The First Year in the Eurozone: Lasting Benefits, Citizens Still Adjusting

The first anniversary of Croatia’s membership in the eurozone is approaching, with the government, central bank, and analysts emphasizing the lasting benefits of this membership, while some citizens, besides considering the euro a partial “culprit” for rising prices, have not yet fully adjusted to the new currency.

Finance Minister Marko Primorac recently stated that all expected positive effects of entering the eurozone have been realized – from an increase in credit rating to a significant reduction in currency risk, as well as the elimination of transaction costs, with savings for the economy amounting to around 160 million euros.

– I believe that the effects will be fully known and visible over a longer period, but everything we have done on the path to introducing the euro will yield lasting transformative effects on the Croatian economy – assessed Primorac.

On the same track is the governor of the Croatian National Bank Boris Vujčić, who also emphasized the removal of exchange rate risk, which has led to a reduction in the country’s risk premium, resulting in significantly lower interest rates than would have been the case without the introduction of the euro.

An example of this, noted Vujčić, are countries that have not adopted the euro, such as the Czech Republic, Hungary, and Poland.

– The costs of borrowing for the state, companies, and households would be at significantly higher levels. Not only that, but the inflation rate would also be higher than it is, as Croatia has a lower inflation rate than all those countries that have not adopted the euro – Vujčić stated recently.

Therefore, the economic consequences of entering the eurozone are in line with expectations, with the governor highlighting that the introduction of the euro has gone “very well” from a technical perspective.

Entering the Eurozone Amid High Inflation, Price Rounding

Last November, inflation reached a record 13.5 percent, after which it began to gradually slow down, with double-digit levels remaining in the first three months of this year. Croatia’s entry into the common European monetary union at a time of high inflation thus represented a specificity and challenge that other members did not have to face during previous expansions.

In the early days of this year, numerous examples of unjustified price increases due to “rounding” prices when converting from kuna to euros appeared in the public, and alongside messages from Prime Minister Andrej Plenković that this rounding should not be used for “unjustifiably large profits,” inspection services also took to the field, while in February the Ministry of Economy launched an application to compare prices in retail chains against the last day of 2022.

At the end of January, the first inflation estimate for that month was also published, indicating that the annual growth had slowed to 12.7 percent, while prices remained on average the same compared to December 2022.

Commenting on that data at the time, Governor Vujčić stated that the introduction of the euro, in line with expectations, did not have a significant impact on the overall price increase, and he reiterated this recently, stating that research from the HNB, ECB, and Eurostat showed that the introduction of the euro had an impact on overall inflation of up to 0.4 percentage points, with that effect practically entirely relating to services in January, while in February and March that impact was already “insignificant.”

The increase in service prices in the summer months, according to Vujčić, is primarily related to the tourist season and demand in tourism, not to the introduction of the euro. Therefore, some citizens have the perception that prices have risen due to the introduction of the euro, but today it is clear that this was not the case, he concluded.

The Impact of the Introduction of the Euro Was Not Significant on Overall Inflation, But…

The impact of the introduction of the euro on inflation in Croatia was analyzed in the paper “The Euro and Croatian Inflation: Much Ado About Nothing?” by extraordinary professor Petar Sorić from the Department of Statistics at the University of Zagreb.

– Euro and inflation in Croatia: much noise about nothing? – as the translation of the paper goes, still ends with a question mark, and as Sorić stated for Hina, it is not that absolutely nothing has happened regarding the impact of the introduction of the euro on price growth.

He emphasizes that this effect was not robust and significant when it comes to aggregate inflation, that is, the total basket of goods measured by the harmonized index of consumer prices.

Also, when he “disaggregated” that index into 13 subcategories, he did not find a significant effect of the euro on price growth in the vast majority of inflationary subcategories, but exceptions were food and beverage prices, hospitality services (restaurants, hotels, cafes, catering, etc.), and clothing prices.

– Very similar experiences were had by countries that entered the euro area earlier – noted Sorić.

He conducted the first analysis three months after the introduction of the euro and already noticed that the impact of the euro on price growth gradually weakens over time. However, when he collected data for the following months, coinciding with the start of the tourist season, up until July, the effect began to intensify.

Economics Professor: Some Traders Likely Exploited the Situation for Unjustified Price Increases

– This likely means that some traders exploited the situation to unjustifiably raise prices and increase margins – believes Sorić.

For example, he determined that the euro was “responsible” for as much as 62 percent of the inflation of clothing prices in June 2023. When it comes to the increase in food and beverage prices, the share of the euro ranged from 0.36 percent in January to 33.03 percent in June.

The effect of the euro was particularly significant in hospitality, where in June approximately half of the inflation, 48.08 percent, can be attributed to the introduction of the euro.

Sorić emphasizes that this is about the impact of the euro on inflation, that is, on the percentage change in prices, not on the absolute levels of prices of individual products and services. In other words, the analysis showed that the increase in food and beverage prices would have occurred even without the euro, but for example, in June it would have amounted to about two-thirds of what we witnessed.

According to Sorić, the price increase is very likely also related to market competition, which in small Croatia is not at the level of, for example, the USA, making it harder to penalize those who unjustifiably raise prices.

