13.12.202115:09 Forex Analysis & Reviews: Digital euro to adversely affect other currencies

The EU has been mulling over the introduction of the digital euro for some time. Policymakers have more than once discussed this possibility. However, they have also pointed out the pitfalls of this project. The main disadvantage may be the dominance of the digital euro over other means of payment.

Experts assume that the main problem with the launch of the digital euro is its overwhelming impact on other currencies. It may be even able to compete with the digital dollar and the yuan, as well as the virtual currencies of other countries. "The digital euro could spread in third countries to the extent that it would crowd out local currencies, leading to a digital "euro-isation", which could hamper the transmission of monetary policy and lead to financial instability," Fabio Panetta, a member of the Executive Board of the European Central Bank, said. "The risks would be greater for emerging economies that have weak currencies and economic fundamentals, and close trade and financial ties with the Single Market and which are integrated into global value chains," he pointed out.

Fabio Panetta assumes that these risks are relevant for countries with developing economies. as their national currencies are weak. Apart from that, they are heavily dependent on stronger trading and financial partners. At the same time, the digital euro is expected to smooth out this difference as it will be backed by the assets of the European central bank. "The digital euro would be a form of sovereign money provided by the ECB in electronic format. It would be used by anyone – households, businesses, commercial outlets – to make or receive retail payments throughout the euro area. It would give citizens the same services they now obtain from paper banknotes: access to a secure payment instrument that is cost-free, easy to use, and universally accepted within the euro area. And as it would be a central bank liability, the digital euro would, like banknotes, be free of any risk, be it market risk, credit risk, or liquidity risk," he added.

The digital euro will be an additional payment method. It will not replace cash settlements. This will help the financial integration of the euro block countries, experts believe. Unlike fiat money, the digital euro can be used not only for money transfers and purchases at retail outlets but also for payments in online stores. "For the ECB, the need to explore the introduction of a digital euro arises from the evolution of people's payment habits. The way we make our purchases has been changing, especially since the start of the pandemic."

The dominance of the digital euro may be promoted by two key trends in 2021: the widespread use of cryptocurrencies and frequent purchases in online stores. Panetta believes that more people will switch to online shopping, boosting demand for the digital euro. Therefore, the EU will only benefit from the digital euro. However, developing countries should carefully introduce digital money. At the same time, the official noted that the issue of the digital euro will reduce the dependence of the eurozone on the US dollar and strengthen the financial stability of the region.

The EU has already achieved great progress with the digital euro. On December 8, the first cross-border testing of virtual payments took place in Europe. Central banks conducted a test of their digital currencies, which turned out to be successful. Therefore, the ECB is likely to cement its progress and improve the current version of the digital euro. Additionally, by checking the capabilities of digital currencies, the central bank is testing the water for the issue of the digital euro in the nearest future.