UK cannot afford to miss euro train

Date: 28/01/1999

By staying outside the single-currency area at its inception, the UK government is forcing British firms to compete with one hand tied behind their backs. British Chamber of Commerce president Jeremy Jennings outlines their concerns

BRITISH businesses will face many disadvantages if the UK prolongs its decision to opt out of the euro project.

Not only will the UK's ability to influence the success of the single currency be severely weakened, but British businesses will also find themselves at an increasing competitive disadvantage.

They will be forced to adapt to the euro without enjoying the tangible benefits of simplified administration, lower interest rates and eliminated exchange risk in the currency area, and the subsequent cost savings each of these benefits will produce.

The 11 EU member states participating in the euro form a single currency area comprising some 290 million people and representing nearly one-fifth of global trade and gross domestic product. More than 50% of UK trade is with this group of countries.

They represent collectively by far our most important trading partner and we theirs. The

success or failure of EMU will have a profound effect on both British business interests and those of our continental trading partners, irrespective of whether or not the UK adopts the euro.

Economic and monetary union is intended to bring huge beneficial changes to the business environment in continental Europe. British businesses will not fully benefit from these changes while the UK remains outside EMU.

Indeed, despite the boost to the single market that the euro will bring, until the UK adopts the single currency, British companies will find themselves disadvantaged both in terms of their ability to win business on the continent and their ability to attract foreign investment.

The new grouping of EMU finance ministers, known as the Euro-11, is likely to discuss issues and form policies which are directly relevant to business. Taxation and social security spending are two examples. At present, Britain does not have a formal presence at these meetings and has very little influence over the decisions made.

A real danger exists that the UK, if and when it adopts the single currency, will be expected to adhere to the policies developed by the Euro-11. It is worrying that decisions over which the country has little influence, and which may be inimical to British business interests, could nonetheless bind it in the future. It is also a real disadvantage for the UK not to be involved in the preparations for decisions to be taken by the participating countries.

A volatile exchange rate is damaging for business. It makes it difficult for exporters to plan for the future and deters inward investment. Over the past six years, sterling first depreciated by more than 20% against the deutschemark and then appreciated by around 30%. There have been fluctuations of 10% in the last three months alone.

The costs of hedging against this sort of currency fluctuation are high. Companies in euro-area countries will not face this currency risk as they attempt to win business in continental Europe. UK companies, on the other hand, will be handicapped by the uncertainty and costs of managing the sterling/euro currency exposure.

EU countries which decide not to join EMU are potentially exposed to greater exchange rate volatility of their currency when compared to those in the euro zone. One has only to look at the relative stability of the Italian lira which, throughout the second half of last year, was protected from speculative currency trading by market certainty that Italy would participate in the euro in 1999.

Certain large continental companies have already said that they will expect all their suppliers, including companies from 'pre-in' countries, to present invoices and price lists in euro.

It is also likely that large UK firms competing in the euro zone will attempt to avoid exchange rate risk by insisting that their British suppliers invoice in the currency. In this way, not only does the euro enter the UK by the back door but the companies which suffer most from the exchange rate risk are those least equipped to deal with it.

Indeed, some suppliers which have previously never had to deal with foreign exchange exposure, because they have supplied exclusively UK-based companies, may find that they must manage euro exchange rate risk if they wish to stay in business.

Short-term interest rates in the euro area are currently 3%. Ten-year bonds yield less than 4%. Both short and long-term interest rate levels in the single currency zone are therefore considerably lower than those applying in the UK.

It would be imprudent in the current political and economic climate to suggest that the UK should reduce interest rates so as to bring them in line with rates in the euro area, and the relatively high level of British interest rates cannot be blamed on the UK's decision not to join the first wave of countries signing up to the single currency.

Nevertheless, the fact remains that all businesses borrowing in the UK to finance investment or working capital will be at a disadvantage to their competitors in the euro area.

Any project as ambitious as that to introduce a single currency across the EU has risks attached to it.

Loss of control of monetary policy by participating countries may cause difficulties if the interest rate set centrally by the European Central Bank does not suit economic conditions in a particular country or countries. Some member states may find it difficult to remain within the bounds of the stability and growth pact after years of austerity. Countries which maintain high social security costs and taxation may see national unemployment rise.

However, given the enormous political will behind this project, these risks should prove manageable over the medium term and should be more than offset by the potential advantages to be enjoyed.

A recent Financial Times survey on UK preparedness for the single currency indicated that almost 60% of respondents felt either ill-informed or very ill-informed. The government needs to make further efforts to distribute detailed and practical information to help business prepare.

A pragmatic step which the government should take to help its business sector is to participate in the new Exchange Rate Mechanism (ERM II) in advance of adopting the euro.

Provided the central parity rate set for sterling is credible and sustainable (a rate of around 75-80 pence per euro has been frequently suggested by UK economists), it should be possible to maintain currency fluctuations well within the 15% bands permitted under ERM II.

Indeed, given the precedent created in May this year of using the central parities to set the indicative fixed rates between the participating currencies, it is likely that the market would assume that sterling would join the euro at the central parity rate, further limiting the likelihood of violent currency swings once sterling has entered ERM II.

In the absence of such membership, sterling will be the only major liquid European currency outside the euro, with only the Bank of England and the UK's foreign exchange reserves to protect it from speculators.

A further advantage of ERM II membership would be that sterling may benefit from intervention on its behalf, if necessary, by the ECB, to the extent that intervention did not prejudice the bank's primary duty to achieve price stability.

It is sometimes argued that the UK should wait until its business cycle is properly aligned with the major economies of continental Europe before joining the euro. The reality is that the only way for the UK to achieve this desired alignment is for it to sign up to EMU.

At present, the differences between the economic position of the UK and those of the major euro-zone economies is not great and it should adopt the euro without further delay.

Jeremy Jennings is a partner in accountancy firm Arthur Andersen. This article is a summary of a position paper agreed by the EU Committee of the British Chamber of Commerce in Belgium.

Major feature. Author is President of the British Chamber of Commerce. He argues that by staying outside the single-currency area at its inception, the UK Government is forcing British firms to compete with one hand tied behind their backs.