Mr Bergo looks at the impact of the euro on the economies of non-member states
Speech by the Deputy Governor of the Central Bank of Norway, Mr Jarle Bergo, to the Scottish
Norwegian Business Forum, in Edinburgh, Scotland on 3/2/99.
At the beginning of this year we witnessed the implementation of the greatest monetary reform of the
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. On the
contrary, it constitutes an important change in the environment of our policy-making, especially with
respect to monetary policy. In addition, there are important questions concerning the use of the euro
by Norwegian economic agents and possible implications for the Norwegian business sector,
particularly the banking and financial industry.
I shall try to address these issues. My basic proposition will be that in most respects the euro does
not give rise to fundamentally new challenges, but almost certainly accentuates some that are already
present.
The euro and Norwegian monetary policy
Monetary policy in Norway has been oriented towards maintaining exchange-rate stability for almost
the entire post-war period. When the Bretton Woods system collapsed in the early 1970s, Norway
joined the European "Snake". However, when the European Monetary System was set up in 1979
Norway chose a link to a trade-weighted basket of currencies. In spite of the objective of a fixed
exchange rate, several adjustments of the international value of kroner were made in the 1970s and
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 a stable
exchange rate as a nominal anchor - against the backdrop of very high price and wage inflation and
relatively high domestic interest rates following the devaluation in 1986. The EU countries'
lowinflation track record was used as an argument for pegging the krone rate to the ECU in 1990.
The currency turmoil in Europe in 1992-93 prompted Norway to abandon the fixed rate against the
ECU in favour of a sort of "managed float", now aiming at keeping the exchange rate "stable"
against European currencies, but with no fluctuation margins. This regime is still in force.
In this context it is important to note that the small and very open Norwegian economy is highly
vulnerable to fluctuations in the international economy. Furthermore, the petroleum sector is of
substantial importance to our economy, and mainland industries are largely commodity-based.
Whatever the choice of exchange rate or monetary policy regime may be, there will be considerable
challenges associated with stabilising an economy which is that heavily exposed to cyclical
fluctuations.
This has been amply illustrated by recent events. Whereas two years ago we were trying to fight off
heavy appreciation pressures against the krone, we have since last summer seen quite the opposite
tendency.
Last year, the krone exchange rate moved on a weaker trend, in spite of continued government
budget surpluses and our still relatively healthy current account. As downward pressure on the krone
grew, Norges Bank raised its key rates in seven steps last year, in line with its mandate to stabilise
the krone exchange rate. In the course of five months, key rates were raised by a total of 41⁄2
percentage points. In spite of this, the krone has been weaker than its initial range vis-à-vis European
currencies since last August. In this situation, the focus of monetary policy must be to adjust
fundamental factors in a way consistent with a return of the krone to its target range. Of course,
monetary policy can do nothing to reverse the terms-of-trade shock brought about by the steep fall in
commodity prices. However, the aim to stabilise the krone against European currencies implies that
inflation over time cannot deviate from the inflation in these countries. If inflation is brought in line
with inflation in the euro area, a return of the krone to its initial level becomes more likely. Thus, in
the current situation Norges Bank must focus on relative inflation when setting interest rates. For the
time being inflation in Norway, although fairly moderate in absolute terms at just over 2 per cent, is
considerably higher than inflation in the euro area. Narrowing this differential is a prerequisite for
strengthening the krone and is thus the best contribution monetary policy can offer in the current
situation. There are, however, obvious limits to how tight monetary policy can be. Interest rates
cannot be set so high that it results in an unnecessary severe economic recession and deflation,
because that in itself would reduce the credibility of monetary policy and most likely weaken the
krone.
Since August last year Norges Bank's key rate has been 8 per cent - close to 5 percentage points
higher than in the euro area. For the time being we find that our instruments are set in a manner
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
commoditiesbased economy against that of larger, more diversified economies. Though a much larger economy,
the UK has also over time experienced problems with exchange rate targets, most recently the events
that led sterling to leave the ERM in 1992 and orient monetary policy towards an inflation target.
