Euro Currency Market

Europeans wished to hold their assets outside their own country or in currencies which is not locally denominated. These investors were driven by the twin concerns of avoiding taxes in their own country and protecting themselves against falling values of domestic currency. Dollar denominated, Euro bonds were designed to address these issues.

These bonds were in bearer forms. Hence, there was no ownership and no tax withheld. The term Euro is used because the transactions originated in the Europe, mainly London. But later on expanded fast to the countries like Honk Kong and Singapore in the far East— at present more than half of the transactions in the Euro markets take place outside the Europe.

Early 1980’s witnessed liberalisation of many domestic economies and globalisation of the same. Issuers from developing countries, were issue of dollars foreign currency denominated in equity shares were not permitted are now able to access the International equity markets through issue of as intermediates instruments called Depository Receipts.

The growth of the Eurocurrency market, also known as Eurodollar market, is one of the significant developments in the international economic sphere after the World War II. Its phenomenal development though poses problems for the national monetary authorities and international monetary stability, has helped the growth of international trade, transnational corporations and the economies of certain countries.

In a narrow sense, Eurodollars are financial assets and liabilities denominated in US Dollars but traded in Europe. Though, the US dollar still predominates the market and most of the transactions are still conducted in the money market of Europe, especially London.

But today, the scope of the market stretches far beyond Europe and the dollar in the sense that the ‘Eurodollar’ transactions are held also in money markets other than European and in currencies other than the USA dollar, interpreted in a currency deposited outside the country of issue. Thus, any currency internationally supplied and demanded and in which a foreign bank is willing to accept liabilities and loan assets is eligible to become Eurocurrency.

In a wider sense, Eurodollar market refers to transactions in a currency deposited outside the country of its issue. In this way, dollar deposits with banks in Montreal, Toronto, Singapore, Beirut, etc., are also Eurodollars, so are the deposits denominated in European currencies in the money markets of USA and the above centers.

Thus, it is evident that the term ‘Eurodollar’ is a misnomer. ‘Foreign Currency Market’ would be the appropriate term to describe this expanding market. The term ‘Eurodollar’ came to be used because the market had its origin and earlier developments with dollar transactions in the European money markets. Despite the emergence of other currencies and the expansion of the market to other areas, Europe and the dollar still hold the key to the market. Today, the term Eurocurrency market is in popular use.

Now, the ‘Eurodollar Market’ consists of Asian dollar market, Rio dollar market, Euro- yen market, etc., as well as Euro-sterling, Euro-Swiss francs, Euro-French francs, Euro- Deutsche marks, and so on. In short, in these markets, the commercial banks accept interest bearing deposits denominated in a currency other than the currency of the country in which they operate and they re-lend these funds either in the same currency or in the currency of the country in which they operate or in the currency of a third country.

It its Annual Report in 1966, the Bank for International Settlements (BIS) described the Eurodollar phenomenon as “The acquisition of dollars by banks located outside the United States, mostly through the taking of deposits, but also to some extent by swapping other currencies into dollars, and the re-lending of these dollars, often after re-depositing with other banks, to non-bank borrowers anywhere in the world.”

The currencies involved in the Eurodollar market are not in any way different from the currencies deposited with banks in the respective home countries. But the Eurodollar is, outside the orbit of the monetary policy whereas the currency deposited with banks in the respective home country is covered by the national monetary policy.

The Important Characteristics of the Eurocurrency market are the following:

(1) It is an International Market and it is under no National Control

The Eurocurrency market has emerged as the most important channel for mobilising and deploying funds on an international scale. By its very nature, the Eurodollar market is outside the direct control of any national monetary policy. “It is aptly said that the dollar deposits in London are outside United States control because they are in London, and outside British control because they are in dollars.” The growth of the market owes a great deal to the fact that it is outside the control of any national authority.

(2) It is a Short-Term Money Market

The deposits in this market range in maturity from one day to several months and interest are paid on all of them. Although some Eurodollar deposits have a maturity of over one year, Eurodollar deposits are predominantly a short-term instrument. The Eurodollar market is viewed in most discussions more as a credit market – a market in dollar bank loans – and as an important accessory to the Eurobond market.

