Malta and the Euro

I recently participated in a conference to mark the upcoming entry of Malta to the euro area on January 1 2008.  (Cyprus will also join on January 1 and the Malta event featured an excellent presentation on the Cypriot economy by Athanasios Orphanides, the new Governor of the Central Bank of Cyprus and former senior economist at the Federal Reserve Board.)

At the conference, I mentioned in passing that one byproduct of EMU membership is that a member country can safely reduce its level of foreign reserves: the optimal reserve level for a small open economy with its own currency is above that for a member of a currency union.  At some level, this relaxes a constraint on the aggregate Maltese financial portfolio and should confer a welfare benefit.  While the impact effect is merely to re-label some of the assets of the Maltese central bank from ‘foreign reserves’ to ‘financial assets’ (as is elaborated in the press release from the Maltese central bank which is detailed below),  it is possible to re-structure the balance sheet of the central bank over time to transfer some of the resource savings to the Maltese treasury. Indeed, this occurred in the Irish case, with several mechanisms invoked to release funds to the finance ministry amounting to about 1 per cent of GDP.

This debate is live in the Maltese media. See the front page article from the Maltese Sunday Times “Lm6 million a year from euro entry” and the response from the Central Bank of Malta “The Central Bank of Malta’s External Reserves After the Adoption of the Euro

On the Irish case,  my colleague Patrick Honohan did some digging and sent me an email:

The surplus income of the Central Bank (i.e. profits after a relatively modest

transfer to reserves) are paid over to the Exchequer in the year after they are

earned.  Since the mid-1980s a variable fraction of the current year’s profits

is paid in advance to the Exchequer (i.e. in the same year they are earned).

Apart from these advances, and a special advance in 1986 related to the

liquidation of the failed ICI insurance company, the main additional transfers to the Irish

Exchequer took place at the time of the currency changeover (2002) and related


(i) A write-off of EUR240million in respect of Irish banknotes not expected to be

presented.  (This increased the CB’s profits for 2002 and meant that the

transfer of surplus income to the Exchequer in 2002 and 2003 was increased by

the same amount).  In practice, all of the EUR240 million was transferred in


(ii)  A special transfer to the Exchequer (out of the currency reserve) of an

estimate of the past net proceeds of coin issues up to and including 2002 of

EUR 360 million.

(iii)  A special transfer to the Exchequer out of the revaluation reserve of

EUR258 million in 2003 following a reassessment of the Bank’s capital reserves


The total of the 3 transactions is thus EUR 858 million, out of total capital

and reserves (including revaluation reserves) of EUR 2979 at end-2001. so about

30% was handed back to the government.  (Note that the end-2001 figure had

already benefited from unrealized capital gains related to USD appreciation to


It’s also true that the change in accounting treatment from 1999 meant

that realized foreign exchange translation gains started to get credited to

profit and hence paid to the Exchequer instead of being just added to reserves.

 But I am inclined to believe that this was just a consequence of aligning with

ECB practice (compared with super-conservative old Irish practice).  In total,

this change increased flow to the Exchequer by a total of EUR 633 million in

the four years 1999-2002.  Thereafter the currency portfolio is essentially

100% hedged and no further significant gains (or losses) will occur.

Adding the EUR 633 million in realized exchange rate gains (that would never

have been transferred under the old regime) gives a total benefit to the

exchequer of the changeover of almost EUR 1.5 billion, or just over 1 per cent

of GDP.  Not to be sneezed at, but not overwhelming.

The end-2006 capital and reserves (including revaluation reserves are EUR 1156

— not much more than a third of what they were in 2001. This is only about 2.5

per cent of the Bank’s balance sheet.  Much lower and it could be argued that

the Bank’s financial independence might be compromised.

Note that this analysis concentrates on the capital and reserves of the Central

Bank and not the foreign exchange holdings.  EMU membership does free these up

also, but in a different way: not to be handed over, but to be employed

differently — more profitably and requiring less liquidity.  The Central Bank

of Ireland has shifted to riskier (e.g. AA+) and presumably longer term

securities to get a higher yield since they don’t need to be immediately

available and we can “afford” to lose them.”

Finally,  in preparing for the Maltese conference, I read the July 2007 IMF Article IV Staff Report on Malta. It makes a very interesting point about balance of payments accounting. In recent years, Malta has become an important centre in the provision of online gaming. In the BOP accounts, the difference between best placed by foreigners and wins paid out is recorded as an inward transfer.  This amounted to 8 percent of GDP for Malta in 2006. However, most of this ultimately accrues elsewhere:  about 7 percent of GDP is absorbed by imports of gaming-related services (such as marketing) and profit transfers.

4 Responses to "Malta and the Euro"

  1. Guest   November 3, 2007 at 5:57 pm

    Interesting piece. Can you explain the positive welfare effects of a reduction of forex reserves? they are not clear to me.

  2. Anonymous   November 3, 2007 at 5:58 pm

    So most of the value added from gaming is going to non residents as it does not seem that much of it is left in Malta, leaving aside some increase in local labor income.

  3. Philip Lane   November 21, 2007 at 5:20 am

    See the latest round in the debate over Malta’s reserves:

  4. From the heart   February 21, 2008 at 3:28 pm

    Hello Phillip,On the NouRoub blog, I put up the following post… (maybe you can answer my questions???)Sorry for the re-post… but I’m hoping to find some answers from the bloggers. Franquis took a stab, but it wasn’t what I was really looking for… In addition, sorry about this topic being “off topic” from NR’s current topic. Anomalies exist! …but for some reason, financial institutions, investors, economists, (like myself or even individuals like the ones on this sight) can never seem to account for them. Falling house value… HOW COULD THAT BE MISSED!!! Quant/Program traders not accounting for large defaults… HOW COULD THAT BE MISSED!!! Some individuals (NR for example) have been significantly more prescient! With that said, I revert back to my earlier question about the EURO Nations. “What hypothetical conclusions can be drawn from a worldwide financial crisis, for countries that have now tied themselves to one another through currency??? If financial Doomsday came, how does Germany eat the bullet, on Spanish debt? Money is the root of all evil. It can destroy friendships and allegiances. It can turn partners into enemies! The US has 2 oceans and now a wall to protect its interests. What do the EURO nations have?” I did not post this as a rhetorical question. (nor did I want to start a political debate or flag waiving match) I ask this as a pre-emptive fact finding mission. Are there agreements/pacts/accords in place, between the countries that are tied to one another, in case of a financial meltdown??? Did they address that ANOMOLY? In America, the taxpayer’s gonna end up eating the bullet. (especially the bottom 99%) Do the Euro nations have that scenario addressed? Does each country have equal responsibility? Are they responsible for only their percent? How does that work? I can’t picture a wealthy individual deflating their lifestyle for excesses that exist in another country. …especially if there are any inequities in the recovery process. We see the problem with lack of transparency with securities. What if there is a lack of transparency of responsibility on the recuperation? If these answers exist, and it is documented somewhere… can someone enlighten me? Miss America Written by From the heart on 2008-02-21 10:51:19