Malta Central Bank Presentation on the Growing of the Euro currency prior to Malta joining the euro zone

1. GROWING WITH THE EUROGROWING WITH THE EURO
Central Bank of Malta
January 2007

2. OUTLINE
Key dates and procedure
Maastricht criteria
Benefits of the euro
Malta’s growth problem
Conditions for successful monetary integration
The need for further structural reforms

3. KEY DATES ON THE ROAD TO EURO ADOPTION
1 May 2004:
Malta joins the EU
assumes obligation to join ERM II and adopt the euro
2 May 2005:
Malta joins ERM II
unilaterally commits to maintain agreed central parity
rate EUR1 = MTL0.429300
1 Jan 2008:
target date for euro adoption

4. ENTRY IN THE EURO AREA IS NOT AUTOMATIC
ECOFIN decides on lifting Malta’s derogationECOFIN decides on lifting Malta’s derogation
in euro area compositionin euro area composition
based on a Convergence Reportbased on a Convergence Report
published with a Council Regulation announcingpublished with a Council Regulation announcing
irrevocable conversion rate and its effective dateirrevocable conversion rate and its effective date
(euro area + Malta, unanimity)(euro area + Malta, unanimity)
Malta will request an assessment once MaastrichtMalta will request an assessment once Maastricht
criteria are metcriteria are met

5. until 31 December 2007
EUR foreign currency, MTL the only legal tender
CBM interest rates continue to apply
EUR-MTL conversions need not occur at CPR
from 1 December, banks will undertake all MTL/EUR
exchanges at the conversion rate, without exchange
charges (euro notes from business customers, 1 July)
euro cash will be available to the public on demand from
euro adoption date
MTL notes and coins exchangeable at CBM for 10 years
and 2 years, respectively, without charge

6. Progress towards fulfilling the
formal criteria for euro adoption

7. PROGRESS TOWARDS MAASTRICHT CRITERIA
The deficit/GDP ratio has been gradually reduced and isThe deficit/GDP ratio has been gradually reduced and is
expected to fall below the 3% limit in 2006. Governmentexpected to fall below the 3% limit in 2006. Government
plans further reductionsplans further reductions
G eneral governm ent balance
(as a % of G D P)
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
deficit ratio (M alta) deficit ratio (EU lim it)
Source: N ational Statistics O ffice

8. The debt ratio is also approaching the reference valueThe debt ratio is also approaching the reference value
PROGRESS TOWARDS MAASTRICHT CRITERIA
General government debt
(as a % of GDP)
0
10
20
30
40
50
60
70
80
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
debt ratio (Malta) debt ratio (EU limit)
Source: National Statistics Office

9. Malta’s unilateral commitment to maintain the central parityMalta’s unilateral commitment to maintain the central parity
rate has been observed since entry in May 2005rate has been observed since entry in May 2005
The Maltese lira in ERM II
02/05/2005
02/08/2005
02/11/2005
02/02/2006
02/05/2006
02/08/2006
02/11/2006
02/02/2007
02/05/2007
02/08/2007
02/11/2007
Upper rate Central parity rate (CPR)
Lower rate Central Bank of Malta middle rate
0.493695
0.364905
CPR
0.429300
central parity rate observed
PROGRESS TOWARDS MAASTRICHT CRITERIA

10. The longThe long--term interest rate has been shadowing the euro areaterm interest rate has been shadowing the euro area
interest rate, at a slightly higher level, but it has remained winterest rate, at a slightly higher level, but it has remained wellell
below the reference valuebelow the reference value
10-year government bond yield
2
3
4
5
6
7
8
Jan-02
May-02
Sep-02
Jan-03
May-03
Sep-03
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
%
Malta euro area EU reference value
Source: ECB, Central Bank of Malta
PROGRESS TOWARDS MAASTRICHT CRITERIA

11. PROGRESS TOWARDS MAASTRICHT CRITERIA
HICP inflation generally below EU reference value, except forHICP inflation generally below EU reference value, except for
some periods in 2004 (VAT increase) and 2005 and 2006some periods in 2004 (VAT increase) and 2005 and 2006
(energy(energy--related costs)related costs)
H IC P inflation in M alta and E U reference value
12-m onth m oving average
0
0.5
1
1.5
2
2.5
3
3.5
2001-01
2001-07
2002-01
2002-07
2003-01
2003-07
2004-01
2004-07
2005-01
2005-07
2006-01
2006-07
%perannum
M alta H IC P inflation rate M alta H IC P inflation rate excl. energy & w ater prices (C B M estim ate) E U reference value
S ource: E urostat N ew C ronos D atabase and N ational S tatistics O ffice, M alta.

