On 10 July the European Council of Ministers of Economic and Financial Affairs confirmed that Malta will be joining the euro area on 1 January 2008 and set the irrevocable fixed conversion rate at

EUR1 = Lm0.4293. To learn more about what led to this historic event and its future implications,

Peter Calleya, Head of Research at the Malta Institute of Financial Services (IFS-Malta) speaks to the Prime Minister, Dr Lawrence Gonzi.

It is now official that Malta will adopt the euro as its national currency at the beginning of next year. What does achieving this milestone really mean?

This is a major achievement we should all be proud of as a nation. Adopting the euro as our national currency has been an objective we have been working hard to attain. We had to overcome certain obstacles that were not always easy. However, reaching this goal made the process worthwhile. It was always in our interest to adopt the euro sooner rather than later. This obviously necessitated addressing the issues relating to budgetary and economic convergence. Achieving this just four years after EU membership is truly satisfying and a reflection of the considerable progress we have made in the last few years.

Fulfilling the Maastricht economic convergence criteria was not an easy task. When we joined ERM II in May 2005 there were those who said it was too early and that seeking early adoption of the euro was not in our interest. Others opined that the central parity rate (now the irrevocable fixed conversion rate) was too high and would be detrimental to the Maltese economy. With the benefit of hindsight, did the process go according to plan?

I have always said that there are significant advantages to be derived from membership in the euro area and it would therefore be a mistake to prolong our entry unduly.

The Maltese economy was always well suited to participate in the EU’s common currency area. Its structure mirrors that of the euro area, with close similarities in the sectorial contribution to GDP, in financial sector integration and business cycle synchronization. Prior to joining ERM II, Malta’s fixed exchange rate regime, with the euro as the main reference currency already necessitated that its monetary policy and interest rates shadowed those of the euro area, hence the degree of autonomy that Malta would forfeit was always going to be limited. The subsequent pegging of the Maltese lira to the euro continued to give our economy stability while foreign exchange reserves remained stable in general.

It should be remembered that during the early months of 2005, the Leader of the Opposition speculated on devaluation on the Maltese lira. This led to a climate of uncertainty that practically resulted in an erosion of 10 per cent of the country’s foreign reserves. Upon entering ERM II, we made it very clear that we would not use the fluctuation band of +/-15 per cent as provided for in the Maastricht Treaty. We did this because we wanted to maintain our tradition of exchange rate stability. As a matter of fact, our decision was proved right since even though we experienced the oil price hikes, our exchange rate did not experience severe tensions during this period.

In 2004 IFS-Malta organised its annual conference on the theme “The Budget Deficit – The major obstacle to Malta’s participation in EMU. This was the main concern at the time. More recently it was the inflation criterion. Where these criteria really that difficult to fulfil?

My government’s vision for Malta is that of having a dynamic, high-value added economy founded on competence, skills and excellence and capable of sustaining a high standard of living for its people.

At the beginning of this decade our general deficit was relatively high and in 2003 reached a peak of 10 per cent of GDP. This was a real concern at the time and something had to be done about it. It was necessary to restructure our economy, which is why we implemented a fiscal consolidation programme to restore our public finances on a sound footing. We removed inefficiencies in the public sector and where beneficial divested government assets and encouraged public private partnerships. Initiatives were also undertaken to upgrade our infrastructure, improve our productivity, increase our competitiveness and attract investment to our shores. These left the desired results as it brought the budget deficit down considerably with a deficit-to-GDP ratio of 2.6 per cent in 2006 with forecasts predicting an even lower one this year.

With regard to inflation, Malta is a small and open economy vulnerable to external shocks, particularly in food and energy prices, and to changes in indirect taxes. Inflation picked up considerably in the latter part of 2005 mainly due to the sharp rise in regulated prices for energy and related products in response to higher oil prices. While we did not really have much control over this it was still a major concern. The impact of higher prices in the utilities sector needed a full 12-month cycle to work themselves out of inflation. In fact, as from the last quarter of 2006, inflation stabilized itself around the two per cent mark in line with that experienced in the euro area. Looking ahead, inflation appears to be on a moderate path although we must still monitor the situation.

Will adoption of the euro be inflationary?

No. My government and its institutions are doing everything they can to ensure the euro does not bring about inflation. The objective of the Euro Adoption Act is to ensure fair practices in euro pricing and make sure that prior to changeover consumers familiarise themselves with the equivalent of prices of goods and services in euro.

