond,” says Zwaan. “Whereas in the past, any one of the European currencies were all to small and did not have the depth and liquidity that the Euro has to day,” adds Zwaan.

ABN AMRO has had to go the extra mile to make sure that a smooth transition takes place. “If you look at our client base, yes we have done a lot of education especially in the last 6 months. Most clients here did not convert to the Euro until the last half of 2001. Our major effort was 3 years ago in terms of converting our systems and our thinking,” explains Zwaan.

According to one senior economist in Saudi Arabia, the kingdom’s government has been paying for goods purchased in the Euro zone countries in Euros for over a year now and it no longer accepts invoices denominated in the old currencies. “As nearly as I can tell, the impact on the Kingdom has been minimal,” said the economist.
With the convergence of 11 currencies, Middle East countries will be little affected, says a senior official from the European Commission in Brussels. “There are different channels through which the introduction of the Euro has an impact on non-European countries,” said the European Commission official. “One of the most important ones is that of trade flows. One element that is important is the invoicing of trade flows, where we see that the Euro increasingly replaces the US dollar, which has, until now, been the major currency in international trade. But this aspect is a lot less important to countries of the Gulf region because the lion’s share of their exports is oil and that is quoted in US dollars, and I don’t think
that will change,” explained the official.
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Some countries in North Africa, like Tunisia that has 75% of its exports going to Europe, benefit a great deal from the absence of currency fluctuations and having a single European currency. But one accidental benefit of the Euro’s introduction has been its weakness against the US dollar since its introduction in January 1999. This has meant that Euro zone export prices for goods and services have been very stable in Gulf currencies (which are mostly pegged to the dollar) and have actually declined in many cases.

So will Arab banks and institutions change their behavior and look at the new currency as an alternative international reserve currency? It is certainly a possibility but several factors work against it. One is that oil is priced in US dollars and as long as that is the case, it makes more sense for oil producers to peg their currencies against the dollar and use it as the major reserve currency, according to the senior economist in Saudi Arabia. But the European Commission official that spoke to Arabian Business says, “This is not the European Union’s policy. It has been stated very clearly both by the European Central Bank and the European Commission that we are neutral about the international role of the Euro. We are not especially favorable to it or negative to it, and there is no intention to promote the international role of the Euro.”

“Having said that, there will not be a single central bank in the world that will not have the Euro in its reserves. One could suspect that the international role of the Euro would become important because it is the currency of the biggest trading block in the world; it is an economic area roughly the same size of the US and it would be a bit strange if that currency would not have the same role that corresponds to that,” said the senior European Commission official.
“Some banks may change their behavior, some may not,” says Dr. Khan H. Zahid, chief economist and VP at Riyad Bank. “The underlying principle is to align your reserves with your financial transactions. If most of your transactions are in US dollars, you would want most of your reserves also to be in US dollars,” explains Zahid.

The Euro does not have much of a record of accomplishment yet, and the record it has is rather dismal. It has only been out for three years, and has lost about 22% of its value against the dollar. Most countries want a strong currency as a reserve currency, not a weak one. Middle Eastern politics might enter into a decision to use some other currency for reserve purposes, but that is not likely to happen until the Euro stabilises and climbs back above parity with the dollar.

Zwaan at ABN AMRO also admits that to rival the dollar would be difficult as the average composition of reserves is 60% held in US dollars and 40% in other Euro-zone currencies. “I definitely think that the composition of the Euro will increase but the dollar is an important transactional currency, as 60% of the world’s trade transactions are executed in dollars as well. Transaction in dollars means that most of the reserves will be in dollars.”
But will the current weakness of the currency and the fact that policies are dictated by one European central bank recreate a similar scenario to that of the British Sterling being withdrawn from the EMU in 1993? According to Zwaan, the market is always right and the current value of the Euro against the dollar is the right value. However, “If you look at the equilibrium value, which is based on fundamentals, trade flows and analysis that looks at a number of factors, we feel that the Euro is undervalued by say 10-30%,” adds Zwaan. But such a view has a medium to long-term bias because at the end of the day the value of the Euro is determined by supply and demand. “I believe the key reason it is undervalued is that the European economy has never really performed up to its forecast and has under performed relative to expectations. Whereas, the US has always outperformed expectations,” adds Zwaan.

However, the senior European Commission official says that it is impossible for the situation with the English pound to repeat itself because the environment is not the same. “That situation in 1993 was very different. We had the European Monetary System which was an exchange rate mechanism where individual currencies were linked to one another, but could fluctuate around a certain exchange rate.” “Today it’s a completely different ball game and we don’t have several currencies that fluctuate, but rather one currency.”
The key product changes are in the Euro zone itself and the UAE, for example, can benefit from those changes. “They will be derived from what is happening in Europe. For example, you see now in Europe a tremendous development in cash management, many companies are reorganizing the way they manage their treasury, cash and trade flows from being 12 countries to being one country. That organisational change which is driven by creating more efficiencies creates also the need for better banking products,” explains Zwaan.

New developments and efficiencies in Europe can spillover into the business arena in the Middle East. The developments in cash management services and best practices in Europe can help a financial institution like ABN AMRO understand client needs much better. “By knowing how clients manage their entire treasury and cash flow in the Euro zone, we can take best practices from Europe and bring them here,” says Zwaan. “Another area is investment funds, which used to be geographically oriented. Now all of our funds are structured along industry sectors,” adds Zwaan.

So is a single GCC currency feasible? Everyone Arabian Business spoke seems to think so. “If Europe can do it, it is feasible and the political will is present here and that is more important because countries relinquish sovereignty when it comes to monetary policy and that requires tremendous political will and the economic advantages are great,” says Zwaan. —By Massoud A. Derhally
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