The extent of these deficiencies was such that in its first opinion on Malta, the European Commission called for ‘a root-and-branch overhaul of the entire regulatory and operational framework of the Maltese economy’ 1 . Although the situation had improved somewhat by the time Malta’s EU application was reactivated in1998, the economy was still not fully equipped to withstand the competitive pressures unleashed by globalization. While reforms were underway, they were not sufficiently ambitious. For example, while the re-introduction of VAT in 1999 was meant to broaden the tax base and reduce the extent of unrecorded activity, the list of exempt or zerorated items was far longer than that of the other Member States. The role of different authorities having competence in the field of competition remained ambiguously defined, and in many sectors an insufficient distinction was made between the regulator and the service provider. The public sector was not only overmanned, but outdated practices and manual procedures were still pervasive. These weaknesses became fully exposed around the turn of the century when the removal of trade restrictions and other protective measures gained momentum in anticipation of EU membership. This process, moreover, coincided with two external shocks that adversely affected two vitally important industries, electronic components and tourism. The former was hit by the sharp decline in demand as result of the global downturn in the high-tech sector, the latter by the increased travel aversion in response to the 9/11 terrorist attacks.
This decision was also dictated by the need to counter harmful speculation at the time about the appropriate level of the exchange rate. Lessons learned One lesson that could indeed be drawn from Malta’s experience is that the discipline imposed by the currency peg was probably the factor that contributed most to the relatively smooth transition to euro area membership, not only in terms of the achievement of the exchange rate criterion, but more so because it helped to focus attention on macroeconomic and structural policies. There was, however, one factor that remained constant as the journey to the euro progressed. That was the small size of the economy and, thus, its vulnerability to shocks. This was compounded by the risk of a speculative attack of the currency, given the combination of still weak economic fundamentals and the dismantling of the capital controls regime which had protected the lira for decades. These realities made the transition from a basket peg to a full euro peg even more challenging. The potential exposure to capital outflows was also a source of preoccupation because the Bank was aware that the typical  6  4  Malta Enterprise. BIS Review 14/2008  interest-sensitive Maltese investor was likely to be attracted by the availability of a wide choice of financial products overseas offering attractive yields. Long before EU accession the Bank had anticipated this challenge by adopting a sequenced programme of capital account liberalisation to test investor reactions.