Malta’s longest serving Central Bank Governor calls it a day

Outgoing Central Bank Governor Michael Bonello speaks to Anthony Manduca about the changes he has witnessed in Malta and the EU, Malta’s euro adoption, the eurozone crisis and lessons for Malta’s policy makers.

Michael Bonello steps down today after 12 years at the helm of the Central Bank, making him Malta’s longest serving Governor. He describes his period in office as one of “significant and rapid change”.

“At a global level we have experienced the impressive rise of the emerging economies, epitomised by China overtaking Japan as the second-largest economy; the intensification of the integration process, which has proved wrong those who argued that emerging market economies had decoupled from the advanced economies; and the most severe economic and financial crisis since the Great Depression,” he tells The Times Business in an interview.

Mr Bonello has seen the European Union expand from 15 to 27 countries, becoming the world’s largest economic bloc, and the introduction of the euro, which was launched in 1999 and has become the national currency of more than 330 million people in 17 countries.

“Monetary union was not accompanied by the required degree of economic integration and the fiscal rules were largely disregarded such that debt levels rose dangerously to the point that we now have an acute sovereign debt crisis,” he warns.

He describes the period since 1999 for Malta as being “one of generally rising living standards and increased social cohesion against the background of an economy which responded to the competitiveness challenge posed by globalisation by investing in high value-added activities and becoming more services-oriented.”

He points out, however, that incomes did not grow as fast as in the EU on average, and “Malta’s economic growth has been accompanied by persistent fiscal imbalances”.

He says EU membership and the adoption of the euro were undoubtedly the main drivers of change at the Central Bank of Malta.

“In the run-up to EU membership our staff was involved in incorporating EU directives relating to banking into domestic legislation, creating a legislative framework for payment systems and launching the first formal payment system in Malta compliant with international standards,” he says.

Mr Bonello points to other major projects carried out by the Central Bank prior to EU accession including the liberalisation of capital controls, one of the four fundamental freedoms of the EU; the alignment of statistical definitions, standards and methodologies to those used by Eurostat; and the creation of a Financial Stability Department.

After EU membership, he says, a change process was initiated to ensure that the Bank would have the technical expertise, organisational structures and technological platforms necessary to join the eurosystem.

“On the policy level, protecting the Maltese lira exchange rate through our monetary policy decisions in the absence of exchange controls was equally challenging,” he adds. Mr Bonello says the Central Bank was very actively involved in Malta’s EU membership process particularly in the negotiations on the chapters concerning the freedom of movement of services, capital and Economic and Monetary Union (EMU).

“The implementation of the freedom of movement of capital was a major challenge. The Bank advised the government on the sequencing and timing of the lifting of exchange controls in a way that avoided sudden capital outflows that would have destabilised the Maltese lira. The Bank was also instrumental in helping the government argue successfully for a permanent derogation on the acquisition of second properties by foreigners. We also kept close contact with the commercial banks and the Malta Stock Exchange,” he explains.

Mr Bonello says the Central Bank’s studies confirmed the benefits of early euro adoption for a small open economy like Malta’s with a fixed exchange rate.

“We argued that the single currency would bring benefits in terms of price transparency, lower transaction costs in exchanging currencies, lower interest rates, a reduced need to hold foreign exchange reserves and the removal of exchange rate uncertainty.”

Once the government bought into this argument, he says, a major task for the Bank was to determine the central parity rate of the Maltese lira against the euro upon entry in ERM II, because estimating the equilibrium exchange rate is always subject to a degree of uncertainty.

“We conducted various studies with the help of independent experts, which showed that there was no significant misalignments in the value of the Maltese lira. So we entered ERM II at the prevailing rate against the euro.

“With capital controls completely lifted, maintaining the value of the lira at this rate was another critical task. The Bank had to act judiciously to avoid excessive pressures on the exchange rate when setting interest rates. The fact that the government pursued a credible fiscal consolidation programme was helpful in maintaining confidence in the currency. The record shows that we came through the two-year ERM II period without any pressures,” he adds.

Another challenge, he points out, was the physical changeover to the euro. Soon after the confirmation of the euro adoption date, the Bank set its plans in motion, starting with the minting of the Maltese euro coins. It also provided training for cash handlers, especially on the security features, and together with the European Central Bank launched a joint communications campaign.

