Are We On for the Euro

22^nd October 2006

The Malta Independent on Sunday

I tried to look at the Budget for 2007 presented in Parliament last Wednesday as a source of assurance or comfort that we are well on the way to joining the eurozone. After all, the projected date of entry is 1 January 2008 and therefore Budget 2007 is the financial bridge that can get us there in time and in good shape.

Conflicting signals unfortunately emerge from the budget documents. In his speech the Prime Minister, with the Opposition firmly in mind, criticised those who argue that we should not rush into the eurozone before we achieve strong and balanced economic growth. Quite rightly, in my opinion, the Prime Minister points out that joining the eurozone could be a catalyst for achieving such growth and that it is risky for our international reputation and for our ability to attract foreign investment if we start having cold feet at this stage.

Then the Prime Minister made a categorical statement “...with satisfaction I say that today everybody is saying that we are on track (for joining the eurozone in 2008)”. Who is “everybody”? What exactly this everybody is saying we are not told but we are expected to take the Prime Minister’s word for it.

Having been trained in financial analysis and credit assessment, I have a natural inclination not to accept anybody’s word for anything. I have to seek corroboration and evidence to base opinions on an array of evidence from different sources rather than on assertions from partial sources. And as future events cannot be black or white, but with a lot of shades of grey, the opinions I form are quite often flexible and thus can be adjusted to new data as it emerges until the future projected event becomes current and, consequently, definite.

The same had happened to me in the run up to EU membership. Government sources made assertions that Malta would definitely qualify for top objective one funding upon membership and in the first full budget 2007–2013. I challenged these assertions, pointing out that we were too close to the criterion for objective one funding to permit such positive conviction. As it so happened we did eventually actually qualify for such top funding but we were sailing very close to the wind. Paradoxically, the slow growth and downright contraction we had in our economy between 2000 and 2004 actually helped us to qualify, as we stayed within the 75 per cent limit of the average EU GDP. Had we had normal growth during this period, we would not have qualified, but as it turned out we were lucky to be rewarded for our failures.

So I sought corroboration from other budget documents to see what is giving the Prime Minister all this certitude to make such unqualified assertions about our being accepted to join the eurozone as planned. One has to bear in mind that last spring Lithuania was denied entry, which was okayed for Slovenia for January 2007, because Lithuania fell marginally foul of its performance on inflation when benchmarked to the Maastricht criteria for entry into the eurozone. This stipulates that our inflation (measured by a Harmonised Index of Consumer Prices – HCIP– worked out on a 12-month moving average) has to be within 1.5 per cent of the average of the best three performers of the EU25.

The latest measures we have for September 2006 shows that our comparable measure of inflation comes out at 3.2 per cent, whereas the average of the best three, Finland, Poland and Sweden is 1.3 per cent, to which adding 1.5 per cent would put the benchmark at 2.8 per cent.

We are therefore 0.4 per cent out of the benchmark and this is categorically confirmed in the documents accompanying the Budget documents and in other official economic and statistical press releases.

Now the jury will stay out till March 2007 and there may be developments that could help us bridge the gap and come within the benchmark. It depends not only on us but also on the performance of the best three in the EU. In a way this comparison is unfair in our regard. Whereas Finland, Poland and Sweden have alternative and natural sources of energy (coal in the case of Poland and hydro in the case of the Nordic countries), they also have an abundance of free potable water. In Malta we consume expensive imported hydrocarbons not only for our energy needs but also for producing our water through energy-hungry reverse osmosis plants.

But a test is a test and the rules were not bent for Lithuania just a few months back. I wonder what comfort the Prime Minister has to feel so positive about our making the grade in the short time still available to us or, if we do not, that the rules will be interpreted less rigorously in our case.

I agree that it is important to be there on time for the euro. But being a realist I cannot help but question the assertions being made by our politicians when hard economic data is giving different signals, which create doubt about our being considered euro-ready. Doubts are doubts and reality could go either way, but we have a very marginal case and there is no room for unfounded assertions. Over-confidence kills the cat. Thankfully the Governor of the Central Bank was much more guarded recently when questioned in this regard.

Frankly, rather then gratuitous assertions, we need a plan B. We need a political effort to rally support for our case even if we are marginally out of the benchmark on the inflation front. And we have to make the case that our inflation will head down if oil prices keep steady, as we are now close to running a full 12-month cycle with fuel surcharges, so the year-on-year inflation increase should moderate and this would show up with a time lag in the 12-month moving average inflation measure.