The European Commission has confirmed that Cyprus and Malta have achieved a "high degree of sustainable economic convergence" with the euro area member states and that they fulfil the necessary conditions to adopt the euro.
On the basis of this positive Convergence Report, the Commission has proposed to the Council that Cyprus and Malta adopt the euro on the 1st of January 2008. The final decision will be taken by EU Finance Ministers in July, after consultation of the European Parliament, and following a discussion by EU leaders at their June summit.
However, Joaquin Almunia, European Commissioner for Economic and Monetary Affairs cautioned that Cyprus must "continue to implement stability-oriented policies in order to safeguard its external competitiveness."
"In addition, Cyprus must also speed up and finalise the crucial practical preparations to ensure that the changeover takes place smoothly, as was the case in Slovenia at the beginning of this year," he added.
Similarly, Almunia called on Malta to "pursue its efforts towards fiscal consolidation and towards preserving external competitiveness, including through policies fostering productivity growth."
On 13 February, Cyprus asked the Commission to assess that it met the criteria necessary to adopt the euro. Malta followed suit on 27 February. To become part of the euro area, a European Union country must satisfy multiple criteria set out in the EU Treaty regarding the government budgetary position, price stability, exchange rate stability and convergence of long-term interest rates. Compatibility of the legal framework with the Treaty must also be examined.
The average inflation rate in Malta during the 12 months to March 2007 was 2.2%, below the reference value of 3.0%. The average inflation rate in Cyprus over the same period was 2.0%. The Commission predicted that inflation in both countries would continue below the reference value in the coming months.
Cyprus had a budget deficit of 1.5% in 2006, down from 2.3% in 2005, a figure which had enabled the Council, acting on a Commission proposal, to close the excessive deficit procedure started upon EU accession, in 2004. For 2007, the Commission's Spring Forecast projects an almost unchanged deficit (1.4% of GDP). The government debt increased between 2000 and 2004 but has been on a declining path since 2005 to reach 65.3% of GDP in 2006. In 2007, it is seen declining further to 61.5% of GDP. The Ecofin Council has considered the budgetary strategy outlined in the latest Convergence Programme as sufficient to reach the Medium-Term Objective of a deficit of 0.5% by 2008 and the underlying risks broadly balanced. However, Cyprus was invited to control public pension expenditure, namely through further reforms in order to improve the long-term sustainability of the public finances and to implement the fiscal consolidation path as foreseen in the programme.
The Commission also concluded that Malta had corrected its budget deficit and recommended that the Ecofin Council abrogates the excessive deficit procedure started upon accession to the EU, in 2004. The deficit-to-GDP ratio decreased from 10% in 2003 to 2.6% in 2006 and, according to the Commission's spring forecast, would amount to 2.1% in 2007. The government debt increased significantly in the first half of the decade, but has followed a downward path since 2004 to reach 66.5% of GDP in 2006. In view of this, the Commission considers that Malta has corrected its deficit in a credible and sustainable way and its debt is diminishing at a satisfactory pace towards the Treaty reference value of 60% of GDP. The EC said that Malta, therefore, meets the budgetary criterion.
Both the Cypriot pound and the Maltese lira have participated in the Exchange Rate Mechanism ERM II since 2 May 2005 and have consistently traded within the fluctuation band and close to the central rate with no "severe tensions," as the Commission put it.
The average long-term interest rate in Cyprus in the year to March 2007 was 4.2%, below the reference value of 6.4%. Average long-term interest rates in Cyprus have been below the reference value since November 2005. They have decreased substantially in the past few years as have spreads to the euro area, which testifies to the low residual country risk priced in by markets. The average long-term interest rate in Malta in the year to March 2007 was 4.3%.
Regarding legal convergence, the Commission said that all "outstanding incompatibilities" have been addressed in both Cyprus and Malta.
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