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Euro Currency System

The document provides information about the Euro currency system. It discusses: 1) The Euro became the official currency of 11 EU member states known as the Eurozone in 1999. 2) The Eurozone has become the world's second largest economy. 3) Member states had to meet certain convergence criteria to join the Eurozone such as maintaining low inflation and deficit levels. 4) The European Central Bank was established to implement monetary policy for the Eurozone.

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Corporate Finance Management Euro Currency System Respectable Teacher: Professor Osman Altay Students: Fatemeh Hashemi 093014007 Fall 2010
official currency of the European Union. Eleven member states have adopted it collectively known as Eurozone.(Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, etc.) Taking official estimates of 2007 GDP, the Eurozone is the 2nd largest economy in the world. The euro was introduced to world financial markets as an currency in 1999 and launched coin and Banknote on 1st, January 2002. All nations that have joined the EU since the 1993 implementation of the Maastricht Treaty The euro sign (€) is the currency sign used for the euro the official currency of the European Union(EU). The design was presented to the public by the European Commission on 12th December , 1996. The international three-letter code (according to ISO standard ISO 4217) for the euro is EUR
Maastricht Treaty  Also known as Treaty on European union  Signed on 7 February 1992 between members of European community  Led to the creation of EURO.
EUROPEAN MONETARY UNION EMU is the agreement among the participating member states of the European Union to adopt a single currency and monetary system. Eleven countries have been selected as the members of EMU. As part of the EMU, these eleven countries now make up the world's second-largest economy, after the United States Greece and Sweden, failed to meet the convergence requirements in time to join the EMU in the first round. Sweden failed to satisfy two of the conditions: laws governing Sweden's central bank were not compatible with the Maastricht Treaty and the currency exchange rates in Sweden were not sufficiently stable for the previous two years. Greece failed to meet all of the requirements
European Monetary Institute  The European Monetary Institute (EMI) was the forerunner of the European Central Bank(ECB).  It encouraged cooperation between the national banks of the member states of the EU  Further budget constraints are required in countries ( Italy and Belgium) meet the requirements of the pact.
CONVERGENCE CRITERIA  Price stability: Inflation rate should not exceed 1.5% that of three best performing member state.  Annual government deficit: the ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3%  Government debt: the ratio of gross government debt to GDP must not exceed 60% at the end of the preceding financial year.  Long-term interest rates. In practice, the nominal long-term interest rate must not exceed by more than 2 percentage points that of, at most, the three best-performing Member States
• SWITCH TO THE EURO AT VARYING SPEEDS • Banking for individuals will probably switch to Euros at a last stage • Done largely in local currency up to final changeover • Corporate banking may well start using earlier • Adoption of Euro in corporate sector • Plan of large companies to adopt euro as company currency • Expected their customers and suppliers to use Euros in transactions • Internationally oriented medium sized companies will probably also turn quickly to new currency in many of their functions • Smaller domestically oriented companies, self employed and households will keep more or less to national currency until euro coins or notes and coins are introduced
Public sector in Germany brings up rear •German public sector didn‟t planned to switch to euro until end of 2001 •Possible to make non cash payments in Euro ex. tax •Companies were particularly concerned to pay income and corporation tax returns in DEM until 2001 •Preferred to use Euro right earlier Shortening of cash changeover phase in Germany •In order to minimize the burden on the retail sector •Banks and retailers continue to give out DEM coin they receive as can be used for any vending machine
THE LEGAL FRAMEWORK FOR THE CURRENCY CHANGEOVER Based on two regulations First regulation •Based on article 235 of the EC treaty took effect on June 20th ,1997 applied to all EU countries •The existing contracts will remain in force with all rights and obligations provided no other agreement has been made after the advent of new currency •Neither investors nor debtors holding long term contracts will enjoy advantage or suffer disadvantage through changeover of currency
Second regulation •Based on article 109 of the treaty-on the introduction of the euro was passed during the May 1998 •Established principle that who wants to use the euro can but no one can be forced to (UK,Sweden,Denmark) •Determines the legal status of euro vs. the national currencies •Euro EG opened company,stock exchange, accounting&currency law to the Euro •Paved way for changeover on the financial markets & exchanges that lead companies to adjust their accounts,equity capital structures
THE EUROPEAN CENTRAL BANK • EUROPEAN ECONOMIC AND MONETARY UNION (EMU): • EMU consists three stages • 1ST Stage(1 July 1990 to 31 December 1993):  The Treaty of Maastricht in 1992 establishes the completion of the EMU as a formal objective and sets a number of economic convergence criteria, concerning the inflation rate, public finances, interest rates and exchange rate stability.  The treaty enters into force on the 1 November 1993. • 2nd stage(1 January 1994 to 31 December 1998):  The European Monetary Institute is established as the forerunner of the European Central Bank
THE EUROPEAN CENTRAL BANK  On 16 December 1995, details such as the name of the new currency (the euro) as well as the duration of the transition periods are decided.  New exchange rate mechanism (ERM II) is set up to provide stability between the euro and the national currencies of countries that haven't yet entered the euro zone  The 11 initial countries that will participate in the third stage from 1 January 1999 are selected.  On 1 June 1998, the European Central Bank (ECB) is created 3rd Stage(1 January 1999 and continuing)  From the start of 1999, the euro is now a real currency, and a single monetary policy is introduced under the authority of the ECB.