(3) The Eurodollar Loans are Generally for Short Periods

Three months or less, Eurobonds being employed for longer-term loans. The Eurobonds developed out of the Eurodollar market to provide longer-term loans than was usual with Eurodollars. A consortium of banks and issuing houses usually issues these bonds.

(4) It is a Wholesale Market

The Eurodollar market is a wholesale market in the sense that the Eurodollar is a currency dealt in only large units. The size of an individual transaction is usually above $1 million.

(5) It is a Highly Competitive and Sensitive Market

Its efficiency and competitiveness are reflected in its growth and expansion. The resiliency of the Eurodollar market is reflected in the responsiveness of the supply of and demand for funds to the changes in the interest rates vice versa.

The origin of this market can be traced back to the 1920s when the United States dollars were deposited in Berlin and Vienna and were converted into local currencies for lending purposes.

However, the growth of the Eurodollar market began to gain momentum only in the late 1950s. Since 1967 the growth of the market has been very rapid, the flow of the petrodollars has given it an added momentum since about the middle of the 1970s. The growth of the market since then has been substantial.

It is pointed out that the phenomenal development of the Eurodollar market since the beginning of 1960s can also be viewed from the viewpoint of the width, breadth and resilience of the market. The momentum of the market development accelerated after 1968 when the international gold and currency problem developed into recurring crisis every year and the United States’ balance of payments deficits supplied additional dollars to the market.

More and more participants were drawn into the market due to its growing economic efficiency, competitiveness and the sure prospect of gain was confidently held out. Besides, central banks and financial intermediaries, multinational corporations, Middle Eastern Oil firms, developing countries and the communist countries also entered the market as participants.

The centre of the Eurodollar market has spread from London and West European Financial centres to other less known places like Bahamas, Singapore, Lebanon and Toronto. The depth of the market is reflected in the longer terms of loans and the increased channels of obtaining them. Since the market is large, efficient and highly competitive it is highly sensitive, too. This is reflected in the fluctuations of interest rates depending on supply and demand factors, internationally.

The following are the important factors that contributed to the growth of the Eurodollar market at different stages and times:

(i) The Suez Crisis

The restrictions placed upon sterling credit facilities for financing trade which did not touch the British shores during the Suez Crisis in 1957 provided a stimulus for the growth of the Eurodollar Market. The British banks, in search of an alternative way to meet the demand for credit on the part of the traders in this sphere, easily found a good substitute in dollars. There was already available a pool of US Dollars, held by residents outside the USA.

(ii) The Players in the Market

The Eurocurrency market is entirely a wholesale market. Transactions are rarely for less than $1 million and sometimes they are for $100 million. The largest non-banking companies have to deal via banks. Borrowers are the very highest pedigree corporate names carrying the lowest credit risks.

The market is telephone linked or telecommunications linked and is focused upon London, which has a share of around one-third of the Eurocurrency market. Commercial banks form the institutional core of the market. Banks enter the Eurocurrency market both as depositors and as lenders.

(iii) Relaxation of Exchange Controls and Resumption of Currency Convertibility

The general relaxation of exchange control, the stability in the exchange market and the resumption of currency convertibility in Western Europe in 1958 provided an added impetus to the growth of the Eurodollar market. In a convertible currency system, some countries are, as a rule, in surplus and others in deficit.

The money market in the surplus country being liquid, short-term funds flow to the Euro market, attracted by the higher rate of interest. On the other hand, credit flows from the Euro market to the deficit countries where the money market is tight. The relaxation of exchange controls not only enable the holder of dollar claims to retain them rather than surrendering the mighty God called dollar to the exchange control authorities, but also increased the demand for US Dollars as they could be freely converted into domestic currency to finance domestic economic activity.

(iv) The Political Factor

The cold war between the United States and the communist countries also contributed to the growth of the Euro market. Due to the fear of blocking or seizure of deposits by the USA in the event of hostilities, the Russian and East European banks sought to place their dollar balances with European banks, especially British and French, rather than with banks in the United States.

