Croatia fulfils all economic criteria to join the euro area in January 2023 despite rising inflation, according to the EU Commission’s biannual convergence report, published on Wednesday (1 June)

Of all the EU countries that do not use the euro, Croatia is currently the only one to fulfil all convergence criteria, the Commission stated in the report. As such, the Commission proposes the euro be introduced in the country, making it the first euro area enlargement since Lithuania in 2015.

“Today, Croatia has made a significant step towards adopting the euro,” Commission President Ursula von der Leyen said, claiming that this would strengthen both the Croatian economy and the euro itself.

The message was well-received in Croatia. “We are very proud of this success and look forward to all the benefits this will bring to Croatia while also being aware of the responsibility this membership entails,” the governor of the Croatian National Bank, Boris Vujčić, said.

Every other year, the EU Commission publishes a convergence report that examines whether EU states outside the euro area comply with the convergence criteria defined in the EU treaties, namely price stability, sustainable public finances, the durability of convergence, and exchange rate stability.

Public debt and inflation

The sustainability of public finances is measured by government deficit and government debt. While debt levels had risen dramatically to 87% of GDP during the pandemic in 2020, they had fallen back to 80% in 2021. The Commission argued that they were on a downward path.

“We are fairly confident with Croatia’s fiscal trajectory,” a senior EU official said.

In terms of price stability, Croatia narrowly fulfilled the criterion. For this, Croatia’s average inflation rate over the past year could not exceed the average inflation rate of the three “best performers” in the EU by more than 1.5 percentage points. This reference value stood at 4.9% for the year from April 2021 to April 2022. Croatia’s average inflation rate of 4.7% thus only just remained below the threshold.

Interestingly, the two countries with the lowest inflation rates, Malta and Portugal, were considered outliers and thus not included in the reference value calculation. Had they been included, the Croatian inflation rate might not have been able to fulfil the necessary conditions.

“With outliers, it’s important that they are applied reasonably and consistently,” a senior EU official said, arguing against the suspicion that the numbers might have been engineered to favour a Croatian accession to the euro area.

The official’s argument is supported by the fact that many previous convergence reports also excluded outliers to prevent distortion of the data. Nevertheless, this shows that the Commission has some leeway in how it calculates the data that determines whether a country can join the euro area.

Low risks from the banking sector

The euro crisis in the past decade has repeatedly shown the structural weaknesses of the euro area, where individual member states give up monetary sovereignty.

A significant risk was posed by the so-called sovereign bank doom loop, in which the distress of major national banks and strained public finances mutually reinforced each other at significant risk to the economy.

However, a senior Commission official argued that this risk was not very relevant for Croatia since its banking system is dominated by big banks from other euro area member states instead of domestic players.

Despite the overall positive message from the Commission regarding Croatia’s euro area accession, the Commission said that challenges remained in Croatia, for example, in the quality of regulation and the fight against corruption.

The door is open

With all the criteria fulfilled, there are only a few last political steps to take.

The EU’s heads of state will have to give their political agreement to Croatia’s euro area accession at their summit at the end of June, and the European Parliament will vote on an opinion regarding the matter in early July. Only then will EU finance ministers formally decide to allow Croatia’s accession to the eurozone in mid-July.

If there are no political hiccups along the way, Croatians can expect to start paying in euros from January 2023.

“The practical preparations for the changeover from the Kuna to the euro are already well underway,” EU Economy Commissioner Paolo Gentiloni said.