ECB FUNCTIONING MECHANISM • ECB working procedures are segregated into three parts: • 1. GOVERNMENTAL • 2. EXECUTIVE SECTION • 3. GENERAL BODY
FUNCTIONS OF EUROPEAN CENTRAL BANK (ECB)  To maintain Price stability  Implement the Monetary policy  Issuance of euro banknotes ECB’S MINIMUM RESERVE SYSTEM The main features of the minimum reserve system, which was specified in November 1998 are: The reserve base will comprise bank deposits, debt securities issued and money market paper. Repos, deposits and debt securities with a maturity of more than two years will not be subject to minimum reserve requirements.  The reserve ratios will be in the range of between 1.5% and 2.5%.
IMPLICATION OF FINANCIAL MARKETS Consequences for the bond markets • Outstanding bonds denominated in currencies of participating countries, in ECU. • Bonds issued by governments, banks, company and other issuers. • It will be equivalent to 50% of the dollar bond market and 130% of yen bond market • Scope for financing and investment provide new opportunities for market participants • The three largest country make up more than three-quarters of the aggregate bond market • Growth of overall market being neglected as the countries continue to consolidate the government finances.
Yields not uniform • Highly liquid segment maintained by a single borrower compared to the U.S bill market • Yields determined by monetary and fiscal policy • The development of economy and international capital flows due to inflation expectations • Yields differential between sovereign issuers will small • Countries were expected to revalue were rewarded with lower yields • EMU having no currency risk and credit standing will be the main risk factor • Individual countries have no longer control on their own money supply
Benchmark bonds • Highly liquid at the lowest possible yields • Appropriate yield premium • Existence of highly developed future market • Issue of trading bonds and coupons separately • Pre-announcement of issues in a regular calendar and low tax rates New issuers and market segments • Debt Issuance by states government • Public Sector issuers • Supranational institutions and foreign issuers • Sovereign borrowers from emerging economies Corporate bonds • France is only which has corporate bonds • There is no difficulties for European investors • Increased Demand from Institutional investors
Currency changeover in the bond markets • ECU claims and liabilities will be converted to euros at the rate of 1 ECU= 1 euro New reference interest rates • EURIBOR is replaced by FIBOR, PIBOR and EONIA • ECB calculates overnight rate(EONIA) charged by references bank Consequences for the equity markets • Second largest equity market all over the world • Japan is leading country • Pronounced differences in accounting, legal and tax regulation A “big bang” in asset allocation • Households, institutional investors and public institutions have already begun to change • Rising of capital and increase in occupational pension funds
The changeover in the equity markets • Share capital and the par value of share redenominated in Euros • Public company‟s should have share capital of at least 50000 Euros • Convert par value share into Euros Consequences for the futures and options markets • Existing will modernized and new ones will be launched • Products become more standardized and transparent • Liquid and trading volume increase and costs will fall • Electronic trading is the another benchmark Competition between the financial centers • “Home” currency will disappear and national regulatory system come under pressure • London Stock Exchange and Deutsche Borse AG announced an alliance which will allow customers to trade on both exchanges
