Strong euro a blessing

The appreciation of the euro against the dollar and other major currencies in the last 12 months may undermine the fragile economic recovery of most eurozone countries. Greece, however, is not one of them. Contrary to conventional thinking, the euro’s rise may be a blessing in disguise for the Greek economy, whose main problem is stubbornly high inflation. Figures show the euro has risen more than 25 percent against the dollar but much less against other currencies, such as the yen, in the last 12 months. It should be remembered that euro/dollar had fallen to a low of 0.822 in October 2000, that is, about 30 percent off since the introduction of the euro as a virtual currency at the start of 1999. The trade-weighted effective exchange rate of the euro is estimated to have risen some 5.5 percent on average in 2002 compared to a year earlier. Although eurozone officials have not voiced their objection to the rise of the euro, which is still thought to be undervalued by some econometric models, few analysts doubt that the stronger euro has a negative impact on the competitiveness of eurozone’s exports at a time of sluggish domestic demand and slow economic growth. On the positive side, the strength of the euro has helped contain inflationary pressures at a time of continuing high oil prices. Pointing to the need for a further boost to the eurozone economy, many analysts are convinced that the dampening effect of the stronger euro on economic activity helps pave the way for fresh interest rate cuts by the European Central Bank (ECB) in coming months, perhaps in the second quarter of 2003 or even earlier. Where does this all leave the Greek economy? With an expected GDP growth rate in the order of 3.9-4.0 percent this year and 3.7-3.8 percent in 2004 and an estimated growth rate of 3.5-3.8 percent in 2002, based on European Commission and Greek government forecasts, the Greek economy is again projected to outperform most of its EMU partners this year and next. At the same time, Greek inflation continues to surpass average EMU inflation by a large margin. Greek inflation averaged 3.6 percent in 2002, measured by the national CPI (Consumer Price Index), and even higher on the basis of EU harmonized figures. Analysts expect average national inflation to range between 2.8 and 3.3 percent in 2003, perhaps slightly higher based on EU harmonized figures, versus a 2.0 percent average harmonized inflation in the eurozone according to the Commission. Given that the Greek economy’s growth trajectory is not in danger thanks to heavy investment spending for projects related to the 2004 Olympic Games and other infrastructure works co-financed with EU inflows, as well as healthy consumption spending supported by tax cuts and low interest rates, the real threat to its economic health seems to be rigid inflation. The Greek economy is small and closed, and a relative high proportion of its goods and services are being exported to its fellow EMU partners. That means the appreciation of the euro has no direct effect on Greek exports to those countries, since everything is invoiced in euros, but it may have an adverse indirect effect if the euro undermines their economic growth prospects. On the other hand, the rise of the euro against the dollar seems to have taken its toll on Greek exports to the US. EFG Eurobank figures show that Greek receipts from exporting goods and services to the US accounted for 17 percent of the total in the first eight months of 2002 versus 27.7 percent in the same period in 2001, posting a steep decline. So the stronger euro seems to have a negative effect on Greek exports, but given their relatively small size this should not be regarded a major threat to the well being of the economy. In addition to that, one may argue that the stronger euro may force local companies exporting to countries such as the US to become more efficient in order to protect their market share abroad and secure access to these markets in the long run. Even Greek companies with operational facilities in foreign countries whose currencies have slid against the euro do not seem to be affected that much. First, Greek companies with subsidiaries in major markets, such as the US and the UK, can easily hedge their exposure cheaply via the liquid foreign exchange market. However, local companies with a presence in foreign countries, such as the Balkans, whose currencies are not traded in a liquid forex market, cannot do the same and have to find other ways to partly hedge their exposure. To that extent, the latter are more exposed to the risk of a rising euro; but even so this has to be seen in the context of the expected long-term benefits and costs. There is no doubt, however, that the strong euro has a positive impact on inflation, which seems to undermine the Greek economy’s international competitiveness in the long run. The strong euro partly offsets the impact of high oil prices at present and helps put a lid on the so-called imported inflation. This is very important for a country where inflationary expectations are well engrained and high oil prices are known to be passed easily to consumers, pushing inflation higher and setting in motion second-round effects via higher unit labor costs. Undoubtedly, the appreciation of the euro has both positive and negative effects on the Greek economy. Nevertheless, its positive impact in containing inflation and stopping the permanent erosion of the Greek economy’s international competitiveness far exceeds its marginal negative impact on economic growth. To that extent, even a further measured rise of the euro should be welcomed by Greek officials.