Title of the Paper s12

TITLE OF THE PAPER : IMPACT OF EURO ON INDIAN INDUSTRY

AUTHOR’S NAME : NEETI K SANAN

AFFILIATION : INSTITUTE FOR INTEGRATED LEARNING IN MANAGEMENT

CONTACT ADDRESS : Institute For Integrated Learning in Management Lodhi Institutional Area. Lodhi Road, New Delhi 32740383, 9810395346

1 IMPACT OF EURO ON INDIAN INDUSTRY

Euro, the common currency of the integrated economic powerhouse, was launched in 1999 with coming together of eleven European Union countries. These countries now represent 379 million people. The Euro is the first currency in the world which is a multinational and not backed by reserves of any one country. Its might depends on the combined might of the Eurozone countires. The euro area is the second largest economic area in the world after the US accounting for 83 % of US GDP and around 18 % of world GDP.( http://www.eurunion.org/profile/facts.htm )

Its share in world exports is 19.1% and around 18 % in world imports. The comparative figures for US are 14.1 % and 23.2 % . ( http://www.eurunion.org/profile/facts.htm )

The Euro alongwith having committed parentage is backed with a sound monetary policy built on solid institutional and technical procedures.

The launch of the Euro has brought about price stability in the eurozone. This has led to

 the elimination of exchange rate risk and the removal of foreign exchange costs within euroland. This has translated into cost savings for exporters further adding to growth in the region.The robust economic policies have paved the way for low interest rates,increased growth, increased employment in the region. Thus price stability and fiscal discipline across the entire population has had a positive impact on growth and income distribution.  the prospect of a stable euro will improve the investment climate and thus increased investor confidence helps to boost growth. This has created an efficient and competetive investment opportunity.  greater transparency in cross-border pricing which helps to consolidate the benefits of the European single market and improve healthy competition;  the eventual emergence of the euro as a partner alongside the dollar as a reserve currency.

The Euro has lead to amalgamation of nationally based capital markets into a single market with common conventions.Now, there is a unified market wherein bonds issued by national governments are interchangeable. With the capital markets becoming more liquid and increasing in depth , the benefit will flow to the end user. Depth and liquidity are key ingredients for capital markets to work in an efficient and stable manner. Well functioning secondary markets provide provide transparent market prices. Along with integrated capital markets, we require a stable and efficient banking sector for growth of the economy.

Even though half of the world exports are still denominated in dollars, the Euro has the potential to be the first full fledged rival to the dollar. It also has the appeal to financial markets outside Europe. By pushing down transaction costs cosiderably, corporate treasurers active in the member states are finding the benefits of a single currency.

2 IMPLICATIONS FOR INDIA

The European Union remains India’s largest trading partner, accounting for 21.73 per cent of India’s exports and 20.42 per cent of total Indian imports in the year 2002-03. As per Table 1.1, total trade between EU and India increased marginally from € 25.0 billion in 2001 to € 25.8 billion in 2002, registering a growth of 2.81%.

TABLE 1.1 Indo European Trade (million euros)

Total Year Imports % change Exports % change % change Trade 2000 12341 23.16 13303 28.60 25644 25.92 2001 12816 3.84 12281 -7.68 25097 -2.13 2002 12964 1.15 12839 4.54 25803 2.81

(Source: EUROSTAT)

Globally, around 50 % of trade is invoiced in US dollar. However, in the Indo – European case, this ratio is around 80 %.

During the year 2002, EU’s major items of exports to India were :

 engineering goods,  gems and jewellery,  chemical and allied products.

All these items constitute a share of around 77.5 per cent in EU’s total exports to India. Other items, which have a considerable share is metal and metal products (6.30%) and transport equipment (5.18%).

During the same period, EU imported from India

 textiles and clothing (30.87%),  gems and jewellery (12.01%),  leather and leather goods (11.67%),  engineering goods (10.93%),  chemical and allied products (8.74%) and  agriculture and allied products (7.38% ).

(Source : EUROSTAT )

Agriculture has been identified as most propitious area for joint action between India and EU. Textiles is yet another area.

3 Beneficial Effects for India:

1. Growth in Eurozone will provide larger market for Indian goods. With reduced transaction costs, Indo European trade will get a boost. 2. Eurozone will become a centralised capital market where Indian companies will be able to raise capital. This might force local rates to come down and stimulate local business environment. 3. Indian exporters will enjoy some savings in transaction costs.

Detrimental Effect for India :

1. The Euro will remove trade barriers within Europe, making way for lower prices and greater transparency within Europe. Trade barriers, including currency differential are completely removed. This could make it difficult for Indian exporters to take advantage of former price differentials between European countries to market their exports. 2. With economic borders eliminated, there could be a spate of mergers to enable firms to produce on a more efficient scale of operation. This could make Indian industry less competetive. There would be increased competetion from East European countries especially for countries not invoicing in the Euro. 3. The small enterprises in Europe would get a boost since now they would not have to handle complex foreign exchange risks. A larger proportion of the intra Euro Zone trade will originate from the small industry sector. This would increase competetion for the Indian corporates.

