Mr Bergo looks at the impact of the euro on the economies of non-member states  (Central Bank Articles and Speeches, 3 Feb 99)
Central bank: norges | Type: speech | Date: 1999-02-03

## Mr Bergo looks at the impact of the euro on the economies of non-member statesSpeech by the Deputy Governor of the Central Bank of Norway, Mr Jarle Bergo, to the Sco Norwegian Business Forum, in Edinburgh, Scotland on 3/2/99.At the beginning of this year we witnessed the implementation of the greatest monetary refo century: the launch of the euro and the final stage of EMU.Norway watches this great experiment from the outside, but we are not uninfluenced by it contrary, it constitutes an important change in the environment of our policy-making, espec respect to monetary policy.

In addition, there are important questions concerning the use by Norwegian economic agents and possible implications for the Norwegian business se particularly the banking and financial industry.I shall try to address these issues.

My basic proposition will be that in most respects not give rise to fundamentally new challenges, but almost certainly accentuates some that a present.

## The euro and Norwegian monetary policyMonetary policy in Norway has been oriented towards maintaining exchange-rate stability for the entire post-war period.

When the Bretton Woods system collapsed in the early 1970s, joined the European 'Snake'.

However, when the European Monetary System was set up in 19 Norway chose a link to a trade-weighted basket of currencies.

In spite of the objective exchange rate, several adjustments of the international value of kroner were made in the 1980s to compensate for the loss of cost competitiveness due to price and wage inflation.From the mid-1980s the focus of monetary policy was increasingly shifted to the role of exchange rate as a nominal anchor - against the backdrop of very high price and wage infla relatively high domestic interest rates following the devaluation in 1986.

The EU countr inflation track record was used as an argument for pegging the krone rate to the ECU in 199The currency turmoil in Europe in 1992-93 prompted Norway to abandon the fixed rate again ECU in favour of a sort of 'managed float', now aiming at keeping the exchange rate ' against European currencies, but with no fluctuation margins.

This regime is still in forceIn this context it is important to note that the small and very open Norwegian economy vulnerable to fluctuations in the international economy.

Furthermore, the petroleum sec substantial importance to our economy, and mainland industries are largely commodityWhatever the choice of exchange rate or monetary policy regime may be, there will be consi challenges associated with stabilising an economy which is that heavily exposed to fluctuations.This has been amply illustrated by recent events.

Whereas two years ago we were trying to heavy appreciation pressures against the krone, we have since last summer seen quite the tendency.Last year, the krone exchange rate moved on a weaker trend, in spite of continued gove budget surpluses and our still relatively healthy current account.

As downward pressure on grew, Norges Bank raised its key rates in seven steps last year, in line with its mandate the krone exchange rate.

In the course of five months, key rates were raised by a to percentage points.

In spite of this, the krone has been weaker than its initial range vis-à currencies since last August.

In this situation, the focus of monetary policy must be fundamental factors in a way consistent with a return of the krone to its target range. monetary policy can do nothing to reverse the terms-of-trade shock brought about by the stecommodity prices.

However, the aim to stabilise the krone against European currencies impl inflation over time cannot deviate from the inflation in these countries.

If inflation is with inflation in the euro area, a return of the krone to its initial level becomes more l the current situation Norges Bank must focus on relative inflation when setting interest r time being inflation in Norway, although fairly moderate in absolute terms at just over 2 considerably higher than inflation in the euro area.

Narrowing this differential is a pr strengthening the krone and is thus the best contribution monetary policy can offer in situation.

There are, however, obvious limits to how tight monetary policy can be.

Inte cannot be set so high that it results in an unnecessary severe economic recession and because that in itself would reduce the credibility of monetary policy and most likely w krone.Since August last year Norges Bank's key rate has been 8 per cent - close to 5 percenta higher than in the euro area.

For the time being we find that our instruments are set i consistent with bringing the krone back to its initial range over time.This illustrates the challenges of stabilising the exchange rate of a small, open, oil and based economy against that of larger, more diversified economies.