“As it turned out, Malta’s changeover was smooth and was widely regarded as a model exercise,” he says with a sense of pride.

Did he believe there are better times ahead for the euro considering the period of great stress the single currency is experiencing?

“The global financial crisis and the subsequent recession have exposed weaknesses both within some euro area countries and in the overall framework of EMU. The stress in these countries derives from a number of factors, alone or in combination, such as losses in competitiveness, largely reflecting an excessive rise in unit labour costs, persistent fiscal imbalances and excessive risk taking in the financial sector.

“From a euro area perspective the crisis has shown that the viability of a monetary union without a political union depends critically on a high degree of co-ordination of macroeconomic policies and fiscally responsible behaviour by individual governments. This has been lacking to the point that the rules and sanctions of the Stability and Growth Pact were actually weakened in 2005. The Governing Council of the ECB had then warned that sound fiscal policies and a monetary policy geared to price stability were fundamental for the success of a monetary union. We are now reaping the fruits of those mistakes,” he says.

However, Mr Bonello says there “will be better times ahead”, but that imbalances accumulated over decades cannot be redressed in the short term.

“That is why it is a pity that it is taking so long for governments to acknowledge that there is a superior interest involved that transcends other, often purely national, interests. Inaction, and the uncertainty it generates, compounded by the procyclical decisions of some financial market players, have already caused much destruction of wealth and confidence, making a difficult situation worse.

“That explains why the Governing Council insists that any solution to the sovereign debt crisis in Greece should not involve any form of debt rescheduling that could result in a default. There is a common interest in avoiding any action that would spread contagion and put financial stability at risk.”

As the eurozone’s crisis continues Mr Bonello says that Malta should not lose sight of its ultimate goal, which is to attain the higher living standards enjoyed by other EU member states. Although Malta’s GDP per capita in purchasing power standards has risen from about 70 per cent of the euro area average in 2004 to almost 75 per cent, Malta could and should have done better, as others have, he insists.

“This can only happen if productivity increases at a faster rate than in our euro area partners. Over the past decade, growth in unit labour costs in Malta has outstripped that of the euro area, and our higher costs are not justified by the productivity growth differential between the two economies. This implies that our policy focus needs to be uniquely on improving Malta’s international competitiveness through measures that enhance productivity.”

He adds: “Fiscal consolidation is also of the essence to enhance competitiveness, especially if the strategy is based, as it should be, on expenditure restraint rather than higher taxation. There is a clear need to reassess social welfare programmes, most notably in respect of health, education and old-age expenditure, to ensure their sustainability, reduce waste and to target them to those who are most in need. The Greek crisis is a stark reminder of the harsh consequences of fiscal profligacy and living beyond one’s means.”

He says he “fully subscribes” to the policy recommendations made recently by the European Commission to the government, and three in particular: to adopt concrete measures to meet the 2012 deficit target and to embed fiscal targets in a binding, rule-based multi-annual fiscal framework and improve the monitoring of budgetary execution; to progressively increase the retirement age by linking it to life expectancy and to encourage private pension savings schemes; and to reform the automatic wage indexation mechanism such that wage growth better reflects developments in labour productivity and competitiveness.

Asked to elaborate on his recent proposal for the establishment of an independent agency to monitor government spending, he replies:

“As I have just mentioned, the Commission has since made a recommendation that is motivated by the same concerns as mine. The point is that a lax fiscal policy over a long period of time leads to bad practices that give rise to a lack of transparency, waste and the accumulation of high levels of debt. In order to address the populist bias towards deficit spending in modern political systems, a number of countries have created independent fiscal councils.

“Typically, their role is give policy advice, evaluate fiscal targets and produce fiscal forecasts. In Sweden, for example, the remit is broad enough to include an assessment of the motivations and financial consequences of government policy. So there are different ways of going about it.”

Mr Bonello first worked for the Central Bank of Malta between 1971 to 1978 and a few years later he joined UNCTAD, the United Nations Conference on Trade and Development in Geneva. He says he never imagined he would ever return to the Central Bank but his work on developing countries with UNCTAD confirmed his conviction that in a globalised world, small open economies stood a better chance of growing if they belonged to a regional integration grouping.