Sorić also highlighted government assistance packages for citizens and the economy, which contributed to the fact that inflation of basic foodstuffs and energy “did not dramatically rise” due to the introduction of the euro.

Research: A Good Portion of Citizens Still Convert Prices to Kunas

From September 2022 until the end of this year, there is also an obligation for dual price display – in kunas and euros. Although many citizens complain that they have not yet adjusted to the new currency, and consumer associations are calling for an extension of this obligation, Finance Minister Marko Primorac recently reiterated that it is not necessary.

Further dual price display would contribute to consumer confusion, and among other things, it is not in line with the recommendations of the European Commission, said Primorac, adding that the period of the dual price display obligation has been extended to 16 months, which is longer than in other countries that adopted the euro.

The adjustment of citizens to the euro has been monitored over the months by researchers from the Department of Psychology at the Faculty of Humanities and Social Sciences at the University of Zagreb, who, in collaboration with the market research agency Hendal, asked them to what extent they convert current prices in euros to kunas.

In November, 47 percent of respondents said they always do this, 46 percent sometimes, and only six percent never.

The research is conducted every month on a nationally representative sample of 500 Croatian citizens, and in the first one from February this year, 60 percent of citizens responded that they always convert from euros to kunas, 36 percent that they do it sometimes, and four percent that they never do.

These percentages can be viewed as an indicator of adjustment, and although there has been a shift compared to the beginning of the year, the fact remains that by the end of the year, approximately half of citizens still convert prices from euros to kunas when tracking prices and making purchases.

Senior Assistant at the Department of Psychology at FFZG Nikola Erceg believes that the conclusion arising from these results is that citizens have still not adjusted to the euro.

– We learned to think and assess values in kunas, and it is difficult to fully “switch” to the new currency in such a short time. I assume that conversion serves as a form of protection against unwanted spending and a safeguard for more rational money management. The euro has the characteristic of being nominally “weaker” than the kuna, and people are sensitive to nominal value, so 20 euros sounds less than 150 kunas. Only when we convert to kunas do we get a sense of how much something “really” costs – Erceg stated for Hina.

Will the Cessation of Dual Price Display Reflect on Price Increases?

According to him, the abolition of dual price display will likely contribute to citizens adjusting to the euro more quickly, that is, to stop converting to kunas sooner, but on the other hand, it could also complicate decisions about spending and purchasing or lead to unwanted expenditures.

Given that the priority should be to ensure that as few citizens as possible “get burned” in the adjustment process, Erceg believes that it might not be a bad idea to keep dual price display for a while longer.

On the other hand, Professor Marijana Ivanov from the Faculty of Economics at the University of Zagreb recently expressed concern that the cessation of dual price display could have an effect on price increases in January.

– A new space for price non-transparency is opening up, which some market providers will likely exploit – believes Ivanov.

According to her, the obligation of dual price display should have lasted shorter, as a good portion of citizens “relaxed” at the start and continue to look at the prices of usual products exclusively in kunas, and most do not even know that this measure will be abolished next year.

A Significant Drop in the Number of Exchange Offices, Turnover Decreased by About 14 Times

One of the effects of Croatia’s entry into the eurozone is also a significant drop in the number of exchange offices and turnover in foreign cash. Thus, according to the latest data from the HNB from mid-December, there are currently 293 authorized exchange offices operating in Croatia, 787 fewer than in the same period last year when there were 1,080.

Given that authorized exchange offices can only perform exchange operations if they have a contract with a commercial bank, this condition is currently met by 254 authorized exchange offices, so the HNB concludes that currently 39 authorized exchange offices are not performing exchange operations.

Before the introduction of the euro, authorized exchange offices provided exchange services at around 3,500 exchange locations, while now that number is around 1,400, and as before, this includes exchange offices of the Croatian Post and Fina, around 950 of them.

Thus, when excluding the Post and Fina, it turns out that currently 252 authorized exchange offices are performing exchange operations at around 450 exchange offices.

In the first ten months of this year, the HNB reported that authorized exchange offices purchased from individuals and sold to individuals foreign cash worth 241.6 million euros, while in the same period last year, the turnover value reached 3.4 billion euros, or about 14 times more.

The highest turnover value during this year was achieved by exchange offices in June, 29.2 million euros, and the lowest in January, 15.9 million euros. For comparison, last year the highest turnover value was recorded in August, 602.8 million euros, and the lowest also in January, but amounting to 183.5 million euros.

During 2023, authorized exchange offices primarily bought and sold cash in US dollars, which accounted for about 54.3 percent of total turnover, followed by the Swiss franc with 19.6 percent, according to data from the central bank provided in response to Hina’s inquiry.

The HNB Will Pay Banks About 478 Million Euros in Interest for Deposited “Excess Liquidity”

Banks have also, unlike in previous years, missed out on part of the income from exchange operations, but they have achieved significant income from interest on “excess liquidity” deposited with the central bank, where interest is calculated at the ECB’s reference rate for overnight deposits, which currently stands at four percent.

Banks have also achieved large “excess liquidity” simply by entering the eurozone, given that a minimum reserve rate of one percent applies there, while before that, this rate was nine percent.

From the beginning of 2023 until November 30, banks in Croatia have been paid around 429 million euros on this basis, and it is projected that the total amount for this year will be around 478 million euros, the HNB reported.