Premature Exuberance

12^th October 2007
The Malta Independent - Friday Wisdom

As we enter the final stretch towards D-day for the adoption of the euro, I cannot help noticing a measure of premature exuberance, celebrating an achievement which has not yet been achieved and risking slip ups through over-confidence at the most crucial time of execution.

It is as if Italy started celebrating winning the FIFA World Cup 2006 two months before the event when they beat Holland 4-1 in a friendly encounter.

The euro adoption project does not consist solely or primarily of the administrative steps needed for its adoption. Indeed in the long run of things this will be a relatively minor part of the project.

This is not to say that the National Euro Changeover Committee has not done an excellent job in administering efficiently the change over process. The praise they have been showered with even from foreign authoritative sources is well deserved. Their job has been facilitated by the political consensus that has surrounded the project. This has permitted the NECC to brand it with a national imprint so necessary to obtain acceptance and cooperation from a very wide cross-section of the population.

But we should not deceive ourselves into believing that this is what the adoption of the euro is all about, and that the good work of the NECC is enough to guarantee the success of the project.

The real success or otherwise of the euro project can only be assessed and measured a posteriori after the actual adoption. There will be two tests that have yet to be overcome. The first one is to ensure that the changeover will not bring about any noticeable increase in prices, neither of a one-event nature and certainly not a spiral of price increases feeding on itself.

I don’t think that enough is being done to ensure that from an inflation point of view the NECC will live up to its motto that only the currency is changing but the underlying prices should remain, all things being equal, the same as if no currency changeover has happened. In a few words if a product was being sold at LM1 before the changeover it will be sold at EUR2.33 after the changeover and there will be no rounding up to 2.35, 2.40 or 2.50.

What else can be done in this regard? We need an intensive educational process of managing expectations of price stability. The consumer has to be trained to challenge price increases caused by the rounding off effect from currency changeover. The anchoring of such no price increase expectations has to be very deeply ingrained in the consumers. In business, merchants sell their products and services for the highest price consumers can take. If merchants perceive any readiness on the part of consumers to accept price increases due to the rounding effect of the currency changeover, rest assured that they will use this pricing power to the detriment of the consumer.

Next Monday is budget day. It is tempting for the government facing an election that will probably be held within two months after euro adoption, to score some political points by offering a financial one-off reward in advance for any price increases resulting from the changeover. What’s more effective to sway voters’ opinions than sending them a cheque in the post during an election campaign?

This will go diametrically opposed to the need to anchor expectations of no price increases and will practically give a license to merchants to round up prices on changeover.

I don’t agree with muted suggestions about imposing temporary price freeze. Apart from the extreme difficulty of policing such price freeze, the price increases will at best be postponed and not avoided. What is needed is correct and easily available information which consumers can use to their advantages in policing directly unjustified price increases. The voluntary price freeze agreements being signed with private sector operators are good and welcome in so far as they go. But who is going to ensure that they are honoured where it matters ie, at the retail end to the delivery chain?

In days of ICT revolution, it should be fairly easy to enforce dissemination of information by forcing retailers, wholesalers and importers to file an official price list with the NECC or Consumer Affairs office at the end of each month between October 2007 and March 2008. This information should be pasted up an on appropriate website where consumers can search by VAT Registration number shown on their fiscal receipt to know whether prices are being unfairly rounded up or indeed increased beforehand in anticipation of the currency changeover. Information is the best tool for consumers to protect themselves from price exploitation.

In the longer term, the success of the euro project will be measured by how much our economy remains competitive to export to the rest of the world and to attract foreign direct investment. Before we joined the ERM mechanism in May 2005, I had argued that we could suffer from loss of competitiveness by locking in at a rate which I perceived as fundamentally overvalued. Once the decision to lock in at just under 43 cents per euro was made I rested my case and worked for competitiveness to be achieved by restructuring in the real economy.

Two and a half years later and just on the D-day threshold, I am pleasantly surprised that our competitiveness has not suffered and that restructuring kept pace. There is no doubt that the euro project itself served as a catalyst for acceptance of an accelerated pace of re-structuring, but we should also thank our lucky stars that the world economy has been experiencing a very glamorous period of economic growth, not perceived likely in May 2005, which has eased the pain of restructuring and helped us to regain competitiveness without resorting to exchange rate adjustments.

The restructuring cannot be considered as having reached its destination on Euro D – day. It must continue relentlessly if we are to keep winning in a competitive world. With very limited or no room for manoeuvre in the monetary, exchange rate and fiscal policies, the restructuring has to be made in the real economy, where after all it is most effective.

This is no time for irrational or premature exuberance. It is time to focus more determinedly to the need to achieve a smooth price changeover without any inflationary impulses and to ensure that euro adoption will continue to be catalyst for accelerating the pace of restructuring.