Remarks made for Singapore Financial Markets Association Euro Seminar
"Managing a successful transition into Euro: The final words before E-day."
Ms Yeo Lian Sim, Assistant Managing Director, Markets & Investments Department, Monetary Authority of Singapore
Date: 23 Nov 1998
Good morning. Thank you for the kind introduction and for inviting me to speak. His Excellency, The Honourable Mr Alan Hunt, British High Commissioner to Singapore; Mr Ronny Tan, President of Singapore Financial Markets Association; Distinguished Guests and Speakers, Ladies and Gentlemen.
The significance of the Euro
The Euro will be launched in less than 50 business days. This is a historic event not only in Europe, but also in the global financial and economic community. EMU demonstrates the ability of its 11 member states to attain the convergence of their economic cycles and embrace a union towards a single destiny.
In the march from initial scepticism to inevitability, the global community has shifted its focus from theoretical, academic debate to the practicalities of the Euro and Euro-based strategies of banking and portfolio management. Now, we confront the administrative Euro-conversion process. Seminars like this one are being conducted around the world.
We will witness the workings of a single currency from Jan 1999. We must, however, re-orientate ourselves as global market participants because the European monetary parameters will have changed.
Few would doubt that the Euro will replace the Deutschemark and its cluster of satellite currencies for international investment, reserves and trade finance. We anticipate that the coming together of 11 economies, each significant in its own right, will generate considerable synergies. The entire Euro-11 economy will shift into higher gear - through the elimination of exchange rate fluctuations, cuts in fiscal deficits and the alignment of inflation and interest rates.
Shrinkage of External Sector
The key question is: "What will the European Central Bank's policy orientation be?" I assume you acknowledge that monetary policy is at the heart of financial price discovery!
Within the Euro-11, I suggest that a clear shift towards a domestic focus will emerge. The growing importance of domestic considerations can be seen from the export statistics. While the external sector is a significant contributor to each European economy in its current state, EMU as a whole will halve the significance of that sector - with exports constituting only 12% of total GDP. As this amount is similar to that of the US, domestic Euro-market and internal demand might gain in importance relative to the external market.
National central banks are accustomed to thinking about export earnings and the competitiveness of their exchange rate. However, in Europe, the exchange rate now falls out of that equation for most national exports. Cost effectiveness is determined by the remaining factors, of which interest rates becomes the central bank's contribution.
Extrapolating from the US situation provides important clues but an incomplete picture about Euro-11's future. In comparison with the US, Euro-11 has lower labour mobility and minimal fiscal transfers. Nevertheless, despite possible initial partisan interests among the Board of the ECB, consensus building, over time, is likely to take precedence over national interests. Individuals on the Board will then set the policy direction of the ECB, rather than the regions from which they come.
THE GLOBAL INVESTOR'S POINT OF VIEW
Now, let us delve into the Euro's implications for financial markets. Firstly, the foreign exchange market.
The Currency Market
As domestic considerations in Euro-11 start to dominate, the ECB could feel less compelled to target the Euro exchange rate. As a seasoned forex professional you can see that the stage is set for possible increase in volatility in the Euro against the US$ and the Yen. This should give definite cheer to forex dealers who worry about the security of their tenure in the face of the demise of Mark/Paris and Mark/Lira. There may be ten fewer currencies to trade in, but there will probably be more volatility in the one that replaces them.
For the European currencies already on the countdown to Euro, volatility versus the Euro should decline as convergence rises. The more successful the Euro, the faster this will take place.
"Will other currencies pick up the slack?"
There used to be speculation that Asian emerging currencies would be the prime candidates. This now seems a little fanciful. It would probably be fair to say that as the markets for individual currencies grow, there could be more interest in trading them, caveat emptor, on the liquidity of small currencies.
The Money Markets
In the money market, a single money market interest rate will enable greater inter-bank liquidity - underpinning the development of a larger market. The ECB has made ample preparations. However, teething problems may still occur, even in the best-planned changeovers.
As you know, investors dislike losing money, for any reason - let alone technical ones. To avoid such irritating hiccups, bankers must keep customers well informed and preferably, beforehand.
The Bond Market
In the bond markets, re-orientation has already taken place. The market has been trading converging spreads between German Bunds and French OATS, Bunds and BONOs, etc. We can expect fewer catchy names - and lower volatility. Yield spreads between the core and the peripherals have collapsed from as much as 500 basis points a few years ago to a minuscule 30 basis points at present.
After the establishment of a single Euro money market and elimination of currency risk, what volatility will remain, will depend on budgetary policy and credit assessments of individual countries - provided that monetary union continues smoothly.
We have heard that the single currency will foster the development of a more liquid bond market - which will be more attractive to investors than the 11 individual markets. This forecast is supported by the fact that as individual countries, Europe already has a substantial footprint on the investor's map of the world.
Many of the component countries are, however, not included in the global benchmark bond indices. If the current indices were to be re-balanced to take into account the advent of the Euro, the "neutral weight" percentage of the EMU-bloc might have the potential to increase from 23-29% to as much as 35%. Investors might be encouraged to participate in the smaller segments of this larger market. Overall activity may increase.
The Equity Market
Euro-11 capital markets are likely to broaden and deepen to resemble those of the US. Thus, another growth area is in the public equity markets.
If individual stock exchanges were to link up (e.g. as planned by the London Stock Exchange and the Deutsche Borse) a single market in European equities will be created, with a market capitalisation of US$ 2 trillion. This is over US$ 600 billion greater than that of Japan. Equity markets are expected to deepen as corporations increasingly tap this avenue of funding, and as investors continue to become more pan-European in their outlook.
The inevitable comparison to the US will force Euro-11 corporations to reassess their return on equity, contribution to shareholder value, operating efficiency and market competitiveness. The acceleration of corporate and industry restructuring will be positive for the corporations and equity investors as well as for the Euro.
As the launch of the Euro approaches, market participants must effect a smooth transition into the new system. Apart from in-house homework, we in MAS have been actively encouraging the banks here in their preparations. Our Financial Supervision Group has issued a reminder to banks and other financial institutions in Singapore, to be sure that they, too, are ready to conduct wholesale operations in the Euro from 1st of January 1999. This is imperative if we are to maintain our position and reputation as a leading financial centre.
In closing, I would like to make the observation that, although Sterling is not one of the Euro-11, it has indeed been our privilege to have twice received distinguished representatives from the Bank of England - to share with us their thoughts on the Euro. They are none less than Mr. Clementi, Deputy Governor; and now Mr. John Townend, who will be speaking later today. Mr. Townend is the Bank of England's First Director for Europe and the Governor's alternate at the General Council.
I believe this seminar will go a long way in enhancing our understanding of the financial and economic environment to come, and leave us better prepared for this Euro-venture.