External implications of Euro on emerging markets

At the outset, I may say that the process of getting to Euro and EMU has been successful. Not only did the process achieve substantial convergence in both fiscal deficit and inflation rates but it also laid the ground for what could become an extended period of generalized sustained, non-inflationary growth. These are very favorable circumstances for the introduction of the new currency, called Euro. The only cloud is the high unemployment level in EU countries.

Today I will discuss the Euro's effects on these emerging market economies, focusing my remarks on Turkey as a prime example. In this connection I will sketch the basic economic structure of my country, which maintains close financial and trade relations with the European Union. I will also comment on the Euro's impact on internal and external economies within the Union.

1- In order to understand the characteristics of the Euro, we must examine the circumstances leading to the introduction of a multinational monetary system in Europe. I see three main factors behind the Euro.

First, the eleven countries which constitute the vanguard of the European Monetary Union have lived in a stable currency environment for more than ten years. The people of these countries, 170 million in number, have come to appreciate the benefits of a stable currency in an environment of low inflation: they can see that a stable currency is good for their standard of living and quality of life.

Second, the EMU countries are enjoying the advantages of minimizing the differences between their macroeconomic policies. They have realized that the convergence criteria give them an important tool for disciplining their own economies.

And third, despite long-standing differences in cultural traditions and attitudes, two major members of the European Union, Germany and France, have joined in promoting the idea of economic cooperation and monetary union. Germany, in particular, has played a major role in creating the EMU.

All of these factors have combined to provide a sound basis for creating the new reserve currency called the Euro.

2- For the EMU countries, the most important short-term goal is to promote the Euro as an international currency. Crucial to this goal is the acceptance of the new currency by the people of the EMU countries. The more rapidly this acceptance can be realized, the stronger will be the Euro's status as a currency in the medium and long terms.

In the medium term, the efforts of the EMU countries to ensure durable stability for their single currency will produce additional real benefits by creating an environment conducive to stronger growth and higher employment. And for Turkey, as for the world as a whole, the greater stability of the international monetary system and the increase in the potential of its neighbors can have only positive effects.

The introduction of the Euro into this situation will affect both the EU countries and other countries, especially those with close ties to the eleven EMU countries.

Turning to the effects of the unified markets in Europe on emerging market economies, it can be said that the magnitude of such effects depends mainly on, first, their share in trade relations; second, the intensity of financial transactions; and third, the size and currency composition of their external debt. The most important near-term effects are likely to be transmitted through trade and financial linkages. More robust activity and higher import demand in the Euro area will lead to increase exports and output in developing countries. Financial linkages reflecting exchange rate arrangements, financial market developments and capital flows will have implications for these countries.

The structural changes resulting from the introduction of the Euro will definitely affect Turkey in the medium term, even though Turkish participation in the EMU is not yet an issue. On the other hand, occupying such a strategic location as the bridge between Europe and Central Asia, it is impossible for Turkey to reject integration into the globalized world economy.

3- Let me point out some facts about our close relationships with the EU countries.

· Europe is our largest trading partner. In 1997, 47 percent of Turkish exports and 51 percent of Turkish imports were to and from EU countries, reflecting the increase in trade relations since the Customs Union Agreement came into force at the end of 1995.
· Turkey's external debt totals about US$80 billion. European currencies account for 40 percent of this total, 35 percent in Deutsche Marks.
· Between 1987 and May 1998 Turkey issued $15 billion Euro Bond, which is 70 percent of all bonds issued in DM..
· Fifty percent of Turkish Banking transactions have been held EU currencies.
· During the last five years, 70 percent of direct foreign investments came from Europe.
· More than three million Turks are living in Europe, particularly in Germany.
· Forty percent of Turkey's total foreign exchange deposits has consisted of EU currencies.
· Turkish worker savings in the Central Bank of Turkey amounts to DM 21 billion.
· Sixty percent of Turkey's official reserves consist of EU currencies.
· Last but not least, despite the relative slowness of the globalization process in Turkey, our trade accounts of balance of payments has been liberalized since 1980, and our capital accounts since 1990. Turkey's capital accounts are among the most liberalized in the world.

