ADOPTION OF EURO A POLICY CHOICE FOR NORTHERN CYPRUS

1
ADOPTION OF EUROA POLICY CHOICE FOR NORTHERN
CYPRUS

• Prepared
• by
• Vargin VARER and Yenal SÜREÇ

2
Why to study the Adoption of Euro?

• Adaption of Euro is one of the issues widely
  discussed in Northern Cyprus
• Republic of Cyprus is going to join Euro area on
  the 1st of January, 2008
• There is no any broad study on this issue in
  Northern Cyprus

3
Literature on dollarisation

• dollarization refers to the use of any foreign
  currency by another country
• It can be both officially as well as unofficially
  with the market choice
• large number of dollarized economies are small
  ones
• Andorra, Monaco, Liechtenstein, Kosovo and
  Montenegro adopted Euro unilaterally, where
  Kiribati, Micronesia, El Salvador, Ecuador using
  US dolar

4
Costs and the Benefits of Dollarization

• Elimination of the risk of currency crises
• Low and stable Price Levels and higher
  credibility for monetary authority
• Lower transaction costs enabling economic
  integration
• - Absence of independent monetary and exchange
  rate policies
• - Loss of lender of last resort
• - The Loss of Seigniorage

5
Some Dollarized Economies
6
Situation at North Cyprus

• Dollarised to Turkish Lira
• Having structural problems
• Unstable growth trends
• High inflationary periods
• Depend on imports
• Not having access to external markets

7
Analysis of the adoption of Euro by the Northern
Cyprus Economy

• Price stability impact
• Trade integration impact
• Financial integration impact
• Cost of adopting Euro

8
Price stability impact

• Long period of insistent inflation due to TL
• impact of exchange rates on prices
• Structural problems in the economy

9
Parallel inflation due to Turkish Lira
10
Budget and Current Account Deficits
11
Impact of exchange rates on prices

• a VAR model used to find the relationship between
  (CPI) and the other factors (exchange rate
  basket, public salaries and public goods prices).
• Quarterly data between 1985 and 2006 periods used
  
• A positive relation found between exchange rate
  consumer prices
• Exchange rate variations explain nearly 90 of
  price changes

12
Trade integration impact

• Dominant share of Turkey both in Imports and
  Exports of goods and services
• Symmetry in business cycles with Turkey
• Constraints on the access to EU markets

13
Goods and Services Flow of Turkish Cypriot
Economy in 2005
14
Business Cycles of TR TC Economies
15
Symmetry Indices between economies
16
Financial Integration Analysis

• Despite to the being in the TL area deposits are
  halfly in foreign currency
• Parallel trend with TL interest rates
• Large differences between deposit rates and
  credit rates on foreign currencies

17
Share of major currencies in Total Deposits
18
GBP Deposit and Lending Interest Rate Development
in NCUK 1995-05
19
Constraints on the financial market integration

• Being integrated with Turkey and using TL
• Problems in the access to EU markets
• Financing the deficits through Turkey
• ECBs position against the unilateral adoption
  of Euro

20
Costs Benefits of Adopting Euro at North Cyprus
case

• There will not be any extra cost in those areas
  due to adoption of Euro
• - Not having independent monetary policy
• - Loss of the lender of last resort
• - Loss of seinorage
• (except for the Turkey which is calculated as
  approximately 35-40 million per year)

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Costs Benefits of Adopting Euro at North Cyprus
case

• Achieving Price stability
• ? Trade integration with EU and South depends
  on the openings of EU (i.e. direct trade and
  direct flight) and the harmonisation of North
  more to the EU Acquis
• ? Risk of loosing competitiveness in Turkish
  market if the wage rate flexibility can not be
  sustained
• (even certain goods and services are invoiced in
  foreign currency reduces this risk)
• - Interest rates will not converge to Euro area
  easily due to the limited inflow of funds as well
  as the shallow structure of the domestic markets

22

• Finally, in the light of what the ECB put
  forward, as well as the current political and
  economical relations with Turkey and the
  structural weaknesses of Turkish Cypriot economy
  considered, it has to be stated that the adoption
  of Euro must be considered as a valid choice.
• It should also bear in mind that in the case of
  any failure of the current monetary policy
  strategy of Central Bank of Turkey will not give
  any other option than the Euro in Turkish
  economy.
• In the case of finding a solution to the Cyprus
  problem Turkish Cypriot economy inevitably will
  join the Euro area. Therefore simultaneously
  adoption of Euro on the both sides of the Green
  Line must be considered as an opportunity for all
  the stakeholders related.