(v) Balance of Payments Deficits of the US

The large and persistent deficit in the balance of payments of the USA meant an increasing flow of the USA dollar to those countries which had surplus with the USA. The USA had had a deficit in international payments every year since 1950, except in 1957. Since 1958, the deficits assumed alarming proportions. This is one of the most important factors responsible for the rapid growth of the Eurodollar market.

(vi) The Regulation IQI

Some of the regulations of the Federal Reserve System, especially the Regulation ‘Q’ which fixed the maximum rate of interest payable by the banks in the USA and the prohibition of payment of interest on deposits for less than 30 days very significantly contributed to the fast growth of the Eurodollar market.

Although Eurodollar rates had their ups and downs, they were all the time – except for brief periods in 1958 for three months’ deposits – appreciably higher than the deposit rates in the USA. Unlike in the USA, the Eurodollar market paid interest on deposits for less than 30 days also.

Further, Selective Controls in the corporations and banks, have made the market larger than it otherwise would have been. Without these controls, much of the market’s activity would instead be carried in the New York money market.

(vii) Innovative Banking

The advent of innovative banking, spearheaded by the American banks in Europe and the willingness of the banks in the market to operate on a narrow ‘spread’ also encouraged the growth of the Euro market.

(viii) Supply of Petrodollars

The flow of petrodollars, facilitated by the tremendous increase in the OPEC’s oil revenue following the hikes in the oil prices since 1973, has been a significant source of growth of the Eurodollar market.

Participants in the Eurocurrency business include governments (including of communist countries), international organisations, central banks, commercial banks, corporations, especially multinational corporations, traders, individuals, etc.

(ix) The Supply of and Demand for Funds in the Eurocurrency Market

It comes from the above participants. Central banks of various countries are very important suppliers. The bulk of the central bank funds are channelled through the BIS in Basle, Switzerland. The enormous oil revenue of the OPEC has become an important source of flow of funds to the Eurodollar market.

Multinational corporations and traders place their surplus funds in the market to obtain short-term gains. Governments have emerged as significant borrowers in the Eurocurrency market. The frequent hike in the oil prices and the consequent increase in the current account deficits of many countries compel them to increase their borrowings.

The commercial banks in need of additional funds for lending purposes may borrow from the Euro market and re-lend it. At the end of the financial year, sometimes they resort to borrowing for ‘window dressing’ also. Business corporations, especially multinationals, and traders borrow from the market for their short-term requirements.

The advantages and dangers associated with the Eurocurrency market have given rise to the doubt whether it is a welcome tonic or a slow poison to the international system.

Advantages of Eurocurrency Market

1. The growth of the Euro market has helped to alleviate the international liquidity problems.

2. The market provided credit to finance the balance of payments deficits, enabled the exporters and importers to obtain credit.

3. The market helped to meet the short-term credit requirements of the business corporations.

4. And provided better opportunities for the investment of short-terms funds. It has provided a market for profitable investment of funds by the central banks.

5. The supply of funds, by the Euro market has enabled commercial banks in some countries to expand domestic credit creation and helped ‘window dressing’.

6. The Eurocurrency has helped to accelerate the economic development of certain countries including South Korea, Brazil, Taiwan and Mexico.

Disadvantages of Eurocurrency Market:

1. The growth of this market has given rise to some serious problems, especially in the sphere of monetary stability.

2. Central Banks and governments have been uneasy about the Eurodollar market ever since it became visible in 1958. Its explosive growth baffles them, they know that something is going on but they are seldom sure what it is.

3. They do know that one of its attractions for the participants is that the Eurodollar market provides opportunities for avoiding many of the regulations that they try to enforce on national money markets. Despite the many advantages of the Eurodollar as a vehicle currency ‘ for carrying on world trade and as a source of international liquidity, there remains the unsettling prospect of a machine, controlled by no one, that can add to the world’s money supply by creating dollars.

