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The debate is over… EMU is here…it’s time for action!
The “first wave” of European Monetary Union (EMU) members has been confirmed. Full Economic and Monetary Union starts in January 1999. Internationally, governments, companies and even individuals should be assessing the impact that EMU will have on them and planning how to meet the challenges and maximize the opportunities afforded by this momentous event. The aim of this article is to give an overview of European Economic and Monetary Union, take a quick look at what is behind EMU, consider the benefits, and assess the key EMU-related issues that businesses may encounter as full monetary union draws near.
Although EMU has no parallel in modern history, the concept of a multi-country monetary union is not new. As long ago as 269 BC the Romans established a regional currency system based on a copper currency unit called the “As”. So far, this is the only successful example of a large pan-regional currency system in Europe. Since then there have been many attempts to establish a single currency across one or more European states, but without a significant common political base to support the initiative, all except for the Belgium and Luxembourg currency union have floundered.
One of the more recent attempts was in 1970 when the Werner report set the goal of achieving monetary union. This failed however, due to a lack of experience of monetary cooperation between members. Since then, over ten years of the European Monetary System has given member states the experience and confidence to progress to a single currency.
EMU is as much a political arrangement as economic. The political capital invested in EMU is huge. EMU binds the states of the European Union into a socially and economically coherent bloc. The European Union was founded on this principal, and the objectives of the Treaty of Rome will not be truly achieved without EMU. Europe needs:
- Political stability through increased interdependence
- Regional cooperation
- Pan-European macro economic policy mechanisms
- A mechanism to complete the process of healing and restructuring in Europe that began after the last world war
Benefits of EMU
EMU is a world event. The establishment of the euro as Europe’s single currency promises to deliver benefits beyond Europe alone. The creation of a coherent currency bloc to rival the US dollar is of vital importance to the world’s long-term economic viability. The imbalance created by an over-dominant dollar (the world’s only significant currency of reserve) would not provide a stable yet flexible world economic operating environment in the long run. A currency with equal weight is of huge importance to the rest of the world, not just Europe.
The euro promises:
A currency for reform and restructuring
A stable, low interest bearing currency that will, in the early years of EMU, devalue against the world basket of currencies (especially the US dollar) and enable European economies to effect the necessary restructuring of their labor and capital markets. By having a single coordination mechanism (the European Central Bank) the euro can be allowed to initially weaken (low interest rates will ensure this). This will provide the cover of a relatively weak currency that will mitigate the “pain” of vitally important restructuring by ensuring a competitive pricing position in world markets. The United States went through this process in the late ’80s and early ’90s. Europe needs to do so now.
A currency for growth
Europe’s leaders want the Union to evolve into an economic powerhouse to match or even exceed the USA. This stupendous vision, if realized, will open opportunities for growth never before seen in modern times within Europe. After pan-European economic restructuring is substantially complete the new, true, single market within Europe (with freedom of movement for capital and goods, no internal currency risk and low real interest rates) will be an environment for sustainable growth.
A currency for consumers
With an increasingly homogenous market, complete with transparency of pricing and free of exchange uncertainty, cost and controls, Europe’s consumers will enjoy greater choice and lower prices. Sophisticated logistics and distribution systems will encourage “wide-area” shopping for best prices for organizations and individuals alike.
Who is in?
Eleven Member States have met the economic criteria defined in the Maastricht Treaty of 1992. The “first wave” entrants are:
Greece failed to meet the Maastricht criteria but is making good progress towards being eligible to join (probably in 2001). Sweden has elected not to join at this stage due to popular opinion, but has no legal basis to do so, unlike Denmark and the United Kingdom. These two countries have agreed “opt-out” clauses in the Maastricht Treaty allowing them to remain out of EMU at their discretion.
The sustainability of key fiscal aspects by some of the Member States has been keenly debated. Proposed “good house-keeping” sanction arrangements (stability pact), enforced by the European Central Bank are designed to ensure responsible economic policy making by Member States. These and the sheer economic, social and political consequences of fiscal imprudence should prevent any major finanacial disasters.