OPPORTUNITIES OF MONETARY UNION  Broader Investment & Financing Opportunities  Greater Role in International Currency System  Doesn‟t Affect Purchasing Power  No Bail-Out of Member States  Boost Growth & Employment in the Long Term  Easier Travel & Money Transfer in EU  Companies to Benefit in Multiple Ways  Political Stability
EURO’s INTERNATIONAL ROLE  No Hedging Costs within EU  Euro v/s USD  Investment & Reserve Currency
WHERE DID EUROPE COME FROM? IS EURO SYSTEM A HEALTHY ONE? A Bumpy ride… euro’s limitations are stressed, but the euro survived. April 2009 Greek crisis pushes the euro to a breaking point. 7/15/08 - Euro sets record high of 10/31/07 - Euro climbs $1.6038 after U.S. above $1.45, for first Oct 2009- government support time. U.S. Fed announces US headlines for Fannie Mae & a 25 basis point cut in its discuss Freddie Mac fails to key interest rate to 4.5%. „demise of quell concerns about the US wider U.S. financial Dollar‟ as a stability. world Dec 2008- ECB currency Expected to lower interest rates by 50 bhp April 2009- Greek debt crisis turns speculation to Euro decline and break-up Oct 2008- „Flight to safety:‟ US dollar rallies as financial crisis goes global
THE TURNING POINT:SEPTEMBER, 2008 7 2008 EUROPE STARTED FACING THE BIGGEST GDP DECLINE SINCE THE GREAT DEPRESSION
EURO GOVERNMENTS STEP IN TO STABILIZE THE FINANCIAL SECTOR, INCREASING DEBT Source: European Central Bank, OCP N109, April 2010
RESULTING IN DEBT AND DEFICITS ACROSS THE EURO ZONE Euro deficit limit: 3% ● Euro debt to GDP limit: 60%
PIGS* IN DEBT: A TANGLED WEB THAT TRAPS ALL OF EUROPE * Portugal, Spain, Italy, Ireland, Greece Source: New York Times, May 1, 2010
FRANCE, GERMANY & THE UK CARRY THE LOAD Debtor Total Germany UK France Country Foreign $ billions Debt Greece $256 $45 $15 $75 Portugal $286 $47 $24 $45 Spain $1,100 $238 $114 $220 Ireland $867 $184 $114 $60 Italy $1,400 $190 $77 $511 Total $3,645 $704 $344 $911 Percentage 19.3% 9.4% 25%
ACTIONS SPEAK LOUDER THAN WORDS Country Past breach periods for Past breach periods for deficit debt Austria 2003-09 Germany 2003-06 2003-09 France 2003-04 2003-09 Italy 2003-09 2003-09 Luxembourg Netherlands 2004-05 Belgium 2003-09 Spain 2008 Portugal 2002; 2005-06 2005-09 Finland 2005-2007 Ireland 2008 Greece 2003-08 2003-09
Will the debt crisis lead to the collapse of the euro?
THE EURO CRISIS JANUARY 1, 1999: BIRTH S THE EURO AND EMU OF Fundamental structural issues with the euro set the stage for today’s crisis Conflicts Monetary vs. Fiscal Policy European Central Bank (ECB) has responsibility for monetary policy; individual central banks retained fiscal policy responsibilities Problem No authority to: • Tax • Spend • Enforce actions/impose penalties for non- compliance
KEY THEMES ECB has no authority EU Members have different agendas European? Yes. Union? No. No common Purpose/Identity/Language/Culture Increasing debt becomes a vicious cycle
A VICIOUS CYCLE OF GROWING DEBT AND DECLINING GDP, EXACERBATED BY GROWING LIABILITIES
what the Greece debt problem means for the euro and European unity? • French banks have the biggest exposure to Greece among European lenders, accounting for $75billion. Contagion from the Greek crisis is “threatening the stability of the financial system” like the Ebola virus . Organization for Economic Cooperation and Development Angel Gurria, Secretary General
GREEK’S DEFICIT AND DEBT FORCE THE EUROZONE TO TAKE ACTION Source: Association for Finance Professionals, March-April 2009
EVEN THE ECB SEES IT GETTING WORSE “The euro zone deficit will climb to 7% in 2010” “…by then, all euro countries will exceed the 3% deficit limit” Source: European Central Bank, OCP N109, April 2010
"..the real story behind the euro mess lies not in the profligacy of politicians but in the arrogance of elites — specifically, the policy elites who pushed Europe into adopting a single currency well before the continent was ready for such an experiment." PAUL KRUGMAN New York Times Op-ed February 14, 2010
Euro Currency System