4. As Milton Friedman has said “… the Eurodollar market has almost surely raised the world’s nominal money supply (expressed in dollar equivalents) and has thus made the world price level (expressed in dollar equivalents) higher than it would otherwise be.” The Eurodollar and Eurobond markets have become important sources of finance for governments and private firms.

5. The growing integration of the world economy and globalisation of business increase the importance of these markets. Government of India has made use of the Euro market on several occasions. There is an increasing realisation of the importance of this market by the Indian companies. The change in the business environment in India increases the importance of this market for Indian business.

Debt and Non-Debt Flows in Indian Capital Market:

Developed countries have been providing financial assistance to countries in earlier stages of development for nearly half a century. The measurement of the flow of external resources is essential for the formulation of development strategies and the evaluation of assistance programmes.

Debt Flows in international capital markets include majorly external commercial borrowings.

External Commercial Borrowings (ECBs) include bank loans, suppliers’ and buyers’ credits, fixed and floating rate bonds (without convertibility) and borrowings from private sector windows of multilateral Financial Institutions such as International Finance Corporation. Euro-issues include Euro-convertible bonds and GDRs.

In India, External Commercial Borrowings are being permitted by the Government for providing an additional source of funds to Indian corporates and PSUs for financing expansion of existing capacity and as well as for fresh investment, to augment the resources available domestically. ECBs can be used for any purpose (rupee-related expenditure as well as imports) except for investment in stock market and speculation in real estate.

External Commercial Borrowings (ECBs) are defined to include commercial bank loans, buyer’s credit, supplier’s credit, securitised instruments such as floating rate notes, fixed rate bonds etc., credit from official export credit agencies, commercial borrowings from the private sector window of multilateral financial institutions such as IFC, ADB, AFIC, CDC etc. and Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds. Applicants are free to raise ECB from any internationally recognised source like banks, export credit agencies, suppliers of equipment, foreign collaborations, foreign equity holders, international capital markets etc.

Regulator:

The department of Economic Affairs, Ministry of Finance, and Government of India with support of Reserve Bank of India monitors and regulates Indian firm’s access to global capital markets. From time to time, they announce guidelines on policies and procedures for ECB and Euro-issues.

Non-Debt Flows in India:

In the Indian capital market, the huge portfolio fund flows and direct investments into projects and companies have substantially increased the share of non-debt obligations to almost half of the country’s external financial liabilities.

The share of non-debt obligations moved up from 42.3 per cent at the end of June 2006 to 50.8 per cent at the end of December 2007. The rise is mainly because of capital inflows under portfolio and foreign direct investment.

The global investment position resulted in net claims of non-residents on India, arising from portfolio and direct investments in the country and external commercial loans. They rose marginally by $1.23 billion to $73.90 billion at the end of December 2007 from $72.67 billion at the end of September 2007.

Among the external financial assets, the reserve assets increased by $27.56 billion over end-September 2007 to $275.32 billion at end-December 2007.

The direct investment abroad rose by $3.57 billion in three months to touch the $38.95 billion mark at end-December 2007. The reserve assets at $275.32 billion exceeded the entire external debt ($201.45 billion) by $ 73.87 billion at end-December 2007.

External financial liabilities of the portfolio investments mainly in equity and equity- related instruments and direct investments in India had increased by $16.08 billion at end- December 2007. The external commercial loans and trade credits had increased by $6.24 billion and $3.78 billion respectively during the same period.

The major part of India’s external financial assets was in the form of reserve assets, constituting around 83.0 per cent. This was followed by direct investment and other investment, accounting for 11.7 per cent and 5.1 per cent respectively. Country’s external financial liabilities at end of December 2007 were composed of items like trade credits, loans, deposits besides direct and portfolio investments.

Other investments consisting trade credits, loans, currency and deposits and liabilities had 44 per cent share in liabilities. The portfolio investment at 30.7 per cent and Direct Investment at 25.2 per cent were crucial elements in liabilities.

The ‘loan’ and ‘currency & deposits’ were having 24.0 per cent and 10.9 per cent share respectively, in the total external financial liabilities of the country whereas trade credit accounted for 8.9 per cent as at end-December 2007.

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