Fear of treading

Malta's decision to join the Exchange Rate Mechanism (ERM II) has been described by Opposition Leader Alfred Sant as a case of fools rushing in where angels fear to tread. Surprisingly, he said nothing regarding the rate of exchange that has been agreed upon - €2.33 for every Lm - something about which former Agriculture Minister Noel Farrugia, now a prominent member of the Labour front bench, should have been very happy about. What else could he be, considering that over the last two years or so he has been predicting that on adoption of the euro, the Maltese currency will be valued at €1.80/1.60 with disastrous consequences?

The Maltese lira will now maintain a stable level against the euro at the agreed rate for a minimum period of two years, with January 1, 2008 being the earliest date when we can switch to the euro - provided other conditions are met, of course. Whatever Dr Sant says, there is no reason why the established parity cannot be maintained, more so as Malta has a high level of external assets to support its currency. Up to the time of joining ERM II, Malta's foreign currency reserves were already 70% in the euro as compared to 51% some three years ago.

Perhaps it is relevant to mention that the Central Bank's prudent investment policy has ensured that Malta's foreign currency reserves have benefited from the Euro appreciation over the last years. Accordingly, it would have been a disaster - as anybody can surmise - had the bulk of our currency reserves been invested in dollar assets given the sharp fall of the US currency during the same time.

This is in dramatic contrast to what happened in the mid-Eighties when under a Labour Government led by Karmenu Mifsud Bonnici, the then already-retired Prime Minister, Dom Mintoff, took over the management of the country's external reserves. In that period, Mr Mintoff put excessive faith in the dollar, in spite of the fact that all authoritative financial opinion was pointing towards a massive devaluation.

Mr Mintoff decided to ignore this advice, and rely on the historic trend of the dollar going strong in a US Presidential election year. He therefore continued to pile Malta's foreign reserves into the dollar. The result was that he was caught exposed in the Reagan dollar devaluation and this cost Malta a loss in external reserves of about Lm88 million in practically a few days. The Ministry of Finance then obligingly covered up this unmitigated financial disaster by revaluing the Central Bank's gold holdings that had been acquired at a relatively low price by the Borg Oliver government in the late Sixties when the Central Bank was set up.

If there was ever a case of fools rushing in, this was it!

It is obvious that the responsible investment policies of the Central Bank are the very antithesis of Mintoff's dollar policy of that time. Malta's entry in ERM II is not the mere operation of chance but the reward for proper analysis and decision taking by the monetary authorities to ensure that our external reserves are prudently managed and diversified.

The country's external reserves today amount to some Lm800 million and these are almost all held in convertible currencies. This is more than sufficient to back the holdings of Maltese currency notes and coin in circulation. In a future scenario, I would assume that it would be possible for a high proportion of these reserves to be released in order to support other beneficial economic activities in Malta including real investment and possibly portfolio investment requirements of collective investment schemes such as pension funds. I say this on the presumption that Malta will have to contribute only a small portion of its external reserves to the European Central Bank once the euro replaces the Maltese lira as our currency.

Rather than criticising for criticism's sake, Dr Sant should have had the decency to acknowledge that Malta's success over the last 18 years in establishing a market-based economy and its prospective adoption of the euro contrast sharply with the bitter experience of the Seventies and early Eighties. It would be folly therefore to forget the lessons of those volatile years.

One cannot, for example, forget and ignore the experience of the Maltese brand of socialism that tried to manage the Maltese economy by imposing far-reaching controls on all sectors of the economy. These extended from inflexible import controls that led to frustrating the population by force-feeding them import substitution, to other extreme controls in the movement of capital.

The result was a shrinking and stagnant economy as capital controls lead inevitably to inefficient use of capital. This translated into massive liquidity in the banking system and an interest rate that did not reflect international market forces, but only the misguided interests of an excessively controlled economy.

The MLP's record in this area is as disastrous as their policies in the education sector. The fools were the people who were led into the socialist 'heaven' that never was. Perhaps, those who have experienced this type of foolishness are more susceptible to suffering from 'fear of treading'!

As we prepare for the challenges of the future, we should understand fully the benefits of Malta's participation in the single currency. It will ensure price transparency, price stability, the removal of exchange costs and commissions, payment efficiency and - most of all - low and stable interest rates that will reflect the European Central Bank policy of keeping inflation as low as possible.

micfal@maltanet.net