I shall only reiterate here that for a small, open economy like ours with no trade or capital controls, keeping a separate currency leaves us exposed to external shocks and volatile capital flows. We are thus obliged to maintain a large amount of external reserves. These are financial assets that could perhaps earn higher rates of return if invested domestically. Instead, we invest them abroad, in effect promoting foreign, rather than domestic growth. That is the price we pay to have an independent currency. This vulnerability is indeed one of the main reasons why some leading academics in this field believe that the small new Member States should have been allowed to lock themselves into the relatively greater security of the euro area as quickly as possible. The validity of this view was underscored by Malta’s experience in late 2004/early 2005 when the Bank’s external reserves declined as a result of uncertainty created by speculative comments on the exchange rate. Your second question reflects the view that the fixed nature of the exchange rate as well as the level at which the lira was pegged to the euro in ERM II are both inappropriate and are stifling Malta’s competitiveness. Let me first address the issue of the fixed peg. This has been a mainstay of our monetary policy for over three decades. It is what Maltese traders and investors, and the public at large, have become accustomed to. The resulting exchange rate and price stability have made a vital contribution to the country’s economic development.
The baseline scenario reflects the developments that the Board believes to be the most likely to occur with the information at hand at the statistical closing of the Report. However, there are risk scenarios that, if materialized, might change the macroeconomic outlook and, therefore, the course of monetary policy. On this occasion, after evaluating the alternative scenarios, the Board estimates that the risk balance is downward biased for output and unbiased for inflation. On the global front, a first risk comes from China, namely the fragility of its financial system, among other factors. As I said at the beginning, the banks’ off-balance-sheet financial intermediation has been increasing and credit has accumulated enormous growth in the past few years, with a substantial portion going to local governments. In other economies, episodes of rapid credit growth have resulted a few years down the line in a deterioration of the quality of banking assets and financial intermediaries’ balance sheets, and in a slowdown in domestic demand. Although the Chinese financial system has some features that differentiate it from others, there is no denying that any difficulties in this field could have negative effects on China’s growth for a longer period. If so, it would hurt world growth and commodity prices, particularly for copper. A second risk coming from abroad has to do with the way emerging economies will accommodate the withdrawal of monetary stimulus packages in developed countries.