Euro Diet

The Malta Independent 
 

The diet to join common currency is not to everyone’s taste, wrote Tony Barber in this week’s Malta supplement in the Financial Times. This is most definitely so given that we have been duped into thinking that we can continue living beyond our means purely by amassing debt rather than investing for growth.

One person who seems to be developing an early taste for this diet is the Governor of the Central Bank, Mr Michael Bonello. He was quoted by Barber as advocating urgent fiscal consolidation so as to make it to the Euro by the earliest possible date in 2007. He stated that late adoption of the euro would imply that the enjoyment of the relative benefits would be postponed and that the country could lose competitiveness if other new member-states successfully adopt the euro at an earlier date.

This type of reasoning worries me. It seems that Mr Bonello would have us reduce the budget deficit from 6% to 3% over a three year 2004-2006 period and in the process work out a miracle to reduce the debt level from the current level of nearly 70% of the GDP to 60%. With the economy expected to stay with real growth of just 1%, with inflation near historic lows and with the public budget in deficit though on a hopefully reducing level, there would remain only two ways how a reduction of relative debt to GDP to the tune of 10% can be achieved over a short period of 3years.

This could come about through a devaluation of the local currency in view of the fact that the large majority of the public debt is internal, denominated in Maltese Lira, whereas the major determinants of the GDP are our net earnings on exports of goods and services. However, with the rate of exchange policy adjustments semi-officially ruled out as a possible source for a solution to our economic ills, the only remaining source of adjustment would be mass-privatisation to provide one-off revenue flows for debt reduction.

Nothing of this sort was provided for in the three year financial framework presented with the budget. This provides for privatisation revenues of Lm135 million over three year which would reduce, though not eliminate, the need to take on new debt, but will certainly not contribute to the reduction of debt.

Which leads me to conclude that the issue of our joining the Euro at an early date is subject to loose talk and wishful thinking.

Why should we hurry to join a monetary union the rules for which seem to be changing to fit the needs of the big countries while being applied with rigour to the not so big countries such as Portugal? And who is going to decide the level at which we will fuse the Maltese Lira into the Euro?

If it is the Central Bank than my worries compound. Because the Central Bank regularly publishes research which shows that Malta has been forced to live with an over-valued real exchange rate in the region of 8-10% for the last five years. They kept the USD content in the Maltese Lira basket at on overweight 21% when the average rate was USD2.25 for one lira and then reduced it to 10% in August 2002 just when the USD was about to collapse from the then level of USD 2.34 to the current level of USD 2.83. This has deprived us the possibility to cleanse the Malta Lira rate of exchange from its full dollar-induced overvaluation.

The risk of joining the Euro too early is to my mind far more serious than of joining too late. If we put the economy through a sausage machine to meet the technical triggers of the Euro we would be missing the wood for the trees. Existing and much stronger Euro members are doing their damn best to extricate themselves of the fiscal straight jacket which would deprive them from cultivating the nascent economic growth, still too fragile to withstand fiscal repression.

The ultimate objective has to be that we have to get our economy efficient and globally competitive and this cannot be done by blindly following the Euro rules just to make it in there at the earliest possible date. The Euro diet is needed to make us competitive and not just to make us qualify for euro membership. And this can only come from efficient allocation of resources and from growth stimulation of which there are pretty few indicators. Indeed the Central bank should itself put deed to its words and set the example by making the organisation more efficient.

It is almost unbelievable that during 2002, when bank regulation was migrating from the Central Bank to the MFSA and when exchange control was being dismantled the Central Bank needed to employ seven trainees economic officers, ten clerks and a part-time gardener taking its workforce to the equivalent of 310 full time employees. The Central Bank of Cyprus, that is also responsible for the entire regulation of a financial sector much larger than ours, employed only 287. The Central Bank of Luxembourg with one of the largest financial centres in Europe employed 208.

The Central Bank should start setting some example about the sort of diet we require to help us join the Euro in good shape rather than force us to join the Euro to take on the discipline which would stifle growth and employment.