Your savings in euro

Henry F. Coppini asks:
Once Malta adopts the euro, would Malta Government Stocks continue to carry the current interest rates or would some directive of the EU or the European Central Bank require otherwise?

Also, would interest rates on new euro stocks issued thereafter be exclusively decided upon by the Maltese government on its own or would interest rates have to follow EU or ECB directives?

In the euro area, that is, in all countries that have adopted the euro as their currency, there is a common official interest rate that is set by the ECB.

However, official interest rates, that is, interest rates set by the Central Bank are different from market interest rates which apply to deposit and loan rates set by credit institutions as well as to Malta Government Stocks (MGSs). And the two should not be confused.

Currently the Central Bank of Malta is responsible for the conduct of monetary policy. As in other developed countries, it implements monetary policy by altering its official interest rate, known as the central intervention rate. This is basically the rate at which the Central Bank is willing to lend to, or to accept deposits from, financial institutions in Malta for a short-term period.

In turn, by setting the central intervention rate, the Central Bank affects a whole range of market interest rates, including the "commercial" interest rates set by credit institutions on their loans and deposits, and also the interest rates on government stocks.

This brings me to the reader's questions.

Interest rates on new government stocks are not the Central Bank's official interest rates but market interest rates. As a result, interest rates on government stocks are set by the government and not by the Central Bank.

This will continue to apply when Malta adopts the euro. No EU directive will dictate the rate the government will have to apply on its new stocks even if these will, of course, be issued in euro.

Equally, interest rates on existing government stocks will remain unchanged and holders of these securities will continue to receive the equivalent interest payment they are currently receiving. Of course, they will start receiving the interest in euro and no longer in liri.

What will change when Malta adopts the euro is that the responsibility for monetary policy will be transferred to the ECB. This means that the official interest rate will no longer be set by the Central Bank of Malta but by the ECB, which sets a common interest rate for the euro area as a whole. The Governor of the Central Bank of Malta, in turn, will be involved in the monetary policy formulation of the euro area. However, the ECB takes monetary policy decisions in the interests of the euro area as a whole and not in the interests of one particular country.

Following the euro adoption, therefore, Malta's official interest rate will be equivalent to that of other euro area countries. However, this does not necessarily mean that the interest rates on new Malta government stocks will be equivalent to those of other euro countries since here we are not talking about the official ECB interest rate but the market interest rate.

The rate at which the government of Malta will borrow funds will also depend on the strength of the Maltese economy - typically the healthier the economy the lower the interest rates and the lower the borrowing costs for the government.

We are already experiencing this. Up to a few years ago, the government used to borrow funds by offering a sizeable premium. This was required to compensate investors for holding a government stock that was relatively riskier than that of the average euro area country. However, over the past years, a number of indicators have shown that the Maltese economy is now healthier and this is duly reflected in interest rates.

Suffice to say that apart from reducing the deficit to less than three per cent of GDP, late last year Malta also hit the inflation target set by the Maastricht criteria. Both these are signs of a healthy economy and make us eligible to adopt the euro, hopefully, by next January.

Readers who would like to ask questions to be answered in this column can send an e-mail, identifying themselves, to contact@simonbusuttil.eu or through www.simonbusuttil.eu.