OPPORTUNITY FOR INDIAN INDUSTRY

Of the EU's global investments, India accounts for a meagre 0.2 percent. Thus, there is a vast scope to improve the trade relations. EU's imports in past two decades grew by 400 percent--from € 2.5 bn in 1980 to € 12.5 bn. (Pascal Lamy, EU Trade Commissioner, at Luncheon meeting at CII on March 14, 2003 )

The potential sectors that drew EU investors' attention include

 telecommunication,  insurance,  banking and  distribution.

Further liberalisation of the financial services sectors and effective implementation of telecom regulations are expected to expand the scope of EU investment in India. With the induction of 10 new members on May 1, 2004, the EU would emerge as world's largest trading bloc. "This will undoubtedly benefit India through an even larger Single Market with a single set of rules for business and a very open economy with a high standard of rules", points out the EU Trade Commissioner.

4 The Indian Economy , in order to become globally competitive should stress on:

 cost-cutting, productivity improvement and efficient management of supply chains, greater public and private investment in infrastructure.  Enhancing Access to Global Markets  Safeguarding Intellectual Property by effectively administering copyright and patent legislation, encouraging more innovations and patenting them.  improving links between small and large firms.  Increasing Exports

Tracking the Euro

Since the Euro was launched in 1999 at the euro dollar exchange rate of USD 1.1667, the EUR has had a fluctuating trajectory. The EUR hit its lowest levels in October 2000 at USD 0.8252. In June 2003 Eur hit its lifetime high at USD 1.193. ( Graph 1 )

Since its launch, the Eur has not performed to its fullest potential against the dollar. Is it the result of an extremely strong dollar rather than inherent weakness in the Euro. Growth of the US economy particularly in the first half of 2000 was spectacular . It was at this time that Euro fell to its lowest level . Subsequently as the economy moved southwards, the Euro reversed the sentiment and recovered in January 2001. One of the primary reasons behind a falling dollar is the fact that the US runs a current account deficit of approx 5 percent of its GDP. The US economy has been arguing for a dollar decline for at least a year and a half . Now with the US worrying aloud, the foreign exchange markets have listened finally. Hence the ascent of the euro from a low of USD 0.80 in May 2001 to USD 1.15 in July 2003. ( Graph 1 )

Graph 1 Historical Euro Dollar Exchange Rates

Since January 1999 January 1999 to December 2003

5 Source : European Central Bank < http://www.ecb.int/stats/eurofxref/ >

THEORETICAL EURO EXCHANGE RATE

Purchasing Power parity Exchange Rate According to the theory of purchasing power parity (PPP) : Big Mac Index Price in USD : $ 2.65 Price in Euro : Euro 2.75 the good is the Big Mac. The BigMac costs €2.75 in the countries that use Euro and costs $2.65 in US, then the PPP exchange rate is 2.75/2.65 = 1.0377. If the actual exchange rate is lower, then the BigMac theory says that you should expect the value of the Euro to go up until it reaches the PPP exchange rate. If the actual exchange rate is higher, then the BigMac theory says that you should expect the value of the Euro to go down until it reaches the PPP exchange rate. (Source : economist.com Jan 15/2003)

What is the expected in the next one year ? "The world economy is still not firing on all cylinders," said Hans Timmer, head of the Bank's global trends team, "but current trends point to a better 2004." "The much improved underlying policy fundamentals in most regions - progress on budget deficits, controlling inflation, and greater trade openness - are a solid foundation for realizing productivity growth in 2004," says Timmer. "But persistent structural problems in rich countries, such as the twin deficits in the US and weaker performance of Japanese and European banks, risk precipitating a disruptive fall in the US dollar or other unexpected confidence shock that cuts off the investment recovery.

