Croatia will give up its national currency, the kuna, and introduce the euro on January 1, 2023. It is the 20th country that joins the Eurozone. Croatia’s euro adoption has been long in the making. But it comes at a time when the Eurozone is facing new difficulties: high inflation and high debt following the pandemic and lower growth prospects in the wake of the Russian war against Ukraine, which will challenge Eurozone policymakers and central bankers in the months to come. Meanwhile, the recent rise in bond spreads and new fears of fragmentation on the back of looming elections in Italy reflects the incomplete nature of the common currency that Croatia is set to join.

How to join the euro: convergence criteria

The road to membership in the European Monetary Union is spelled out in the Maastricht Treaty of 1992. All European Union member states (except Denmark, which negotiated an opt-out) are formally obliged to adopt the euro once they meet the so-called convergence criteria (or Maastricht criteria).

These criteria provide a set of economic benchmarks designed to ensure sufficient economic convergence before entering the monetary union. They include:

  • Keeping inflation and long-term governmental interest rates below specific reference values;
  • Complying with limits to public deficit (3%) and debt (60%) that are also outlined by the Stability and Growth Pact to which the member states have to adhere after adopting the euro and stabilizing the currency’s exchange rate against the euro by participating in the European Exchange Rate Mechanism (ERM II) for at least two years before joining the Eurozone;
  • And ensuring that national laws are in line with the EU legal acquis on central bank rules.

The original purpose of the convergence criteria was to achieve economic stability within the Eurozone. They were designed to ensure that any new currency union member was operating in a stable macroeconomic environment that fitted the other currency members and to demonstrate that the country could manage its economy without recourse to excessive currency fluctuations.

As argued elsewhere, the Maastricht concept of stability proved to be too narrow for the monetary union. Budgetary stability was and is a crucial element of the monetary union’s framework, as a low-debt country should have more leeway for countercyclical policies in times of crisis.

However,  the euro crisis, in particular, has shown that other factors such as macroeconomic imbalances between member states, a lack of adaptability to different economic cycles, missing crisis management instruments, too lax banking supervision and the danger of a self-reinforcing dynamic between weakened banks and over-indebted states should also be taken into consideration when it comes to the stability of the Eurozone.

Moreover, the fiscal framework – particularly its deficit and debt targets – has proven to be of limited functionality. The Stability and Growth Pact has neither proven to effectively rein in member states’ budgetary profligacy in “good times,” nor does it grant the needed room for important long-term investments. Its sustained suspension in the wake of the Corona pandemic and the Russian war against Ukraine is a case in point.

Croatia’s path to euro membership

Despite challenging experiences with the euro’s governance, particularly during the financial crisis, the rules for joining the monetary union have remained essentially unchanged since their inception, and Croatia has followed the path into the Eurozone as set out in the Maastricht Treaty.

The European Central Bank and the European Commission publish Convergence Reports at least every two years to check how well EU members aspiring to join the euro comply with the above criteria as well as other factors relevant to economic integration and convergence.

Croatia’s convergence assessments from 2014 to 2020 showed that the country met the inflation and interest rate conditions but did not fulfill the public finances, ERM membership, or legislation compatibility criteria. Since 2018, Croatia’s government under Prime Minister Andrej Plenković has doubled down on its efforts to adopt the euro by 2023 and the country joined ERM II in July 2020.

The past months have seen the last hurdles to euro membership fall: The Commission’s Convergence Report in June 2022 concluded that Croatia fulfilled the criteria for adopting the euro – with an exemption made for a higher debt level (for a recent overview of Croatia’s macroeconomic developments click here).

After Croatia’s accession to the monetary union was endorsed by the European Council of heads of state and governments at their summit in late June, Eurozone Finance Ministers gave their official green light on July 12, 2022. The exchange rate for turning kuna into euro was fixed at 7.53450 to 1, and the country has until the end of the year to prepare for the transition. Croatia will be the 20th country to join the single currency on January 1, 2023.

