The Benefits, and Challenges, of a Very Strong Euro
At the moment, the euro is worth $1.58. On March 18, it reached its historic high of $1.5904. Many analysts believe that if the current trend continues, the euro will rise above $1.60, maybe even as high as $1.70. So far this year, the euro has appreciated by more than 8.5%. Looking back, the European currency has gained almost 20% in international markets since January 2007.
The strength of the euro means that rising prices of imported raw materials have less impact on the economies of the euro zone and on their inflation rates. That’s because prices for petroleum, grains and metals are quoted in dollars, which translate into fewer euros. On the other hand, those companies that generate a large portion of their revenues overseas see that their goods and services are much more expensive, at least in countries that use the dollar and other currencies. These companies’ revenues suffer, and they become less competitive.
“The appreciation of the euro will have a significant impact on Spanish and European companies,” notes José Ignacio Galán, director of social corporate responsibility at the University of Salamanca [in Spain]. “There is a certain delay in getting statistics and reports about [the impact on] corporate earnings. We are involved in a process that began in financial markets but is now having an increasingly serious impact on ‘real’ markets. The impact of the appreciation of the euro on Spanish and European companies is two-fold. It has a positive effect and a negative effect, although I think the negative effect will be significantly more important than the positive effect.”
Pere Puig, professor at the ESADE business school, believes that “the strength of the euro has a global impact on European companies given today’s conditions because there are great imbalances in exchange rates.” The impact, he adds, “is in the loss of competitiveness in the U.S. market as well as in other countries where U.S. products are imported more cheaply, thanks to the fact the dollar is so cheap.”
According to a recent report by Standard & Poor’s, “The strong appreciation of the euro versus the dollar threatens European businesses because, according to analysts, a 10% rise in the euro can have the impact of lowering exports by one percent, and lowering GDP by 0.25%.” Galán believes that “it is hard to establish, a priori, a specific figure” regarding how much GDP growth the strong euro will take away from the euro zone’s GDP. However, he estimates that “it is going to be a serious problem for business activity, and the recovery process is not going to be a short-term one…. In other words, once economic activity slows down as a result of the loss of competitiveness that stems from foreign exchange rates, the recovery process in the ‘real’ economy will be slow.”
Mauro Guillén, director of the Lauder Institute at Wharton, warns that “the European companies affected the most are those companies whose sales depend less on trade within the euro zone, and depend more on the U.S. market and the dollar zone (especially, the Near East).” In that regard, S&P identifies aerospace and defense as one of the sectors most exposed to exchange rate fluctuations. One of the companies that will suffer the most is EADS, which earns about 35% of its revenues in dollars. Another could be Britain’s Rolls Royce, which earns 25%. The automotive sector will also suffer, including BMW, which has 22.4% of its total sales in the U.S.; Daimler, which has 19.7% and Volkswagen with 5.2%. According to S&P, during the first nine months of 2007, the rise of the euro had a negative impact of $300 million on the operating profits of Volkswagen. As for BMW, its revenues would have increased by 14%, but only rose by 11.1% during the same period because of the strong euro.
Guillén notes that, in Spain, “most exports are shipped to the euro zone, so there is no impact.” In 2006, Spanish companies exported €74.4 billion worth of goods to countries outside the euro zone, a 23.8% increase from the previous year. A year later (2007), exports to those regions grew three times more slowly (by 8.1%) than the overall growth rate of exports. By 2007, the Monetary Union had already absorbed 56% of Spanish sales, and analysts were forecasting that this percentage would continue to rise.
Nevertheless, Rafael Pampillón, professor at the Instituto de Empresa business school, believes that “if the big economies of the euro zone, such as Germany and France, grow less because they export less, they [Germany and Spain] will also buy fewer products from Spain. As a result, there could be a chain reaction. Spain will also suffer some damage to its foreign sales.” Pampillón suggests that tourism will be one of the sectors that suffer the most in Spain. “Travelers from regions that have weaker currencies will realize that taking their vacations in Spain is more expensive than doing so in other tourist locations,” he says.
