Croatia joins the EU - July 2013

Croatia joins the EU, but the euro is still far away

Croatia's path to membership of the European Union was a tortuous one, punctuated and delayed by armed conflict, French protectionism, fugitive generals, border disputes, fisheries protection zones, shipbuilding subsidies, bank failures and all manner of bureaucratic pedantry on the part of Brussels eurocrats. But eventually, a dozen years after serious discussions began, Croatia has finally joined the European Union.

With parts of peripheral Euroland in political and financial turmoil as a result of bailouts made necessary by banking losses and government debt, the timing of Croatia's accession could have been better. However, it did mean the country's struggling economy was in better shape than some of its new partners'. Croatian gross domestic product (GDP) contracted by -1.5% in the 12 months to March, a considerably sharper shrinkage than the -0.2% for the euro zone as a whole, but the Netherlands' contraction was -1.7% and in Spain it was -2.0%. Few would deny that unemployment in Croatia was too high at 19.6% but it looked better than the 27% in Greece and Spain and even in the euro zone unemployment was well into double figures at 12.2%.

Whilst Croatia did not enter the EU as its most economically dynamic member nation, nor did it do so as a basket case. More importantly, at entry the country was better-equipped than many existing members to meet the criteria for euro membership. Inflation had slowed to 1.6% in May, well below the 2.5% upper limit specified in the Maastricht treaty. The annual government deficit as a proportion of GDP was 4.4%, lower than in a dozen member states. Total national debt was about 54% of GDP, beating 17 members. The 10-year interest rate in Croatia was within bounds (though only just) at 4.81%. With some economic tuning, a modicum of luck and two years as a member of the Exchange Rate Mechanism (ERM2) Croatia looked set to join the common currency in 2015.

But that timetable would have been over-optimistic. Whilst Hrvatska Narodna Banka Governor Boris Vujcic believed his country should join the join the euro "as soon as possible", he conceded that the process would last a minimum of three years. An improvement in the country's economic performance and a reduction in overall government debt would take at least that long to achieve. In the meantime, the central bank would prevent "large fluctuations" in the exchange rate in either direction, as it had for several years.

The Bank has proven over the last five years its ability to maintain the stability of the kuna against the euro. With very few exceptions the EUR/HRK exchange rate has remained between 7.1 and 7.7, averaging 7.5kn = €1. That track record means ERM2 will hold few fears for the kuna and when Croatia does sign up for membership of the mechanism it is likely that its currency will track the euro even more closely.

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