Cyprus and Malta: two islands, one currency
Cyprus: the challenges beyond euro entry
by Michael Sarris, Minister of Finance of the Republic of Cyprus
From 1 January 2008, Cyprus will have a new currency, the euro. The Cyprus pound, which has been legal tender since 1960, will cease to exist and will be replaced by the common European currency. This is a fundamental, albeit natural, change for a small economy, brought about by Cyprus’ accession to the EU in 2004. The economy can reap important benefits from its participation in the single currency area, although it will face significant challenges. Everyone must play its role in this important journey, the government and the Central Bank, businesses, workers, and consumers.
Cyprus is now principally a services-based economy with strong links with the euro area and the EU. Its business cycle is highly associated with that of the euro area and its monetary policy has been linked to that in the common currency area since 1992, through a unilateral hard peg vis-à-vis the ECU and then the euro. Its geographic position offers important prospects for developing business links between the east and the west, and the changeover to the euro will undoubtedly play an important role in this process.
The economy has expanded steadily in the past years, supported by prudent macroeconomic policies and a dynamic private sector. Since 1992, the year in which the Cyprus pound was formally pegged to the ECU, growth has averaged 3.5% and inflation 3.25%. Unemployment has remained relatively low at around 4-5%, despite the sizeable inflow of foreign workers who today amount to some 18% of the labour force. The budget deficit averaged -3.25% but has displayed some tendency to follow political business cycles. In 2007, the fiscal position improved markedly and the general government will register a surplus of 1.5% of GDP, a very positive development which will further contribute towards reducing the public debt.
The accession to the EU in 2004 has brought about a fundamental tax reform which switched emphasis away from direct taxation (raised the tax-free income level, lowered marginal income tax rates, and introduced VAT at a standard rate of 15%), speeded up, and in many cases initiated, important structural reforms in labour, product markets and in the financial sector, and led to the creation of a credible policy framework which has further strengthened policies and bolstered macroeconomic stability. As a result, competition has been boosted in product markets and the dynamics of change have transformed the market place.
Importantly, EU accession has brought about fundamental reforms to the policy framework, both fiscal and monetary. A new monetary policy framework has been introduced and the statutory independence of the Central Bank of Cyprus has been strengthened further, based on the standard required by the Treaty. In terms of fiscal policy, Cyprus has been obliged to meet the requirements of the Stability and Growth Pact (SGP), resulting in the implementation of a fiscal consolidation programme, first outlined in its Convergence Report in 2004. The fiscal deficit, which had reached 6.5% of GDP in 2003, was reduced gradually and turned into a surplus, estimated at 1.5% of GDP in 2007.
A principal challenge for the government inside the euro area is to maintain this strong fiscal position while, at the same time, strengthening the social safety net, redirecting resources towards growth-enhancing expenditure categories and improving physical infrastructure in various sectors of the economy. At the same time, fiscal policy should aim further towards consolidating the improved public finances, with a view to reducing public debt and thus addressing the long-term sustainability of public finances.
Overall, policies will have to support investment and private sector development, and to contribute towards the further enhancement of productivity and competitiveness of the economy. In this respect, the government can play a special role in reducing the administrative burden of regulations, promote R&D and investment and play a role in determining wages in the economy, through public sector wage setting. Labour market reforms must be undertaken to increase overall flexibility and allow businesses to operate in a business-friendly environment.
Monetary policy also faces challenges. Credit has expanded at a very strong pace since 2004 (averaging some 11%), both to residents and nonresidents, financing a construction boom, which has continued unabated and has contributed to rising asset prices. The key challenge for the Central Bank of Cyprus (CBC) is to ensure that banking institutions avoid taking undue risk, especially by concentrating lending into one specific sector or activity, and continue to apply prudential safeguards on lending. These challenges for CBC policies will continue to be important in view of the fact that interest rates will remain relatively low over the coming months.
For the private sector the introduction of the euro will bring about increased competition, inside a large market with many players. Staying competitive will require changes in business models, investment in new technologies, innovation and expansion in other markets. These changes must be undertaken with careful preparation, taking into account evolving regional and global changes, including those in relative factor prices.
Workers and unions also have a critical role to play in this process. Wages constitute an important input in the production process, especially in a services-based economy. In this competitive environment wage increases must be accompanied by productivity improvements otherwise losses in competitiveness will bring about job losses and economic stagnation coupled with higher inflation. Experience from other countries reveals that while competitiveness can be lost relatively quickly, especially during periods of economic buoyancy, to regain competitiveness a country must go through a long and painful adjustment process during which the costs will be disproportionally high.
The economy of Cyprus is indeed in a very strong position and can reap important and lasting benefits from the adoption of the euro, though it will face significant challenges which can be addressed adequately with careful policy formulation and coordination. Sound policies have had a considerable impact in recent years, and will continue to lay the foundations for more growth and increased prosperity for all the citizens. Everyone must play an important role in this journey.