The introduction of the euro from 1 January 1999 did not in itself require changes in Norwegian
monetary policy. The euro could replace the ECU as the operational indicator of the external value
of the krone. However, last spring Norges Bank also reviewed the merits of a change in anchor
currencies.
Norges Bank found the potential benefits of changing the exchange rate target to a trade-weighted
basket to be relatively marginal and fairly uncertain, and recommended that the Government refrain
from modifying the Exchange Rate Regulation. In the Revised National Budget for 1998, the
Government affirmed this view and decided that the Exchange Rate Regulation would continue to
apply without any changes, with the euro replacing the ECU as the indicator of the krone's value
against European currencies. Thus, the consequences of the introduction of the euro for the
orientation of Norwegian monetary policy might not appear particularly great at the outset. The
launching of EMU nevertheless entails changes in the environment for our monetary policy, for the
following reasons among others:
First, the European Central Bank formulates its monetary policy with the aim of maintaining low
inflation for the euro area as a whole. Euroland will be a more closed economy than the individual
member countries used to be, and thus exchange-rate changes less important. This can result in
larger exchange rate fluctuations between the major countries than in the past. If so, keeping the
krone stable against the euro might become more challenging.
Second, the launch of the euro will reinforce global financial integration and contribute to higher
capital mobility, and the establishment of an efficient payment and settlement system in euros
reduces the cost of moving capital. Increased mobility of capital, both in and out of countries,
including Norway, could follow.
As I indicated earlier, we, like others, have experienced increasing difficulty in maintaining a stable
exchange rate in a world of large, unrestricted capital flows. The relative calm within the euro area
during the recent turmoil linked to the financial crises in Asia and Russia and later Brazil could be
indicative of future differences between Europe's "ins" and "outs". Finland, despite its dependence
on raw materials and relatively large exports to Russia, was less adversely affected than the other
Nordic countries. For Norway, success in maintaining a stable exchange rate could become more
challenging in the new environment.
Use of the euro in Norway. Euro and the Norwegian banking industry
Use of the euro in Norway
I would now like to comment on how, and to what extent, Norwegian economic agents might be
expected to use the euro in the future. There are many indications that the euro will be used more
extensively in trade between Norway and euro countries than the currencies of the 11 member states
combined today. Over time the euro will most likely be used on an even wider scale. Obviously, the
euro would increase in importance in the Norwegian market should Sweden, Denmark and the UK
join EMU.
The euro may also play a role - though probably limited - as a settlement currency between
residents. This will primarily be of relevance for import and export enterprises as well as
subcontractors in industries that are heavily exposed to the euro area. However, several factors point to
the continued use of Norwegian kroner among enterprises and households. Government payments
such as pensions, social security and taxes will continue to be in Norwegian kroner, as, most
probably, will wages. Furthermore, Norwegian residents are not permitted to settle outstanding
claims in foreign currency in cash, according to Norwegian Foreign Exchange Regulations.
Regulatory issues
Norway is under no obligation to incorporate EU legislation pertaining to the introduction of the
euro into Norwegian law. However, there has been some discussion as to whether it would be
appropriate to implement some changes in the regulatory framework.
One issue has been whether there is a need for statutory amendments to assure the continuity of
contracts in which the parties' payment obligations are expressed in ECUs or in one of the
participating countries' currencies. Norwegian law is considered to be clear on this issue, however,
and in the view of the Ministry of Finance there was no need for legislative changes. In its
deliberations on the Revised National Budget last spring, the Storting (Norwegian parliament) took
note of this.
Another issue is the possibility of keeping accounts in currencies other than the Norwegian krone.
The new Accounting Act, which entered into force on 1 January 1999, provides for the registration
of accounting information in Swedish, Danish, English or Norwegian. Annual company accounts,
however, are to be recorded in Norwegian kroner and in the Norwegian language unless otherwise
provided for by regulation or separate decisions by the Ministry of Finance. The annual report must
be written in Norwegian. Under certain circumstances, consolidated accounts may be recorded in a
foreign currency. Accounts expressed in a foreign currency may also be published as a supplement to
accounts in Norwegian kroner.
