The European Central Bank (ECB) informed, in June, that Croatia fulfills the requirements and can join the euro on January 1st, 2023. If this happens, Croatia will be the 20th member of the European Union (EU) to be part of the single currency.
The European Commission also recommended Croatia’s entry into the eurozone to the Council, stating that the country meets the conditions to do so. Plus, the Eurogroup recommended Croatia’s adhesion to the euro as well.
The European commission also stated that
…the Council [Ecofin] will take the final decisions on Croatia’s adoption of the euro in the first half of July, after discussions in the Eurogroup and the European Council, and after the European Parliament and the European Central Bank have delivered their opinions.
According to the ECB’s assessment, Croatia fulfills the convergence criteria (price stability, budget deficit and public debt to GDP ratios, exchange rate and long-term interest rate) and its legislation fully complies with the requirements of the Treaty on the Functioning of the European Union and the statutes of the European System of Central Banks and the ECB:
In April 2022, the 12-month average rate of consumer price inflation by the Harmonized Index of Consumer Prices (HICP) was 4.7 percent in Croatia, below the reference value of 4.9 percent. However, considering the 10.7 percent annual consumer price inflation for Croatia in May, the ECB stated that the sustainability of inflation convergence in Croatia in the long run is a concern.
Budget Deficit and Public Debt to GDP Ratios:
Croatia’s public deficit at the end of 2021 was just below the 3 percent of GDP reference value, while public debt was above the 60 percent of GDP reference value (but it was lower than in the previous year). The budget deficit was 2.9 percent of GDP in 2021, which meets the deficit criteria. The public debt was 79.8 percent of GDP in 2021, which represents a reduction from the maximum value of 87 percent of GDP recorded in 2020.
The Croatian kuna was included in the ERM II on July 10th, 2020 at a central rate of 7.53450 kuna per euro with a normal fluctuation band of ±15 percent. In the two-year reference period (May 26th,2020 to May 25th, 2022), the kuna exchange rate had a lower degree of volatility and the currency traded close to its central rate.
Long-Term Interest Rate:
In the reference period from May 2021 to April 2022, long-term interest rates in Croatia averaged 0.8 percent (below the reference value of 2.6 percent for the interest rate convergence criteria). Long-term interest rates in Croatia have fallen since 2012, with the 12-month average rates falling from a value slightly below seven percent to a value below 1 percent.
In addition to Croatia, there are six countries that have not yet joined the euro but should do so once the requirements are met: Bulgaria, the Czech Republic, Hungary, Poland, Romania, and Sweden.
The ECB concludes that only Croatia and Sweden meet the price stability criteria. And all other EU members mentioned above meet the public finances (budget deficit and public debt to GDP) criteria, with the exception of Romania, which is currently the only member subject to an excessive deficit procedure (Romania’s budget deficit was 7.1 percent of GDP at the end of 2021, while Croatia’s was 2.9 percent of GDP).
According to the ECB’s assessment, Bulgaria and Croatia meet the exchange rate criteria. The long-term interest rate criterion is met by Bulgaria, Croatia, the Czech Republic and Sweden.
What Can Joining the Euro Mean for Croatia and the Rest of the Eurozone?
As Philipp Bagus explained in The Tragedy of the Euro, the mechanism behind the euro produces an incentive for its members to get into debt over time. Yes, there are periods when most countries decrease their indebtedness (albeit very slowly). But eventually they increase it to an even higher level (so, in the long run, indebtedness increases).
At first, Croatia’s adhesion to the euro should be beneficial to the country’s inhabitants, as the euro is stronger than the kuna (1 euro has fluctuated between 7.1 and 7.7 kuna since 2004). If Croatia joins the euro, its inhabitants will have greater purchasing power than they do today, even though the euro is devaluing at a greater intensity, leading to the highest consumer price inflation in the history of the euro. Croatians will be able to import more (and better quality) goods. And long-term investments will be more possible than they were with kuna. This can improve the standard of living of Croatia’s inhabitants.
On the other hand, joining the euro can also bring problems. Like other eurozone governments, Croatia’s government may become larger (increase its spending and indebtedness) over time. It may increase intensely (as happened with Portugal, Spain, Italy and Greece) or at a lower intensity (as in Germany and Luxembourg, which despite being countries with more frugal governments, their indebtedness increased in the long run).
In any case, it is likely that, by joining the euro, Croatia will increase its indebtedness (which means that the government will absorb more resources from society, decreasing the productive investments in the country). Furthermore, if Croatia goes down the higher debt path, it will be yet another major source of debt issuance that the ECB should eventually buy (yes, the ECB announced it will cease its Asset Purchase Program in July, but this halt will hardly be permanent). If this happens, Croatia’s indebtedness would be another major source of inflation for the euro, further decreasing its purchasing power over time. Everything will depend on how the Croatian government behaves in the years following its adhesion to the euro.