Though a much larger ec the UK has also over time experienced problems with exchange rate targets, most recently th that led sterling to leave the ERM in 1992 and orient monetary policy towards an inflationThe introduction of the euro from 1 January 1999 did not in itself require changes in N monetary policy.

The euro could replace the ECU as the operational indicator of the exter of the krone.

However, last spring Norges Bank also reviewed the merits of a change in currencies.Norges Bank found the potential benefits of changing the exchange rate target to a trade basket to be relatively marginal and fairly uncertain, and recommended that the Government from modifying the Exchange Rate Regulation.

In the Revised National Budget for 1998, Government affirmed this view and decided that the Exchange Rate Regulation would contin apply without any changes, with the euro replacing the ECU as the indicator of the krone against European currencies.

Thus, the consequences of the introduction of the euro orientation of Norwegian monetary policy might not appear particularly great at the out launching of EMU nevertheless entails changes in the environment for our monetary policy, following reasons among others:First, the European Central Bank formulates its monetary policy with the aim of maintain inflation for the euro area as a whole.

Euroland will be a more closed economy than the member countries used to be, and thus exchange-rate changes less important.

This can r larger exchange rate fluctuations between the major countries than in the past.

If so, krone stable against the euro might become more challenging.Second, the launch of the euro will reinforce global financial integration and contribut capital mobility, and the establishment of an efficient payment and settlement system reduces the cost of moving capital.

Increased mobility of capital, both in and out of including Norway, could follow.As I indicated earlier, we, like others, have experienced increasing difficulty in maintai exchange rate in a world of large, unrestricted capital flows.

The relative calm within t during the recent turmoil linked to the financial crises in Asia and Russia and later Bra indicative of future differences between Europe's 'ins' and 'outs'.

Finland, despite its on raw materials and relatively large exports to Russia, was less adversely affected tha Nordic countries.

For Norway, success in maintaining a stable exchange rate could become challenging in the new environment.Use of the euro in Norway.

Euro and the Norwegian banking industry

## Use of the euro in NorwayI would now like to comment on how, and to what extent, Norwegian economic agents might expected to use the euro in the future.

There are many indications that the euro will be extensively in trade between Norway and euro countries than the currencies of the 11 membe combined today.

Over time the euro will most likely be used on an even wider scale.

Obviou euro would increase in importance in the Norwegian market should Sweden, Denmark and the join EMU.The euro may also play a role - though probably limited - as a settlement currency residents.

This will primarily be of relevance for import and export enterprises as we contractors in industries that are heavily exposed to the euro area.

However, several fact the continued use of Norwegian kroner among enterprises and households.

Government payme such as pensions, social security and taxes will continue to be in Norwegian kroner, probably, will wages.

Furthermore, Norwegian residents are not permitted to settle out claims in foreign currency in cash, according to Norwegian Foreign Exchange Regulations.

## Regulatory issuesNorway is under no obligation to incorporate EU legislation pertaining to the introducti euro

into Norwegian law.

However, there has been some discussion as to whether it wou appropriate to implement some changes in the regulatory framework.One issue has been whether there is a need for statutory amendments to assure the conti contracts in which the parties' payment obligations are expressed in ECUs or in one participating countries' currencies.

Norwegian law is considered to be clear on this issu and in the view of the Ministry of Finance there was no need for legislative change deliberations on the Revised National Budget last spring, the Storting (Norwegian parliam note of this.Another issue is the possibility of keeping accounts in currencies other than the Norweg The new Accounting Act, which entered into force on 1 January 1999, provides for the regi of accounting information in Swedish, Danish, English or Norwegian.

Annual company accou however, are to be recorded in Norwegian kroner and in the Norwegian language unless othe provided for by regulation or separate decisions by the Ministry of Finance.

The annual re be written in Norwegian.

Under certain circumstances, consolidated accounts may be record foreign currency.