12. Forecasts suggest that Malta could meet all the MaastrichtForecasts suggest that Malta could meet all the Maastricht
criteria by Spring 2007criteria by Spring 2007
HICP inflation rate (% year-on-year)
0.00.00.00.0ERM II (% deviation from CPR)
-
2.6
-
69.0
-2.7
2007
-
3.0
4.3
69.6
-2.9
2006
EU Commission CBM
-2.4-2.7government deficit (% of GDP)
67.268.0government debt (% of GDP)
2.0
2.8
4.8
2006
1.9excluding energy
1.6headline figure
5.3LT interest rate (% per annum)
2007
FORECASTS

13. The single currency:
economic benefits and limitations

14. THE ECONOMIC RATIONALE BEHIND THE EURO
an EU perspectivean EU perspective
a single currency is the natural complement of aa single currency is the natural complement of a
single marketsingle market
supports achievement of Lisbon Agendasupports achievement of Lisbon Agenda
a national perspectivea national perspective
trade, efficiency and investmenttrade, efficiency and investment
signalling effectssignalling effects
protectionprotection

15. SOME EVIDENCE
High and low estimates of effect on intra-euro trade
0
5
10
15
20
25
30
35
40
45
De Nardis &
Vicarelli (2003)
Farquee (2004) Baldwin &
De Nino (2006)
Flam &
Nordstrom
(2003)
Micco, Stein &
Ordonez (2003)
Bun &
Klaassen
(2002)
Overall%increaseinintra-euroareatrade

16. SOME EVIDENCE
The euro has delivered price stability and
anchored inflation expectations at around 2%
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
%
HICP Core Inflation - HICP excl. energy & unprocessed food expected inflation five years ahead
Source: ECB and Eurostat

17. … HOWEVER
euro adoption is not sufficient for faster growtheuro adoption is not sufficient for faster growth
single currency benefits can only be realised with:single currency benefits can only be realised with:
ability to take advantage of growth opportunitiesability to take advantage of growth opportunities
flexibility to respond to external shocksflexibility to respond to external shocks
tools to address countrytools to address country--specific developmentsspecific developments
(asymmetric shocks limited but not negligible)(asymmetric shocks limited but not negligible)

18. WHY IS THIS RELEVANT FOR MALTA?
one of the slowest growth rates in EU in recent years
failure to return to past growth rates amid favourable
global economic conditions
neighbouring countries experienced:
less prolonged recessions
earlier and more sustained recovery in good times
result:
widening income gap viz. euro area
narrowing income advantage viz. NMS

19. GROWTH DEFICIT REFLECTS
STRUCTURAL FACTORS
Real GDP growth - comparison with other countries
78 77 78
74 75 74
71 70
-4
-2
0
2
4
6
8
1998 1999 2000 2001 2002 2003 2004 2005
GDPgrowth(%perannum)
0
20
40
60
80
GDPpercapita(EU25=100)
EU15 Malta CEECs Mediterranean Countries Malta's per capita GDP (% of EU25)
Source: World Bank, Eurostat

20. need for rapid implementation of comprehensive reforms
…HOW?…HOW?
rrange of policy options available is limited by EMUEMU
constraints, particularly in a Maltese contextconstraints, particularly in a Maltese context
ADDRESSING THE ECONOMY’S
STRUCTURAL WEAKNESSES

21. THE POLICY CONSTRAINTS OF EMU
exchange rate permanently fixedexchange rate permanently fixed
interest rate decisions centralised + inflation orientedinterest rate decisions centralised + inflation oriented
output stabilisation depends on fiscal policy, but scope foroutput stabilisation depends on fiscal policy, but scope for
fiscal stimulus in EMU is limitedfiscal stimulus in EMU is limited
monetary and fiscal policy, therefore, have limited capacity tomonetary and fiscal policy, therefore, have limited capacity to
address country specific problemsaddress country specific problems
realisation of EMU’s benefits depends on structural flexibilityrealisation of EMU’s benefits depends on structural flexibility
and supplyand supply--side policiesside policies

22. SOME EMU CONSTRAINTS ALREADY APPLY
limited utility of monetary and exchange rate tools
small size + openness warrant a stable exchange rate
stability commitment + free capital flows condition
interest rates to follow rates of anchor country
devaluation is costly (inflation)
fiscal policy has limited effectiveness as an adjustment tool
high import propensity means effect is lost abroad

23. a prudent fiscal framework
more room for manoeuvre during downturns
increased resources for investment
stronger support to private sector
better prospects to attain medium-term objective
step up pace of structural reforms
economy still lacks the necessary flexibility to adjust toeconomy still lacks the necessary flexibility to adjust to
external and countryexternal and country--specific developmentsspecific developments
POLICY PRIORITIES FOR GROWTH

24. Comparisons that matter

25. 14.820.917.4private investment (% of GDP)
Source: Eurostat data for 2004 or 2005, as available, except domestically funded R&D
33.761.355.2
female employment rate
(% of population aged 15-64)
0.20.60.8
government appropriations of R&D
(budgeted provisions as % of GDP)
18.660.056.3
percentage of R&D expenditure
funded by domestic industry
(% of total R&D exp.)
3.11.00.6state aid (% of GDP)
11.421.220.1private savings rate (% of GDP)
MaltaSloveniaeuro area

