Euroisation Debate

1
Euroisation Debate

• Unilateral Euroisation in North Cyprus Economy

From Partial to Full Euroisation
By Dr. Mustafa Besim 27 February, 2007
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Scope of the Presentation

• The present regime Partial Euroisation
• Why Does North Cyprus Need Full Euroisation?
• Does North Cyprus Satisfy Convergence Criterion?
• Can Unilateral Euroisation Be Beneficial?
• Fiscal Discipline
• Does Full Euroisation Eliminate North Cyprus
  Structural Problems
• Conclusion

3
Partial Dollarized (Euroised ) North Cyprus
Economy

• Medium of exchange
• (YTL, GBP, Dollar, Euro and CyP)
• Store of value
• (YTL 50, GBP 37, Dollar 9, Euro 4)
• Unit of account (Multiple-currency regime)
• Budget, Import based pricing, services priced in
  FC
• Multiple accounting
• Instability in the TL and with the free,
  convertible regime has already brought the North
  Cyprus Economy down the way to be partially
  dollarized
• Question Shouldnt the benefits and costs of
  dollarization already been realized in the
  economy?

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Why Does North Cyprus Need Full Euroisation?

• Political Ambition
• EU vision
• Economic Benefits
• Expected Stability
• Low and stable inflation and interest rates
• Lower FOREX volatility, elimination of risk of
  currency crisis, uncertainty and other risks
  (i.e. credit) ? more investment and better trade
• Transaction cost savings
• Price transparency within island ? contribute to
  integration of markets
• Better and more trade with South and EU? towards
  a single market
• Convergence ? contribute to a settlement in
  Cyprus

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Does North Cyprus Satisfy Convergence Criterion?

• The Maastricht Treaty specifies that EU member
  countries must satisfy several convergence
  criteria
• Price stability
• Exchange rate stability
• Budget discipline
• Since this not an official process and it is an
  unilateral act, does not require satisfying
  criterions!
• Given that NC has no monetary policy, shouldnt
  NC at least shadow and try to satisfy non
  monetary policy criterions?
• Or should we think full euroisation, if its
  possible, as a vehicle to achieve stated targets
  and satisfy these criterions?

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Can Unilateral Euroisation Be Beneficial? (1)

• Low and stable inflation rates
• Causes / sources of inflation
• Fluctuation of YTL against FOREX (absorption
  problem)
• Distorted integration of FOP and goods market
  (capital, labour ? political, institutional
  barriers, self-imposed embargoes, inappropriate
  policies)
• Structural problems i.e. insufficient
  infrastructure
• High degree of rigidity in the labour market
  (Role of govt)
• Wage / Salary policy of the government
• With these causes present, can Euroisation
  guarantee us low and stable inflation rates?

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Low and stable interest rates (2)

• The partial dollarization has already enabled the
  economy to realize the benefits - if there is any
  - by having all hard currencies in our financial
  system.
• The real interest rates are high (political risk,
  property issue, political and institutional
  barriers blocks entry into cheaper supplied
  capital markets)
• Banks will continue to search for higher return
  for their deposits in TR money markets
• Unless the political problems are solved and / or
  barriers are eliminated, and also real interest
  in TR is lowered, the risk premium seems to be
  continuing to stay at high levels

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Single currency but many different real exchange
rates (RER) within Euro zone

• - Nominal exchange rates will be set in stone but
  not real exchange rates adjusted for the
  differences in inflation rates.
• - i.e. Italys RER has appreciated more than 20
  relative to Germanys since launch year 1999
• Its been estimated that Germanys labour costs
  are now lower than of Italy.
• Source Economist, Feb 17, 2005.

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Real Effective Exchange Rates of Euro
The importance of RER in trade -? CA may need
more funds (Euros) as competitiveness may be lost
as a result of labour costs ?and productivity ?
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RER Productivity and Real Wages

• RER measures competitiveness
• Productivity growth rates have negative growths
  (Çiftçioglu and Besim (2006) and Hoffmaister
  (2006) )
• If prices rise more in North compared with other
  economies using euro, than the RER against other
  euro using economies will rise even the nominal
  rate will be fixed. This decreases the
  competitiveness of the sectors i.e. Tourism,
  Higher education.
• Terms for trade may be lost.
• Need for government reforms to help decrease the
  labour- market rigidities.

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Fiscal Discipline

• Along with the restructuring of the rigidity of
  the Labour market, fiscal discipline seems to be
  the most important pre-condition for euroisation.
• The past years have not demonstrated a success in
  fiscal discipline for NC budget.
• Given that NC have had no monetary policy, the
  fiscal policies should have been developed to
  become effective policies being sufficient at
  least for rational use of resources and
  facilitating the growth of private sector.
• Tax policies, even though improving, still has a
  very narrow tax base.
• Over all revenue policies are not that effective
  with manoeuvre capacity for certain shocks.

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Fiscal Discipline (2)

• Most of current expenditures are allocated to
  public employees, wages being indexed to CPI and
  adjusted every two months.
• Facing inflation with euroisation, will increase
  the wage bill of the government, create huge
  burden on the budget.
• Will the tax payers and/or donors be willing to
  give more euros to compensate public employees?
• Can the government choose to change the wage
  policy or will use funds that are actually for
  investment (infrastructure) to pay higher wages?

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Fiscal Disciple (3)

• The government debt stock has not been declining
  but still very high

Source SPO, 2007, p.19

• Continues high budget deficits (aid and
  credits) over 10 of GNP and accumulated
  high government debt stock do not demonstrate a
  fiscal discipline and strong footing for testing
  euroisaiton.

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Does Full Euroisation Eliminate North Cyprus
Structural Problems?

• Structural and inappropriate policies are source
  of inflation and will not disappear with
  euroisation
• For better trade and integration (SC and EU), as
  far as legal and institutional barriers are not
  resolved, the minor benefits have already been
  realized by partial euroisation.( Price
  transparency may have minor positive effects)
• More investment with euro? Partial euroisation
  have already realised the benefits and costs by
  the present currency regime allowing the use of
  hard currencies (high real interest rates)
• Weak fiscal footing signals for major risks that
  may not be mitigated by the present economic
  structure

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Unilateral Euroisation

• If unilateral euroisation takes place with
  unsolved structural problems, there will be a
  need for continued support by donors (TR) to feed
  the economy with euros! Are donors willing to
  finance?
• It seems that unilateral full euroisation is
  still remote, not only because of the economical
  reasons that I have tried to underline but also
  the political will is not matured yet

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Conclusion Euroisation Requires Political
Will

• If the vision of the Turkish Cypriots is to
  achieve a sustainable development and be part of
  EU, all parties should work for a stronger
  political will which can fight against the
  structural problems and try to satisfy at least
  certain criterion that can eliminate risk
• Shadowing the acquis, the government is moving
  very slow (political will?)
• Change the wage policy Target for aligning wage
  with productivity. Wage policy by the government
  should be gradually eliminated (political will)
• Strengthening the public finances to push for
  solving structural problems eliminating sources
  of inflation (political will)
• The government in the North should have a
  time-table, demonstrating its political will for
  euroisaiton.