Accounts expressed in a foreign currency may also be published as a suppl accounts in Norwegian kroner.A third question was whether it should be possible to quote financial instruments traded o Stock Exchange in euros and, if so, whether this would require changes in stock ex legislation.

A broadly based committee appointed by the Oslo Stock Exchange has addresse question.

The committee concluded that, although this situation may change, there is littl the Norwegian securities market in quotations and settlements in euros.

The committee f legal obstacles to quotations and settlements in euros.

Consequently, the Ministry of Fina found a basis for recommending changes to stock exchange rules.

The Ministry of Finance h considered whether conversion to euros should be regarded as realisation within the interp tax legislation.

The Ministry has concluded that the parties' positions are not actuall conversion.

The Ministry therefore maintains that assets and liabilities recorded in the cu EMU country cannot be considered as realised after that currency was replaced by the euro.A common monetary policy in the euro area is contingent on cross-border payments in euros place just as rapidly and efficiently as payments in national systems do today.

All participating in EMU are therefore linked to a common payment system, TARGET.

In additio being a channel for monetary policy, TARGET is, however, designed to enhance the efficien reliability of cross-border payment systems.

TARGET is therefore used for settling both policy and commercial transactions.

EU countries outside the euro area are also linked to tPayment settlements using TARGET take place on a real-time gross basis.

This means transactions are settled individually and with finality throughout the day.

The system is settle net positions generated through netting of gross positions between banks.The TARGET system consists of the national settlement systems linked together in communications network called Interlink.

Payments are transferred from one country to anot the settlement system of the payer country, where the central bank debits the payer bank' and credits an account of the central bank of the beneficiary country.

In turn, the centra beneficiary country credits the recipient bank.There are several alternative systems for making cross-border payments in euros.

Th important are probably the Euro Banking Association (EBA) clearing system and the tradi network of correspondent banks.

In addition, some large domestic clearing systems like Euro Frankfurt (EAF) allow banks from all EU countries to participate.

The participants natur such factors as price, risk and time into account when considering whether to make use of or any of the other options.The Norwegian banking industry has expressed an interest in having Norges Bank pro settlement services for a multilateral netting system for domestic transactions in euros. member, Norway participates fully in the single market (with the exception of agricultural and Norwegian banks are subject to the same requirements and obligations as those applyin EU.

Access to the common payment system on virtually equal terms is therefore regard desirable and natural.

Norwegian banks attach importance to being able to offer competit services, and a Norwegian euro settlement system could make a contribution in this respect Bank is pursuing this matter with the ECB.

We have taken note of the solutions found with r the non-euro EU members, including the UK.

## Developments in the Norwegian banking industryThe industry that will probably be most affected by the euro is the banking industry.

Th industry in Norway and other countries has undergone, and will continue to experience, su changes as a result of technological advances, internationalisation, deregulation and customer behaviour.

This has intensified competition and reduced margins, thereby promp need for restructuring and reducing overcapacity.

In addition to increased competition banks, new participants - both financial and non-financial - have contributed to incre pressure on margins.

Securities markets have also become more important in terms of their saving, financing and risk management, adding to the pressure on financial intermediaries banks.Like banks in other countries, Norwegian banks have had problems compensating for the decl net interest income by increasing other income or reducing costs.

Intensified competit between banks and from other financial market participants suggests that banks will in g facing major challenges in the years to come.

On top of this comes EMU, which will pr amplify some of these trends.The euro will have varying effects on different market segments.

The most immediate conse of the transition to the euro is the elimination of foreign exchange and hedging transaccurrencies concerned.

As exchange between euro-country currencies accounts for a very l share of total currency exchange in Norwegian banks, this will be of little consequence.Two other areas that will be directly affected are international payment transactions an management.

International payment transactions do not represent a substantial source of in Norwegian banks.

However, it will be important for banks to be able to provide competitive services in euros to avoid losing customers.Foreign lenders today account for close to 30 per cent of all loans to Norwegian enterpris that has been stable for the past five years.

