Euro given more weight in lira basket of currencies

In a bid to better reflect both present and future trends in Malta's external trade, the monetary authorities yesterday decided to upgrade the weight of the euro in the Maltese lira basket from 56.8 per cent to 70 per cent.

"The euro's increased weight in the Maltese lira basket will help to attenuate fluctuations in the exchange rate of the lira against the euro and, thus, have a beneficial impact on trade between Malta and its European partners and on domestic price levels," the Central Bank said in announcing the decision which became effective yesterday.

The weighting of the component currencies in the lira basket was last changed on January 4, 1999.

The Central Bank recalled yesterday it had been the declared objective of the monetary authorities over the years to pursue exchange rate stability by pegging the Maltese lira to a basket of currencies of the country's major trading partners.

"The experience of the past 30 years has shown that this fixed exchange rate arrangement has achieved credibility and the stability the Maltese lira has enjoyed as a result has indeed been an important factor underpinning the country's economic development and its attractiveness as an investment location," it explained.

The fixed exchange rate also served as an appropriate nominal anchor for monetary policy, contributing significantly to the Central Bank's objective of achieving price stability. In support of this strategy, the monetary authorities constantly monitored the effectiveness of the exchange rate arrangement while seeking to ensure that the basket adequately reflected developments in Malta's external trade patterns in goods and services.

"Consistently with this approach, this latest review is aimed at updating the weights of the three currency components of the basket - the euro, the US dollar and the pound sterling - so that these reflect more closely current trends in Malta's external trade. In allocating new weights to the currency components, the authorities have also taken into consideration likely future developments in external trade. These considerations are reflected in a larger weight being allocated to the euro, which besides being the currency of many of Malta's leading trading partners, is also assuming a major role as an international reserve currency," the Central Bank said.

As a result of this latest decision the euro now has a weighting of 70 per cent in the Maltese lira basket, up from 56.8 per cent, as against 20 per cent in the case of the sterling - down from 21.6 per cent - and 10 for the US dollar - down from 21.6 per cent .

The Central Bank also explained that the revised weights were applied to the current value of the Maltese lira to derive the new currency portions of the basket currencies. These were then translated into the respective currency equivalents at the cross rates for the currencies quoted in major foreign exchange markets early yesterday morning. Henceforth, the new fixed currency portions will serve as the basis for deriving the daily exchange rate of the Maltese lira. The new portions are: the euro - 1.6937 (from 1.2793); the sterling - 0.3084 (0.3462) and the dollar - 0.2341 (0.5777).

Finally, the Central Bank also felt it had to underscore the fact that the review in the currency weights did not involve a change in the value of the Maltese lira. "The new portions are in fact derived on the basis of the value of the lira as calculated under the previous basket weights," it said.

This latest move should not come as a complete surprise. In fact, addressing the annual dinner of the Chartered Institute of Bankers last November, Central Bank governor Michael C. Bonello had said the Central Bank was actively considering the possibility of increasing the weight of the euro in the basket while reducing that of the other components, particularly the dollar.

Mr Bonello had termed such a move as "a logical step forward" given the two existing scenarios with regard to Malta's future relations with the European Union.

The first scenario, based on the premise of EU membership, implied a commitment to participate in EMU and, therefore, to adopt the euro as the national currency, Mr Bonello had said, adding that the exchange rate regime would, therefore, have to evolve towards the establishment of a full link to the euro.

In considering the second scenario, based on the premise that Malta does not join the EU, the governor had said that the overall exchange rate strategy would not necessarily need to differ substantially from the one currently prevailing. Since the alternative policy to membership also appeared to emphasise a close economic relationship with the EU, through the establishment of an industrial free trade area, this could also imply a heavier weight for the euro in the Maltese lira currency basket, Mr Bonello had argued.

The move was also recommended by experts of the International Monetary Fund on their latest mission to Malta earlier this year, sources close to the financial authorities said.

The Labour Party's spokesman for the economy and finance, Leo Brincat expressed concern about the reduced weighting of the dollar.

He said that as Malta purchased oil and grain in dollars, the new weighting would result in greater fluctuations against the dollar, especially given the liberalisation of oil purchases.

He said the euro was also being given more weight at a time when it was relatively strong compared to some months ago.

"There is a risk that we will lose our competitivity in foreign trade with countries both in Europe and outside the eurozone," he said.

"It is clear the government is more influenced by a strategic decision to bring the Maltese lira close to the euro rather than by the country's international trade. On the other hand, if one were to accept the Central Bank's reasoning, this indicates that the government is truly worried by the reduction in exports and by the rhythm of trade in the country," Mr Brincat added.