Malta will on Monday embark on the road that would eventually lead to the adoption of the euro, though this would not be possible before two years' time.
The announcement was made in Brussels late last night and confirmed in Malta by the government. The Prime Minister and the governor of the Central Bank are expected to give further details at a press conference early this afternoon.
The European Union said in a statement that "at the request of the Maltese authorities, the ministers of the euro area member states of the EU, the president of the European Central Bank and the ministers and the central bank governors of Denmark, Estonia, Lithuania, Slovenia and Malta have decided, by mutual agreement, following a common procedure involving the European Commission and after consultation of the Economic and Financial Committee, to include the Maltese lira in the Exchange Rate Mechanism II".
The statement said that the central rate of the Maltese lira was set at €1 to 42c9m3 and that the standard fluctuation band of +/- 15 per cent will be observed around the central rate of the lira.
The EU stated that "upon entry into the mechanism, the Maltese lira will be re-pegged to the euro from the current basket arrangement. Moreover, the Maltese authorities have declared that they will maintain the exchange rate of the Maltese lira at the central rate against the euro as a unilateral commitment, thus placing no additional obligations on the ECB.
"The agreement on participation of the Maltese lira in ERM II is based on a firm commitment by the Maltese authorities to pursue sound fiscal policies, including containing current government expenditure and lowering the high debt level, which are essential for preserving macroeconomic stability, containing the current account deficit and ensuring the sustainability of the convergence process.
"The authorities, together with the responsible EU bodies, will closely monitor macroeconomic developments. The Maltese government's medium-term consolidation strategy requires a high degree of budgetary discipline and needs to be implemented decisively. Strict monitoring of budget execution will be required, aimed at a timely detection and correction of slippages."
The statement said: "Continued vigilance will be needed to ensure that wage developments remain in line with productivity growth. The authorities will continue to ensure effective financial supervision. Further structural reforms, aimed at supporting productivity growth and enhancing the economy's flexibility and adaptability, will be implemented in a timely fashion so as to strengthen domestic adjustment mechanisms and safeguard the overall competitiveness of the economy."
The EU concluded that the compulsory intervention points in the exchange rate mechanism would be communicated by the ECB and the Central Bank of Malta, in time for the opening of the foreign exchange markets on Monday.
Malta will be joining the ERM II, together with Cyprus and Latvia.
ERM II serves as a period where the national currencies are locked into a parity rate against the euro and can only move within a +/-15 per cent band around the locked rate for at least two years. After that, member states can adopt the euro provided they also have a budget deficit below three per cent of gross domestic product, a maximum debt to GDP ratio of 60 per cent and inflation and interest rates not much above those in the eurozone.
According to a convergence plan agreed with the EU, Malta should be in line with the euro entry criteria by the end of next year.
Malta's average inflation rate was 2.7 per cent last year, with a similar figure projected for this year. The general government deficit stood at 9.6 per cent of the GDP in 2003 and 5.2 per cent of the GDP last year, and a projected 3.7 per cent for this year. According to projections, the only problem will be that related to the government debt figures which are estimated to stand at 72 per cent of the GDP at the end of this year.
With the entrance into the ERM II mechanism, Malta, Cyprus and Latvia will be joining Estonia, Lithuania and Slovenia which joined the ERM II last year, signifying their intention of adopting the euro by 2006. On the other hand, the four largest new EU members - Poland, Hungary, the Czech Republic and Slovakia - are not expected to join the mechanism this year and are still undecided whether to adopt the euro by the end of the decade, the main reason being the bad state of their government finances.
Malta had its first opportunity to join the ERM II mechanism last year but the government had decided to postpone its decision in order to make more in-depth analyses and give some time for the government finances to be in better shape.
Effectively, the only significant change that will happen on Monday when Malta joins the ERM II mechanism will be a change in the basket of currencies supporting the Maltese lira. At present this basket is made up of a mix of three currencies amounting to 70 per cent euro, 20 per cent sterling and 10 per cent US dollar. As from Monday, this will be 100 per cent euro.
Although the EU rules specify that Malta will have to remain for a minimum of two years in ERM II, there is no limit and the country can decide to take its time before dropping the lira for the euro. At the end of the two-year ERM period, the EU, acting on a request by the Maltese government, will carry out another assessment and if the outcome is positive, the government will be able to decide when to adopt the euro currency.