On 1 January 2023, Croatia became the eurozone’s twentieth member. By reducing foreign exchange risk, euro adoption significantly improves the country’s macroeconomic solidity.
Croatia is a small economy, and a member of the European Union since 2013. Domestic demand fuelled by declining unemployment, increasing real wages (notably in the public sector), and a relatively supportive fiscal stance, as well as investment benefits from European funds fuelled a relatively sustained economic growth during 2015-19. The over-reliance on tourism activity (around 25% of GDP) has exacerbated the adverse economic consequences of the COVID-19 pandemic. Several years of macroeconomic improvement and EU financial support should help the country to face this crisis.
Fiscal and external metrics have significantly deteriorated, resulting in an increase in government debt. The state-owned enterprises (SOEs) sector is significant, with a large part of them showing low productivity and profitability. However, direct contingent liabilities are manageable. For the time being, external liquidity is adequate and ensures the credibility of the de-facto Kuna (HRK) peg to the euro. Progress has been made on euro adoption with the request to enter the exchange rate mechanism ERM-2 expected in 2020. After at least two years in the mechanism, the formal adoption of euro is possible.
In the medium term, structural issues reduce Croatia’s growth potential. The lack of an adequate labour force could be a constraint on corporate expansion, and the heavy role of the public sector in the economy constrains its efficiency.
