Europe's monetary union has been at the centre of the global financial sector for some time now. India is no exception. What does the advent of the Euro mean, both for Europe and India? As the head of KPMG's EMU unit, Leslie L Gunde is ideally placed to assess the implications of the introduction of the euro. During a recent visit to the Capital, he took time off his busy schedule to speak to Anil Padmanabhan and Cherian Thomas on this major emerging issue. Excerpts:
Q: How will the advent of the euro impact Indian companies?
A: The impact will be at a number of levels. First, there will be Indian companies that are trading with European companies in countries that will be part of the euro in the first wave. So they will need to deal with the euro as a new currency in making and receiving payment. And even in countries that will not be a part of EMU in the first wave, businesses will be looking to use the euro in their transactions.
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Of course, there are some major Indian companies that have full-fledged operations in these 11 countries. Their subsidiaries and distribution networks will already be dealing in the euro in their own particular environment.
But there are also Indian businesses that simply supply to those countries, like software companies. These would definitely be affected. Something like 30 per cent of India's current export trade is with the European Union countries _ so there would be a major impact there. Also, there are particular industries that deal with the external sector that will be affected _ such as leather goods manufacturers.
Q: What about the financial sector? What adjustments are required there?
A: The financial sector will need to be prepared to deal with the new currency and facilitate transactions in it _ and it will need to bring forward market products to do that. Of course there is the issue of which currencies are used in international trade. Today, something like 48 per cent of international trade is US dollar denominated, more so in the Asian region. It is expected that the European Union currencies _ when they are combined to form a single currency including the pound sterling _ will account for 31 per cent of international trade. Of course, if you look at the individual currencies, then even the pound sterling only accounts for five per cent of world trade, and is not a major trading currency today.
But, if you add all the currencies together, then you are starting with 31 per cent, and that percentage would grow as the currency gains acceptance _ perhaps in the next five years. So the financial sector will need to recognise this currency, hold reserves in it, and bring forth sophisticated financial products for euro-denominated transactions.
Q: What does this mean for currency management for central banks?
A: Initially, for the central bank, it will not be a big issue, because the central banks generally are largely conservative and they will probably maintain their present policies and prefer to have reserves in dollars. But I think, with time, when the euro becomes more established, that position may change.
The problem with the euro is that it is a new currency. Though it is a package of existing currencies, it is a still a new currency. So there is no track record. You don't know what value it will have _ whether the market would push the value up or down. Maybe it will be quite volatile when it is introduced. So there there will be an adjustment period.
Also, the central banks will have to think about the proportion of international trade within their countries. So the euro may have an increasing role eventually, reflecting the proportion of trade India has with the European countries.
Q: Will derivative products follow naturally?
A: Yes, I think they will follow automatically. This is already happening. You can already deal in derivative products that are targetted at the euro, which will come into effect on January 1. And this practice will gain currency, as the derivative products for national currencies will no longer be relevant.
Q: There will be some volatility in the new currency. So will there be tremendous scope for currency traders to speculate?
A: I think there will be. But of course the European central bank will have currency stability as its main aim _ and it will try and prevent undue fluctuations in the foreign exchange market.
Q: Will the coming of the euro also affect borrowings _ either in debt or equity _ in the European market?
A: Borrowing will be made much easier in many ways. The euro is effectively a single currency environment in a pool of markets. So equity or bonds or any other instrument will be used to access a much larger pool of capital. And, of course, the interest rates after the euro are expected to be quite low, although perhaps not as low as Germany. So there is good scope for borrowing in these national markets and with competitive advantage.
Q: A lot of transactions these days are conducted on the internet. Does the euro complicate transfer pricing problems or ease them?
A: What we mean by transfer pricing is internal pricing within a group. If today one subsidiary in one European country sells to another subsidiary in another European country, then an internal transfer price structure comes into play. And typically these transfer prices have to be agreed upon by the tax authorities in the buyer and seller country.
With the euro, all that will disappear, and the tax authorities will be looking for transfer pricing based on economic factors. These would have to be realistic, and should reflect the percentage of value change taking place in each country. So most pan-European operations will have to address this problem _ they will have to restructure their transfer price structure and renegotiate with the revenue authorities.
Q: What are the implications for the taxation structure under the euro?
A: At the moment there is no provision within the euro project for tax equalisation or tax harmonisation. The Maastricht treaty itself has no provision for bringing taxes or duties in line. But I think it is an inevitability that will have to be addressed. In fact, the council of finance ministers has already recognised this, and they have set up a working party to see how major discrepancies in taxes could be brought in line.
I think it is a major problem, because what happens is that with the integration of the European market in 1992, we had the single market project, which removed most of the trade barriers inside Europe. Now we have a single currency that removes the currency barrier. But we still have discrepancies in taxes _- so it is not quite a perfect market yet _- but we are in the right direction.
Q: You have talked about supply chain management issues. Can cost transparency put pressure on prices?
A: With a single currency, you are removing a curtain, and you are making prices and cost visible between various countries. Not only visible, but practically interchangeable, because the exchange rate risks and transactions costs are no longer there.
Now, with single currency and price transparency, there will be some pressure on prices, particularly on those that differ between countries. It may arise from the direction of the consumer or from within the supply chain itself. So there are all sorts of points where price equalisation pressures may arise. Price equalisation, if it comes about, would imply that the higher price markets will have to come down _ and that puts pressure on margins. So what you do is turn the process around and apply price equalisation to the supply chain, and manage the process in order to protect your margin.
Q: This would mean that the less competitive firms would be squeezed out...
A: The single currency was basically introduced to make Europe more efficient. So a number of businesses will feel the squeeze because either they have been protected by their local currencies or protected by the market. But they will now have to learn to be competitive in an open environment.
Q: How will it affect the operations of European companies elsewhere
A: There are number of things that must be taken into account. It depends on how strong the euro will be.
If it is a strong currency, then it would be cheaper to source goods from outside. If the euro is a weak currency, then that does not work.
Q: Given the Indian corporate structure, which are the industries that can take advantage of a strong euro?
A: There are many industries, particularly the auto industry, that can benefit from a strong euro. The Indian automobile industry is growing strongly, what with investments pouring in.So sourcing automobiles from India could be cheaper.