23 March 2005

The Web

Adopting the euro: now or later?
By James Debono

With the debate over the best possible timing for Malta’s eventual adoption of Europe’s single currency currently raging, The Malta Financial and Business Times spoke to former Finance Minister Lino Spiteri and economist Gordon Cordina to assess their views on the heated subject.
While former finance minister Lino Spiteri advised caution and argued that postponing the decision would not have a negative economic impact, economist Gordon Cordina argued that Malta should join the euro at the earliest possible opportunity.
As regards the adjustment of the rate at which Malta should lock in with the euro, Lino Spiteri warned that getting this wrong could have a negative impact on the cost of living. Cordina, meanwhile, excluded the likelihood that the adoption of the euro would trigger currency devaluation.
On Saturday a cabinet meeting to evaluate the strategy that would lead to the introduction of the euro as Malta's national currency was held, while the final decision on when Malta will join the Exchange Rate Mechanism is expected to be taken by June. The aim of ERM II is to maintain exchange-rate stability between the euro and the participating national currencies. Earlier in the month, the Prime Minister announced that if Malta joined ERM II now, it would be able to introduce the euro by 2008. If not, the adoption of the euro would be postponed to a later date.
The Malta Labour Party revealed its position on the adoption of euro in The Malta Financial and Business Times’ sister paper, MaltaToday, last Sunday. MLP Deputy Leader Charles Mangion had called on the government not to rush in to ERM II. Mangion cited Britain as an example of a country that took a cautious approach in adopting the euro. “Britain has a more growth orientated economy and I think it’s advisable that we adopt a similar approach based on objective assessments, bearing in mind, primarily, the interests of Malta.”
Asked whether it would be advisable for Malta to join ERM II at the present time with a view to becoming eligible to adopt the euro come 2008, economist Gordon Cordina argues: “It is desirable for Malta to join the euro area as soon as possible. The adoption of the euro would imply lower interest rates, reduced exchange rate costs and risks and greater monetary stability for Malta. It is an obvious course for a small economy, which is a member of the EU Single Market. One of the requirements for a currency to join the euro area is participation in ERM II, a system where the exchange rate of the Maltese lira would be determined with reference to a central value against the euro and perhaps be more exposed to market forces.”
Lino Spiteri, in contrast, was far more cautious on the issue, warning that, “The wrong rate, despite initial wide margins, can be harmful. It might be better to raise the euro weighting in the Maltese lira formula, rather than join now.”
According to Gordon Cordina, pegging the Maltese lira to the euro would not entail insurmountable difficulties for the economy. “This does not mean that the exchange rate of the Maltese lira would need to fluctuate to any larger degree than it is already doing. ERM II accommodates a range of exchange rate arrangements, from a hard peg by means of a currency board to a float within relatively wide 15 per cent margins. The essential aspect of ERM2 is that the central rate of the Maltese lira, defined in terms of the euro, would have to be maintained without any devaluation.”
Writing on The Times on Monday, Lino Spiteri posed the question "Why should the government take us there without proper widespread discussion, particularly to become clearer about the rate at which we should lock in with the euro?"
The former Minister told this newspaper, “The social and economic implications - negative ones - lie in getting the rate wrong. Adjusting it to fine tune in line with relative purchasing power has various implications - to the cost of living on the one hand, competitiveness on the other. As with all decisions, what one has to attempt to determine is the net balance of the various considerations, the effect at the margin.”
According to Cordina, “The most significant factor of ERM II participation is that our economy would be held under closer scrutiny by international investors, also as our economy is now open to international capital flows. This means that changes in the fundamental performance of our economy, such as competitiveness or the fiscal deficit, would be more quickly and forcefully reflected in changes in domestic interest rates or movements in the exchange rate.” On the other hand Cordina warns that there will be “significant costs if the economy's fundamental performance is not strong enough.”
Lino Spiteri and Gordon Cordina hold contrasting views on the costs of postponing the decision to join ERM II. According to Cordina, “Postponing joining ERM II would be giving the signal that Malta is not sufficiently strong in its economic fundamentals to face the scrutiny of international investors and eventually adopt the euro. This would give a wrong signal to potential investors, which could perhaps further complicate the task of adopting the euro later on.
“Moreover, Malta would be postponing the enjoyment of the benefits of the adoption of the euro.” Writing in The Times on Monday Lino Spiteri wrote: “Haste is never the wisest spur to action. Undue haste leading to a mistake on this fundamental policy issue would make a sad joke of the government's objective to improve competitiveness.” Lino Spiteri told this newspaper that postponing the decision to join ERM II would not be harmful to the economy, “especially since we can still increase the euro weighting gradually if the monetary authorities think that would be advisable.”
Cordina considers a devaluation of the Maltese lira in the process of adopting the euro as unlikely. He says, “A devaluation of the currency would be rendered necessary if there is an actual or expected run on the foreign assets of the Central Bank by investors wishing to covert Maltese lira into foreign currency. There appears to be little reason why such an eventuality would be rendered more likely by the adoption of the euro - weak economic fundamentals and expectations of a devaluation are more likely triggers of such an event.”
In June of last year Finance Ministry Parliamentary Secretary Tonio Fenech had told The Malta Business and Financial Times in an interview, “The government’s policy is that we want to join the euro sooner rather than later” but he also added that this depended on a number of issues. In the same interview Tonio Fenech added that if the government manages to address the deficit problem, “there is nothing holding us back from going into the euro today after tomorrow.”
The choice between joining ERM II now and postponing the decision could have serious political consequences, especially when one considers that the earliest date earmarked for joining the euro coincides with the next general elections.

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