Welcoming Croatia & Saying Goodbye To Kuna

On July 10th, 2020, Croatia entered the euro waiting room. Already at the time, the Government and the Croatian Central Bank (HNB) emphasized their strategic goal: euro adoption at the earliest possible date - January 1st, 2023.

 While the plan was strongly supported by the public, it has also been made feasible by a long period of a stable FX rate, low inflation and fiscal consolidation. The economic and inflation cycles of the euro area and Croatia have been highly correlated for a long time already. However, it's important to consider sustainability when meeting the criteria for convergence, which includes not neglecting soft criteria. Convergence must be achieved on a lasting basis, and institutional strength and the rule of law are important factors in achieving this goal.

Two years later, the Council of the European Union formally approved the accession of Croatia to the euro area on January 1st, 2023. This did not only mean that Croatia managed to meet all requirements in the shortest period possible, but has also improved its position on international competitiveness rankings significantly. This partly reflects the process of European integration itself, which presupposes strengthening of institutional capacities and implementation of reforms.  

The participation in the Exchange Rate Mechanism II, which is the lobby for entering the society of countries that share a common currency and monetary policy, was even marked by a truly challenging time. This was perhaps unprecedented in European history. The period was marked by the outbreak of the pandemic in the spring of 2020, the war in Ukraine, the energy crisis, rising inflation and uncertainty.

Unlike the previous euro area candidates, Croatia had to make several commitments in policy areas to smoothly transition to, and participate in, the ERM2, which they fulfilled by March of this year. In addition to banking supervision, these commitments related to the country’s macro prudential framework, its anti-money-laundering framework, the collection and dissemination of statistics, public sector governance and reduction of the financial and administrative burden. 

The EUR/HRK exchange rate has been stable with strong fiscal metrics and interest rates, but meeting the inflation criteria has been challenging. However, Malta and Portugal were excluded from the threshold calculation, so Croatia met the criteria. Croatia is still catching up in terms of GDP per capita and price levels, which may result in positive inflation differentials compared to the euro area. Inflation rates have increased due to the consumer basket structure and slightly higher food and energy weight. Core inflation also reflects convergence of prices to the euro area average. The European Commission expressed concerns about the sustainability of inflation convergence and called for appropriate policies.

Starting January 1st, 2023, giving up monetary sovereignty is inevitable for Croatia, but it is a small drawback.  Specifically, the "potential" loss of monetary sovereignty in the Croatian case seems to be irrelevant, as the ECB already has a decisive influence on the financial conditions in the small and open, plus highly euroized, European economy. 

The high level of euroization, which has been present for decades, and the consequent fulfillment of the fundamental goal of inflation stability, through exchange rate stability as the main anchor of monetary policy, resulted in high constraints in monetary policy. For that reason, de facto, the central bank has never used interest rates to influence the financial markets. 

The FCY indexation, deeply ingrained in Croatia's financial markets, goes down in history with the adoption of the euro, which ultimately means easier planning and trading, facilitating foreign trade activities and investments. However, eliminating the cost of conversion for private individuals and businesses also represents a reduction in the income of the banking system. 

So finally, we can say that throughout the journey, Croatia received strong political support from the European institutions. The relevant criteria were interpreted in a flexible and targeted way under special circumstances, which we consider a political success for both Croatia and the EU. This shows that the EU and its institutions can act effectively during crises.

For Croatia the euro area membership can mean an opportunity - albeit not a guarantee - to reap substantial benefits. As history demonstrates, monetary stability in a stable and low real interest rate environment may also expose a country to vulnerabilities (remember Greece) if monetary stability is misused to substitute for disciplined and sustainable economic policies.  

In Croatia’s case, it took 2.5 years, slightly more than Slovenia (2 years), but, apart from Greece (2.5 years), significantly shorter than for other members that have accepted the euro. Therefore, considering everything said in terms of normative criteria and with strong political support of European institutions, the euro has become the official Croatian currency on January 1st, 2023 resulting in an enlargement of the euro area to 20 countries.

If you have questions or need further information, please contact