Strong Euro – Weak Eurozone

 

By Dr. Jim Leontiades

Cyprus International Institute of Management

 

The currency of the Eurozone keeps getting stronger while the economic performance of the Eurozone continues to show weakness. This comes as a surprise, since it was only a few weeks ago that the good news was announced. Eurozone economic performance had exceeded that of the United States during the second quarter of this year. This was after many years of lagging the USA growth rate. Unfortunately, the hoped for economic renaissance (of the 12 Eurozone countries) was short lived. After a few weeks, growth in the Eurozone has slumped again, not only below that of the United States but also as compared to the wider European Union (the EU 25 nations of which the 12 Eurozone countries are also a part).

What does this mean for Cyprus? Firstly, there is little doubt that joining the Eurozone is a “must” for  Cyprus. In a world whose global economy is determined by a few, increasingly large trade blocks, economic isolation is not an option.

Secondly, there will be a number of advantages for tourism. Tourists from the Eurozone coming to Cyprus will find it easier to estimate their holiday expenses. Since we will all be using the same currency, they will also feel secure from exchange rate movements. The expense of exchanging one currency for another will be eliminated. In short, joining the Eurozone will be a positive influence for Cypriot tourism – the major source of our foreign exchange. These advantages of a common currency will, of course, also extend to Cypriots visiting other Eurozone countries.

Our merchandise exports may also benefit due to the use of a common currency – but they would undoubtedly benefit more if the Eurozone’s economic growth were more dynamic. Joining a slow growth group of countries is not the best option one could hope for.

 

What has gone wrong?

 

Not all the countries in the 12-nation Eurozone are growing slowly. Spain,    Portugal, Greece and Ireland are enjoying healthy growth, well above average. Germany and France, the two largest members of the zone are the problem. After a good second quarter, French economic growth has come to a halt with virtually zero growth for the third quarter of this year. The latest announcements for Germany indicate investor confidence there has dropped to the lowest in more than eight years. Germany‘s future growth rate is expected to shift from a disappointing 2% for the current year to an even more disappointing 1.3% for 2007.

 

Eurozone Diversity

 

Part of the problem stems from the vary diversity of the Eurozone, its member countries growing at different rates. Despite this overall slow rate of growth, the European Central Bank appears to be ready to announce its sixth interest rate increase in a year. This is hardly what one would what one would expect. Interest rate increases are generally considered bad for investment and future growth. But with some of the Eurozone countries (mentioned above) growing rapidly, lowering the interest rate or even keeping it steady would court an upsurge in inflation.

Blaming it all on the European Central Bank and the interest rate is an oversimplification. Behind the slow growth rate of France and Germany and the need to raise interest rates are a series of interrelated issues including low growth in labour productivity, heavy taxation, high welfare spending, strong labour unions and aging populations. Germany, for example, has just announced another increase in VAT to 19%. This is predicted to have an additional negative effect on growth for an economy already in the doldrums. But the German and French commitment to welfare measures makes such tax measures necessary. Whenever there has been a move to reduce welfare payments – their populations have strongly rejected them. Strikes and demonstrations follow.

Since the Eurozone countries will be our closest economic partners, it is important to understand something of the factors underpinning their performance – why some are growing rapidly and some stagnating. Perhaps we can learn something.