Firm pro-euro official stance…

The long history of distrust in the domestic currency goes back to the 1980s, a time of high inflation in Yugoslavia when businesses and households used the German Deutschmark as a means of payment and informal unit of account. Consequently, Croatia’s currency, the kuna, has used the D-Mark and the euro as a reference since its creation in 1994.

For instance, prices for real estate, motor vehicles and accommodations have often been quoted in euros. At the same time, most private and corporate deposits are already held in euros – along with more than two-thirds of debt (see also Why Croatia Sees Joining the Euro as Path to Security).

The de facto “euroization” of large parts of the Croatian economy has been key in countering the competitive devaluation argument against euro membership – i.e., that being able to decrease the value of the domestic currency may be a useful instrument to increase competitiveness in the short-term.

Together with the rise of a Croatian service economy focused on tourism (which generates a fifth of GDP), an economic environment was created in which the Croatian state had exclusive control over its currency. This has increasingly been seen as obsolete (see this economic argument for euro membership spelled out in more detail here).

Joining the euro has become official government policy in the past several years. Throughout this period, becoming a Eurozone member has been presented by Croatia’s policymakers and central bankers as an important step towards integrating the country into the EU’s core and guaranteeing future economic prosperity.

… meets lukewarm public support

According to a recent Eurobarometer poll, there is a stable majority of 55% of Croatia’s public in favor of introducing the euro. Particularly the tourism sector has high expectations for the common currency that will reduce changeover costs for people visiting Croatia.

Yet the same poll shows that 49% of Croatians fear that the euro will have negative consequences for their country, while only 45% believe that it will have overall positive consequences. This figure is all the more striking as the assessment has changed dramatically over the past year – and for the worse.

In 2021, only 40% of Croatians feared negative consequences from euro membership, and 56% expected positive. While Croatia’s political leadership continues to be optimistic about the prospects of joining the euro, only one in three citizens think the country is well prepared to join the Eurozone. And a total of 81% worry that the introduction of the euro will lead to higher prices.

This growing skepticism towards euro membership is most likely in part a reflection of the state of the domestic economy. Croatia suffered a severe economic blow in the first phase of the pandemic when tourism almost came to a standstill.

The country is currently experiencing uncertainty in the face of the ongoing Russian war against Ukraine and rising prices. But the lukewarm support for euro membership might also be indicative of the state of the monetary union that Croatia is set to join.

Fresh turbulences for the Eurozone?

While euro membership is a long-term decision for any country, one important question for any country joining is what happens in crises. Croatia is entering the Eurozone in such a period amidst economic uncertainty and new turbulences.

Eurozone inflation rate is higher than ever, and after two years of the pandemic, so is the national debt in many Eurozone countries. The euro is worth less than it has been in a long time. Croatia coincidently signed up to join the Eurozone on the day the euro hit US-dollar parity for the first time since 2002.

Triggered by the Russian war against Ukraine, the worsening energy crisis – in particular, a possible stoppage of gas supplies from Russia – in addition to global supply shocks on the back of the Corona pandemic – could throw the Eurozone economy into a severe recession over the coming months.

On the political front, the end of Mario Draghi’s unity coalition government and looming elections in Italy in September have fueled speculations about the country’s ability to manage its public debt and to make good use of its significant EU corona funds.

This puts Eurozone policymakers and particularly the ECB, on a tightrope. The central bank needs to tighten monetary policy to rein in unexpectedly high inflation while ensuring that rising interest rates do not choke off the weak economy – and preventing fragmentation of financial markets across the Eurozone.

Even if the euro’s governance has become more focused and less existential as the currency union matures, the recent rise in bond spreads within the Eurozone continues to reflect the incomplete nature of the common currency that Croatia is set to join.

About the author

Katharina Gnath is Senior Project Manager at the Bertelsmann Stiftung. She is an expert on European and international economic governance and is in charge of the foundation’s work on the European economy. 

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