The governor of the Central Bank of Croatia talks about adopting the Euro and the role of the ECB in Croatia’s economy. Governor Vujcic and other central bankers are featured in our annual Central Banker Report Cards issue, coming in October for the IMF/World Bank meetings in Morocco.
Global Finance: How does adopting the Euro affect Croatia’s ability to manage its particular monetary challenges?
Boris Vujčić: Exchange rate stability has been the cornerstone of the Croatian monetary policy for three decades. Therefore, we had most of the costs arising from participation in the monetary union, but none of the benefits. Euro adoption virtually eliminated currency mismatches and improved risk perception. Also, Croatian National Bank became lender of the last resort in the true meaning of the phrase as overwhelming majority of deposits in our banks is now in domestic currency—the euro.
GF: Much has been said about the European Central Bank’s (ECB’s) role in Croatia’s economy. But, conversely, what role will the Central Bank of Croatia now play in the ECB?
Vujčić: Indeed, a small newcomer to the Euro system can sometimes feel a bit overwhelmed by the vast resources employed to monitor and analyze economic developments. Nevertheless, we bring a unique set of experiences to the table as we have successfully maintained monetary and financial stability in a small open economy over repeated episodes of severe global and regional crises. Our peculiar perspective should enable us to provide an important contribution to decisions concerning the entire euro area.
GF: Inflation has been a significant concern in Croatia, outpacing wage growth. How do you plan to address this issue, particularly in the context of joining the eurozone?
Vujčić: Wages recently recovered the lost ground, not least due rapid rebound of the economy as GDP has caught up not only with the pre-pandemic level, but also with the trend. However, over the last couple of months we have seen some moderation in wage growth, diminishing some of the “homegrown” risks for persistent differentials from euro-area averages. Also, elevated profits of the corporate sector provide a buffer that should absorb some of the pressure arising from wage increases.
GF: How can Croatia ensure economic diversification amid the tourism boom resulting from its inclusion in the Schengen zone?
Vujčić: Euro-area and Schengen zone entry definitely proved to be a boon for tourism amid rotation of demand back towards the services in general and travel related services in particular. However, over the decade since Croatia joined the EU, we have seen a significant rise in goods exports. Ranks of export-oriented companies expanded and their sophistication improved, while their embeddedness in trans-European supply chains further strengthened. This process is likely to continue, supported by near-shoring and friend-shoring activity of European companies. Still, we need to energize it by improving business environment and streamlining public services.
GF: Croatia had been taking huge steps toward financial digitalization prior to joining the ECB. Has the change in currency helped or stalled that process?
Vujčić: The euro adoption in 2022 presented all financial institutions with a highly complex and demanding task of modifications of their business processes. It temporarily postponed the digitalization projects in several credit institutions. However, following the successful introduction of euro and the subsequent stabilization phase, majority of credit institutions renewed their focus on further digitalization of their business processes and began accelerating the related projects.
GF: What are the main challenges for the Croatian banking system going forward?
Vujčić: The domestic banking system remains strong with healthy solvency and liquidity (average CAR of about 23%, leverage ratio 10%, LCR is around 230%, C/I ratio 42% and the latest ROE 17%) ratios while profits are reaching a decade high. However, deteriorating macroeconomic outlook and rising debt servicing burden on the back of higher lending rates could have an adverse impact on the loan quality. There are also some signs of excesses in the real estate market that we need to keep monitoring. Good times for banks will not last forever and they need to remain vigilant on improving efficiency and cutting costs in order to remain competitive in the changing financial landscape as new challengers arise by finding new applications to technological innovations.