The effects of EMU
EMU is of global concern. It will impact all the world’s economies to some extent and its effects should be considered by business leaders throughout the world, whether:
- Based in the euro-zone (one of the 11 participating Member States)
- Trading with partners based in the euro-zone
- Having subsidiary companies or cooperative ventures based in the euro-zone
- Owning assets in the euro-zone
- Competing in world markets with euro-zone based competitors
EMU is a catalyst for increasing change. The change will ultimately be positive, but all change involves a certain level of uncertainty. Good understanding and management of the uncertainty will be a critical success factor in business.
EMU promotes competition. Businesses with regional or global aspirations must seize the opportunities opened up by EMU, adopt leading-edge business practices and flexible, change-ready, organizational structures.
EMU may impact a company through the demands of a trading partner. In the so-called “out” countries of the European Union, many large multinational companies are adopting the euro as their operating and prime trading currency. Their business partners are being asked to conduct mutual business in euro. These partners are, in turn, asking their other partners to use the euro for business purposes. The effect of this commercially driven preference for the euro is that many companies outside the euro-zone will very quickly find that a significant portion of their business is conducted in euro.
EMU brings certain organizational and legal requirements. Changes will have to be made to IT infrastructures in order to switch to or trade using the euro. During the three and a half year dual currency phase there will be a mass of national legislation governing the introduction of the euro, sometimes differing from Member State to Member State.
EMU, through the use of the euro, may impact upon foreign subsidiaries of euro-zone based companies as they may be obliged to report, if not account, in the euro by their parent organizations.
Change in business environment and practices
With the reform and restructuring of labor and capital markets in the EMU, the potential for a lower operating cost base for companies will emerge. Coupled to the euro-zone becoming an area of low interest rates, companies are taking a wider view on where they should be based to take advantage of the lowered costs. Many companies based outside the euro-zone may now find it attractive to move all or part of their operations into the zone.
The new transparency of pricing across the euro-zone will increase the opportunity to source goods at the best price. Purchasing cooperatives shopping across the whole euro-zone will be more common and the real freedom of movement of funds and goods will further support these buying organizations.
The ease of movement of goods will also enable companies to change suppliers more quickly in response to better prices. Businesses will need to be more nimble and reactive to competition coming from further afield.
To price goods in euro has some interesting implications. During dual currency phase (3.5 years) there will be a doubling of price data (and possibly cost) to be stored and maintained. This will increase the cost of maintaining price records and will impact on the data handling systems supporting point-of-sale pricing.
Companies in EU “out” countries using euro or dual pricing will be effectively trading in a foreign currency within their own borders and with locally based partners. Exchange rate risks will be created where before they never existed. Does this add to the cost of business? It certainly will add to the risk. Some participating Member States may require a period of dual pricing, for example Austria may make dual pricing mandatory from January 2002.
Translating and the setting of new price points in euro will be a difficult marketing and merchandising challenge. For example, a price point like DEM 2,99 does not have an equivalently “natural” point in euro. The euro equivalent is approximately EUR 1.5194. To drop to EUR 1.49, a recognized price point, will mean a decrease in margin. Consumer organizations will be keen to see that retailers do not increase prices due to EMU and pricing in euro. Sensitive management of price point change will be important.
Maintaining advantageous price differentiation for a similar product across the euro-zone’s markets will be increasingly difficult due to the new transparency of prices (and internet shopping). To do so may involve developing region-specific products that will not lend themselves to wide, pan-European consumption or use. This way a direct comparison between products and prices can be avoided.
Legal and Contractual
Use of the euro
The Madrid European Council of 1995 established the principle of “no compulsion, no prohibition” for the use of the euro during the dual currency period. “Economic agents”, i.e. companies, individuals and public bodies will be free to use either their national currency or the euro. In contracts (see below) parties should agree on the unit of currency measure to be used. Until July 2002 it will be commercial considerations that dictate the use of the euro, not legal.
There are mandatory regulations governing the mechanics of the euro, mainly in the area of exchange calculations. These rules will apply to participating states and also apply to the “out” EU countries as well. Although this is not clear at present, there is a concern as there are significant IT system implications involved. Please see “IT Systems”
The adoption of the euro does not have any affect on the validity of contracts denominated in a constituent national currency. As stated previously, the euro is a direct substitute for a national currency. It may, however, be good practice to audit all current contracts to determine those that should be redenominated in euro upon renewal if relevant.
Contracts established after 1999, that are valid beyond July 2002, are denominated in euro where applicable.