A third question was whether it should be possible to quote financial instruments traded on the Oslo
Stock Exchange in euros and, if so, whether this would require changes in stock exchange
legislation. A broadly based committee appointed by the Oslo Stock Exchange has addressed this
question. The committee concluded that, although this situation may change, there is little interest in
the Norwegian securities market in quotations and settlements in euros. The committee found no
legal obstacles to quotations and settlements in euros. Consequently, the Ministry of Finance has not
found a basis for recommending changes to stock exchange rules. The Ministry of Finance has also
considered whether conversion to euros should be regarded as realisation within the interpretation of
tax legislation. The Ministry has concluded that the parties' positions are not actually altered by
conversion. The Ministry therefore maintains that assets and liabilities recorded in the currency of an
EMU country cannot be considered as realised after that currency was replaced by the euro.
Euro payment systems
A common monetary policy in the euro area is contingent on cross-border payments in euros taking
place just as rapidly and efficiently as payments in national systems do today. All countries
participating in EMU are therefore linked to a common payment system, TARGET. In addition to
being a channel for monetary policy, TARGET is, however, designed to enhance the efficiency and
reliability of cross-border payment systems. TARGET is therefore used for settling both monetary
policy and commercial transactions. EU countries outside the euro area are also linked to the system.
Payment settlements using TARGET take place on a real-time gross basis. This means that
transactions are settled individually and with finality throughout the day. The system is also used to
settle net positions generated through netting of gross positions between banks.
The TARGET system consists of the national settlement systems linked together into a
communications network called Interlink. Payments are transferred from one country to another via
the settlement system of the payer country, where the central bank debits the payer bank's account
and credits an account of the central bank of the beneficiary country. In turn, the central bank of the
beneficiary country credits the recipient bank.
There are several alternative systems for making cross-border payments in euros. The most
important are probably the Euro Banking Association (EBA) clearing system and the traditional
network of correspondent banks. In addition, some large domestic clearing systems like Euro Access
Frankfurt (EAF) allow banks from all EU countries to participate. The participants naturally take
such factors as price, risk and time into account when considering whether to make use of TARGET
or any of the other options.
The Norwegian banking industry has expressed an interest in having Norges Bank provide
settlement services for a multilateral netting system for domestic transactions in euros. As an EEA
member, Norway participates fully in the single market (with the exception of agricultural products)
and Norwegian banks are subject to the same requirements and obligations as those applying in the
EU. Access to the common payment system on virtually equal terms is therefore regarded as
desirable and natural. Norwegian banks attach importance to being able to offer competitive euro
services, and a Norwegian euro settlement system could make a contribution in this respect. Norges
Bank is pursuing this matter with the ECB. We have taken note of the solutions found with respect to
the non-euro EU members, including the UK.
Developments in the Norwegian banking industry
The industry that will probably be most affected by the euro is the banking industry. The banking
industry in Norway and other countries has undergone, and will continue to experience, substantial
changes as a result of technological advances, internationalisation, deregulation and changes in
customer behaviour. This has intensified competition and reduced margins, thereby prompting a
need for restructuring and reducing overcapacity. In addition to increased competition between
banks, new participants - both financial and non-financial - have contributed to increasing the
pressure on margins. Securities markets have also become more important in terms of their role in
saving, financing and risk management, adding to the pressure on financial intermediaries such as
banks.
Like banks in other countries, Norwegian banks have had problems compensating for the decline in
net interest income by increasing other income or reducing costs. Intensified competition both
between banks and from other financial market participants suggests that banks will in general be
facing major challenges in the years to come. On top of this comes EMU, which will probably
amplify some of these trends.
The euro will have varying effects on different market segments. The most immediate consequence
of the transition to the euro is the elimination of foreign exchange and hedging transactions in the
currencies concerned. As exchange between euro-country currencies accounts for a very limited
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 and liquidity
management. International payment transactions do not represent a substantial source of income for
Norwegian banks. However, it will be important for banks to be able to provide competitive payment
services in euros to avoid losing customers.
