Croatia Joins Euro and Schengen

Croatia's Euro Gamble: Economic Dawn or Consumer Disquiet?

A deep-seated coffee culture permeates Croatian life. Venture through the avenues of Zagreb, even during the coldest winter days, and you will witness pavement cafés bustling with locals savouring their daily cappuccinos. This cherished ritual, however, faced a bitter turn at the beginning of last year. Interfering with a Croatian's coffee ritual is a move reserved for the boldest or most foolish.

On 1 January 2023, a decade after becoming the European Union’s newest member, Croatia officially began using the euro. The transition from the national currency, the kuna, was a momentous step. Yet, for many citizens, it coincided with a growing conviction that businesses, from cafés to retail outlets, were exploiting the transition to implement baseless price increases. This sentiment quickly brewed into a national controversy, stirring public debate and prompting governmental action.

A Bitter Taste for Consumers

The initial weeks of euro adoption were marked by widespread consumer complaints. Local media became a platform for grievances about perceived price gouging, as shoppers and diners expressed their shock at the new costs of everyday goods and services. An informal survey in Zagreb's central plaza captured the public mood, with many feeling confused and short-changed by the currency conversion.

One resident, Vina, alongside her friends, recounted paying for just two coffees and a soft drink with six euros, a price that left her stunned. The feeling was that while the numbers on the price tags looked smaller, the actual expense had significantly increased. Another person in the city, Zivana, noted that price rises had begun months earlier but intensified under the spotlight of the euro transition, leading to dissatisfaction with how the government was handling the situation. This growing public consternation created a pressing challenge for the authorities.

Governmental Intervention and Business Backlash

The escalating controversy compelled the Croatian government to intervene decisively. Officials summoned business owners to meetings, issuing stern warnings that unwarranted cost inflation would not be tolerated. The government made it clear it had an arsenal of tools to punish those who took advantage of the currency switch. Prime Minister Andrej Plenković gave businesses an ultimatum to revert their prices to the levels of 31 December 2022.

In response, business associations expressed outrage, accusing the government of tarnishing their reputations. They argued that any price adjustments were due to broader inflationary pressures, such as rising energy and raw material costs, not opportunistic profiteering. Despite these protests, the authorities remained firm, determined to prevent the euro from becoming synonymous with stealth price increases. State inspectors were swiftly deployed, launching legal action against hundreds of non-compliant businesses and imposing fines.

The Debate Over Price Rises

While many consumers felt the sting of higher prices, some within the business community maintained that the controversy was overblown. In a bustling Zagreb cafe, one barman, Luka, suggested that public anger was misplaced. He explained that his establishment had displayed prices in both kuna and euro for a significant period before the official changeover, and the cost of their offerings had not changed.

Economists and central bank officials also weighed in, offering a more nuanced perspective. The Croatian National Bank, in conjunction with the European Central Bank and Eurostat, conducted studies which concluded that the direct inflationary impact of the euro adoption was minimal, estimating it to be between 0.2 and 0.4 percentage points. They argued that Croatia entered the eurozone during a period of high global inflation, which was the primary driver of rising costs, not the currency transition itself.

A Long-Term Economic Strategy

Croatia's journey to the euro was a long-term strategic goal, intrinsically linked to its accession to the European Union in 2013. Adopting the shared currency was a prerequisite for its entry, a commitment that required years of preparation and adherence to strict economic convergence criteria. This included maintaining stability in inflation, government budget deficits, its public debt relative to GDP, and interest rates over the long run.

The country's determination stood in contrast to some other EU member states. Neighbours like Hungary, which once planned to replace its forint in 2007, continues to operate well outside the eurozone. Countries like Poland, the Czech Republic, Sweden, and Romania are also, in principle, required to transition to the euro, yet have no current intention of doing so. This makes Croatia's successful transition all the more significant, reflecting a sustained effort to align its economy with the eurozone's rigorous standards.

The Pre-existing 'Euroisation' of Croatia

A key factor in Croatia's relatively smooth transition was the high degree of "euroisation" that already existed within its economy. For decades, the Croatian kuna had been pegged first to the German Deutsche mark and subsequently to the euro. This long-standing policy meant that many significant transactions and savings were already linked to the European currency.

Boris Vujčić, who governs Croatia's National Bank, highlighted that debts for corporations, the government, and private households were predominantly denominated in or indexed to the euro long before the official adoption. Consequently, the switch to the euro aligned incomes with existing financial obligations, effectively eliminating currency risk for a large portion of the economy. This pre-existing familiarity and integration helped to mitigate some of the potential shocks of the currency changeover.

Shielding the Economy from Inflation

Far from being the cause of inflation, Governor Vujčić argued that embracing the euro actually shielded the nation from the most severe inflation that affected countries outside the single currency bloc. He suggested that the markets had already accounted for the country's forthcoming eurozone entry, which contributed to greater economic stability during a period of global financial turbulence.

