Malta 'far from ready' to adopt the euro

A report adopted by the European Commission yesterday says that Malta does not fulfill four out of five convergence criteria that must be met in order to join Europe's single currency system.

Malta has declared it wants to join the euro "at the first possible occasion". However, sources close to the Commission told The Times the report published yesterday clearly indicates that the island's task is very difficult.

Malta is not the only new member state in this situation and is joined by practically all the other new entrants as well as by Sweden.

The report examines whether the member states not opting out of the single currency meet the convergence criteria on price stability, the government budgetary position, exchange rates and interest rates and whether they ensure the compatibility of their legislation with that required for euro membership.

The report concludes that none of the countries examined adheres to all the conditions for adopting the euro at this stage.

Economic and Monetary Affairs Commissioner Joaquin Almunia told a press conference in Brussels that "the Commission concludes that there should be no change in the status of the 11 countries assessed as a 'member state with a derogation'," namely the 10 new member states and Sweden.

He added that satisfying the accession criteria required a huge effort by all the new member states. A lot of progress has been made on the road to convergence but further effort was required, he said.

According to EU rules, the Commission is bound to publish a report once every two years on the progress made by the "member states with a derogation" with respect to the compliance with the euro entry requirements.

The first possible date for entry for a new member state into the euro system is January 2007.

The report says that Malta satisfies only one criterion, that of long-term interest rate convergence, and fails in the other four benchmarks.

Estonia and Slovakia are in the same situation as Malta while Hungary and Poland are in a worse position, satisfying none of the criteria.

Out of the new member states, Lithuania and Slovenia seem to be the most advanced and with the biggest chance of adopting the euro in 2007.

The convergence report gives details about the state of Malta's convergence on every criterion.

It says that as regards Central Bank integration, legislation in Malta, in particular the Central Bank of Malta Act, is not fully compatible with article 109 of the treaty and the European Central Bank Statute.

The average inflation rate in Malta over the 12 months to August 2004 stood at 2.6 per cent and therefore Malta does not fulfill the criterion on price stability.

The general government deficit in Malta was 9.7 per cent of GDP in 2003 and the government debt was 71.1 per cent of GDP. This disqualifies Malta from fulfilling the criterion on the government budgetary position.

Regarding the Maltese lira, which is pegged to a basket of currencies in which the euro has a weighting of 70 per cent, the Commission says Malta does not fulfill the exchange rate criterion.

The only positive criterion Malta adheres to is the convergence of long-term interest rates. The report states that long-term interest rate differentials with the euro area were about 0.4 percentage points in the period January-August 2004.

The Commission concludes that in the light of this assessment there should be no change in the status of Malta as a "member state with a derogation", that is, an EU country which has yet to join the single currency.

Commission sources told The Times that a similar report will be issued in 2006, a year when a decision will be taken on which states will be eligible to join the euro as from 2007. The sources said the next report will be crucial to Malta if it really intended to join "at the first possible occasion".

Central Bank governor Michael Bonello referred to the euro entry criteria when he spoke last week at a conference on the theme Opportunities And Challenges Of The Euro For Business.

He said that since the legal, institutional and operational preparations were on track, the only significant challenge was represented by the Maastricht criteria.

"As for the inflation rate and the long-term interest rates, these have generally been within, or close to, the reference values in recent years.

"As far as ERM II is concerned, the minimal exchange rate movements observed over the past few years suggest that Malta would have kept within a hypothetical ERM II band. The indications are, therefore, that this criterion, too, is achievable. Indeed, this should not be any more difficult than the current task of maintaining a hard peg with a currency basket."

(ERM II (Exchange Rate Mechanism) is the stage prior to joining the euro. During that time the Maltese lira will be fully pegged to the euro with limited variability to the lira/euro exchange rate.)

Mr Bonello said the major outstanding problem was the budget deficit, which is well above the three per cent limit set by the Maastricht criteria, and the debt ratio, which exceeds the 60 per cent reference value.

"The need to curb the deficit is widely acknowledged and is a central objective of the government's convergence programme 2004 - 2007. This is most welcome because progress in the area of fiscal consolidation and structural reforms is desirable not only because of the need to satisfy the Maastricht criteria. It is also required to support the exchange rate as long as Malta continues to pursue a fixed exchange rate regime," Mr Bonello said.

"Progress in this direction is certainly also necessary if we want to have a smooth passage through ERM II. Indeed, the size of the fiscal deficit is a determinant of the degree of exchange rate fixity which a country can afford and thus also has implications for the width of the band which will apply to the Maltese lira in ERM II.

"On the one hand, Malta's successful experience with a peg in terms of price stability, coupled with the importance of exchange rate fixity for a small open economy that is heavily dependent on foreign trade and investment, suggest that it would be desirable if the features of the present exchange rate regime - predictability and stability - were preserved while Malta participates in ERM II.

"On the other hand, the appropriate width of the bands in ERM II is inversely related to the degree of convergence achieved with the euro area but positively related to the size of the fiscal deficit."

Mr Bonello said that whether the continuation of the features of the current regime will remain possible or not, with all the advantages that it brings to the business community, depended on the extent of progress with structural reforms and fiscal consolidation.

"It is, therefore, vital that the reform agenda remains on track. It is in the common interest to ensure that the economy converges faster towards the high levels of efficiency and living standards of the euro area. The business community clearly has an interest in contributing to the achievement of this objective, both by modernising its structures and operational practices so as to be better placed to seize the opportunities and also by participating constructively in national fora such as the MCESD."