The Benefits, and Challenges, of a Very Strong Euro

At the moment, the euro is worth $1.58. On March 18, it reached its historic high of $1.5904. Many analysts believe that if the current trend continues, the euro will rise above $1.60, maybe even as high as $1.70. So far this year, the euro has appreciated by more than 8.5%. Looking back, the European currency has gained almost 20% in international markets since January 2007.

The strength of the euro means: 

1.Rising prices of imported raw materials have less impact on the economies of the euro zone and on their inflation rates. That’s because prices for petroleum, grains and metals are quoted in dollars, which translate into fewer euros. 

2.Those companies that generate a large portion of their revenues overseas see that their goods and services are much more expensive, at least in countries that use the dollar and other currencies. These companies’ revenues suffer, and they become less competitive.

The strength of the euro has a global impact on European companies given today’s conditions because there are great imbalances in exchange rates.The impact is in the loss of competitiveness in the U.S. market as well as in other countries where U.S. products are imported more cheaply.

According to a recent report by Standard & Poor’s, “The strong appreciation of the euro versus the dollar threatens European businesses because, according to analysts, a 10% rise in the euro can have the impact of lowering exports by one percent, and lowering GDP by 0.25%.” In other words, once economic activity slows down as a result of the loss of competitiveness that stems from foreign exchange rates, the recovery process in the ‘real’ economy will be slow.”

 

Mauro Guillén, director of the Lauder Institute at Wharton, warns that “the European companies affected the most are those companies whose sales depend less on trade within the euro zone, and depend more on the U.S. market and the dollar zone (especially, the Near East).” In that regard, S&P identifies aerospace and defense as one of the sectors most exposed to exchange rate fluctuations.

          One of the companies that will suffer the most is EADS, which earns about 35% of its revenues in dollars. Another could be Britain’s Rolls Royce, which earns 25%. The automotive sector will also suffer, including BMW, which has 22.4% of its total sales in the U.S.; Daimler, which has 19.7% and Volkswagen with 5.2%. 

Chain Reaction

Nevertheless, Rafael Pampillón, professor at the Instituto de Empresa business school, believes that “if the big economies of the euro zone, such as Germany and France, grow less because they export less, they [Germany and Spain] will also buy fewer products fromSpain. As a result, there could be a chain reaction. Spain will also suffer some damage to its foreign sales.” Pampillón suggests that tourism will be one of the sectors that suffer the most in Spain. “Travelers from regions that have weaker currencies will realize that taking their vacations in Spain is more expensive than doing so in other tourist locations,” he says.

 

Some analysts believe that some companies exposed to Latin America are also feeling the impact. They argue that the impact is generated by the foreign exchange earned by companies that receive part of their revenues in the euro zone, and part in dollar-denominated countries. This includes the big banks. 

Counter View

Galán believes that Spanish companies are not affected by their exposure to Latin America. “Many of the companies exposed to Latin America are in the service sector, along with energy, construction, telecommunications and so forth. They have made a lot of direct investment in the region. In principle, therefore, they don’t need to make large scale international transactions of goods and services. They generate their business volume in their respective countries, with their own profit centers.” In principle, Galán adds, they should not be strongly affected by the appreciation of the euro versus the dollar. Although some companies may be affected by international transfers of inputs and outputs, that isn’t the key problem for Latin America. 

Incentive to be More Efficient

 

According to Guillén, “The strength of the euro will come at very little or no cost to the GDP of Spain and the euro zone…. The net effect is beneficial since a strong currency reduces inflation and increases the buying capacity of corporations.” Guillén goes even further, saying he is certain that the appreciation of the euro “provides an incentive for exporting companies to be more efficient. In addition, it lowers the cost of inputs that they import in order to produce (energy, raw materials…).”

 

At a time when the U.S. economy is slowing down and global financial systems are experiencing turbulence, Puig believes that “European exporters are more worried about the loss of growth in international markets than about the appreciation of the euro.” Given these conditions, he recommends “companies not only move into countries that have lower costs and weaker currencies but that they also focus on expanding in markets where demand is growing faster, such as in Asia.” China and India will both be key countries in coming years, says Puig.

 

Nevertheless, he notes that the instruments within reach “involve two concepts that are at the origin of corporate competitive advantage: organization and innovation.” Another useful variable for ending this sort of problem, he adds, “is diversification, not only in product categories but also geographies, in an effort to reduce this type of risk.”

Source-wharton.universia