First, it is generally acknowledged that Malta’s pegged exchange rate regime has in the past served the economy well, in that it kept inflation and inflationary expectations at bay. As for the level of the central parity rate of the lira in ERM II, studies conducted by the Central Bank of Malta found no evidence of a significant exchange rate misalignment, a conclusion which was not contested by the competent EU institutions. There being no compelling reasons for change, therefore, the exchange rate level prevailing prior to entering the Mechanism was retained in the interests of continuity and stability. As for the unilateral commitment to maintain the currency at its central parity rate during the ERM II phase, I would remind the proponents of a flexible exchange rate regime of Malta’s high dependence on foreign trade. For such an open economy, the resultant volatility and consequent uncertainty would entail additional costs associated with insuring against exchange risk, thereby inflating both retail and export prices. Changes in the nominal exchange rate, moreover, are not likely to have a significant impact on competitiveness via adjustments in the real exchange rate. This is because a weakening of the currency is typically followed by a rapid pass-through in the shape of higher prices of imports and wages, as the 1992 experience proved. On the other hand, due to downward rigidities, a strengthening of the Maltese lira cannot be expected to be followed by commensurate reductions in price and wage levels.
Despite weak growth, the fiscal balance improved significantly in 2004 and again this year. This has not escaped the attention of international observers. The recent assessment of the Maltese economy by the IMF, for example, commends the progress achieved in strengthening macroeconomic management, including the substantial reduction in the fiscal deficit. Looking ahead, I am pleased to note that the Budget for 2006 bears the hallmark of continuity. Operating within the constraints represented by the natural upward creep in spending on health, pensions and welfare programmes, on the one hand, and the need to avoid increasing the burden of taxation on a slow moving economy, on the other, the Government has charted a course which envisages a continuation of the process of fiscal consolidation, leading to a further reduction in the deficit to GDP ratio to below 3 per cent. This is an ambitious target whose attainment will depend crucially on a rigorous implementation of all the Budget measures, together with an intensification of efforts aimed at cutting costs and collecting taxes. On the monetary front, the financial markets have so far considered the level of domestic interest rates as appropriate and inflation remains moderate. Monetary stability is also being promoted by participation in ERM II, which is proceeding smoothly. Allow me at this point, Mr. President, to reiterate the reasons behind the Bank’s advice to the Government to maintain the value of the Maltese lira constant against the euro within ERM II at the rate prevailing prior to entry in the Mechanism.