4- Given these close ties with the European Union, the introduction of the Euro and the creation of a Euro currency area obviously have several effects on the Turkish economy over the medium and long term. Let me summarize some of them.

First, provided that the Euro is accepted by international financial markets as a stable reserve currency, the Euro's share in Turkey's financial accounts would increase further. I do believe that it will take less time for the Euro to be accepted in Turkish daily life and financial transaction than in other countries, mainly because of the large numbers of Turkish citizens living in Europe, high value of trade and tourism transactions with Europe, and the observed stability of the Deutsche Mark for over 20 years.

Second, by reducing transaction costs and removing the risk connected with more volatile currencies, the introduction of the Euro will provide incentives for greater reliance on direct financing in European capital markets. A deep, liquid, and efficient Euro bond market will provide an opportunity to Turkish sovereign and private bond issuers. In addition, the volume of transactions in the Euro bond market is expected to be much larger than today.

Third, a larger acceptance of Euros for trade and financial transactions in Turkey, of course in combination with a low inflationary environment, will make direct investment opportunities in Turkey more attractive to European firms. The very small amount of direct foreign investments in Turkey by European investors would surely be encouraged to grow by the disappearance of foreign exchange risks.

Fourth, under these circumstances, one can expect an increasing trend for both Turkish and European banks to increase their merger and acquisition activities. As it becomes more deeply integrated with the European financial markets, the Turkish Banking system will face new competition. But the dynamism of Turkish banks, together with their high technology, electronic infrastructure, better quality services and manpower, will be attractive to European counterparts.

Fifth, in addition, the concept of independent central banks is the core issue in the European monetary system. The countries that belong to the EMU are no longer thinking about independent central banks in this connection. They have completed their structural and legal changes to prepare the unification. A uniform monetary policy will be implemented by independent national central banks. For this reason, independence for the central bank is more important than ever for Turkey. It will become a must for a globalized environment, and particularly important for a healthy relationship with the European Union.

Sixth, changing values of the Euro vis-à-vis the dollar and yen may affect countries with substantial levels of external debt. An appreciation of Euro would benefit countries that peg to Euro and export to Euro area countries but service a substantial debt in dollars since this would decrease the domestic currency cost of debt service, probably without a fully offsetting decline in export revenues. On the contrary, a depreciation of Euro would increase the domestic currency cost of debt service.

Last but not least, there will be obvious legal effects of Euro to existing contracts, foreign exchange accounts and debt instruments. In order to reduce legal issues and conflicts, the legal department of Central Bank of Turkey has prepared a draft law which is now under the reconsideration by the related authorities. After finalization of this law, we would summit to the government.

These are some thoughts about the effects of Euro to emerging market economies generally and Turkey specifically. But I do believe that countries with sound macroeconomic policies together with addressing structural weaknesses will take advantages of euro-integration. Otherwise the benefits of Euro would not be a major issue in those countries.

5- Let me make some comments on recent developments in the global environment. Spillover effects from the crisis in Asia and Russia, pose risks to the current upswing and could add uncertainty to some indicators and complicating policy decisions. I do believe that the effect of recent turmoil in the financial markets would be limited in Europe than other regions, mainly because of its stability oriented macroeconomic policy is much stronger in Europe than anywhere else in the world. I may say that this is a baseline scenario.

On the other hand, if the crisis is deepening, it provides changes for EMU. First, should the crisis deepen or spread to other markets, domestic and external demand could also be weaker than expected. It of course dampens the current cyclical swings in Europe and confidence effects could have adverse implications for domestic demand. Second, if the expected portfolio shifts to Euro have not been realized, it could be difficult to make assessment by the ECB for money demand and thus the outlook for growth and inflation. Third, volatility in the yen-dollar exchange rate could influence financial conditions and monetary policy deliberations in the Euro area. Finally, if the Euro-area commercial banks are in a position to adjust their balance sheets to make substantial provisions for non-performing loans in the emerging markets, it could influence the transmission of policies to the real economy.

* Governor, Central Bank of Turkey