Speech by Joaquín Almunia
European Commissioner for Economic and Monetary Affairs

The euro and the main challenges to achieve convergence

Visit to Malta
Valletta, 14 July 2005

Ladies and gentlemen,

It is a great pleasure for me to be in Malta today. First of all, this gives me the opportunity to congratulate you on the recent entry of the Maltese lira into ERM II. By entering ERM II with a unilateral commitment to exchange rate stability, Malta has built on its track record of successfully managing a fixed exchange rate regime. I particularly welcome the commitments by the Maltese authorities to underpin ERM II participation by steering a prudent fiscal course and by pursuing a structural reform agenda that aims to bolster the Maltese economy's flexibility, productivity and competitiveness. ERM II entry is obviously also a first step towards your country's eventual adoption of the euro.

When the Spanish Emperor Charles V donated the Maltese Islands to the Order of St John of Jerusalem, the Knights of Malta obtained the privilege of minting their own coins. After the introduction of the euro in Malta, your country will obviously preserve this privilege, subject to one change. It will mint euro coins with a Maltese national side and a common European side. This perfectly illustrates the complementarities between the European Union and its Member States and the principle of `Unity in diversity'.

Today I would like to speak about the future introduction of the euro in Malta. I will concentrate on three main issues.

• Firstly, I believe that my visit to Malta is a good opportunity to explain and clarify why the adoption of the euro will be an important asset for your country and what the benefits are which you can expect from it.
• Secondly, I would like to discuss the challenges ahead in terms of achieving the sustainable convergence that Malta will have to accomplish with a view to joining the euro area.
• Thirdly, I would like to focus on the practical preparations which are necessary for a smooth introduction of the euro. The ongoing and future co-operation between the Commission and your national authorities will play an important role in this process.

1. Benefits stemming from the euro adoption

Let me start with the benefits stemming from the adoption of the euro. Recently, some have incorrectly blamed the euro for their country's woes. I would, therefore, like to recall the numerous benefits associated with the introduction of the single currency.

• The first one relates to the importance of preserving price stability. If one compares the economic context in the early 1990s with today's situation, there is no doubt that the euro has marked a clear break with the past. When the Maastricht Treaty was signed in 1992, some euro-area countries were still suffering from double-digit inflation. Today, inflation in the euro area is hovering around 2 per cent. In addition, the average budget deficit in the euro-area countries at the time was nearly 6 per cent of GDP. Today, the average budget deficit is below 3 per cent. This is still too high but it shows that Economic and Monetary Union and its fiscal framework helped to bring about important changes in public finances. Moreover, the unemployment rate is also lower than in 1991 although further improvement remains necessary.
• When adopting the euro, Malta will share the benefit of the euro-area's price stability. An enhanced degree of monetary stability will pave the way for increased investment and employment within your country. Moreover the European fiscal framework will have positive effects on the Maltese financial markets and on the economy of the country at large.
• The second main benefit associated with the euro is linked to the euro's shielding effect against currency turmoil. Both in 1998 and after 2001, the euro has already proven its effectiveness in protecting the euro area from the potentially damaging effects of such shocks.
• This is particularly important for a small country like Malta which, even before its accession to the European Union, developed strong trade relations with the European Union, which constitutes its major trade partner. Malta's trade relations with the Union indeed represent about half of its total exchanges. Recent studies demonstrate that the euro reinforces trade among participating countries.
• The third major benefit stemming from the European Monetary Union is linked to the possibility to reap the full potential of Europe's single market notably by eliminating transaction costs and associated currency risks. Travellers and businessmen will no longer have to change currencies each time they cross your country's national border. Not only will their travelling be simplified but it will also become cheaper since there will no longer be any transaction costs to be borne.
• The euro moreover brings about higher price transparency and improved comparability of prices. Both elements stir up competition and result in lower prices. Over time, this will reinforce the gains from a more efficient allocation of resources and from the economies of scale associated with greater economic integration. Economic operators will be able to make better informed decisions which will increase Malta's economic efficiency and improve its international competitiveness. All these elements are conducive to higher growth and employment.

Steps to be accomplished in terms of convergence

Let me now turn to the second topic of my intervention, namely the challenges which the Maltese economy is still facing in terms of convergence. Malta is a small and open economy which is already closely integrated with the EU economy. Its sectoral composition of employment and GDP are very similar to those of the euro area. Its financial sector appears to be healthy and well supervised. There is a relatively high degree of business cycle synchronization and the currency is strongly pegged to the euro. However this does not mean that no further efforts are required or that you can become complacent.

As you know, the Commission and the ECB assess a country's readiness for the adoption of the euro on the basis of a coherent set of criteria. These criteria aim to provide a comprehensive picture of the macroeconomic convergence to be achieved on a sustainable basis by a prospective euro area entrant. Our last convergence examination in 2004 took stock of the progress made in Malta but also pointed to a number of challenges ahead, notably as regards its public finances and its inflation performance. Malta is nevertheless well placed to maintain a firm and credible path towards sustainable convergence, provided supportive policies remain in place.

