THE pound's slide in recent days has eased the problem of the strength of the Irish currency within the EU exchange rate mechanism. But further hurdles lie ahead in the run up to EMU including the French general election.
With sentiment relating to EMU - and the likely rates at which currencies will join - likely to ebb and flow, foreign exchange risk management must be a priority for businesses. Last week was evidence of just how sharp currency moves can be as speculators consider the outlook for monetary union.
The outlook for the German and French economies is now crucial to the outlook for EMU and therefore to the volatility likely between ERM currencies in the run up to 1999.
The EU Commission believes that Germany and France would meet the Maastricht budget criteria. The German deficit is forecast to fall from 3 per cent of gross domestic product in 1997 to 2.7 per cent in 1998. In France, the Commission sees the deficit steadying at 3.0 per cent in both years.
But it should not be forgotten that the improvement in the French deficit this year was helped by one off measures which reduced the 1997 deficit by about 0.5 per cent of GDP. Furthermore, the Commission's favourable assessment of the French economy includes a forecast that real GDP will grow by a robust 3 per cent in 1998 after 2.3 per cent in 1997.
French unemployment is expected to fall to 12.1 percent next year from 12.5 per cent in 1997. But neither the pickup in the rate of economic growth nor the stabilisation of the annual fiscal deficit as a percentage of GDP will be sufficient to prevent a rise in the French national debt to GDP ratio closer to the 60 per cent limit set out in the Maastricht Treaty.
Nobody really believes that France's economic problems will be solved easily or quickly. This view is obviously shared by the French President Mr Jacques Chirac, in his decision to call an early general election before the scheduled March, 1998, date. This will now be a major focus of the currency markets with the British election now out of the way.
If the current government wins the election, it will make it easier to push through new austerity measures, most likely in the 1998 budget which is due in the autumn. Such measures are needed to ensure that France continues to meet the fiscal criteria of the Maastricht Treaty. A fresh mandate for the President would make it far easier to implement the necessary longer term measures.
The opinion polls, however, indicate that the President will not get it all his own way. The centre right coalition which currently holds 464 of the National Assembly's 577 seats is expected to be pulled back to a much slimmer majority. The President's gamble of seeking a vote of confidence in the government's economic policies is also effectively a referendum on Economic and Monetary Union.
The French Prime Minister, Mr Alain Juppe, has emphasised the continuation of existing policies which will include a reduced role for the State. Both the left and the right are committed to the introduction of the euro on schedule in 1999 but Socialist Party leader Mr Lionel Jospin has said that he was not prepared to impose a new bout of austerity to move France closer to a stricter interpretation of the Maastricht Treaty criteria. Nevertheless, the recent history of French politics suggests that policies quickly adapt to the requirement of joining Germany in EMU.
A victory for the centre right, albeit with a much reduced majority, is the most likely outcome. With the continued commitment to the "franc-fort" policy, there is no prospect of a shift in the value of the franc ahead of the start of EMU in 1999. What this means for the relationship between the Irish pound and the French franc, therefore, is relatively straightforward.
If the key deutschemark/French franc rate remains solidly within a narrow range around the ERM central rate of Ffr3.3538, the outlook for the Irish pound/French franc rate will be dictated by the movement of the Irish pound against the German currency.
With the French election out of the way, a key potential difficulty on the road to EMU would be gone. This would lift the growing mood of optimism that the euro would be introduced on schedule in 1999. It would also open up the debate on technical issues such as the likely conversion rates for the national currencies joining the euro.
This issue has already affected the pound, as was evident on the Irish foreign exchange market last week. The pound still remains well above its central rates in the ERM and there is scope, therefore, for further declines in its value.
However, in the world of euro politics, this should not be seen as a one way bet. There are many issues to be considered in deciding on the appropriate conversion rates so the Irish authorities would have to examine the wider implications of a lower pound, particularly in relation to inflation.
For domestic reasons, therefore, the exchange rate implications of Irish membership of the euro are considerable and with the operational issues to be considered in preparation for the euro, businesses will need to put foreign exchange risk management at the top of the agenda.