“So when I unexpectedly received an offer to head the Bank in 1999, soon after Malta had reactivated its application to join the EU, I saw this as a challenge I could not walk away from.”

He explains: “The past 12 years have indeed been a source of great satisfaction. I am proud to have contributed to Malta’s successful journey to EU membership in 2004 and to the euro less than four years later. I have tried to assert the Bank’s credibility and independence by providing objective economic analyses and policy advice. My Board of Directors, my management colleagues and all the staff have joined me in embarking on a major project to transform the Bank into a fully functional member of the eurosystem.”

Mr Bonello says in the process the Bank has become a primarily analytical and knowledge-based institution with a clear focus on its eurosystem responsibilities.

“This did not just happen of course. The Bank offers various learning opportunities. Since 1999 about 140 staff members have obtained first degrees or diplomas while another 76 have obtained post-graduate qualifications. Today, 51 per cent of the staff have at least a first degree. And over the past 12 years, some 25 staff members benefitted from work attachments with the ECB, other central banks or the European Commission.”

He points out that today, the officials of what is possibly the smallest central bank in the EU contribute to the work of 16 committees and some 77 working groups and task forces of the European System of Central Banks. They also participate in 13 Commission bodies, in the European Banking Authority and in three sub-structures of the European Systemic Risk Board. All in all some 80 staff members are upholding the Bank’s name abroad while adding to their own expertise, he emphasises.

He adds: “I am also pleased that the gender profile of the Bank has improved. The share of female employees has gone from 33 per cent in 1999 to almost 40 per cent, which is by far higher than the national average. Furthermore, females account for 17 per cent of senior management positions. And during my tenure, the Bank has had its first ever female board members.”

He describes his work in the Governing Council of the European Central Bank as “the highlight” of his career.

“It has been intellectually challenging and rewarding. Under the enlightened leadership of President Jean Claude Trichet, the Council has successfully delivered upon its price stability mandate, acting with full independence as the guardian of the common currency of the second-largest economy in the world.

“I have come to appreciate more the importance of consensus building and compromise, of intellectual integrity and consistency, and of camaraderie, especially at times of acute tensions. I feel privileged to have been a member of the Council.”

He says that after 41 years, 21 of which in the service of the Central Bank of Malta, he would now like to work at a slower pace and spend more time with the family.

“At the same time I would like to put my expertise as an economist and a central banker to practical use and to remain somehow close to the Maltese economy.”

What advice does he have for his successor, Josef Bonnici?

“Every Governor interprets his role in his own way. The job does not come with a manual, except of course for the Treaty and the other relevant legislation. So I would limit myself to mentioning three aspects of my own experience.

“First, upon taking office I found it useful to listen and observe, I tried to understand the Bank and its role at the time, before attempting to identify the challenges ahead and how to tackle them. In devising strategies and policies to respond to these challenges, I relied heavily on my Deputy Governor, who had been at the Bank since its birth, and I adopted a collegiate approach to decision-making with my senior colleagues.

“Second, I took a firm stand in defending the Bank’s independence, as required by the Treaty and our own Central Bank of Malta Act, while increasing its accountability through the creation of an Audit Committee; expanding considerably the explanatory information supporting the Bank’s annual accounts; and reporting regularly to Parliament.

“Third, upon Malta’s accession to the EU, and more so since we adopted the euro, I hoped that a structured and regular exchange of views would take place with the Ministry of Finance on matters of common and national interest. After all, under the Central Bank of Malta Act, the Bank is required to be an advisor to the government. My expectations in this regard, however, have not been entirely met, especially during the past three years of financial crisis. I still think such a dialogue is important,” he says diplomatically but firmly.

Profile: Michael Bonello

1965: BA Languages and Economics, University of Malta.
1969: Honours degree in Philosophy, Politics and Economics, Oxford University.
1973: MA, Oxford University.
1971 – 1978: Senior Research Officer, Central Bank of Malta.
1978 – 1983: Worked in private sector in Malta.
1983 – 1999: Senior official at UNCTAD, Geneva.
1999 – 2011: Governor, Central Bank of Malta.