Thus far, foreign branches in Norway have focused on the largest enterprises and financial market segments that demand more ad services.

As the euro gradually gains a foothold in the Norwegian business sector, the N market may prove to be of greater interest to foreign banks.

Nor can we disregard the poss mergers and acquisitions in the Norwegian business sector - which may partly be perceiv response to consolidation in the business sector in the euro area - will lead to a situat larger number of Norwegian enterprises move into the 'division' where foreign competit strongest.

Norwegian enterprises with close ties to the euro area will also demand a wid euro services from their banks.

For this reason, foreign banks will probably compete more with Norwegian banks in the future.

Technological advances, including the development o channels of distribution, will reinforce this tendency.Substantial overcapacity in the financial sector in European countries, particularly in banking, has spurred the need for enhancing efficiency and consolidation.

Over the last years we have seen a considerable increase in the number of mergers and acquisitions in with mergers taking place both within and across national borders.

The introduction of European currency has probably been an important catalyst in this process.

Mergers and acq create entities with ambitions, financial strength and, not least, a range of services we compete on international markets.

This points to increasing competition across national borSeveral large Nordic bank conglomerates define the Nordic area as their home market, an established, or plan to establish, branches in most Nordic countries.

The largest Swedish banks have been the most active so far.

A few of them, in contrast to other internatio established in Norway, have started to show an interest in the market for households and medium-sized enterprises.

The strengthening of the position of Nordic banks in their home may partly be perceived as a defensive strategy to keep out large global banks.

The launc single currency in Europe may have been an important driving force.The euro is likely, at least in the short term, to be of greater consequence to the bank euro countries than in Norway and other countries outside the euro area.

The loss of incom areas, such as currency trading, is greater for banks in the euro area, and the costs as adapting systems, etc. are also higher.

In addition, cross-border competition is likely more between countries with a single currency than between euro countries and non-euro cou although this is not certain.

These factors point to a reduction in earnings for euro However, increased competition may in the longer term enhance the efficiency and competiti of banks.The introduction of the euro will also have a considerable influence on the development of markets in euro countries.

There is reason to believe that capital intermediation via t market will increase at the expense of financial institutions.

The elimination of forei risk, greater price transparency and harmonisation of market practices will increase liqu market, leading to conditions similar to those in the US.Losing the advantage of operating in the national currency will result in keener compe securities markets for brokers, issuers, investors and stock exchanges.

National ties wilimportance as participants are drawn towards markets with the lowest costs.

The integratio exchanges will increase.

The Oslo Stock Exchange, for example, is one of several stock ex currently evaluating prospective partners.The possibility that the euro may lay the foundation for a European market for private bon be of interest to enterprises both within and outside the euro area.

This market is lar developed in the US, whereas European enterprises have primarily relied on bank financin introduction of the euro will also result in a broader and more differentiated selection o a single currency, while increased competition in issue and investment services will prob it less expensive to raise capital directly in the securities market.

The elimination of c the euro area will also enable investors to focus more on credit risk, thereby improving to evaluate this risk.

This may make the market more receptive to private bonds, as invest willing to accept higher credit risk when seeking a return.

This factor, combined wi borrowing costs, may give medium-sized enterprises, which so far have had to rely on financing, increased access to the bond market.It should be emphasised that the expected increase in competition in securities markets i area is not solely due to the single currency.

Technological advances, deregulat harmonisation of laws and regulations are important forces contributing to a freer flow of services in the single market.

There is little doubt, however, that the introduction of a s will make a major contribution to accelerating this process.In sum, trends influencing developments in the banking and financial industry such as dere internationalisation, changes in customer behaviour and rapid technological advances - l intensified competition - have been there for some time and will continue.

Howeve establishment of monetary union will probably intensify existing trends, creating eve challenges with regard to competition in the banking and financial industry.This brings me back to the basic proposition made in the introduction.

In many respects, will not give rise to fundamentally new challenges.

It is highly likely, however, that t accentuate challenges that are already present.

And that, I think, goes for the UK as well