Phase III of EMU and European Competitiveness : why should Industry become more involved ?


Jacques Marot


In Europe, Eastman Kodak Company has subsidiaries in all Western European countries which are in charge of sales, customer service, and photo finishing operations in their home territory.

Our company also has three manufacturing facilities (as well as R & D units) in the UK and France for sensitized products and in Germany for equipment. These factories supply the needs of the West European subsidiaries and also export to outside Western Europe (mainly Eastern and Central Europe, C.I.S. countries, Africa and Middle East). Since we do not manufacture in Europe everything we sell for reasons of economies of scale, one of the factories imports for the balance of our European needs, mainly from the US. A Regional Office, located in London, coordinates our activities in Europe, Africa and the Middle East.

About two years ago, our company decided to investigate the pros and cons of using the ECU. We were helped in this task by the work already done by the Association for European Monetary Union, of which we are members.

This led us to survey 5 multinational companies which all used the ECU for their internal transfer pricing systems to reduce foreign exchange risk. In addition, two of them kept their accounting and reporting systems in ECU's. An other one made price offers in ECU to its pan European customers. None of them actually billed their customers in ECU's since this would have generated a duplication of conversion costs to "real" currencies of the supplier and of the customer.

Pros and cons for KODAK OF :

- EMU Phase II

We concluded there was no benefit for us to use the ECU except when treasurers find that borrowing in ECU's makes sense from an interest rate point of view.

- We already make price-offers in ECU to some of our pan-European customers, but the actual billing is made in the currency of the purchaser.

- For intercompany billing, we invoice the importing countries in their own currencies, concentrating the exchange risk and the conversion costs after netting in the exporting companies.

- For accounting and reporting, we already have a common currency with the U.S. dollar.

The only reason we would use the ECU more broadly in our external transactions would be the one where we would have receivables or payables in ECU (like taxes), which is not yet the case.

- EMU Phase III

This phase, although very detailed in the Treaty on European Union is still surroundered by a lot of uncertainties :

- by the end of 1996, the European Council, after having taken into account the reports prepared by the Commission and the EMI, the vote by qualified majority of the ECOFIN, and the opinion of the European Parliament, will decide by qualified majority :

- whether a majority of Member States fulfil the necessary conditions for the adoption of a single currency.

- whether it is appropriate to enter the third stage.

- if so, set the date for the beginning of the third stage.

- If no date has been set for the third stage by the end of 1997, the European Council will confirm, before July 1st 1998, what Member States qualify for the adoption of a single currency (no minimum number of countries required) for January 1999

This leaves businesses with a lot of question marks :

- on the date for the beginning of stage 3 : the way the Treaty is written, the European Council may decide by the end of 1996 to move to stage 3 even if some countries do not quite match the convergence criteria.

One might also imagine, although this appears unlikely, that even if a majority of countries fulfil the criteria, a postponement of phase 3 (if for instance there is a negative trend for these criteria in some countries) : so the alternative for business is Jan. 97 or Jan. 99.

- on the 1st wave of countries which will enter into Phase III. Every company will have to develop its own scenario.

- on the rate at which domestic currencies will be irrevocably fixed to the ECU : if this date is not the one at which the European Council makes its decision to move to Phase III, this could lead to speculative moves on these currencies, for which the decision has been made to move to Phase III, between the date of the European Council and the date at which irrevocable exchange rates will be set.

- on the length of the "reasonable" period between the beginning of Phase III and the actual conversion of national currencies into the ECU. Policy-makers like the French former President Giscard d'Estaing and the former President of the Bundesbank, Dr. Schlesinger, agree that before replacing the national currencies, the ECU has to build up its credibility and awareness vis a vis European people, by beginning to be used not only by financial institutions but also by businesses.

But while President Giscard d'Estaing suggests buil-ding this credibility during Phase II (started since January 94), Dr. Schlesinger wants to build it only after Phase III has started (i.e. after the conversion rates have been irrevocably fixed).

The risk with Dr. Schlesinger's approach is, how irrevocable will the rates stay without a real single currency for several years.

The chances that Dr. Schlesinger's proposal is the right one are increased by the time which will be needed by the banks to change their information and reporting systems as well as their equipment, which might take up to 5 years. In addition, because of the above uncertainties, the private sector is reluctant to anticipate the changes.

