Recently, the euro achieved parity with the US dollar. In other words, in terms of the exchange rate, one euro became equal to one US dollar. The Euro is the currency and monetary unit of the European Union, symbolised by the € sign. It is adopted as the official currency by 19 member nations of EU.
Declining value of Euro –
- Recently, the euro and the U.S. dollar reached parity, meaning one dollar could buy one euro in the foreign exchange market.
- Since the beginning of this year, the euro has lost about 12% against the U.S. dollar and it is expected to lose more value going forward.
- The latest blow to the exchange rate has come from the energy crisis in the wake of Russia’s war against Ukraine.
- This is only the second time since 2002 that the euro has fallen this low to a dollar.
What are the reasons behind its fall?
- The weakness of the Eurozone’s economy —
- The Covid-19 pandemic and the fiscal response to counter it had left the eurozone with a weak economy facing historically high inflation.
- Germany, the biggest Eurozone economy, in May 2022, registered its first trade deficit since 1991.
- In this moment of weakness, Russia’s war on Ukraine and the consequent ban on Russian energy have left the European economies completely vulnerable.
- Europe was completely dependent on Russian oil and gas.
- The unprecedented spike in energy prices has created a cost-of-living crisis for common people.
- It also raised questions in the minds of investors about the viability of future investments in the Eurozone.
- Many companies are planning to shift their base to the US, which is far more independent in energy terms.
- The difference in the monetary policy response between the US and European central banks —
- The US Fed has made it clear that it will not stop until inflation, which is also at multi-decade highs in the US, comes back to the target rate of 2%.
- As such, the Fed is aggressively raising interest rates, even if that brings in a recession.
- The ECB, by contrast, hasn’t moved.
- Faced with the scenario where raising interest rates (in order to control inflation) may dampen the economic recovery, the ECB hasn’t raised rates.
- This has created another big reason for the money to flow out to the US because it offers better returns for investments.
- Russia’s invasion of Ukraine —
- The value of euro has been affected by the uncertainty in energy supplies in the wake of Russia’s invasion of Ukraine and the ensuing actions against Russia.
- Europe now has to shell out more euros to import limited energy supplies, which in turn has adversely affected the value of the euro.
Impact on rupee –
- Many experts believe that if the euro continues to stay weak and trend below parity, it will also take the rupee down with it.
- In other words, if the euro continues to weaken, the rupee, which is already just a whisker away from 80 to a dollar, will further weaken against the dollar.
- This is because the euro has immense trade linkages with India and similar emerging economies.
- So far, the rupee has done better than euro against the dollar because the RBI has intervened in a manner to ensure rupee stays that way.
- In fact, the Indian rupee, despite its continued weakness, has shown more resilience against the dollar than most other currencies.
- A case in point is the fact that the rupee has sharply appreciated against the euro since the start of 2022.
- It was close to 90 at the start and is now close to 80 to a euro.
Way forward for Eurozone economies –
- As the U.S. Federal Reserve continues to raise interest rates, this is likely to exert further downward pressure on the euro.
- The ECB may be forced to raise interest rates to slow down money supply growth in the Eurozone in order to prop up the value of the euro against the dollar.
- But this is likely to lead to a slowdown in growth in the Eurozone — 19 countries use the currency — as its economy will have to readjust to tighter monetary conditions.
- If so, European nations might opt to enact tax and regulatory reforms to expedite the recovery.