04 May 2005

The Web

Shaping up for the Euro odyssey

Matthew Vella and Julian Manduca

Malta enters the Euro with a tough road ahead of it. Prime Minister and Finance Minister Lawrence Gonzi is confident the country is on track to send the deficit below three per cent of the GDP but the sceptics believe the added pressure on cutting down in record time will not help the economy.
Last week Labour shadow finance minister Charles Mangion poured doubts over the government’s bid to get its finances into shape ahead of eurozone accession in a possible 2008. “Even if Government seems to have abided by the deficit projections for 2004,” Mangion told MaltaToday last week, “the result was achieved by playing around with numbers and one-off incomes from privatisation.”
It is an ominous reminder that the stable of public entities which are planned to be sold will not leave Malta’s structural deficit any better than simply allaying the nominal deficiency in Malta’s accounts. Economist Gordon Cordina says privatisation receipts would not be included in recurrent revenue but they “could help in reducing government expenditure, particularly on debt servicing.”
His reading on Malta’s entry into the Exchange Rate Mechanism (ERM II), the two-year waiting room which will have the Maltese lira pegged 100 per cent to the Euro, is that it is “never too early” for Malta to start benefiting from the introduction of the euro.
He lists lower interest rates and enhanced exchange rate stability on the horizon, given the economy’s smallness and openness to international trade. If the decision had been postponed, as Charles Mangion would have had when he described the move as “hasty, premature and not in the national interest”, it would have placed Malta on the loser’s bench, with all those countries that are “relatively backward in their degree of economic integration with the EU, with adverse consequences for international business and investment.”

The misgivings of an early entry into the ERM II, which will require the government to cut the deficit, its public debt to 60 per cent of the GDP, and low inflation rates, were based on the burgeoning task of managing a frigid economy which is not attracting much investment and is losing out to competition.
Mangion stated that around EUR14 billion poured into the EU’s New Member States but “few of that money made it into Malta”. With their attractively low corporate tax rates – a stark contrast from Malta’s 35 per cent rate – Poland was the country that benefited most in FDI, without having joined the ERM II. Nor have other countries like the Czech Republic, who are waiting until 2007 to be able to take the plunge.
Vince Farrugia, the director-general at the Malta Chamber of SMEs (GRTU), is also adamant that the pegging of the Lira to the Euro at a fixed rate must be followed up by an increase in FDI.
Following hot on the heels of the Central Bank’s alarm at the rate of decline in currency reserves flowing out of the country into Euro-denominate asset portfolios, amongst others, Farrugia is clear that Malta had to act to protect its currency and reserves after a period of uncertainty about the value of the Lira and much Maltese investment going abroad. Alfred Sant’s own flirtations with devaluation and depreciation of the Lira has not helped.
“If there was political consensus on the matter, it might have been different, but much public speculation and the flow of funds going abroad was weakening Malta’s position and endangering its reserves. Since we have an open economy it is vital that Malta retains a strong reserve base.”
Cordina admits that entry could have been preferable had there been “more certainty” on progress with Malta’s deficit odyssey. The economist however banks on the rigid rules of the Euro to get the technocrats cracking their whips: “Adoption of the euro requires Malta to strictly adhere to the fiscal consolidation programme which it has presented,” he says about Gonzi’s plan to the Council of Ministers for his route to financial sanity. “This will require further efforts by fiscal policy, which would be ideally supported by a constructive input from the social partners. ERMII participation should itself provide the drive for fiscal consolidation efforts to be pursued more effectively.”
Economist Prof. Edward Scicluna says the choice for the government was clear:
“Either undertake the full restructuring now and then join later, once the economy is fully prepared, for a short ERMII transitory period of 2 years. Or else join now and undertake the restructuring along, during a longer transitory period, using the relative restrictive conditions of ERMII to goad and discipline the cabinet and the social partners to keep to the tight restructuring programme.”
He says that with the latter option, the risks involved may be no different from the previous. “Delaying going in for ERM II now may have raised a few ‘international eyebrows’. Delaying the actual going into the Euro bloc in the future, because we cannot get the economy right, would raise much more eyebrows. Let us hope this tactic works.”
And as Scicluna points out, the relatively high central parity chosen by the government, at a fixed exchange rate of Lm0.4293 to EUR1 is a very daring move.
“We are actually going to walk a very tight rope,” Scicluna says about the Central Bank’s unilateral commitment not to allow fluctuations on the hard central parity. “Without any variability being allowed around the peg, as permitted by the ERM rules themselves, the onus now is on the real economy to do the required adjustment.”
But if the other Member States can afford to wait longer, Vince Farrugia says Malta’s lack of political consensus makes early entry urgent. “In Malta it has become a political football and the sooner the issue is resolved the better – Malta needs the stability.”
Farrugia is concerned that the recent economic climate has been encouraging several of the GRTU’s members to downsize or set up shop outside the islands, and is calling on the Prime Minister to take action so as introduce fundamental changes in strategies, policies and, above all, people.
Farrugia does not believe the pegging of the Lira to the Euro will stem investment from abroad on its own. He warns that government must take action to encourage companies in Malta to remain here and those planning to invest abroad to keep their funds on the islands.
Retailers, Farrugia’s main concern amongst others, are not expected to feel any impact from the pegging for now, but will have to start working to adjust their cash registers for dual currency. According to Farrugia plans are underway to ensure a smooth introduction of the Euro, with both the government and the EU showing a willingness to assist. “At the same time we have been following the problems faced with the introduction of the Euro abroad so as to avoid any of the pitfalls.”
Indeed, the pitfalls could prove to be ones that Malta-based companies which mainly trade in dollars might face in the future. Companies like ST Microelectronics, whose spokespersons were not available at the time of going to press, had already been caught in the pincers of a falling dollar. Even the CEO of Toly Products, Andy Gatesy, whose company also trades in dollars, said that devaluation of the Maltese Lira was the only way of making their products competitive in a market with falling labour costs.
“Companies using the dollar will experience a marginal increase in the fluctuations of the Maltese lira against the dollar, thus facing some more currency risk which will however be no worse than that experienced by their counterparts in the euro area,” Cordina says. “This might entail a small increase in cost of exchange rate hedging, or possibly, a shift of business towards the euro area. But these effects are not likely to have a significant impact.”



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