The response from retailers to the FAIR initiative administered by National Euro Changeover Committee (NECC) has been overwhelming. Participants of FAIR specifically undertake not to increase prices due to the monetary changeover. This should facilitate a smooth non-inflationary changeover process.

The experience of other countries demonstrates that a strong communications campaign is an effective tool against euro perceived inflation. That is why the NECC has been and will remain very active on this front by empowering consumers and providing leadership to the business sector. As the government, we also decided to lead by example, by rounding down in favour of the consumer any government induced costs, be it fees, tariffs and fines.

Besides embarking on a Price Watch initiative ourselves, other organisations are also proactively monitoring prices and providing information to their members and the public. It is also important for consumers themselves to be on the lookout and not pay more than they have to.

The last country to join the euro area was Slovenia, which has recently stated that the currency changeover was not inflationary. Therefore, there is no reason why it should be inflationary here.

We have read and heard a lot about the Treaty of Maastricht and the economic convergence criteria. However, the main focus has been on nominal convergence, assessed through the stipulated macro-economic benchmarks. What about real economic convergence, which is just as important?

An interesting and very important point. It is perhaps only natural that the focus is on what could be objectively measured. However, as you correctly state, the treaty also calls for more economic and social cohesion among member States, by raising the standard of living and quality of life, achieving a high level of employment and social protection, and sustaining growth that respects the environment.

Although more remains to be done there and, like any other functioning market economy we have had our setbacks, this is an area in which I am particularly proud of our achievements. Through our policies we have managed to generate new initiatives that have expanded our economic activity and created a business-friendly environment, attracting investment, creating good employment opportunities, leading to sustainable growth. At the same time we upgraded our infrastructure and did not neglect our social obligations as we continued to invest in those areas that are of fundamental importance to our country and our well being, namely the environment, health and education.

Perhaps the main achievement lies in the fact that we have invested record amounts in all these three sectors and still managed to bring our deficit down to below the benchmark of three per cent of GDP. This accomplishment was achieved over three budgets, two of which did not introduce a single tax, and one that reduced income tax bands to further encourage industriousness.

The actual changeover of our currency is still a gigantic task. Are you happy with the preparations so far?

Yes. I know NECC and its sectoral committees, with the assistance of the Central Bank of Malta and Ministry of Finance, have already done a lot of work. All this activity is being constantly monitored by Cabinet and the Euro Adoption Steering Committee.

Constituted bodies, unions, trade organisations and NGOs have also done a lot of work. All these initiatives of promoting awareness on the main issues of the euro changeover process and disseminating information are commendable.

Are there any areas where you think more can be done?

It is not a question of doing more in any specific area as the strategy and communications framework are well in place and there is a good level of cooperation at all levels of society. A lot of technical and IT preparations are already being addressed and a good amount of information and literature is available.

What must be done as EUR-day approaches is to ensure everyone has the necessary information and knows what to do or where to seek advice if needed. Confidence in the changeover process is essential for its success.

Through a concerted effort we can ensure the changeover happens as smoothly as possible.

So are communication and education the key?

Yes. More importantly, we must ensure that we communicate effectively and not overlook anyone or any aspect of the changeover process. This can be achieved through cooperation and working together towards our common goal.

It is important that we do not leave what needs to be done until the last minute, as this will defeat the purpose of preparing in advance. We must also be vigilant and report any attempts to benefit unjustly from the changeover especially where prices are concerned. Through continuous and coordinated communication and education there is no reason why the transition should not be a smooth and efficient one.

The financial services organisations have a key role to play in this process due to the nature of their work and the fact that they interact with customers on financial matters on an ongoing basis.

On 1 January 2008 Malta will be sharing a common currency with 14 other countries and hundreds of million of people. From an international perspective what does this imply?

Sharing the world’s second largest currency within the European single market will create a more stable macro-economic environment, which is conducive to business. This will increase our economy’s competitiveness, facilitate trade and investment and make Malta a much more attractive destination for doing business.

Adopting the euro as our national currency will definitely enhance our international reputation and allow us to integrate further in European and world markets.

What would you like to say to the Maltese people about this historic event?

The adoption of the euro as our national currency is a historic event and the next logical step in the country’s social and economic development.

In the coming months we will all be affected to a greater or lesser extent by this changeover. However, this necessary change will only last for a short time. By working together there should be no reason why we cannot ensure that this transition to the euro will be a smooth one.

Thereafter we will be able to enjoy the benefits of sharing an international currency that will be more convenient and make our lives easier. Let us all do our part to make this a success.