Foreign lenders today account for close to 30 per cent of all loans to Norwegian enterprises, a share
that has been stable for the past five years. Thus far, foreign branches in Norway have primarily
focused on the largest enterprises and financial market segments that demand more advanced
services. As the euro gradually gains a foothold in the Norwegian business sector, the Norwegian
market may prove to be of greater interest to foreign banks. Nor can we disregard the possibility that
mergers and acquisitions in the Norwegian business sector - which may partly be perceived as a
response to consolidation in the business sector in the euro area - will lead to a situation whereby a
larger number of Norwegian enterprises move into the "division" where foreign competition is
strongest. Norwegian enterprises with close ties to the euro area will also demand a wide range of
euro services from their banks. For this reason, foreign banks will probably compete more intensely
with Norwegian banks in the future. Technological advances, including the development of new
channels of distribution, will reinforce this tendency.
Substantial overcapacity in the financial sector in European countries, particularly in traditional
banking, has spurred the need for enhancing efficiency and consolidation. Over the last couple of
years we have seen a considerable increase in the number of mergers and acquisitions in Europe,
with mergers taking place both within and across national borders. The introduction of a single
European currency has probably been an important catalyst in this process. Mergers and acquisitions
create entities with ambitions, financial strength and, not least, a range of services well designed to
compete on international markets. This points to increasing competition across national borders.
Several large Nordic bank conglomerates define the Nordic area as their home market, and have
established, or plan to establish, branches in most Nordic countries. The largest Swedish and Danish
banks have been the most active so far. A few of them, in contrast to other international banks
established in Norway, have started to show an interest in the market for households and small and
medium-sized enterprises. The strengthening of the position of Nordic banks in their home market
may partly be perceived as a defensive strategy to keep out large global banks. The launching of a
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 banking sector in
euro countries than in Norway and other countries outside the euro area. The loss of income in some
areas, such as currency trading, is greater for banks in the euro area, and the costs associated with
adapting systems, etc. are also higher. In addition, cross-border competition is likely to intensify
more between countries with a single currency than between euro countries and non-euro countries,
although this is not certain. These factors point to a reduction in earnings for euro area banks.
However, increased competition may in the longer term enhance the efficiency and competitiveness
of banks.
The introduction of the euro will also have a considerable influence on the development of securities
markets in euro countries. There is reason to believe that capital intermediation via the securities
market will increase at the expense of financial institutions. The elimination of foreign exchange
risk, greater price transparency and harmonisation of market practices will increase liquidity in the
market, leading to conditions similar to those in the US.
Losing the advantage of operating in the national currency will result in keener competition in
securities markets for brokers, issuers, investors and stock exchanges. National ties will be of less
importance as participants are drawn towards markets with the lowest costs. The integration of stock
exchanges will increase. The Oslo Stock Exchange, for example, is one of several stock exchanges
currently evaluating prospective partners.
The possibility that the euro may lay the foundation for a European market for private bonds should
be of interest to enterprises both within and outside the euro area. This market is large and well
developed in the US, whereas European enterprises have primarily relied on bank financing. The
introduction of the euro will also result in a broader and more differentiated selection of securities in
a single currency, while increased competition in issue and investment services will probably make
it less expensive to raise capital directly in the securities market. The elimination of currency risk in
the euro area will also enable investors to focus more on credit risk, thereby improving their ability
to evaluate this risk. This may make the market more receptive to private bonds, as investors may be
willing to accept higher credit risk when seeking a return. This factor, combined with lower
borrowing costs, may give medium-sized enterprises, which so far have had to rely on bank
financing, increased access to the bond market.
It should be emphasised that the expected increase in competition in securities markets in the euro
area is not solely due to the single currency. Technological advances, deregulation and
harmonisation of laws and regulations are important forces contributing to a freer flow of capital and
services in the single market. There is little doubt, however, that the introduction of a single currency
will make a major contribution to accelerating this process.
In sum, trends influencing developments in the banking and financial industry such as deregulation,
internationalisation, changes in customer behaviour and rapid technological advances - leading to
intensified competition - have been there for some time and will continue. However, the
establishment of monetary union will probably intensify existing trends, creating even greater
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, the euro
will not give rise to fundamentally new challenges. It is highly likely, however, that the euro will
accentuate challenges that are already present. And that, I think, goes for the UK as well as Norway.
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