Bringing public finances back on a sound footing constitutes the main policy challenge for Malta in this context. I hasten to add that fiscal consolidation should be recognised as a necessity in its own right, in order to increase the economy's potential growth - rather that something that has to be done because of "Brussels" or the euro. Significant progress in reducing fiscal imbalances has already been made. However, further action is required. I am confident that the government will continue to implement its Convergence Programme with vigour and determination. This would also help Malta to bring down the high ratio of public debt to GDP, which currently stands at about 75 per cent.

As regards inflation, certain risks definitely subsist. For example, in 2004 Malta did not meet the inflation convergence criterion. While, as a small open economy, Malta is necessarily strongly influenced by international trends, keeping domestic inflationary pressures in check will have to remain a key priority. This includes appropriate wage policies as well as fiscal discipline and measures to foster competition in the economy. ERM II participation may help to stabilise inflation expectations at low levels by reinforcing the exchange rate anchor. Participation in the framework will also further foster credibility and catalyse the convergence process, thereby helping Malta on its way to become a member of the euro area.

The Maastricht convergence criteria also include an assessment of the level of long-term interest rates, which notably reflect financial markets' appreciation of the country's long-term stability perspectives. Maltese long-term interest rates have consistently remained well below the reference value, indicating the high degree of macroeconomic stability in your country as well as a positive market perception on its longer-term prospects. To sum up, there is every reason to be confident about Malta's ability to tackle the challenges of achieving sustainable convergence, but vigilance and a firm commitment to sound and stable policies remain necessary.

Practical preparations for the introduction of the euro and mutual co-operation between the Commission and the Maltese authorities

Let me now move to the third and final part of my intervention. Besides the need to comply with the Maastricht criteria, there is definitely a necessity to start a number of practical preparations. We should bear in mind that it took six years in total for the present euro-area countries to be fully prepared.

In this respect, allow me to highlight the three main factors to be taken into account.

• First, the experience of the first-wave countries clearly shows that countries which invested heavily in careful, pro-active and extensive preparations were rewarded for their efforts. This applied in particular to
• the speed of the changeover, the public acceptance of the new currency and the smoothness of the transition to the euro. Speed constitutes a key ingredient of success since all economic actors suffer from the parallel use of two currencies.
• National governments and the public sector in general have a particular role and responsibility. Their primary task is to draw up a comprehensive changeover scenario at an early stage. This general framework will allow the private sector to initiate its own preparations. Public administrations also have a general role of co-ordination, information and dialogue with all relevant economic sectors and the general public.
• I would like to highlight the need for timely information and communication. This should be one of the key priorities in Malta, in view of the prevailing concerns among the public on the introduction of the euro. According to the Eurobarometer survey of November, at 49 percent Malta has the highest number of respondents who believe that the replacement of the national currency by the euro will cause a lot of inconvenience. The average among the newly acceded Member States was of 36 percent.
• Second, the mental or psychological changeover of the citizens is by far the most difficult challenge. This applies to issues such as the erroneous perception of price increases, or to the difficulty for many people to start thinking and calculating in euro.
• The possibility of price increases in certain, generally well-defined, sectors should also be addressed with determination. Commitments to price stability should be negotiated in advance with the retail sector and could be materialised by a sticker showing the retailer's commitment to stable prices. Moreover, consumers' perception of price increases should also be tackled. A regular monitoring of the evolution of prices could also help to keep the public informed and neutralise any false inflation rumours.
• Regarding the mental changeover, this process invariably takes time. The mental switchover appears to be considerably faster for small-value items. The early introduction of dual displays helps considerably in this respect. However, I would not recommend implementing dual display before the conversion rate has been irrevocably fixed, in order to avoid undesirable fluctuations. In addition, while dual displays assist consumers in their mental changeover to the euro, keeping them in place for too long could have the perverse effect of prolonging the reference to the national currency beyond what is necessary.
• Third, when it comes to preparing the introduction of the euro, I firmly believe that the European Union in general and the European Commission in particular, should be your active partners. In order to assist future euro-area candidates, the Commission has re-launched the Public Administration Network (PAN II). In the past, the PAN was an essential forum for discussion and exchange of views among the national representatives in charge of the changeover in their respective countries. It is again playing a very important role for the preparations of future euro-area entrants.
• In the area of information and communication, the European Commission stands ready to help in the form of a partnership agreement. It is notably prepared to share part of the financial burden under the PRINCE programme. The Commission is developing its communication activities on the principles of decentralisation and subsidiarity, as well as coordination and partnership. Communication policies should indeed be adapted to the specific needs and situation of each Member State.

Ladies and gentlemen,

Let me now conclude. The euro is a vital element of Europe's prosperity. Every day, it is proving its value and importance. This is one of Europe's greatest achievements and we should be proud of it.

Malta is on the right track for the adoption of the euro in the foreseeable future. This will allow the country to enjoy the full benefits of the European integration and further reinforce the foundations of Malta's future economic prosperity. However there are several challenges ahead and further improvements, in particular regarding Malta's public finances, are needed.

Regarding the practical preparations, I encourage you to prepare yourselves in good time so as to ensure a smooth, short and efficient changeover to the euro. The Commission will be your active partner in this process. It will contribute as much as it can to a successful changeover in all future euro-area entrants.

Thank you very much for your attention.