One year with Euro

Zagrebacka Banka d.d.
Fri, 22/03/2024

Euro accession has brought measurable benefits                                                                                                                                                                                                         

Croatia entered 2023 as a new member of the Euro and Schengen area. These developments were intended to support the positive sentiment in the Croatian economy, which diverged for most of the year from the same indicator for the eurozone, calculated by the European Commission. This ultimately turned out to be very important, as in 2023 the euro area came to the brink of recession, seeing some of the larger members indeed enter recession. Still, a solid growth rate was maintained in the Croatian economy. The final reading of the growth rate in 2023 is expected to be around 2.5% (2.4% in the first three quarters). This growth is primarily driven by investments, government spending, and the export of services.

During the last year, the contribution of personal consumption increased as inflation slowed, and real income increased again due to the real recovery of wages. As a consequence of the faster growth of prices in tourism and a generally higher number of night stays realized during 2023, the real income of tourism also increased, even if, during the main tourist season, a decrease in night stays was recorded, which was initially seen as a warning for Croatian tourism.

Investments were also greatly influenced by a more intensive use of EU funds in a year when Croatia had access to a record amount of these funds from various sources. Additionally, the remaining funds from the 2014-2020 financial perspective were also available, and the Solidarity Fund for reconstruction after the earthquake in 2020 had to be used up.

However, Croatia is the leading country in Central and Eastern Europe and one of the three leaders in the EU in terms of meeting the conditions of reforms, and policy measures and withdrawing funds from the NGEU allocation, including the Fund for Recovery and Resilience. Croatia absorbed the third tranche by meeting the required conditions and was approved for the modification of the National Plan for Recovery and Resilience, in which Croatia also defines the withdrawal of the available loan allocation within this instrument (4.4 billion euros on top of 5.5 billion euros in grants and 269 million euros for the REPowerEU program).

The Euro accession also implied various benefits and costs. Benefits were expected to be more long-term, though some of them were reflected in 2023, while costs should have been more short-term and one-off. The main benefit of accession was related to lowering the risk of currency exposure, by replacing the local currency – Croatian kuna – with the euro. Different eurozone instruments and tools for coping with such risks are made available with the euro accession. This, in turn, also resulted in the improvement of the sovereign credit rating, by two notches already in 2022 to BBB+ by Fitch/S&P and Baa2 by Moody's. All major agencies have rated Croatia with a positive outlook during 2023, opening the possibility for further rating upgrades, potentially to the A-class level in the period ahead. Lower sovereign yields and spreads are notable as well, and even below those of Italy. Furthermore, the increase in Croatian yields during this period of high inflation and interest rate hikes, was less pronounced than for most of the CEE countries, especially those which are non-euro.

By fully accepting the ECB monetary policy, the Croatian National Bank had to align existing monetary policy instruments up to those of the ECB – which then also resulted in a big expansion of liquidity in the banking and monetary system. Together with the existing strong competition amongst commercial banks, and lower risks achieved by removing the local currency exposure from the equation, these policy adjustments helped prevent a quick and direct spillover of rising benchmark interest rates (ECB hikes) toward clients as well as a deceleration of demand for loans. This also allowed for credit expansion in the private sector, as loan growth decelerated, but remained strong, especially within households.

The fear of one-off upward adjustments in consumer prices during the conversion from kuna to euro was the main concern for citizens, sometimes even utilized in political interests. However, the conversion was implemented during a period of higher inflation in the global environment. Early surveys, conducted by the ECB, estimated that inflation hikes due to the conversion were no different than for other economies joining the eurozone in previous cycles, and generally were largely overshadowed by other inflation factors. Compared to price increases in non-Euro countries in CEE, overall increases within Croatia were visibly lower.

So far, the general consensus is that Croatia has benefited visibly from the euro accession, despite all the initial costs that it brought with it. Moreover, the accession has allowed the local economy to be better prepared for global economic challenges, with more tools and higher confidence.