Money walks

The Malta lira is overvalued. Exporters say so. The Central Bank currency index confirms it. Should Malta adopt the euro at an overvalued rate, gains would be more than offset by negative effects. That worry is at least three years down the road. If, meanwhile, things do not improve and we do not become more competitive, through a combination that must include various factors, events may take their own course. Money does not only talk.

It also walks. So, what is to be done? Had we stayed outside the EU we would still have had to ponder on how to regain competitiveness. So, should the Malta lira be devalued? That is the traditional measure used to claw back competitiveness. But, as those who recommend it acknowledge, it will work no miracle on its own.

For devaluation to have a positive impact, three conditions are necessary. The economy must not be overly dependent on imports. It must have spare capacity, for which read underutilised or idle human and capital resources. And, though prices of imports will rise immediately, wages must not rise rapidly in compensation, thereby eradicating the competitive margin gained by producers.

We do have spare capacity. But Malta is heavily dependent on imports. Meaning that for devaluation to work somewhat those who will be negatively affected by the resulting rise in the cost of living would have to be all the more ready to tighten up for as long as can be. That is not possible as things stand. Higher prices feed into the statutory cost of living increase.

This Lm1.75 COLA for 2005, while not enough to restore consumers' purchasing power to the 2003 level, intensifies the worries of exporters who, as the export index is now revealing, are facing falling prices for their output. If a devaluation automatically raised wages and salaries, the exercise would be futile. Even if there is a reasonable bargain for wages and salaries to 'pause', the effect until the pause ends is unlikely to be enough, on its own.

Should, then, the Central Bank administer the exchange rate to nudge it down gradually? If the exchange rate was not 'pegged' to a major currency, or set at a given level, but was allowed to 'float', the market would 'wash out' overvaluation. In fact if our current account of the balance of payments remains in deficit, it would do more than that.

Some purists say that once you peg to a basket of currencies, you cannot 'administer' the rate. Purists and the demands of reality do not make good bedfellows. The dictates of realism tend to be very strong. Central banks whose governments were, or are, leading their country towards the euro zone would warn them that the exchange rate must not be overvalued to the point of locking in permanently.

They would do so quietly, far from the excitable crowd. Policy considerations are discussed in private. I have no means of knowing what the central Bank had been telling the Minister of Finance before the current polemic. But, once the Opposition leader proposed a gradual depreciation of the Malta lira, the government's position against any action hardened. Politics is now the issue.

Rather, the issue should become - how best to answer the question, What is to be done? The Opposition leader initially held out the queer prospect of a gradual depreciation without inflationary consequences. Now he says that the downward adjustment he proposes in the value of the lira should be done gradually within a reasonable timeframe that would cater for effects on the cost of living (The Times, December 2).

As with devaluation, even this more realistic premise cannot stand on its own. The gradual inflationary effect - a steady addition to underlying prices - of a gradual depreciation would still feed into the statutory cost of living increase, even if the unions did not demand earlier compensation. Any gain from a reduced exchange rate value would be dissipated.

Whatever action is taken - whether clean depreciation, or administered depreciation - it would not have meaningful effect without a pact with the unions premised on the reality of urgent need and the prospect of eventual gain. That would still leave the social aspect to be catered for, particularly the effect on those who live close to or at the margin, like most pensioners and social assistance beneficiaries.

To conclude: the discussion on the real state and prospects of the economy and on competitiveness has to include the exchange rate, provided it is not used as a political football, scaring away capital, now that it can move freely. But it has to range far wider and go much more deeply than that mechanism.

Concluded