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Strategy for the Adoption of the Euro in Croatia in Euro the of Adoption the Strategy For STRATEGY FORSTRATEGY THE ADOPTION OF THE EURO IN THE REPUBLIC OF CROATIA GOVERNMENT OF THE REPUBLIC OF CROATIA CROATIAN NATIONAL BANK STRATEGY FOR THE ADOPTION OF THE EURO IN THE REPUBLIC OF CROATIA April 2018 STRATEGY FOR THE ADOPTION OF THE EURO IN THE REPUBLIC OF CROATIA Contents Main highlights .................................................................................................................... 5 Summary ............................................................................................................................... 7 1 Introduction ..................................................................................................................... 11 2 The appropriateness of the euro for Croatia under the optimum currency area theory .................................................................................................................................. 13 3 Cost-benefit analysis of the adoption of the euro in Croatia ................................... 21 3.1 Benefits of euro adoption .......................................................................................... 21 3.1.1 Elimination of the currency risk from the economy ...............................................21 3.1.2 Reduction of the borrowing costs of domestic sectors ........................................24 3.1.3 The reduction of the risk of the outbreak of a currency and banking crisis ...26 3.1.4 Lower transaction costs................................................................................................... 27 3.1.5 Stimulus to international trade and investments ...................................................28 3.1.6 Participation in the allocation of the Eurosystem’s monetary income .............30 3.1.7 Access to financial assistance mechanisms for euro area ....................................31 3.2 The costs of euro adoption ........................................................................................ 32 3.2.1 The loss of an independent monetary policy ...........................................................32 3.2.2 Increase in the price level due to conversion ...........................................................38 3.2.3 The risk of excessive capital inflows and accumulation of macroeconomic imbalances ..........................................................................................................................41 3.2.4 One-off changeover costs ..............................................................................................42 3.2.5 One-off costs of Croatian National Bank joining the Eurosystem ......................43 3.2.6 Participation in providing financial assistance to other Member States .........44 3.3 The total cost-benefit assessment of the adoption of the euro ........................... 45 4 The process of euro adoption ....................................................................................... 49 4.1 Participation in the Exchange Rate Mechanism II .................................................. 49 4.1.1 Support for joining the Exchange Rate Mechanism II ...........................................50 4.1.1.1 Income convergence (real convergence) ....................................................50 4.1.1.2 Price convergence ...............................................................................................52 4.1.1.3 Presence of macroeconomic imbalances ....................................................55 4.1.2 Procedures and main features of participation in the ERM II ..............................56 4.2 Fulfilment of the nominal convergence criteria ..................................................... 58 4.2.1 Setting the criteria ............................................................................................................58 4.2.2 Croatia’s performance according to nominal convergence criteria so far ......59 4.3 Legal convergence....................................................................................................... 61 4.4 Receiving confirmation by EU institutions on the fulfilment of all requirements for the adoption of the euro ...................................................................................... 63 5 Activities of the Government of the Republic of Croatia and the CNB in the period until the adoption of the euro ......................................................................................... 64 5.1 Implementation of economic policy with a view to reducing economic vulnerabilities and meeting convergence criteria ................................................. 64 5.1.1 Implementation of economic policy with a view to reducing economic vulnerabilities .....................................................................................................................64 Government of the Republic of Croatia and the Croatian National Bank STRATEGY FOR THE ADOPTION OF THE EURO IN THE REPUBLIC OF CROATIA iii 5.1.2 Making efforts to meet nominal convergence criteria ..........................................67 5.2 Application of additional rules and agreements of euro area Member States . 68 5.2.1 Rules of the European economic governance framework applicable to the euro area ..............................................................................................................................68 5.2.2 Accession to the banking union ...................................................................................70 5.3 Operational adjustments of the CNB related to joining the Eurosystem ........... 72 5.3.1 Adjustment of monetary policy instruments ...........................................................72 5.3.2 Adjustments in cash transactions ................................................................................73 5.3.3 Adjustments in the payment system ..........................................................................74 5.3.4 Financial adjustments due to the accession to the Eurosystem ........................74 5.4 Other adjustments in the context of euro adoption .............................................. 76 5.4.1 Measures to prevent the rise in consumer prices due to currency conversion . 76 5.4.2 Legal, accounting and IT preparations .......................................................................77 5.4.3 Adjustments in the area of statistics ...........................................................................78 6 Guidelines for economic policy after the adoption of the euro .............................. 79 6.1 The importance of prudent fiscal and structural policies ..................................... 79 6.2 The role of macroprudential policy in mitigating macroeconomic and financial risks ................................................................................................................................ 81 7 Conclusion ....................................................................................................................... 83 References ........................................................................................................................... 86 Legal sources ...................................................................................................................... 91 Abbreviations ..................................................................................................................... 92 Abbreviations for Member States ................................................................................... 93 Government of the Republic of Croatia and the Croatian National Bank iv STRATEGY FOR THE ADOPTION OF THE EURO IN THE REPUBLIC OF CROATIA Main highlights The benefits of the adoption of the euro in Croatia exceed the costs. While benefits are permanent and relatively considerable, costs are predominantly low and one-off. The adoption of the euro will reduce the risks to financial and macroeconomic stability and positively affect financing conditions, thus accelerating growth and strengthening the economy’s resilience. All new EU Member States of comparable size have therefore already introduced the euro. The adoption of the euro eliminates currency risk for citizens, corporations and the government. It eliminates the possibility of a currency crisis and diminishes the risk of potentially expensive banking and balance-of-payments crises. The new financial architecture of the euro area strengthens protective mechanisms in case of economic disturbances. Interest rates and transaction costs will decrease. The elimination of the currency risk will favourably affect the country’s risk premium, while regulatory costs for banks will substantially reduce, having a positive effect on interest rate levels. In addition, citizens and corporations will save on currency conversion transactions and charges for cross-border payments in euro. The lowering of transaction costs and greater price comparability will spur international trade and tourism. Investments are expected to be positively affected. Lower interest rates will boost the competitiveness of domestic corporations and provide additional impetus to investments and employment, while the elimination of currency risk will positively affect the confidence of international investors in Croatia and thus contribute to attracting foreign direct investments. The loss of independent monetary and exchange rate policy will not represent a substantial cost for Croatia. High credit and deposit euroisation and dominance of foreign-owned banks in the domestic banking system have narrowed the
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