Tying regional currencies to the euro offers stability but poses potential risks to economic growth and competitiveness, particularly in developing economies
The monetary policies of the Adria region are intriguing because they reveal a unique blend of stability and vulnerability. With most countries informally or formally tying their currencies to the euro, questions arise about the long-term effects on trade competitiveness, inflation, and economic growth—particularly in economies that are still developing.
In this interview, Professor Dejan Šoškić, from the University of Belgrade’s Faculty of Economics, explores the benefits and potential risks of this strategy, offering a deeper understanding of how such policies shape the region’s future.
How has tying regional currencies to the euro benefited economies, and what are the potential risks or misleading signals that could arise from this monetary policy, particularly for weaker economies?
Yes, you are right. Most countries in the region have tied their currencies to the euro or have fully adopted it. This policy reduces currency risk, simplifying business calculations, especially when purchases and sales are often made in euros. Fixing the exchange rate benefits borrowers with foreign currency clauses, as their credit payments become predictable.
However, the dangers of fixing the exchange rate are often overlooked. A key risk is when tying the exchange rate to the euro is not accompanied by reducing inflation to eurozone levels. If the exchange rate is fixed while inflation is higher than in the eurozone, it leads to the so-called real appreciation of the domestic currency.
This real appreciation results in higher prices in euros for locally produced goods, making exports more difficult and reducing domestic competitiveness compared to imported goods. Such trends gradually erode competitiveness, lower growth rates, and increase public and private debt. In practice, this often leads to foreign direct investment favouring real estate and non-tradable services (e.g., banking and retailing) over production of tradable goods and services, while domestic manufacturing becomes too expensive compared to imports.
Such policies gradually reduce the space for competitive domestic entrepreneurship, especially in sectors crucial for economic development that rely on domestic raw materials and other domestic inputs.
The only way out is to boost productivity while keeping wage growth below productivity increases. Furthermore, a fixed exchange rate in conditions of higher inflation than in the eurozone artificially inflates GDP in euros beyond real rates of growth since it does not exclude nominal GDP growth due to local inflation, creating illusions of higher growth and distorting debt ratios underestimating the level of indebtedness. The same applies to wages, which grow faster in euros than in real purchasing power, creating further illusions of economic success.
How do such policies affect intra-regional trade and competitiveness on the global market?
— The competitiveness of any national economy in the region declines whenever domestic inflation exceeds eurozone inflation under a fixed exchange rate without corresponding productivity growth. For exchange rate fixing to be sustainable, policymakers must understand what other economic measures need to be implemented. However, tying the currency to the euro simplifies regional trade and strengthens economic ties between businesses within the region.
Is it possible to pursue a monetary policy that is between the extremes of a fixed and freely floating exchange rate? What would be the advantages and risks of changing the current approach?
— For Serbia, a devaluation would certainly improve the competitiveness of the domestic economy and create conditions for higher GDP growth. However, given that little has been done to promote the use of the dinar in the financial system since 2012, and most loans are in euros, devaluation would lead to significant inflationary pressures and widespread difficulties in repaying loans.
The only way out is to boost productivity while keeping wage growth below productivity increases
Unfortunately, this could have severe consequences for financial stability, both at the microeconomic (business and household) and macroeconomic levels. The inflation-targeting model, which was abandoned in 2013, is difficult to reinstate without risking inflation and financial stability.
Which policies would enhance competitiveness in highly euroised markets, and should they be sought in the monetary sphere or elsewhere?
— The solution, in my view, lies in increasing productivity. This can be achieved through greater investments in tradable sectors of the economy (manufacturing, agriculture, energy, export services) and significantly improving education and healthcare. Education and public health are vital for workforce productivity, and investments in advanced technologies can raise this workforce’s position in the value chain. Unfortunately, what we see in Serbia is the opposite—low investment in education, science, and health, with high investment in non-productive projects (e.g., stadiums, etc.).
In former Yugoslavia, there was often resistance to products from other republics. How effective have regional integration efforts like CEFTA, Open Balkan, and EU policy harmonisation been in overcoming these barriers, and which initiative do you see as the most successful?
— The international community has tried to foster regional cooperation with limited success. I believe regional countries themselves must take the initiative to simplify trade and increase cooperation. Simplifying border procedures, harmonising regulations and policies, and duty-free trade are key to boosting economic growth in the region, as was the case with the Benelux and Scandinavian countries some time ago. We all need to realize that a larger, harmonised regional market gives each country a better chance to accelerate growth.
What realistic synergies could closer regional economic cooperation bring, and is it possible to reverse the current ‘race to the bottom’ strategies of lowering taxes, wages, and worker protections that have largely benefited elites and foreign investors?
— Harmonising tax policies, investment incentives, environmental standards, and institutional reforms would improve the region’s negotiating position with potential investors. A fully unified regional market would attract higher-quality foreign investments, particularly benefiting smaller countries of the Region.
What tools do governments in the region have to support domestic companies that have managed to compete globally but were long ignored by policy?
— Companies that have already succeeded in exporting have often overcome their greatest development hurdles. However, cheaper and more accessible financing for export-oriented projects should be systemically supported. Quality education, stronger institutions, and state financial mechanisms (e.g., credit guarantees) for export projects should be a priority for all regional countries.
Given the trends of deglobalisation and the resurgence of industrial policy, what would be appropriate policies to stimulate domestic industries?
— The region could seize the opportunity presented by nearshoring and friend-shoring trends, positioning itself as a reliable supplier of raw materials, semi-finished, and finished products to the EU. This requires a full understanding that human resources (well-educated and healthy workers) and institutional development (competence, impartiality, rule of law) are the key levers for accelerating economic growth in the region.
INTEGRATION NEEDS HARMONISATION
Regional integration has eased trade barriers, but true success lies in harmonising regulations and making cross-border cooperation smoother, particularly through initiatives like CEFTA
EURO TIES RISK COMPETITIVENESS
Tying currencies to the euro simplifies business and stabilises the economy, but it risks undermining competitiveness, especially when inflation rates diverge from the eurozone
FOCUS ON PRODUCTIVITY GROWTH
For long-term growth, the region must focus on productivity, education, and sustainable investments rather than relying solely on currency ties or non-productive projects