This article addresses the background to the decision to introduce a full European Currency Unit (ECU) within ESA, taken at last year's Meeting of the ESA Council at Ministerial Level, in Toulouse (F). It discusses the various possible scenarios in the evolution towards European Monetary Union (EMU), as well as its expected impact on the financial system of the Agency.
The Maastricht Treaty was not the first attempt to establish European Monetary Cooperation. In the early 1960s, discussions had already started as to whether evolution to economic and monetary union was indeed necessary and politically feasible. Following the successful introduction of a Customs Union in 1969, closer monetary cooperation was set as one of the next targets. In late 1970, the so-called 'Werner Plan' established the first timetable for the realisation of Economic and Monetary Union within a period of ten years. But the time was not ripe.
Due to heavy turbulence in the financial markets, the so- called 'Gold (Dollar) Standard' was indeed abolished to provide relief to the old and rigid system of fixed exchange rates related to the US Dollar measured in gold. While the US Dollar faced the consequences of being exposed to the volatility of the market, Community countries for the first time tried vigorously to control variations within a band of 2.25% above or below an average exchange rate to the Dollar: the so-called 'currency snake'. The snake did not prove sufficiently stable to provide a dam against the considerable monetary tensions and variations between European currencies and the US Dollar. The difficult situation led to a joint initiative by France and Germany in 1979 to create the European Monetary System (EMS) with in principle fixed (but in practice to some extent flexible) mechanisms and a common denominator in the form of the European Currency Unit, or 'ECU', determined on the basis of a basket of European currencies.
Until 1993, this relatively limited band for exchange variations of 2.25% was tested heavily by the financial markets. On 2 August 1993, Member States and participants decided to raise this band to 15% in both directions. Since then, the system seems to have worked quite well, weathering several speculative storms, but at the same time highlighting the persistence of the phenomenon of 'weaker' and 'stronger' currencies within and outside the EMS in countries without well-coordinated and solidly pursued economic and financial policies.
Based on the recommendations of the Delors Report of April 1989 and the Maastricht Treaty on the European Union of 1992, the process of convergence to European Economic and Monetary Union (EMU) commenced in three stages, starting on 1 July 1990. The first stage enshrined the complete liberalisation of capital movements in the European Union, and economic and monetary convergence in certain areas, including closer coordination of financial policies. The second stage started on 1 January 1994, serving as a transition to the third and final stage, which is supposed to establish the necessary legal, institutional, financial and economic conditions for the introduction of EMU.
An important element was the creation of the European Monetary Institute (EMI) in Frankfurt as the forerunner of the future European Central Bank. The EMI's main objectives are the coordination of Central Banks' policies and mechanisms with a view to achieving price stability, the supervision and control of the functioning of the EMS in its present form, and the preparation of the third stage in terms of developing the instruments and procedures needed for a unified monetary policy.
According to the Maastricht European Union Treaty, the third stage starts on 1 January 1999.
Automaticity is implied only for those member countries that fulfil the established convergence criteria. A strict interpretation of Maastricht would presumably only allow EMU to commence with a relatively small circle of countries, leaving the door open for other member countries to fulfil the necessary conditions for joining at a later date. Special arrangements are currently foreseen for the United Kingdom and Denmark. The European Council will review and decide at the beginning of 1998 which countries will be participants in EMU in its start phase.
Quantifiable criteria for participating countries are:
The European Council decided in December 1995 in Madrid to call the new European Currency the 'EURO'. It will replace the ECU once EMU is fully established. The European Council also took decisions on the timetable and the modalities as to how the EURO should be introduced.
In a 'First Round' during 1998, the number of qualifying participants for EMU will be established. The (present) basis for the review of the main convergence criteria are the actuals of the year 1997. Until 1 January 1999 - the so-called 'Interim Period' - the new European Central Bank will have to be made operational on the basis of recommendations provided by its forerunner, the EMI. Monetary procedures and instructions for the banking and public sectors should preferably be in place in 1999 to allow financial activities to proceed undisturbed and for preparing the changeover to the new EURO banknotes and coins.
In the 'Second Round', EMU will commence on 1 January 1999 with those member countries that have qualified. Whether that early date will indeed prove to be realistic, and whether it will be feasible to start with the relatively small number of countries presently eligible for membership, will be discussed at the next European Councils. The present Maastricht decisions foresee as a major financial milestone that the beginning-of-1999 exchange rates for national currencies of EMU participants vis-a- vis the EURO will be fixed permanently. This is why it is not possible to exactly predict today the final rates at which the EURO will be frozen in parallel with national currencies as of January 1999.
What is important is the following: the EURO will not replace national currencies immediately. It is already recognised that a further three years (1999-2002) will be needed for sufficient EURO banknotes and coins to be produced and made available over the counter. During this period, the EURO will be used primarily as a parallel and payment-unit currency for all non-cash payments among EMU participants, more and more replacing national currencies in banking and industrial payment-transfer activities wherever feasible. All parties will have a choice during this period between continuing to use their national currencies at a fixed rate to the EURO, or using the EURO for non-cash operations. National Central Banks, in coordination with the new European Central Bank, will offer their good services in terms of conversion facilities and transfer arrangements.