According to Galán, “the sectors that will be damaged the most are those that, because of their very nature, are not appropriate for direct investment, and which are based on exportation or have a specific character tied to geography.” Among those, he adds, are “the traditional manufacturing sectors and their various offshoots, along with the tourist industry.”
Spainand Latin America
Along the same lines, Puig believes that “the Spanish sectors feeling the rise of the euro are strong competitors in terms of price, such as manufacturers.” For example, Puig adds, “those companies that are involved in manufacturing high-quality shoes are suffering much more when they ship to the United States.” Balbino Prieto, president of the Spanish Exporters’ Club, noted recently that small- and mid-size companies are also very much affected because they have to reduce their margins so they don’t lose market share. “They are reaching the point at which they will not be able to continue to reduce their margins,” he said.
Some analysts believe that some companies exposed to Latin America are also feeling the impact. They argue that the impact is generated by the foreign exchange earned by companies that receive part of their revenues in the euro zone, and part in dollar-denominated countries. This includes the big banks. According to Ibersecurities, the invest bank, Santander is exposed to the dollar for 34% of its revenues, while in the case of BBVA, that figure is 59%. For its part, Telefónica derives more than 30% of its sales from regions tied to the dollar and/or in Latin America.
Galán has a completely different view. He believes that Spanish companies are not affected by their exposure to Latin America. “Many of the companies exposed to Latin America are in the service sector, along with energy, construction, telecommunications and so forth. They have made a lot of direct investment in the region. In principle, therefore, they don’t need to make large scale international transactions of goods and services. They generate their business volume in their respective countries, with their own profit centers.” In principle, Galán adds, they should not be strongly affected by the appreciation of the euro versus the dollar. Although some companies may be affected by international transfers of inputs and outputs, that isn’t the key problem for Latin America. Its main problem, he adds, is having the sort of organization and productivity required for competing in the international arena, and converting these sorts of international monetary imbalances into a competitive advantage.
Incentive to be More Efficient
Some experts say that the appreciation of the euro won’t have as much negative impact as expected. Clearly, the latest macroeconomic data suggest that is true. If we focus on Germany, the European country most dependent on foreign sales, we see that its exports increased by 3.8% in January, on a month-to-month basis, and by 9% on a year-to-year basis. This shows that Germany is strongly resistant to the upward flight of the euro.
According to the German federal office of statistics, the month-to-month increase of 3.8% in January was the highest since September 2006. This shows that German exports continue to be strong despite the record high value of the euro and the economic slowdown in the U.S. Germany’s trade balance registered a surplus of €17.1 billion in January, 4.2% more than during the same month a year earlier.
According to Guillén, “The strength of the euro will come at very little or no cost to the GDP of Spain and the euro zone…. The net effect is beneficial since a strong currency reduces inflation and increases the buying capacity of corporations.” Guillén goes even further, saying he is certain that the appreciation of the euro “provides an incentive for exporting companies to be more efficient. In addition, it lowers the cost of inputs that they import in order to produce (energy, raw materials…).”
At a time when the U.S. economy is slowing down and global financial systems are experiencing turbulence, Puig believes that “European exporters are more worried about the loss of growth in international markets than about the appreciation of the euro.” Given these conditions, he recommends “companies not only move into countries that have lower costs and weaker currencies but that they also focus on expanding in markets where demand is growing faster, such as in Asia.” China and India will both be key countries in coming years, says Puig. “This is the time for positioning yourself in these markets, not only as way to protect yourself but also to expand your business and grow.” Companies have various alternatives for doing this, including “direct investments and acquisitions” stimulated by the strength of the euro. Puig recognizes the down side of this strategy, however. “When you’re talking about unfamiliar markets, there is a higher risk for your company.”
According to Galán, “It is not hard for companies directly affected by all these factors to deal with a scenario of economic deceleration, such as the one we are immersed in at the moment.” Nevertheless, he notes that the instruments within reach “involve two concepts that are at the origin of corporate competitive advantage: organization and innovation.” Another useful variable for ending this sort of problem, he adds, “is diversification, not only in product categories but also geographies, in an effort to reduce this type of risk.”
Guillén is more optimistic and less worried about the current situation. He believes that “companies don’t have to combat the current climb of the euro with any special weapons. They only need to adapt themselves so they are more efficient.”