Letter of Intent Sent, Croatia to Introduce Euro in 2023?

Lauren Simmonds

Croatia will officially adopt the euro as its currency within the next few years, abandoning the Croatian kuna entirely. As we recently reported, Croatia has been given one year exactly to meet all of the rather stringent requirements for Eurozone entry, and the final decision lies with the current member countries of the Eurozone and the European Central Bank.

The move has been met with significant opposition from the general public, but the Croatian Government is continuing to press forward. While some desire a referendum on the matter, the government has stated several times that agreeing to the introduction of the euro was one of the requirements Croatia had to agree to to join the European Union, of which it became a full member back in July 2013.

Countries like the United Kingdom had the ability to opt out of this when it joined the European Community, long before it became the EU, several decades ago, but the rules have since altered, and Croatia had to sign on the dotted line for eventual Eurozone entry.

As Novac/Frenki Lausic writes on the 5th of July, 2019, at yesterday’s session, the Croatian Government authorised Finance Minister Zdravko Marić’s signing of Croatia’s official letter of intent to join the ERM II exchange rate mechanism, after which the Ministry of Finance announced that Croatia had sent the letter of intent to enter the European Exchange Rate Mechanism to the member states of the Eurozone, Denmark, and the European Union institutions (ERM II).

The letter of Intent was signed by Finance Minister Zdravko Marić and Governor of the Croatian National Bank (CNB/HNB) Boris Vujčić on behalf of the Republic of Croatia. This move marked the very first formal step towards Croatia’s intention to join the ERM II, which is seen as a sort of ”lobby” which precedes the introduction of the euro as a country’s official, main currency. In addition to the letter of intent, the member states and institutions of the EU were also sent an Action Plan detailing the reforms Croatia will make sure to undertake before entering the ERM II.

In line with what is expected from the competent institutions of the European Union, the aforementioned Croatian ministry emphasised in its letter of intent, the promise to implement reforms in six areas: the strengthening the supervision of the banking system by establishing close cooperation between the Croatian National Bank and the European Central Bank, strengthening the framework for implementing macroprudential policies by introducing an explicit mandate for measures aimed at borrowers, strengthening the anti-money laundering framework, improving the system for collecting, processing and publishing statistical data, improving public sector management, and reducing administrative and financial burdens for the sake of Croatia’s economy.

Croatia has already started implementing some of these measures, and on May the 27th, 2019, a request was made to the European Central Bank for the establishment of close cooperation between the Croatian National Bank and the European Central Bank.

The Ministry of Finance argues that Croatia intends to properly implement all of the measures listed in the letter of intent and the action plan by mid-2020, after which the EU institutions will evaluate whether the measures have been adequately implemented.

It is expected that Croatia will begin participating in the ERM 2 exchange rate regime after obtaining a positive assessment. If Croatia enters the ERM 2, after having been in the exchange rate mechanism for at least two years, Croatia should formally meet the exchange rate criterion of so-called nominal convergence.

Croatia has actually been satisfying other remaining criteria, which include price stability, public finance sustainability and interest rate convergence – for some time now, and a prudent monetary and fiscal policy, the Ministry of Finance stressed, should ensure that those conditions remain the same.

Vedran Šošić, the Vice Governor of Croatian National Bank, stated that he hoped that Croatia would be able to implement all of the necessary reforms by that time so as to ensure all the conditions for moving towards adopting the euro are met.

Velimir Šonje stated that Croatia’s entry into the ERM 2 involves four procedural steps, the first of which is to send a request for membership in the Eurozone, followed by an in-depth meeting of the ERM 2 Committee, which discusses the central parity (the exchange rate according to which the national currency will be converted into euros) and the fluctuations of the exchange rate of the accession country (which are automatically determined within plus/minus fifteen percent around the central parity).

Subsequently, the ERM 2 Committee will conduct a deep macrofinancial analysis of Croatia’s economy to determine whether the existing macroeconomic framework is compatible with that of the ERM 2, the EU’s economic policy, and the stability and growth pact.

The next step will take place at a foreign currency exchange meeting, where the final parity and fluctuation margins will be determined, followed by the so-called final communication.

The period of stay in ERM 2 differs considerably among the seven EU member states that have most recently introduced the euro and, as was noted by Šonje, ranges from 2.5 years (Slovenia) to more than ten years (Lithuania). Such a large range therefore indicates that entry into the ERM 2 doesn’t have to lead to the automatic introduction of the euro in the short term – ideally, Croatia could adopt the euro by 2023, but it is clear that this period can be extended.

Here’s what Croatia has to do in order to be granted entry into the ERM 2 and eventually abandon the kuna for the euro:

1. An application for Eurozone membership

2. The ERM 2 Committee discusses the exchange rate of the kuna to the euro, as well as fluctuation margins

3. The committee “deeply” analyses Croatia’s economy in a macro-financial sense

4. The final parity and fluctuation margins are determined

5. Croatia can enter the ERM 2 by 2020 at the very earliest

5. Croatia’s ”stay” in the ERM 2 may be much more than two years. The time varies considerably across countries – Slovenia spent 2.5 years there, whereas Lithuania remained there for more than a decade

6. Ideally, Croatia will introduce the euro as its official currency in 2023

Here are the six reforms Croatia must ensure:

1. Boosting banking system supervision

2. Strengthening the protection of borrowers

3. Strengthening the fight against money laundering

4. Improving the system for collecting, processing and publishing statistical data

5. Improving public sector governance

6. Reducing administrative and financial burdens on Croatia’s economy

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