Analysis | Why Croatia Sees Joining the Euro as Path to Security

1. How close is Croatia to joining the euro? 

Croatia wants to swap its national currency, the kuna, for the euro on Jan. 1, 2023 — eight years after Baltic state Lithuania became the latest addition to the 19-member currency bloc. The former Yugoslav republic of 3.9 million people is very close to attaining its goal: It joined the euro-area waiting room known as ERM-2 in 2020, and hopes to get approval for membership this summer.

2. Why does Croatia want to join?

Croatia began its push for the euro as soon as it won accession to the EU in 2013 — a step that was delayed by the bloody 1990s wars sparked by the Yugoslav breakup. Like elsewhere in the continent’s east, the move is partly aimed at cementing a Western alignment after about half a century of communist rule following World War II. 

3. What about the economic logic?

That’s arguably even more compelling. The country relies more than any other EU state on tourists, who generate a fifth of gross domestic product and find holidaying much easier when they needn’t grapple with exchange rates. Meanwhile, most private and corporate bank deposits are held in euros, along with more than two-thirds of debt totaling about 520 billion kuna ($75 billion). Euro-area membership would lower interest rates, improve credit ratings and make Croatia more attractive to investors, according to central bank Governor Boris Vujcic.

Adopting the euro would formalize a chunk of economic activity that’s already carried out using the common currency — from apartment and car sales to short-term rentals for vacationers. It would trim foreign-exchange costs outside tourism to the tune of about 1.2 billion kuna a year, according to the central bank. Croatia would gain access to European Central Bank liquidity and potential bailout financing from the European Stability Mechanism during periods of crisis. With Greece’s troubles now largely in the rear-view mirror, there’s popular support to switch to the euro. Almost all political parties back the move.

In terms of monetary policy, there’s not much to lose by relinquishing control to the ECB since the kuna’s exchange rate has been locked in a tight trading band to the euro and, before that, to Germany’s mark since the 1990s. Croatia’s expected euro adoption will cost local banks about 1 billion kuna annually in lost conversion fees, but the switch will reduce currency risks and improve stability, according to the national association of banks. Euro adoption is also expected to cost banks between 80 and 100 million euros in one-time expenditure aimed at adapting their IT services and ATM networks. 

6. What must it do to join?

In short, it must meet EU limits on public debt and government finances, along with targets on inflation and the exchange rate. There’s some ambiguity, however, because Brussels is reviewing how its borrowing and fiscal curbs should look in the aftermath of the pandemic. Croatia plans to trim its budget deficit back within the original ceiling, while its ratio of debt to gross domestic product is set to fall to just over 80% — about in line with previous requirements and likely to be sufficient within the new rules.

7. What’s the toughest challenge?

Inflation is the biggest uncertainty. Europe’s spike in energy costs alongside the Russian invasion of Ukraine and the Croatian economy’s rebound in 2021 have sent consumer prices surging. What counts is how Croatia stacks up against a one-year average of the three euro-area states with the lowest rates. That calculation will be made once data for April are in. Eurostat’s data for March, released on April 21, showed Croatia’s annual inflation rate at 7.3%, just under the euro area’s average of 7.4%. The Croatian central bank said in response to a Bloomberg enquiry that it expects the country’s annual average inflation to be about 5.4% for 2022, adding that “one can with a high degree of likelihood expect that Croatia will satisfy the criterion of price stability.” The International Monetary Fund predicted in its World Economic Outlook in April that Croatian consumer prices would rise 5.9% in 2022, compared with 5.3% for the euro area.

8. Are there other obstacles? 

A probe by Croatia’s market watchdog, Hanfa, into deals by top central bank officials including Vujcic threatened the process. Yet the investigation — started in January — cleared the central bank chief in early May. Vujcic had denied any wrongdoing and said the allegations sought to sabotage the Balkan country’s plans to adopt the euro.

9. Are other countries eager to join?

One certainly is: Bulgaria. But it has pushed back its timetable by a year to 2024 after being accepted into ERM-2 at the same time as Croatia. Romania has also expressed a desire to follow eastern European peers Estonia, Latvia, Lithuania, Slovakia and Slovenia into the currency bloc. Despite being obligated to join themselves at some point, however, the biggest countries in that region aren’t rushing. Poland, for one, attributes its ability to survive the 2008 global financial crisis without a recession to it retaining an independent monetary policy.

10. What are existing euro countries saying?

Paschal Donohoe, Ireland’s finance minister who also leads gatherings of his euro-zone colleagues, has hailed Croatia’s “huge efforts” to prepare for euro adoption, saying he’s “hopeful” progress can be made. Beyond Brussels, public debate about expansion has been limited since warnings following a string of money-laundering scandals in the Baltic region. Such caution has recently been directed more at Bulgaria.

11. What would Croatia’s new coins look like?

The coins would feature the checkerboard pattern that, found on Croatia’s coat of arms, is considered one of the oldest national symbols in Europe. They’ll also have images of a kuna, or weasel in the Croat language, and will feature Nikola Tesla, one of the world’s great inventors, who was an ethnic Serb born in the present-day Croatian town of Smiljan. Serbia’s central bank has said it would take action if Croatia was allowed to use Tesla’s image.

• Bloomberg articles on Croatia’s central bank urging citizens to move their savings into banks, and its plans for euro coins.

• A Bruegel analysis of the euro coming of age.

• A Brookings Institution study on whether European integration increases people’s life satisfaction in Croatia and elsewhere.

(Updates with Eurostat inflation indicator for March in question 7.)

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