Will Croatia be a benefit or a liability for the Eurozone?

For Croatians, the new year began with optimism. Croatia had just joined the Eurozone and the Schengen Zone - two of the big achievements of the European integration project.

As with most matters pertaining to the European Union, the process for gaining Eurozone membership is highly technical and tedious. Member states need to comply with and fulfil the ‘convergence criteria’, also referred to as the ‘Maastricht criteria’ of 1992 - a set of binding economic and legal conditions, that include stable exchange rates and low inflation, amongst others. 

Alongside assessments from the European Central Bank, the country in question requires a green light from the EU’s institutions including the European Commission, the European Parliament, and unanimous consensus from all EU member states through the Council of the EU.  

In July 2022, the Council’s decision affirming Croatia’s accession to the Eurozone paved the way for Croatia to formally enter the Eurozone starting in 2023. 

As a result, even though Croatia joined the EU in 2013 after its independence in 1991 following the disintegration of Yugoslavia, it has taken the country ten years to finally become a member of the Eurozone - the latest country to do so after Lithuania’s adoption of the euro in 2015.

Yet, many observers have highlighted how this is not the most opportune moment for Croatia’s accession to the Eurozone, amidst a weakening of the euro itself and a looming recession in the continent. Indeed, for the first time in twenty years, the euro stooped to the level of the American dollar in mid-2022.

Will the Eurozone help Croatia? 

In the immediate term, joining the Eurozone will accord key advantages to Croatia, not least in enhancing the ease of doing business and travel. 

Firstly, eliminating the need to exchange currency for tourists would give a boost to Croatian tourism, an industry that accounts for 20 percent of Croatia’s GDP where 70 percent of tourists arrive from the Eurozone.

Naturally, the same benefits would be accorded to Croatians visiting the rest of the Eurozone. Over half of Croatia’s external trade also takes place with countries that are fellow Eurozone members and trading in the same currency makes the process more seamless. Moreover, adoption of the euro will make Croatia more attractive for investments, boost competitiveness, reduce interests rates and transaction costs, increase economic resilience and provide cushioning from external shocks, thereby leading to greater economic growth, financial security and better standards of living, which are vital for a country that has lower than average income levels compared to the rest of the EU.

Adopting the euro will also help in tackling soaring inflation, including skyrocketing food and energy prices, triggered by Russia’s war in Ukraine, as evident in the relatively lower inflation levels experienced by Eurozone countries at 10 percent compared with Croatia’s higher rates at 13.5 percent in November 2022. In addition, Croatia would also gain from deeper financial links with both the European Central Bank as well as the Eurozone’s 19 other member states. 

However, despite these benefits of joining the Eurozone, sentiment among Croatians is mixed, with citizens expressing apprehension and skepticism. Such is the lukewarm support that only 55 percent of the country’s citizens are in favour of the euro, while others fear potentially higher prices amidst raised costs of living in a period where Croatian consumers are already battling surges in inflation given the overall economic environment. 

Still, others also fear that the currency change would enable businesses to round up prices during conversion, resulting in an increased cost of living. What’s interesting is that a similar story unfolded in 2013 when Croatia was about to join the EU where similar fears propelled only 45 percent of Croatians to approve of Croatia’s EU membership.

And yet, despite this mixed sentiment, the euro is not new to Croatians at all. As the ECB states, “Croatia’s economy was also characterised by a high degree of euroisation”. In fact, many prized assets in Croatia including cars and real estate along with 80 percent of bank deposits and 60 percent of loans were valued in euros, based on a lack of confidence in the local kuna currency created in 1994.

Consequences for the Union

While Croatians remain divided on these benefits of accession, Croatia’s entry may have negative consequences on the state of the Eurozone itself. The Maastricht criteria’s aim was to enable the Eurozone to be economically stable, yet reports indicate that Croatia did not totally meet the Eurozone’s accession criteria. 

In the period between 2014-2020, although Croatia did meet the inflation and interest rate criteria, the country’s convergence assessment reports demonstrate that it did not fulfill the public finances and other legal conditions. In 2022, Croatia's debt stood at 70 percent of GDP, which is above the 60 percent cut-off enshrined in the criteria. Besides, memories of the systemic 2010 Eurozone crisis after the collapse of Greece still haunt the Union. 

Moreover, the incentive for Croatia to further implement economic reforms could also diminish after its entry. Thus, one may question the rationale behind the expansion of the single-currency union, given the significant disparate gaps in wealth amongst countries in the Eurozone. 

Yet, the picture is not so bleak, given that even founding members of the Eurozone did not always comply with all the necessary fiscal conditions. Moreover, the Eurozone has become more secure since the 2010 crisis, as evident in the several emergency funds such as the European Stability Mechanism and the Single Resolution Fund established in 2012 and 2016 respectively to aid in potential bailouts. 

The European Central Bank has also taken on the intervening role of lender of last resort, if required, that could prevent a potential financial crisis in one member country affecting the entire Eurozone. In addition, the Croatian financial system is much smaller than that of many other EU member states to pose a substantial threat to the entire Union. 

Besides, Croatia’s higher-than-desirable debt levels are also attributable to the devastating economic impact of the Covid-19 pandemic, further exacerbated by Russia’s war in Ukraine and coinciding with high debt levels and inflation in most Eurozone countries. 

However, even though the adoption of the euro will undoubtedly deliver significant economic value, Croatia will need to go beyond this and adopt appropriate policies to increase the country’s productivity and promote investment, according to the World Bank. This could include a reorientation of its economy from being heavily dependent on services to also include production. Additionally, a declining general population, coupled with exoduses of young Croatians preferring to work in wealthier neighbouring countries, have also contributed towards slow economic growth.

Even so, Croatia’s entry into the Eurozone and its deeper integration into the EU appear to be as much a political decision as it is an economic one, demonstrating the attractiveness of the common currency in a period when Russia is vying for European unity to fracture while it continues its war on Ukraine.