Oil prices seen hampering inflation criteria

The hike in international oil prices is making it difficult for the new European Union member states to control inflation, hampering their efforts to converge with the Maastricht criteria required to adopt the euro, Central Bank Governor Michael C. Bonello said yesterday.

Addressing a seminar on the adoption of the euro organised jointly by the Central Bank of Malta and SUERF, the European Money and Finance Forum, Mr Bonello said the EU benchmark which the 10 new members have to meet is influenced by countries that use less oil for their energy needs and which, therefore, have low inflation.

"This argument could also apply to Malta in the future since not only is oil the sole source of electricity generation, but a high proportion of drinking water needs are also met by the transformation of sea water, a process that involves a high consumption of electricity," Mr Bonello said.

The difficulty in controlling inflation in current circumstances was also reflected in the fact that three of the present euro area members exceeded the inflation reference value by an average of one percentage point, Mr Bonello said. New member states have registered rates of inflation between 2002 and 2005 that were around one half those recorded during the preceding four-year period, he added.

A similar argument was put forward in a paper presented by Iulia Traistaru-Siedschlag, from the Economic and Social Research Institute, Dublin, and Jurgen von Hagen, from the University of Bonn, which showed that the Baltic states are trotting ahead while Malta is lagging behind on a number of counts.

Estonia, Hungary, Latvia, Malta and Slovakia violated the critical value for the inflation rate, which was 2.6 per cent in 2005.

Ms Traistaru-Siedschlag said the method with which the inflation rate is calculated is not necessarily a good yardstick.

Entitled Macroeconomic Adjustment In The New EU Member States, her paper argues that since the enlarged EU has many more small open economies the method of setting the critical value for the inflation rate used to admit countries into the European Monetary Union is not a good yardstick.

The critical value for the inflation rate is presently based on the average of the three lowest inflation rates in the EU - Sweden, Finland and Denmark - plus 1.5 per cent. But since new member states have to cope with the euro area's inflation rate, the most sensible thing to do would be to change the inflation criterion to 1.5 per cent above the euro area rate of inflation, the paper contends.

"This would raise the critical rate to 3.8 per cent in 2005, and allow Malta, Slovakia and Hungary to pass."

According to the same study, new member states have already achieved a substantial degree of nominal convergence on the basis of the five Maastricht criteria - low inflation, low nominal interest rates, stable exchange rates, stable exchange rates against the euro, and the compliance with two reference values for general government debt and deficits relative to GDP.

When it comes to real GDP per capita growth between 2001 and 2005, the Baltic countries achieved a growth rate of seven to eight per cent. Overall, new member states achieved a growth rate in the region of four to five per cent. Only Malta had a negative growth over the five-year span.