Malta: rising to the occasion
by Lawrence Gonzi, Prime Minister and Minister of Finance, Malta
Ever since Malta became a member of the European Union, the Maltese people have risen to the occasion of making the most out of EU membership. This entrepreneurial spirit was deeply grounded in the government’s vision of making Malta a centre of excellence in the Mediterranean.
The euro brings clear and lasting benefits to the countries of the euro area. Only few years since its creation, the euro has delivered tangible success: not only is the euro a strong and credible currency for the euro area, but it is now the second most important international currency. The euro has contributed decisively to price stability. Additional gains brought by the single currency include low interest rates, the reduction of transaction costs and increased price and cost transparency which facilitates the functioning of the common market, leads to more integrated financial markets and increases trade.
For the above reasons Malta has striven hard to achieve the convergence criteria in the least time possible. This challenge has been met and today the smallest country in the European Union is a euro-area member fully committed to sound economic policies and bold reforms in line with the vision set out in the Stability and Growth Pact. We are convinced that for Malta, the economic benefits of the euro will be substantial. Having one of the most open and vulnerable economies, with average import- and export-to-GDP ratios of over 80%, the euro will anchor us solidly in the European single market and provide a shelter from external shocks and volatility.
In July 2005, the National Euro Changeover Committee (NECC) was established by the Cabinet, with the clear brief of steering the technical preparations and the information campaign required to ensure that the country was adequately prepared in time for the adoption of the euro. Following the establishment of the technical groundwork through the publication of a series of guidelines, the NECC launched the euro information campaign on 6 June 2006. The effectiveness of this campaign has been tested through the Eurobarometer surveys commissioned by the European Commission. As demonstrated by the most recent survey, the information campaign has significantly contributed to a sharp increase in the level of awareness on the euro, which is also reflected in the level of support for the euro project amongst Maltese and Gozitan citizens.
Various concepts and innovative tools were used by the NECC in order to achieve a smooth and seamless changeover. Specific information campaigns targeted specific groups, including the business community, vulnerable groups, the elderly, children and consumers. These segments of the population were informed through specialised tools including ad hoc publications, web portals, corporate and information meetings (and in some cases one-toone meetings), specific seminars and more focused advertising and public relations initiatives. A series of train-the-trainer sessions have had the desired multiplier effect. Teachers and carers, company management and directors, public sector heads and executives, euro assistants and volunteers were all a means of reaching out to all sectors of Maltese society.
A number of tailor-made tools were developed to address the needs of groups that could potentially require particular attention. A ‘euro curriculum’, including plastic euro-money kits and wallets given to all school children and vulnerable groups, led to greater familiarity with the euro notes and coins. As Malta is a country where religion plays a central role in social life, the NECC also worked closely with the religious authorities in order to disseminate the information to everyone.
The euro helpline attracted hundreds of callers on a daily basis. The euro website proved to be a key tool in driving the right message home. Information sessions by NECC officials were delivered in each and every locality during the last months of the campaign. These varied from business-oriented training sessions to assistance in household budget management to women at home and senior citizens.
The launch of the voluntary Fair Pricing Agreements in Retailing (FAIR) in January 2007 invited businesses to commit not only to adopt dual display prior to the mandatory period, but also to not increase prices due to the euro changeover. The vast majority of businesses have been awarded the FAIR trust mark. This is a pledge by businesses to their customers. Legislation and enforcement structures were in place to ensure businesses honour their FAIR commitments by mid-2007.
Another innovative initiative was the signing of price stability agreements with various importers, distributors and companies which voluntarily pledged not to increase prices between October 2007 and March 2008. These price stability agreements are intended as a tool to ensure transparency in pricing, to enhance consumer confidence and to continue promoting fair pricing.
We believe that the setting up of the National Euro Changeover Committee was a critical success factor in the management of the currency changeover. The NECC is recognised as the leading authoritative institution in charge of the complex task of managing the changeover. Its arms-length-from-government approach has enabled it to establish collaborative relationships and build by itself the necessary credibility required for its information and education campaigns to be balanced, apolitical and factual. The work of the Central Bank of Malta in spearheading the preparations for the logistical preparations related to the cash changeover should also be commended.
With the physical cash changeover behind us, there are elements that will still require particular attention during the first months following adoption of the euro. The need to keep up communications post €-day is crucial. The communication campaign must continue to dispel myths, replacing them with facts. Effective price-monitoring mechanisms will still need to be maintained to eliminate any potential for abuse during the dual-display period and beyond.
The European Commission’s intention to ask Malta to document its euro communications strategy as an example of best practice to those other countries which are still aiming to join the euro area is a great source of satisfaction for the Maltese government.
Our successful path towards the adoption of the euro would not have been possible without the technical and practical assistance of the European Commission and the European Central Bank. To them we are undoubtedly grateful. We are, however, also indebted to the Maltese population who have been with the government through thick and thin to realise the euro project. Today, Malta stands proud to be placed at the core of European political, economic and social life.