How will the euro affect Indonesia?<\/p>\n
The following is an excerpt of a paper presented at the ABN-
\nAMRO Conference on the European Single Currency on June 17 in
\nJakarta by J. Soedradjad Djiwandono, a professor of economics at
\nthe University of Indonesia and Governor of Bank Indonesia. This
\nis the first of two articles.<\/p>\n
JAKARTA: I will try to describe the development of the
\nEuropean single currency, to analyze the importance of the new
\neuro market being created and its impact on Indonesian and other
\nfinancial markets. Overlying these issues are the uncertainties
\nthat surround how and when it may all happen. As a measure of
\nthis, we can look back to just the last couple of weeks.<\/p>\n
The failed German gold revaluation incident, the outcome of
\nthe French election, the Luxembourg summit on June 8 and the
\nAmsterdam summit currently underway have all resulted in almost
\ndaily changes to the economic forecasts for the method and
\ntimetable for the euro's introduction.<\/p>\n
Basically, the argument goes as follows: given the historical
\nlarge fluctuations between the dollar and European currencies,
\none important key in considering the European Monetary Union
\n(EMU) is how it effects the exchange rate of the dollar against
\nthe new European currency, the euro.<\/p>\n
My emphasis is on the short and long-term prospects of the
\neuro, its contribution to the international monetary system as
\nwell as its potential as a huge financial market and the
\nopportunities opened for Indonesian business communities.<\/p>\n
Since the Treaty of Rome, which laid the foundations for the
\nmodern European Union, it was felt that a single currency among
\nthe member states would reinforce the objectives of the creation
\nof a modern European Union. The idea of a joint currency appeared
\nfor the first time in 1972 and led to the creation of the
\nEuropean Currency Unit before the euro was christened in Madrid
\nin 1996.<\/p>\n
Although the principle of the EMU was formally adopted at
\nMaastricht in February 1992, the details of its birth and in
\nparticular which countries will join at the outset, have not yet
\nbeen decided despite the indicative timetable that aims for an
\nirrevocable fixing of exchange rates on Jan. 1, 1999, and
\ncompletion of the project in January 2002.<\/p>\n
There are many possible outcomes to the European Monetary
\nUnion process:<\/p>\n
* First, a core group of countries, including Germany and
\nFrance, proceed toward the EMU as planned, with a second group
\nscheduled to participate at a fixed future date;<\/p>\n
* Second, the EMU occurs on time and includes all member
\nstates that wish to join, excluding the United Kingdom and
\nSweden, or those that have failed all the Maastricht criteria by
\na wide margin;<\/p>\n
* Third, a very small group proceeds as planned and other
\ncountries join after a short delay, during which time their
\neconomies converge further with the first wave countries; and<\/p>\n
* Fourth, a much longer or even permanent delay in which the
\nconsensus for the EMU is revisited.<\/p>\n
I believe it is a safe assumption to make that although some
\ncountries may not participate in the initial round, the EMU in
\nsome form is likely and within a short period of time a majority
\nof those countries wishing to proceed to a full EMU will have
\ndone so.<\/p>\n
Therefore, we may consider that there is a high probability of
\nthe euro becoming a reality in the near future. When it happens,
\nboth immediately before and after the actual irrevocable fixing
\nof exchange rates, foreign exchange markets will be asked to pass
\njudgment on the nature of the new currency.<\/p>\n
In the shorter term, a number of key factors will influence
\nthe value of the euro. These include:<\/p>\n
- The behavior of national central banks with regard to their
\nforeign currency reserves. How European central banks, which are
\ncurrently holding larger amounts of foreign currency reserves,
\nrespond to the euro will be watched closely by the markets.<\/p>\n
- The perception in the markets of the state of the European
\neconomy and politicians desired policy responses. The value of
\nthe euro will be influenced by how national governments respond
\nto the economic criteria laid down by the Maastricht Treaty.<\/p>\n
- The agreed composition of the currency and the perceived
\nconservatism of the new European Central Bank (ECB). Probably the
\nkey to the markets perception of the new currency will be its
\ncomposition and the latitude that the ECB will have in the
\nconduct of monetary policy.<\/p>\n
In the long term, it is too early to tell and too difficult to
\npredict whether the impact of strict monetary policies by the ECB
\nwill result in a stronger or weaker euro. However, in the longer
\nterm, the euro would appear to have all the characteristics of a
\nstrong currency.<\/p>\n
The new central bank has its independence enshrined in
\ninternational treaty. Given this independence, and the bank's
\nobjective of ensuring price stability, it is likely that
\ninflation and nominal interest rates in Europe will be low in the
\nlong term.<\/p>\n
In addition, the reduction of exchange rate uncertainty within
\nthe euro zone could also lead to an increase in trade and
\ninvestment and consequently to additional economic growth.<\/p>\n
Long term euro strength will also be bolstered by the huge and
\nliquid financial markets that Europe possesses and will be merged
\nafter the EMU. London is already the largest foreign exchange
\nmarket in the world, with a turnover that is greater than New
\nYork and Tokyo combined. European equity and bond markets are
\nlarge and liquid and are expected to develop further.<\/p>\n
The future euro bond market, when fully developed, can be
\nexpected to be much bigger, broader and more liquid than the
\npresent national markets. It will offer market participants new
\nopportunities in the form of wide-ranging funding and investment
\npossibilities.<\/p>\n
It should become the second largest bond market in the world
\nafter the United States dollar market, even with only limited
\nEMU. When it happens, we would expect that, over time, many
\ninternational and multinational institutions that hold dollars as
\ntheir sole reserve currency will seek to diversify their holdings
\ninto the euro. This stream of demand will bolster the currency
\nand support a long term appreciation of the euro.<\/p>\n
The development of the euro may also influence European
\ncapital markets. The European Monetary Union has been seen as the
\ncapital market's equivalent of the European Single Market in
\ngoods and services that has been fully applied since 1992.<\/p>\n
At present, despite the convergence of key financial
\nindicators among many of the most prominent European countries
\nand the prospect of an imminent EMU, capital markets within
\nEurope remain fragmented along national lines.<\/p>\n
The EMU will mean that interest rates across the single
\ncurrency zone are the same. Investors will no longer face a
\ncurrency risk when investing within the currency zone. This
\nreduction in risk will reduce the premium investors will demand
\nwhen investing in other euro countries.<\/p>\n
This united capital market will rival that of the United
\nStates. The economy of the European Union (EU) is 22 percent
\nlarger than that of the United States. Its population is 370
\nmillion, 112 million more than in the U.S.<\/p>\n
The EU accounts for 21 percent of world trade, excluding trade
\nwithin the EU, versus 18 percent for the U.S. In addition, the EU
\nhas a higher savings rate than the U.S. and runs a smaller
\ncurrent account surplus with the rest of the world, allowing it
\nto export capital.<\/p>\n
The potential strength of a united European capital market is
\nfurther evidenced by the fact that while the U.S. capital market
\nis a US$17.5 trillion market, the current size of the fragmented
\nEuropean capital market is already $16 trillion.<\/p>\n
The euro area, therefore, has the makings of one of the
\nworld's principal capital zones. The factors that drive the
\ninternal capital market will, because of the market size, be
\ntransmitted well beyond the area's boundaries.<\/p>",
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