Double-decker calamities

The last place the Malta lira needs to be is the political arena. That does not mean the exchange rate should not be discussed in public, and by politicians as well. But it should not be kicked about as yet another political football. Not unless we want to score sacks of own goals and pile fresh agony on us all. In any discussion, reality and the bare technical facts should be kept in constant sight.

The reality is that we are far too small to have an independent currency. The exchange rate of the lira has to relate to its main trading partner or bloc. When we were part of the sterling area, the trade flow was mainly with the United Kingdom. It made sense to keep the lira linked to the pound sterling, even on a one for one basis.

Sense has its limits too. When sterling was devalued in November 1967, the Malta lira too was devalued. The Nationalist government then passed legislation to break the automatic link, but kept the lira on par with the pound. Prime Minister Mintoff began breaking the total link soon after he won office in June, 1971. In time the trade-weighted concept, hitherto theorised about by Hungarian and other economists, was brought into practical play.

Though the exchange rate, still not independent, is based on a basket of currencies, their fraction in the basket was set (weighted) according to trade flows. The concept was then diluted, with additions (of the Swiss franc and the Japanese yen) to keep the lira 'strong'. In time, it became unrealistically strong. The Malta lira formula turned into a static mechanism in a context which is in itself dynamic - the value of the internationally traded currencies changes daily, in fact constantly, according to supply and demand for them.

The strong link to the euro, set at 70 per cent of the 'basket' basis, was a return to the respectable theory that an independent currency had best be linked to that of its main trading partner. Intricate influences come into play, some easily understood, like interest rate differentials and differing efficiency and productivity levels. Also, being totally or extensively linked to one currency forces the dependent currency - in our case, the lira - to follow vagaries that do not necessarily reflect domestic economic conditions.

That is why monetary unions, like the euro zone, require economic convergence. In our case our economy has not converged with that of the EU, though the currency is 70 per cent tied to the euro. Inflation and interest rates demonstrate that. Less evidently, there are productivity levels, and intangibles, like attitudes. In the process according to a Central Bank index covering 25 countries which also allows for the importance of competitor countries in foreign markets, and which measures what is termed as the effective exchange rate, that rate is on an upward trend, both on a nominal as well as a real basis.

More recently, the strong tie with the euro, justified in currency theory, has seen the Malta lira value soar relative to the US dollar, and is rising again against sterling. The dollar falls away merrily, the effect of the horrendous Bush budget deficit mirror-imaged in a yawning and grotesque current account gap.

With these various factors in play, if only because of the exchange rate Malta was bound to lose competitiveness. Rising domestic costs relative to already low cost in our main competitor countries, compounds the loss. Meanwhile the government seems impatient to take Malta fully into the euro zone. If Malta moved in at an overvalued exchange rate the result could be a double-decker calamity.

Small wonder, then, that the exchange rate of the lira in our pocket should come up for discussion. The question is, are we discussing in the right way?

To be continued