The thorny euro question

After becoming a fully-fledged member of the European Union almost a year ago, Malta's next important step is to join the European single currency, the euro. Extreme caution and prudence need to be exercised here, because once the fixed conversion rate is established it cannot be altered. The timing of joining and determining the exact value of the Maltese lira against the euro is therefore of fundamental significance. Both tasks are really difficult to undertake.

The way the original six EU founder member states have tackled the European drive towards unity provides a clear example. Unlike the Zollverein, when the separate German states in the 19th century were united in all spheres of activity - political, cultural, legal and economic in a relatively short time - the present EU has taken half a century to evolve so far, and the venture is not yet concluded. The major characteristic underlying EU's convergence has been to let time mature the measures introduced so that expansion and its beneficial effects are never jeopardised.

The euro's introduction is a case in point. The European Commission had in mind to introduce a single currency; its problem was the name to be given to it. At first its intention was to call it the ecu (European Currency Unit) that was made up of a basket of European currencies. But the Commission had second thoughts about this name. It preferred to call the single currency the euro. Three years before the official launching of this currency it established its official name.

Legally, the euro was introduced on January 1, 1999; however, another three years were allowed for all national currencies to be completely replaced by the euro that was based on a fixed conversion rate between it and each EU member's currency. Thus on January 1, 2002, all national currencies of the states forming part of the Eurozone disappeared from circulation.

Another important precaution that the European Commission took before the establishment of the euro was the introduction of the Exchange Rate Mechanism, commonly known as ERM. This has the function of linking together all the currencies on which the euro is based.

Within the ERM, each individual currency had to follow a central rate against every other currency. Up to 1992 the fluctuation bands were in the region of +/-2.25%. As these bands were considered too narrow to contain prevalent currency problems, they were widened to +/-15% in 1993. To manage the euro the European Central Bank came into being on June 1, 1998, with Wim Duisenberg, a Dutchman, as its first president - seven months before the official launching of the euro.

Joining the euro was, and still is, not simply a political decision; it has a vast array of economic considerations. To avoid the possibility of economic problems in one EU country causing havoc in another, the European Commission established five convergence criteria for joining the euro. The most familiar ones are that the government's deficit must not exceed 3% of the country's GDP and that the national accumulated debt must not exceed 60% of GDP.

Members countries who break these rules are heavily fined. However, before punishment is meted out, the EU considers whether the 3% of GDP limited has been exceeded by a small or temporary margin and whether government investment levels in case of the 60% of GDP are better than debt rates.

The other criteria are related to inflation, bond yield and exchange rate stability.

Firstly, the average inflation rate must not exceed 1.5% over the three lowest inflation countries during the year previous to the one when the application for joining the Eurozone is submitted.

Secondly, for two years before the application date, the average yield on long-term government bonds must not exceed 2% on government bonds of the three lowest inflation countries.

Thirdly, for two years before the application date, the country filing the application to join the euro, must not have its currency experiencing a wider fluctuation than that contemplated in the ERM and must not have devalued its currency.

Of the 15 countries that were members of the EU on January 1, 1999, only Denmark and the UK did not join the euro - a facility that was negotiated by each country and was included in the final Maastricht Treaty. A third EU member, Greece, was excluded because it failed to meet the convergence criteria. But following restructuring within the Greek economy, it was admitted to Euroland on January 1, 2001.

There must be considerable advantages to join the euro as only two countries have decided to opt out. The most telling benefit is that which derives from exchange rate stability. With a single currency there will be no more currency fluctuations that sometimes cause worries and costs.

Thus policymakers shoulder a tremendous responsibility when they come to fix the conversion rate. It can neither be too high nor too low; mistakes in either are conducive to the national economy being heavily penalised.

The true value of the Malta lira has to be clearly and unmistakably established before joining the ERM, the first step for joining the euro. One has to question the correctness of the present weighting and whether it is advisable to ignore the black economy that is presumed to exist.

Furthermore, since Malta is the most open and smallest economy within the EU, the impact the fixed conversion rate of the Maltese lira with the euro will have on exports, imports and services must be given extremely serious consideration. One has to keep in mind that there is no turning back after joining the euro.

Moreover, with the euro, no conversion costs will be incurred when transacting dealings with EU countries; on the contrary, substantial savings will be made in this respect. In addition, with a single currency, greater efficiency and wider economies of scale will result. Consumers benefit with a better price transparency.

Allowances, however, should be made in respect of different tax regimes and other incidental expenses on the volume of trade.

Finally, there should be greater access to all EU financial markets, benefiting investors, companies, corporate bodies and making it possible to have a wider range of financial products.

Looking at the other side of the euro coin, some disadvantages can also be discerned. Changeover costs may be substantial. But Malta may not be so hard hit in this respect because it can certainly learn from the experience of other countries.

What is important is that Government is already preparing the people to get used to the euro currency. A greater disadvantage is that relative prices may increase because of rounding up. It is also possible that the business sector will attempt to profit from people's ignorance.

But the focus of criticism is that of having one European Central Bank setting interest rate levels to all members irrespective of different economic growth rates, the one-size-fits-all approach. As devaluation (or appreciation for that matter) cannot be considered, each EU country has to manage its internal economy solely with fiscal measures. But this policy tool has been widely discredited as it may be misused on account of governments' tendency to have a greater share of the national economy.

It is still so very early to conclude that this disadvantage outweighs the many benefits that may accrue from the introduction of the euro. One has to take a long-term view and hope that all teething problems will eventually be ironed out so that the benefits of a single currency may be felt.

As the smallest member of the EU, both in terms of size and population, Malta is likely to benefit handsomely from the single currency. Less party politicking but more information on EU institutions will certainly help. If all parties unite we preclude the possibility of a cardinal mistake being committed if we fix the incorrect conversion rate. This is the thorniest question we have to tackle in Malta's EU venture.

Dr Borda is an economist specialising in the economic development of small states.