26. 53.790.573.5youth education attainment level
8.48.73.9cumulative change 2003-2005 (%)
Source: Eurostat, refers to 2004/2005. ECB (unpublished) for nominal unit labour costs.
8.524.55.6
nominal unit labour costs
cumulative change 2000-2002 (%)
4.86.05.0
public expenditure on human
resources (% of GDP)
41.65.218.0early school leavers (% of pop.)
3.68.712.7
science and technology graduates
(per 1000 pop.)
MaltaSloveniaeuro area

27. UNIT LABOUR COSTS EXPLAINED
Average annual productivity growth
vs. average annual growth in compensation per employee
-2
-1
0
1
2
3
4
5
-2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12
% change in compensation per employee
(period average)
%changeinproductivity
(periodaverage)
SLO 2000-02
ULC =
COMPENSATION PER
EMPLOYEE
OUTPUT PER
EMPLOYEE
(productivity)
SLO 2003-05
EUR 2003-05
EUR 2000-02
MT 2000-02
MT 2003-05
Source: European Commission, AMECO database

28. UNIT LABOUR COSTS RELATIVE TO EURO AREA
Nominal unit labour costs
0.85
0.90
0.95
1.00
1.05
1.10
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
mtl/eur slo/eur
Source: AMECO database

29. Reducing ULC growth:
slower wage growth
or faster productivity?

30. WAGE MODERATION SHOULD CONTINUE BUT
MUST BE SUPPORTED BY PRODUCTIVITY GAINS
Compensation per employee - annual growth rate
0
2
4
6
8
10
12
14
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
%perannum
euro area Slovenia Malta
Source: Slovenia and euro area: AMECO Database. Data for Malta: National Statistics Office and CBM forecasts.

31. PRODUCTIVITY GAINS AMONG THE LOWEST IN THE EU
Employment and productivity growth in the EU
(2000 - 2005)
-2
-1
0
1
2
3
4
0 1 2 3 4 5 6 7 8
growth (%) in productivity (real GDP per person employed)
Averageannualemploymentgrowth
(%)
Source: European Commission, AMECO Database
MT
EU25
euro
area
SL

32. THE ROAD AHEAD
deliver more value for moneydeliver more value for money
public and private sector, goods and servicespublic and private sector, goods and services
a more investment friendly environmenta more investment friendly environment
expenditureexpenditure--driven fiscal consolidation with incentivesdriven fiscal consolidation with incentives
for selffor self--helphelp
coco--operation of social partnersoperation of social partners

33. DELIVER MORE VALUE FOR MONEY
better use of resources to generate more outputbetter use of resources to generate more output
in public sectorin public sector
ensure employees achieve performance standardsensure employees achieve performance standards
equivalent to those in private sectorequivalent to those in private sector
in private sectorin private sector
capital accumulation and technology transfercapital accumulation and technology transfer

34. ACHIEVING AN ENVIRONMENT
THAT IS BUSINESS FRIENDLY
education and training relevant to industryeducation and training relevant to industry
better regulationbetter regulation
simpler administrative proceduressimpler administrative procedures
longer availability (hours) of key public serviceslonger availability (hours) of key public services
port reformport reform
lower taxeslower taxes

35. FISCAL CONSOLIDATION MUST BE
EXPENDITURE DRIVEN
pension reform (first pillar is not enough)pension reform (first pillar is not enough)
apply means testing more widelyapply means testing more widely
subcontract to private sectorsubcontract to private sector
ensure it is done well first timeensure it is done well first time
incentive structureincentive structure
penalise tax evasion, undeclared income and inefficienciespenalise tax evasion, undeclared income and inefficiencies

36. A ROLE FOR THE SOCIAL PARTNERS
the case of Finlandthe case of Finland
“established social dialogue has been helpful in the“established social dialogue has been helpful in the
implementation of some reforms … although challengesimplementation of some reforms … although challenges
still remainstill remain””
““as a small open economy Finland has adopted aas a small open economy Finland has adopted a
pragmatic approach to economic policy issues and oftenpragmatic approach to economic policy issues and often
been less resistant to economic reform and deregulationbeen less resistant to economic reform and deregulation
than some of the larger EU countriesthan some of the larger EU countries””
ErkkiErkki LiikanenLiikanen (2006) Finland, EMU and euro(2006) Finland, EMU and euro

37. CONCLUSION
euro is delivering benefits to current ‘ins’euro is delivering benefits to current ‘ins’
in 2007 Malta stands a good chance of fulfilling the criteriain 2007 Malta stands a good chance of fulfilling the criteria
for euro adoptionfor euro adoption
benefits of euro area membership are not automaticbenefits of euro area membership are not automatic
the euro is not the answer to all Malta’s problemsthe euro is not the answer to all Malta’s problems
more structural reform is indispensablemore structural reform is indispensable
the responsibility to deliver is national: it must be shared bythe responsibility to deliver is national: it must be shared by
the public sector, business and the social partnersthe public sector, business and the social partners

38. Thank you