In the 'Third Round' beginning in 2002, EURO banknotes and coins are supposed to be ready for exchanging with old currencies. Presently it is foreseen that this (complicated) exchange procedure will last six months, with the idea that the changeover to the new single currency will have been successfully accomplished for all EMU participants by 1 July 2002. After that date, the national currencies of EMU participants that have continued to be used in parallel with the EURO will no longer be valid. Theoretically, there will be no losses in existing assets validated at that date. Cash, deposits, loans, debts, salaries, prices, rents, life insurances, mortgages, etc. will be recalculated and transferred into EUROs from national currencies at the exact future exchange value. This recalculation is basically a technical process, so in the end market participants and European citizens should break even financially, becoming neither richer nor poorer compared with their prior status.
Despite all of the efforts to fulfil convergence criteria for monetary stability and to qualify for EMU, it could well be that several countries will not be onboard, either at the starting date of 1 January 1999 or at the final date foreseen for the replacement of national currencies by the EURO in 2002. It is therefore to be assumed that there will be participating and non-participating States within the EU after 1999. This possibility is recognised by the Maastricht Treaty. While this can eventually lead to a situation of duality, it does not necessarily mean that monetary tensions in Europe will rise. The door is left open right from the start in 1999 for all other EU countries to join, provided they make the additional effort to respect convergence criteria and to qualify for EMU participation.
A formal review process is foreseen every two years after the kick-off date of 1999. Non-participating countries will continue to cooperate with EMU members through a reformed EMS II. In that case a basket of non-EMU countries' currencies is set against one anchor, the EURO. The monetary cooperation between EMU and EMS II certainly seems to be important for overall monetary stability in the interim, but can have the built-in structural weakness of two systems floating against each other. It is therefore still under discussion whether EMS II should only be of limited existence and serve the notion of bringing non-participants into EMU, or whether EMS II should be used as a separate monetary mechanism to avoid barriers in financial transfers in Europe and to prevent unfair competitive advantage.
One of the most contentious issues of the discussion up to now has been whether non-members of EMU should have unconditional access to the planned EURO payment system, the so-called 'TARGET'. The European Monetary Institute (EMI) has issued a first report on this topic. Options on how companies, banks, public institutions and/or other entities should be afforded access to TARGET are still under review. There are no clear indications as to when this question might be fully resolved. Uncertainty in this area would be a difficulty for all industries and financial institutions of countries presently not planning to join EMU.
The issue of access to the newly emerging financial markets of EMU has become controversial since the banks of prospective EMU members do not tend to support the idea of equal treatment and automatic access to the TARGET system. In addition, several EMU candidates have requested the imposition of strict conditions for access to intra-day liquidity and Central Bank credit lines in the EURO, in order to avoid the spill-over into commercial overnight credit facilities. This will be a sensitive point for businesses situated outside the EMU members, which are already looking at best opportunities and lowest costs throughout the whole of Europe.
Eventually political wisdom will prevail, since the recommendations by the EMI and the European Commission focus on the non-controversial technical elements of the new system. If these do not affect monetary policies and maintain the eminent overall objective, which is the final participation of all, or certianly most EU Member States in EMU, then the door is open not only for further cooperation under an extended EMS II system, but also for the final merging of EMS II with EMU if prevailing convergence criteria can be met in the years to come.
The Ministers at the ESA Council Meeting at Ministerial Level in Toulouse in October 1995 decided to reform the Agency's financial system as of January 1997 through, inter alia, introducing a single payment unit in 'the form of the ECU as defined in document ESA/C(96)100, rev. 3, corr. 1'. To achieve this goal, the old Article V (paras. 1 and 2) of Annex II of the ESA Convention was replaced with the following text:
'The Budgets of the Agency shall be expressed in ECU as currently defined by the European Union's competent bodies and subsequently in the European payment unit which may replace it as soon as it is set into force by these bodies'.
'Each Member State shall pay its contribution in ECU and in the subsequent replacement for it as referred to in paragraph 1 above'.
While the all-ECU system of the Agency will be introduced as of 1 January 1997, Council equally decided to facilitate a smooth introduction by means of a transition period from 1997 to 2000, during which existing non-ECU contractual commitments will be phased out gradually and income in ECU increased to 100%. Full symmetry between the income and expenditure sides will exist at the beginning of the year 2000, with the exception of certain running costs still to be paid in national currencies as long as a fully-fledged EMU system does not yet exist. On the basis of the revised Article V of Annex II to the ESA Convention, the situation is quite clear: the all-ECU system of the Agency enters into force as of 1 January 1997 without automaticity or direct links with the starting of EMU and the parallel use of the EURO as from 1999 onwards, since it is not directly linked to the Maastricht agreement as such.
One can distinguish three cases that can have some bearing on the future of the Agency's financial system:
'the budgets of the Agency shall sub-sequently be expressed in the European payment unit which may replace the ECU as soon as it is defined and set into force by the EU's competent bodies'.