Global GDP projections, 2003-2005

6 Percentage change 2000 2001 2002 2003 2004 2005 Euro Area 3.5 1.5 0.8 0.7 1.7 2.1

Source: World Bank, Development Prospects Group

ECONOMIC PROSPECTS FOR EURO IN THE SHORT TERM LOOKING GOOD  Interest rates are still very low,  fiscal policy is still very expansionary ,  many of the financial and real economic imbalances that have restrained the global recovery over the past couple of years, are now receding.  business investment spending is growing quite strongly again.  Although still high, the unemployment situation is showing signs of some improvement across the euro zone and this should gather further momentum during the year, particular if the proposed structural reforms are implemented in Germany. Introduction of a package of tax cuts is a step in the right direction in terms of igniting domestic demand.  One of the biggest risk factors for the global economic recovery, and particularly that in Europe and Japan, would be a further sharp fall in the value of the dollar against the yen and euro.  The weakening of the dollar against the euro over the past couple of years has been driven by concerns about the widening US current account deficit and a belief in the markets that the U.S. Administration desires a weaker dollar in order to help the ailing manufacturing sector, which saw massive job losses since 2001 and which was the real victim of the recession. The manufacturing sector represents a key source of political and financial support for President Bush.  The course of the dollar in 2004 is very uncertain. Based on economic fundamentals, one would expect to see a stronger US currency as the U.S. recovery will outpace the Euro Zone recovery the near-term at least it is likely that the dollar will lose further ground to the fledgling European currency.  A strong euro might be good for Euro Zone inflation, but would do further serious damage to export competitiveness.  Rising interest rates in 2004 should not cause too many difficulties for markets as they would indicate stronger economic recovery and at the end of the day that is the most important consideration. The coming year should deliver positive returns again, but they are unlikely to match this year, unless we get a serious positive growth surprise. A lot of good news is built into current market valuations, so miracles should not be expected

PROSPECTS FOR THE LONG TERM The primary concern is to keep the economic fundamentals in Europe healthy, which will support a stable euro. There is need to address many structural economic and social problems in Europe, get rid of rigidities of the labor market, invest heavily in education,

7 training and technological skills.This will ensure a currency which will be a fierce competetor to the dollar.

INTEGRATION OF EUROPEAN CAPITAL MARKETS

Several areas around the globe are undergoing a process of economic integration involving the creation of free trade areas and currency unions. This process has significant implications not only for the macro performance of global and national economies, but also for entrepreneurial businesses working within this dynamic environment.

Capital markets are a fundamental element of the financial system of any modern economy. They are in the business of trading in bonds and equities that have been issued in the past. The “ new capital “ deals are a small percentage of the total volumes traded. Deep and liquid markets are vital for any economy. Deep capital markets imply that no one seller or buyer is in a position to have significant impact on market prices. Liquid capital markets imply that portfolios can be adjusted without incurring huge costs. Both depth and liquidity can be acquired by having active secondary markets. Active markets provide transparent market price, thereby rendering an environment for growth and investment.

The European capital markets have gone through a structural change with the introduction of the Euro. Different national markets have received a strong impetus to integrate into a single euro area capital market.

There is now an amalgamation of different mechanisms to allocate and and price near term financing into a single mechanism for the entire euro area. The common objective is the opening up of markets i.e liberalisation with the ultimate aim of increasing the efficiency of financial services and therefore consumer welfare.

What are potential benefits of integrated markets ?

Financial markets integration could be an important stimulus for the badly needed economic growth in the European Union. The potential for higher growth through financial market integration is in the order of an additional 1% of GDP per year or €130 billion extra. (Federation Banca Iredel’ Union Europeene , 2003 ) The gains come from lower funding costs associated with capital raised in the form of equities and bonds as well as bank loans.

The endeavour of an integrated capital market is to remove barriers to retail financial services. The Single Market has increased EU output by 1.8 per cent and created about 2.5 million jobs, equivalent to a gain of around €5,700 for every household in Europe. ( Bolkestein, 2003 )

Deeper capital markets, a single pool of liquidity, with more competition and a greater range of investment. This should result in a more efficient financial system and increased

8 output, more jobs and lower prices. And a lower cost of capital for the EU’s 18 million businesses.

Which areas will change ?

Europe’s banking system - the role of the European Central Bank, payment systems, cross-border relationships, long-term trends and strategies; the effects of the single market on the corporate sector including M&A and corporate finance; the overhaul of pension funds and the resulting increase in demand for equities and fixed income products; the rise of e-commerce and its effect on the capital markets, retail business and industry; and the debt, equity, derivatives, credit derivatives and money.

The various participants which need to be integrated are :

Stock exchanges provide liquidity and transparency to the market

Central counterparties interpose themselves between the parties to a transaction and act as a seller to each buyer and as a buyer to each seller

Central Securities Depositories (CSDs) are the "public notaries" of the securities settlement systems. CSDs would be utilities and natural national monopolies, who bear limited financial liability because of their close links with central banks

Banks, who compete to provide services to market participants, such as custody and financing of cash and securities

Models for Integration:

Horizontal mergers, for example between stock exchanges,

Vertical mergers, i.e. between a stock exchange and a clearing house.

Why horizontal consolidation :

 The role of any two players eg: CSDs as registrars should be clearly separated from the role of banks.  "Vertical" consolidation destroys the level playing field among banks and other players thereby reducing competition.

