Point of View | Wednesday, 08 August 2007

The restructuring of Malta’s economy (part 3)

Adopting the Euro as a means to improve competitiveness

The rate
While the euro will soon be our national currency, it is opportune to remember that as recently as 2004 there were those advocating that the Maltese lira should be devalued to give our economy the necessary boost it required prior to joining ERM II. Devaluation was a measure we were always against as we firmly believed that any short-term gains would be more than offset by the associated costs and consequences.
Upon joining ERM II in 2005 we again heard that the central parity rate was set too high and rumours that devaluation was necessary continued to be heard. The setting of the irrevocable fixed conversion rate between the euro and Maltese lira by the ECOFIN council last week, which I remind you, is the same as the central parity rate we have participated in ERM II for over two years, is proof that this talk about devaluation was pointless. We still managed to reach our goal, maintain stability in our external reserve account and generate employment and growth without taking such a drastic measure that would have resulted in hundreds of millions of euro worth of lost wealth for Maltese asset and currency holders.

Nominal vs. Real Convergence
While we have read and heard a lot about the Maastricht Treaty and the economic convergence criteria, the main focus has always tended to be on nominal convergence, assessed through the stipulated macro-economic benchmarks. However, from the outset we were also committed to achieving real economic convergence with the most advanced and developed countries in the EU.
In fact, while less talked about, Malta would not be joining the euro area if it did not also manifest that it was also on track to reaching a good level of real economic convergence with its European counterparts. The Treaty itself calls for more economic and social cohesion among Member States, by raising the standard of living and quality of life, achieving a high level of employment and social protection, and sustaining growth, which respects the environment.
Perhaps the main achievement lies in the fact that we have invested record amounts in all these three sectors and still managed to bring our deficit down to below the benchmark of three per cent of GDP. This accomplishment was achieved over three budgets, two of which did not introduce a single tax, and one that reduced income tax bands and gave a number of fiscal incentives to further encourage more economic activity.

Participating in the euro area
We often mention the direct benefits of EU membership and those accrued by adopting the euro. However, when doing so we often forget that we also benefit by being part of one of the most successful projects of our time. Thus, our European dimension should not be overlooked.
Europe has contributed to political and economic stability both at home and globally. The EU and, in particular the euro area, has become a stabilising element in the world economy. What has been achieved was unthinkable by many observers 15 to 20 years ago.

The euro is presently in its eighth year and serves as a single currency for over 320 million citizens. The introduction of the euro as a currency on 1 January 1999 was an event of the greatest historical, institutional and economic significance.
The euro area is the third largest economic area in the world in terms of real GDP [15%], after the US [20%] and developing Asia [27%]. The euro area is also one of the most important partners in global trade. And the international use of the euro is growing: nearly one third of all international debt securities are denominated in euro, and the share of the euro in global foreign exchange reserves is around 25%.
If we look at the labour market, the unemployment rate has fallen continuously since mid-2004 from a peak of 8.9% to below 8% more recently. The euro has also improved employment prospects. During the last eight years employment in the euro area increased by more than 12 million people, compared to 3 million people during the preceding eight years.
Economic reforms have been launched in many euro area economies which have seen taxes reduced, increased privatisation and reforms to public pension systems and a renewed focus on growth and employment objectives.
While EMU is a success story with respect to the single monetary policy there is still more that needs to be done in the areas of fiscal policies and structural reforms to fully exploit the benefits of the single market and the euro. The final goal is to increase wealth by enhancing growth and job creation by way of increasing cross-regional trade in a stable macroeconomic environment.
One must also not underestimate the role of the ECB in this process. The ECB created a strategy for the conduct of a single, stability-oriented monetary policy for the entire euro area. In line with its Treaty mandate to maintain price stability, the ECB pursues this strategy so as to keep annual consumer price inflation at rates below, but close to, 2% over the medium term. The process of transition towards the single currency was based upon convergence towards the best performers and not convergence towards an average of the various countries’ performances. As a result, the ECB and the euro inherited the high level of credibility achieved by the most stable national currencies.
It is important to remember that the single currency and the single monetary policy for the euro area are very long-term projects. Many benefits stemming from the single currency are of a structural nature and will become even more obvious over a longer period of time. Moreover, the achievements of the single monetary policy should not be seen in isolation from the broader process of economic integration. The introduction of the euro has helped to consolidate the tremendous gains derived from European economic integration over past decades and will continue to be a key catalyst for further integration. Nowhere is this more apparent than in the financial domain.
Financial integration is of key importance for the conduct of the single monetary policy, as it enhances the smooth and effective transmission of monetary policy impulses throughout the euro area. It is also highly relevant to the Euro system’s task of contributing to safeguarding financial stability and fundamental in promoting the smooth operation of payment systems and the safe and efficient functioning of securities clearing and settlement systems. Finally, it is generally accepted that financial integration fosters financial development and the modernisation of the financial system and, ultimately, contributes to increasing the potential for stronger non-inflationary economic growth.

ADDRESS BY THE HON TONIO FENECH, PARLIAMENTARY SECRETARY IN THE MINISTRY OF FINANCE, DELIVERED AT THE VODAFONE ECONOMIC FORUM HELD AT THE RADISSON SAS BAY POINT HOTEL, ST JULIAN’S ON TUESDAY 17TH JULY 2007