Comparing Croatia's inflation trends with those of its neighbours like Hungary and Poland, which have not adopted the euro, supports this view. In many cases, inflation in Croatia was lower, suggesting that the euro provided a degree of insulation from external shocks. This perspective counters the public perception that the common currency was the primary cause of rising living costs, pointing instead to its role as a stabilising anchor.

A Double Boost: The Euro and Schengen Area

The currency shift coincided with another landmark achievement for Croatia: its entry into the Schengen Area. This dual integration provided a significant boost to the nation's economy, particularly its vital tourism sector. Joining the borderless Schengen zone eliminated prolonged waits at border checkpoints for tourists arriving by road from other EU countries, making travel significantly easier and more appealing.

Simultaneously, the euro removed the hassle and cost of currency exchange for the millions of visitors from eurozone countries who flock to Croatia's shores each year. This combination of seamless travel and a shared currency has made Croatia a more attractive destination, simplifying the holiday experience for a large portion of its key tourist market. Projections indicated a substantial lift for the tourism sector, which was poised for substantial growth.

A Boon for Tourism and Trade

The practical benefits for tourists were immediately apparent. Travellers from Germany and Austria, two of Croatia's largest tourism markets, expressed relief at no longer needing to deal with exchange rates. An adviser for the Croatian National Tourist Board, Dubravko Miholic, noted the positive feedback on travel forums, with many visitors welcoming the convenience of using their home currency.

Economic analysts also foresee a benefit for Croatia's exporters because the common currency removes the final hurdle to frictionless commercial activity within the EU. Goran Saravanja, the lead economist at the Croatian Chamber of Commerce, notes that in less than a decade of EU participation, the amount of exported products has more than doubled. The euro and Schengen entry provided further impetus for growth.

Enhancing Investment and Competitiveness

Embracing the euro also enhanced Croatia's attractiveness as a destination for foreign investment. For international companies considering a base in Europe, Croatia's inclusion in the eurozone expanded their options. The country's strategic geographical location, coupled with the reduced costs and complexities of operating within the shared currency area, strengthened its competitive position.

The elimination of exchange rate risk was a particularly significant advantage. It provided a more stable and predictable economic environment, which is highly valued by investors. This stability, in turn, was expected to lead to lower borrowing costs for Croatian businesses and the government, further stimulating economic activity and contributing to long-term growth prospects. The move was seen as completing Croatia's full integration into the European Union.

The Path to Broader Eurozone Expansion

Croatia's successful admission has sparked new debate on the future growth of the single currency zone. While several countries remain on the sidelines, Bulgaria appears to be the next in line, with ambitions to join in the near future. The European Commission and the European Central Bank continue to monitor the progress of candidate countries, assessing their readiness to adhere to the strict convergence criteria.

Romania has also stated a long-term ambition of transitioning to the euro, although a specific timeline has not been set. The experiences of newer members like Croatia provide valuable lessons for these aspiring nations, highlighting both the benefits of integration and the challenges that can arise, particularly in managing public perception and addressing concerns about price stability during the transition period.

Lingering Consumer Concerns and Future Outlook

Despite the strong macroeconomic arguments in favour of the euro, concerns among Croatian consumers about the cost of living have persisted. Data on consumer confidence has shown fluctuations, reflecting ongoing anxieties about personal finances and the broader economic outlook. The government has acknowledged these concerns and has continued to monitor pricing practices to prevent unfair exploitation of the currency change.

To reassure the public, shops were required to continue showing prices in the old currency for an extended period, a measure designed to promote transparency and help consumers adapt. While the kuna is no longer in circulation, this dual-display policy aimed to convince patrons that even with a different name, the underlying worth has not been altered. This measure was a crucial part of the effort to build trust in the euro.

Navigating the New Economic Landscape

As Croatia moves forward, the long-term benefits of euro and Schengen membership are expected to become increasingly evident. The International Monetary Fund has projected continued economic growth for the country, supported by robust private consumption and investments funded by the EU's Recovery and Resilience Facility. The focus for the government is now on implementing structural reforms to further enhance competitiveness and ensure sustainable growth.

The initial controversy over coffee prices has subsided, replaced by a more nuanced understanding of the economic forces at play. While the transition to the euro was not without its challenges, it has ultimately positioned Croatia for a more stable and prosperous future within the heart of the European Union. The journey reflects a deep commitment to European integration and a strategic vision for the nation's economic development.

The Verdict on the Euro

Eighteen months following the historic shift, the consensus among economic experts is that the benefits of euro adoption have been substantial. The elimination of currency risk, reduced transaction costs, and increased resilience to financial crises have strengthened the Croatian economy. Governor Vujčić has stated that the euro brought all the advantages that were anticipated, making the economy stronger and more resilient, particularly in the turbulent global environment in which the changeover occurred.

For the average Croatian consumer, the adjustment continues. The initial shock of seeing new prices has given way to a gradual adaptation to the euro. The debate sparked in the cafés of Zagreb has highlighted the critical importance of clear communication and robust consumer protection measures during such a significant national transition. Ultimately, Croatia's euro story is one of strategic foresight and a firm step towards deeper European integration.