Why vertical consolidation :

 The supporters of vertical consolidation see an increasing overlap between trading, clearing and settlement. The declared aim of such integration is to "deepen the value-added chain", both upstream and downstream, that is, to cover all the steps in a securities transaction, from the placement of an order, to delivery of the securities against payment, to subsequent safe custody.

9 Competition at all levels in the provision of financial services infrastructure can only increase in the coming years, to the benefit of capital markets, of the economy as a whole and of consumers. Market participants, regulators and competition authorities have each their role to play to ensure that we move in the right direction.

The European Regulatory Agenda for Financial Markets:

Member States ( MS ) have set themselves the ambitious target of creating a single financial market by 2005.

 Investors will be free to buy and sell financial instruments issued or listed in other MS.  Intermediaries will be free to transact freely with clients in other Member States on the same terms and conditions as domestically.  Issuers will be able to tap a deeper and more liquid market.

This will generate significant dynamic benefits:

 access to efficient and innovative service providers;  availability of flexible and competitive financing for European corporate borrowers;  a healthy rivalry between dynamic financial centres;  state-of-the-art infrastructures.

The key to unlocking these benefits is the removal of regulatory and other non-tariff barriers to cross-border finance. An integrated single market requires that national regulatory structures be knitted into a coherent system which avoids legal conflict and duplication of supervision. At the heart of our policy is the concept of the "single passport" – a financial institution which is duly authorised and supervised in its Member State of origin should be considered fit to do business throughout the EU.

10 LESSONS FOR THE INDIAN INDUSTRY

 A single set of trade rules, a single tariff, and a single set of administrative procedures will apply not just across the existing fifteen member states but across the enlarged Union of twenty-five. This will greatly simplify the dealings that Indian operators have within Europe.

 In services, wherein India has a critical competitive niche, services providers will benefit from the implementation of the single market , where they will get the same treatment as in the rest of the EU. For investors, the very high standards of treatment currently afforded by investors in the EU will be applicable throughout the Union

 With one single European currency and drive towards a unified European capital market, Indian operators are looking at aggregations. Aggregation or concentration enables a company to operate at a world level. Market shares of companies which stay small are destined to decrease as they become uncompetetive. However, Indian operators in a) sectors which are less affected by globalisation b) sectors which are dominated by brands c) or sectors which are protected by high tech specialisation will be able to survive for quite some time.

Another impact of the Euro on is that a domestic company finds it difficult to access capital markets in comparison to Multinationals. They have to revert to self financing or bank credit , both of which increase its cost of capital. Hence, their capacity to make use of unified capital markets and therby lower their cost of capital is restricted.

 The advent of the Euro is going to bring about realignment of prices across the European Union owing to greater transparency.This is going to make competetion more fierce in the European Union.

The Euro with its promise of lower taxes, lower labour costs, better infrastructure, will act as a precipitator of thriving competetion. Thus, Indian operators would need to  continue to work on product improvement.  create brands with an international image  be oriented towards expansion at the international level  prepared to accept the challenge of transparency.

With the incoming of single currency, there will be a cut throat competition. Prices will go down hence profitability can reduce. So to improve profitability , Indian operators should reduce cost. It thus becomes imperative to know where the major chunk of the actual cost lies. Service improvement, geographical expansion and strategic alliances , very soon will provide the cutting edge to our indigenous corporates.

11 References: 1.Buchan,David Europe:TheStrangeSuperpowerBrookfield,VT: Dartmouth Publishing Company, 1993. 2.Dinan,Desmond Ever Closer Union: An Introduction to European Integration Boulder, CO: Lynne Rienner, 2nd ed., 1999.

3. Pascal Lamy, EU Trade Commisioner , (Luncheon meeting at CII on March 14, 2003 )

4. Yves-Thibault de Silguy, “The euro and the International Financial Market” (Speech delivered on 18 September 1997 at Bangkok).

5. Koen, V., Boone, L., de Serres, A., and Fuchs, N., "Tracking the euro", OECD Economics Department

6..The Economist, Jan15, 2003

7.Hans Timmer , 2003 , Global Economic Prospects 2004 - Realizing the Development Promise of the Doha Agenda"

8. Federation Banca Iredel’ Union Europeene , 2003 :Eurozone Financial Markets’’Integration Much Achieved , a lot to do.

9. Frits Bolksetein , (Keynote speech to the FESE Convention at the Guildhall in London on Friday, 13 June 2003 )

10. Sunita Jilla, “Know How the euro Will Affect Business”, The Economic Times (17 September 1998).

11. Galati,Gabriele and Kostas Tsatsaronis. 2001 The Euro in international financial markets : where do we stand? Paper prepared for a meeting of the “ Euro 50 Group “ in Washington ( November )

12. OECD, Economic Survey of the Euro Area, Paris, 2001.