Two to Go

28^th April 2006

The Malta Independent - Friday Wisdom

The legislature is about to slip by its third anniversary and with two years to go, the next election is on the horizon of any decision being made by our political formations.

This time round, the date of the next elections can be predicted with reasonable accuracy, down to a narrow time envelope.

With the project to join the euro on 1 January 2008, holding an election before such date will bring about instability given that the opposition has expressed itself negatively on the exchange value chosen for converting the Maltese lira into the euro at 42c9 for every euro. The prospect of a change of government before the euro D-Day can stimulate holders of Maltese lira to switch to euro before the elections, causing problems for the level of our foreign reserves and for the sustainability of the chosen conversion rate. This could bring into question the realisation of the whole project to join the euro smoothly and effectively.

Holding the election too much beyond the changeover date, which in any event cannot constitutionally be beyond July 2008, could risk bringing to the surface some unpleasant consequences in inflation terms of the changeover to euro. So I quite realistically expect the next election to be held somewhere between February and May 2008, and hence two years to go.

Quite in line with this reasoning, the changeover to euro was this week the chosen flavour for the endless warfare between our opposing political camps. In particular, the argument was about the impact on the profits of the Central Bank of Malta, up till now an important source of revenue for our government, by the changeover to the euro.

Among technicians, this is no discovery as the subject has been quietly discussed for some time and indeed was addressed by the deputy governor of the Central Bank in a technical briefing for financial operators held last year soon after the decision to join the ERM II mechanism.

One is therefore surprised by the claim made by the opposition that in the briefing it received from the Central Bank about the euro project, such a matter was not addressed at all.

There seems to be all round agreement that given our high level of currency in circulation the change over to euro, all things being equal, will negatively impact the profits of the Central Bank and consequently prejudice an important revenue source for the government. Difference of opinion seems to be about the timing of such impact, whether immediately upon accession to the euro or some time down the road.

Let me try to put in plain layman’s language the reason for such expected negative impact. In Malta we have as at last December Lm520 million worth of cash in coin in circulation, equivalent to Lm1,300 per capita.

In theory, this is meant for transaction purposes, but the size and the composition (a large proportion of this is in Lm20 notes form) indicate clearly that a large part is really cash out of circulation hidden under the mattress for various reasons, not least that its owners are prepared to forego the potential interest they could earn thereon in order to remain anonymous and out of the taxman’s reach.

On this element of cash out of circulation, the Central Bank makes a nice clean profit as it pays no interest on hidden cash while it earns interest on the corresponding foreign reserves backing such cash. Once we join the euro and the hidden Maltese lira, all things being equal, are replaced by hidden euro notes (which coming in maximum denomination of E500 equivalent to about Lm215, makes their stacking under the mattress so much easier) the nice clean profits currently made by the Central Bank of Malta will be transferred to the European System of Central Banks and Malta would be compensated for a normal quota for currency genuinely needed for transaction purposes. This will be much lower than the current per capita quantum of Lm1,300.

Our challenge is to ensure that things do not remain equal and that we promote schemes that could permit the reduction of cash in circulation to a level that truly reflects transaction needs. One way of doing this is to launch a fiscal amnesty scheme offering protection from tax investigations (certainly not from criminal or money laundering offences) to holders of Maltese lira cash who transfer the balances to a medium/long term special government bond, either through payment of a percentage penalty or through the payment of sub-market interest coupon on such bond.

Such bond should not be marketable but should be repaid in graduated annual instalments in order to avoid the grave inflation risk for asset prices that will be caused by currency out of circulation suddenly rushing into circulation.

Such measures have to be well- planned and executed and as there is less than two years for the euro conversion date, it is certainly not too early to do something to protect an important source of government revenue.