In this regard, given our track record and assuming a strong national commitment to the convergence process, our strategy should also benefit from the added credibility which the prospect of support by the ECB and other NCBs would confer on it. On the basis of similar considerations, a leading credit rating agency has concluded that ERM II participation can be a rating strength. While we believe this to be a viable approach to euro area membership, it is clear that new, and possibly uncomfortable situations cannot be ruled out. International capital movements, for example, may well present a challenge for monetary policy during the ERM II phase. While econometric evidence and recent experience since the liberalization of capital controls suggest that the Maltese economy has already coped successfully with significant capital outflows, it must nevertheless be clear that monetary policy will have to stand ready to neutralise any pressures on the exchange rate should these develop. Higher interest rates, of course, would not be helpful for economic activity; and they could compromise progress towards the achievement of the convergence criteria. Successfully managing the exchange rate will thus be a major challenge. And it is not the only one. There are others at the broader, macroeconomic policy level and which arise because the tools available for economic adjustment are limited compared to the many reforms that need to be undertaken. Many of the tasks to be accomplished, moreover, are subject to tight deadlines.
This also means that the main cost of joining the euro area - the loss of monetary policy independence has already been largely incurred as the euro carries a 70% weight in the currency basket and the progressive lifting of exchange controls has reduced the central bank’s ability to set interest rates independently of world markets. Second, the Maltese economy is already closely integrated with the euro area. This is borne out not only by trade patterns, but also by the similarity of Malta’s sectoral distribution of value added and employment. Our business cycle, too, has become increasingly correlated with that of the euro area. BIS Review 16/2004  1  This synchronization is likely to grow further as exchange rate volatility declines and transactions costs fall and, if the correlation between business cycles is indeed endogenous in a monetary union, as our trade with the euro area intensifies. In addition, differences in productivity levels between Malta and the euro area in the traded goods sector appear to be minor, which suggests that the BalassaSamuelson effect is unlikely to be strong. Similarities are also to be found in the financial system. For example, the degree of financial intermediation in Malta is comparable to that of the euro area, and the long-term interest rate is well within the Maastricht reference value. Further evidence that the economy seems well prepared to join a monetary union is the fact that nominal wages have been sufficiently flexible to carry the burden of adjustment implicit in a fixed exchange rate regime.