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.