As far as our company is concerned, our emphasis is on the single market as a means to improve the competitiveness of our European operations : from a business prospective, a single market is a market where products and services are differentiated only due to customers' requirements, not because of differing regulations.

We are not there yet, a number of technical, fiscal, legal, financial obstacles still exist and among them the lack of a single currency is a significant one.

As a consequence, the cost of doing business in Europe is much higher than in the US or Japan. This translates into higher prices (what products can we buy cheaper in Europe than in the US ?) and/or lower profit margins, both of which having a negative impact on the competitiveness of our European operations.

Let us now examine how Phase III of EMU would improve European competitiveness.

One obvious benefit would come from the reduced foreign exchange transactions. Our Finance Company alone would save at least 2 M $ a year. We would also save the costs of converting currencies back and forth for travels throughout Europe.

There would be more netting of flows between companies, reducing the cost of transferring money.

There would be reduced costs in holding a float of European currencies.

It would be possible to significantly reduce the number of our bank accounts. This would enable us to negotiate better bank charges and services with a much fewer number of banks.

It would be easier and less expensive for our Corporate Headquarters in Rochester to hedge European foreign exchange exposures, since there would be more netting of exposures and less contracts required to cover the position.

From a management point of view, it would be easier to compare the performances of our European companies.

It would make it easier to have one accounting centre in Europe, leading to savings. We would have further substantial savings in administrative costs if this was coupled with a real "Single European Company", i.e. a European company with a single balance sheet and a single tax return. (Incidentally, this is an issue we are lobbying for with other European and American companies.)

The most important benefit for our company would be on the pricing issue : our strategy has long been, to generally provide identical products to our customers, wherever they buy them from, wherever they have been manufactured. This has led us to try and harmonize our prices throughout Europe for many years, but this has proven to be an endless task because of currency realignments in several Member States. For example, how to cope with an average depreciation of the Italian lira close to 20 % or of the Spanish peseta above 15 % ?

Since we do not manufacture in these two countries, we would have had to increase our prices in local currency by 25 % and 18 % respectively. Obviously unacceptable both from a consumer point of view and within a strongly competitive environment ! So we had to accept lower margins when selling in these two countries.

A consequence has been a significant increase in the parallel flow of products from lower priced countries to higher priced ones with further negative consequences on our profit margins in these latter countries. Because of European competition law (article 85 and 86), we cannot do anything to prevent this from happening. No doubt that irrevocable exchange rates, provided they hold, would fix this problem.

An other benefit a single currency would bring to our company relates to the development of central purchasing : more and more multi national companies want to negotiate contracts with their suppliers for all their European subsidiaries.

This is a painful process since, even if we can use the ECU for price offers, actual billings have to be made in national currencies in order to avoid conversion costs : receivables or liabilities in ECU still do not exist.

Obviously, a single currency would favour foreign direct investment by eliminating uncertainties within Europe.

Finally, although not claiming to be exhaustive on this subject, I would suggest that a single European currency is a necessary prerequisite, unfortunately not a sufficient condition, to help create global monetary stability :I've always been amazed by the amount of time which has been spent during the recent Uruguay Round negotiations on reducing customs duties, while not much effort has been dedicated to achieve global monetary stability. Everyone knows that these customs duties reductions may be more than wiped out by swings in currency exchange rates. A recent IMF report, which was mentioned in the previous issue of this magazine 1, suggests that the current exchange rates of the 4 "Dragoon" countries vis a vis Europe are half what they would be based on purchasing power parity. Certainly, a more orderly world-wide monetary system would help European competitiveness. It would also remove some of the uncertainties when making investment decisions.

In this respect, I am encouraged by the initiative taken by Mr. Paul Volcker, former President of the Federal Reserve, who, with the help of a working group, raises the question why since the beginning of the 70's, the growth of industrialised countries has declined from an average of 5 %, to 2.5 %, and suggests that the main reason has been the fluctuation of exchange rates, which has slowed down growth by creating uncertainty in the private sector, forced to allocate important resources to manage this exchange risk. Mr. Michel Camdessus, General Manager of the IMF, has recently made similar comments and volunteered several proposals.


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For all these reasons, our Company is a strong supporter of EMU and would like the move to phase III to happen sooner than later. We do feel, however, that business should speak up more loudly on this issue to keep the momentum vis a vis our European policy-makers in order to reduce the uncertainties which still surround this very important change.