It took Croatia nearly two decades, from the submission of its request to join the EU, to navigate through the integration process and finally become eligible to join the eurozone. Throughout this period, the Croatian economy underwent substantial changes to meet the requirements for introducing the euro. On January 1, 2023, Croatia switched to the euro, a move preceded by high expectations from Croatians and other economically involved parties. These expectations encompassed reduced vulnerability to risks associated with currency fluctuations, favourable loan terms for the country, and simplified currency usage.
This analysis-series aims to examine the circumstances and the consequences of introducing the euro in Croatia.
The first essay focuses primarily on foreign investments. It tries to illustrate how the volume of foreign investments and investor confidence have changed through the fluctuations in Foreign Direct Investment (FDI) before and after the transition. Although the research method is limited in scope, since it does not examine other economic indicators, the analysis shows that the introduction of the euro has not had a negative impact on the dynamics of changes in Croatian FDI.
Zsanett Gréta Papp
The circumstances
As all member states of the European Union (excluding Denmark and previously the United Kingdom), Croatia was also committed to introducing the euro in the spirit of broader integration within an indefinite timeframe. Countries must meet strict requirements to be eligible for that, which, in the case of Croatia, were considered fulfilled by the Council of the European Union – more precisely, its formation dealing with economic and financial matters, the so-called ECOFIN – by 2022. That paved the way for introducing the euro, a move supported by half of the Croatian population by that time.
In 2023, Croatia's accession brought the number of countries in the eurozone to twenty. Subsequently, only seven countries remained outside the monetary union: Sweden, Denmark, Poland, the Czech Republic, Hungary, Romania, and Bulgaria. These countries do not fully meet the convergence criteria outlined in Article 121 of the Maastricht Treaty and the related legal requirements, or they are unwilling to relinquish their monetary policies, and possibly both. Itis worth examining how the introduction of the euro has impacted the Croatian economy and how foreign investors perceive the new situation.On the way to the euroCroatia submitted its candidacy to join the European Union in 2003, expressing its strong commitment to EU integration (for economic and political reasons). As a result, Croatia became the 28th member state of the European Union in 2013, undertaking – among other things – to enter the common currency zone, thereby relinquishing the kuna, its official currency since 1994.To achieve this goal, they had to meet Maastricht criteria:
— Compliance with the requirements of the exchange rate mechanism of the European Monetary System (ERM-II).
— An inflation rate that closely aligns with the rates of the three best-performing member states in price stability.
— The sustainability of the state's financial system, therefore stable budget balance.
— Interest rates for long-term loans that closely align with the interest rates of the three best-performing member states in price stability.
The exchange rate mechanism among these mimics the monetary conditions of the eurozone to assist the respective country in preparing for the introduction of the euro. Important to add that upon entering the exchange rate mechanism, a country's currency must not fluctuate by more than 15%, and it must avoid devaluation against the euro for a continuous period of at least two years. Croatia applied for admission to ERM-II in 2019, and by meeting its requirements and the other Maastricht criteria, the country introduced the euro on January 1, 2023,It is the result of a 20-year long, 20-year-long process.
Expected benefits
Although countries using the euro cannot mitigate the effects of an economic crisis by devaluing their currency, they are also not as exposed to the risks of fluctuating inflation. In the case of Croatia, nearly two-thirds of the national debt was denominated in euros even before it became the country's official legal tender. Previously, when the kuna devalued against the euro, it led to a nominal increase in the national debt and a worsening budget balance. This risk ceased for the country with the introduction of the euro, however, the consequences of the recent COVID-19 pandemic and the increasingly unpredictable changes in global politics have made their impact on the Croatian economy as well. In such times, a crucial consideration is that transitioning to the euro may provide the country with favourable loan conditions.It is not only the state that benefits from vanishing currency rate fluctuations between the kuna and the euro, but also the market players, investors, and citizens. This is particularly true in the case of Croatia, due to the country's key sectors are tourism and hospitality (constituting nearly 20% of the GDP)The conditions of money exchange can be significant, as the sector provides a livelihood for lots of citizens and attracts numerous investors. Furthermore, Croatians - in line with other states in the Adriatic region (excluding Bosnia and Herzegovina and Albania) - experienced a considerable simplification of currency usage and the disappearance of the previous exchange costs thanks to the transition to euro.Impact on foreign investments
The impact of introducing the euro on foreign investments is best observed through the value of Foreign Direct Investment (FDI), which indicates how much foreign capital flows into the country during a specific period. If a foreign investor holds at least a 10% ownership stake in a company registered in an economy outside their home country the value of their acquired stake adds to the FDI for the examined period. That is expressed then as a percentage relative to the country's GDP. This value fluctuates typically between 2-3% on a country-by-country basis. In Croatia, FDI has averaged around 3.14% yearly since the country acceded to the EU (between 2013 and 2022). However, in the last four years (starting from 2019), this number increased to 5.15%, indicating an outstanding economic performance. While data from the first and second quarters of 2023 do not allow for far-reaching conclusions, it seems like FDI will not surpass the average of the past four years. A 5.48% FDI was recorded relative to GDP in the first quarter, while in the second quarter, it was 1.07%.
The recent strong performance of the Croatian economy and the increased confidence in the investment sector can be associated with the prior expectations surrounding the introduction of the euro. The primary investing countries in the Croatian market are all members of the eurozone. The Netherlands, Austria, Luxembourg, Germany, and Italy especially are at the forefront in this regard. Croatia has indeed become an even more appealing investment destination for them since it officially adopted the common currency. The trend in the FDI reflects this, showing that economic uncertainties have not suppressed considerably the interest of these leading investors.
Summary
Analysing the FDI (Foreign Direct Investment) trend shows that, in terms of percentage relative to the GDP, there hasn't been a substantial decrease in the scale of foreign investments in recent times. It suggests that the opportunities presented by the Croatian economy remain appealing to investors.
Toma Tamás Áron
This article was made in cooperation House of European Affairs and Diplomacy - Szeged.
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