The main impact on contracts will, again, be through commercial demands and considerations. This is particularly true of long term contracts. With the change (and fixing) of exchange rates all such contracts should be reviewed to determine their competitiveness. This is true for parties resident both in and outside the euro-zone.
Under the principle of “subsidiarity” it is for each participating Member State to enact into national law the regulations and guidelines issued by the European Commission. Unfortunately, this process opens up the possibility for multiple interpretations of the EU regulations resulting in differing national laws – a confusing scenario for pan-European enterprises. Many countries have not yet developed and enacted EMU-related laws, so it is not possible for an organization to respond accordingly.
Defining precisely what an organization’s EMU-costs are likely to be is the subject of some debate, however, it is generally agreed that the following should be included:
- Consultants’ and legal costs
- Change or updating of IT hardware and software
- Change of cash handling and point-of-sale equipment
- Additional staff, even if only temporary
- Staff education and training
- Stationery, sales and publicity media
- Diversion of management time
Different businesses will experience different costs.
Source: N.Jones, “The IT Cost of a Single European Currency”
Gartner Group Strategic Analysis Report, May 7 1997
It is generally agreed that EMU-related costs will exceed Year 2000 related costs. The Gartner Group estimates global EMU-related IT system costs to exceed $100 billion. Retail companies estimate a range of one to two per cent of turnover over three and a half years to be their EMU costs, Europe’s governments (Europe’s largest IT users) talk of an increase of nearly 40 percent of IT budgets until 2004. As always the tax payer pays.
EMU has effectively started. With the confirmation of the first participants on May 3, 1998 exchange rates between the member national currencies are being tightly managed. Interest rates are converging towards the projected common point of about 3.5 percent, per annum.
From January 1999
For the next three and a half years there are two measures of value in the euro-zone – the euro and the national currencies of the participating countries. The euro is not a different currency, merely a redenomination of national currencies, like Fahrenheit and Celsius are different scales of the same absolute temperature.
Theoretically, the concept of national currencies ceases to exist. However, as there are no euro notes and coinage in circulation yet national currencies will continue to enjoy joint legal tender status with the euro for this transitional period.
On January 1, 1999 the exchange rates of participating currencies are irrevocably fixed to the euro. These rates are now called conversion rates or factors, no longer exchange rates.
In order to eliminate significant differences due to the use of different ways of converting to and from euro, and the profiting from such different methods, The European Commission has prescribed a set conversion methodology. This aspect is covered further in the “Legal and Contractual” and “IT System Implications” sections later.
Euro is legal tender and the sole means of inter-governmental settlement in the euro-zone. Government debt will be issued in euro from now on.10
The all-important monetary policy of the participating countries is now under the control of the European Central Bank. Fiscal policy remains with Member States. An important question to be answered is how governments will live with this mixed economic structure. Will nations endure this half-sovereign, half-not arrangement?
Euro notes and coinage will be introduced from 1st January 2002. For six months there will be dual circulation of national currencies and euro. This is the maximum period allowed, many countries want to reduce it having anticipated the level of confusion that may be experienced in everyday life. Some even advocate an “overnight” release of euro notes and immediate switch away from national currency.
From July 2002
Now is the time of full EMU, national currencies of participating nations cease to exist.
At some point between January 1, 1999 and January 1, 2002, organizations in the euro-zone are required to change their operating currency to the euro. Others in the “out” countries may chose to do so. This is a complex and risky transition process and the following business implications should be considered:
- Organizations based in EU “out” countries must create or realize foreign exchange differences by adopting the euro. When is it best to do so?
- Relationships with business partners. Will they be affected?
- Change all group companies to euro at once or in a staggered manner?
- What alternative reporting arrangements need to be in place if local requirements still demand national currencies? This may be the case in some countries (for example Germany) where the payment of tax, etc, must be made in Deutch Marks until 2002.
Remember that the changes resulting from EMU will be happening for a long time. It is easy to think that all will occur in the first few, transitional years. This will probably not be the case. Many changes to the business environment will happen quickly, but it will mainly be the formulation of change that will take place first. The real manifestation of these change strategies, company restructuring, re-locations, mergers, labor market shake-outs and consolidation of capital markets and so on will be put into place over the decade after full EMU starts.
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