By Igor Ilic
ZAGREB (Reuters) - Adopting the euro would offer "numerous and lasting" benefits for Croatia's economy, central bank governor Boris Vujcic told Reuters, although he declined to indicate when it might enter the single currency's ERM-2 "waiting room".
Prime Minister Andrej Plenkovic said in October that he wanted the newest European Union member to start using the euro within seven or eight years. He said Croatia hoped to enter the European exchange rate mechanism II (ERM-2) by the time it takes over the revolving presidency of the EU in 2020.
"Advantages (of euro membership) are numerous and lasting, the costs are small and mostly one-off," Vujcic, whose current six-year term expires in July, said in an interview on Tuesday.
"The biggest advantage is removal of currency risk, as most deposits and 54 percent of domestic loans are indexed to the euro. The overall amount of euro-denominated debt equals 150 percent of gross domestic product."
Euro adoption would also reduce regulatory costs for the banking sector, more than 90 percent of which is owned by parent banks from other EU countries, he said.
Vujcic declined to say when Croatia might join ERM-2, which aims to ensure currency stability for at least two years as a precursor to euro zone membership.
The central bank already keeps the national kuna currency in a managed float of roughly 7.3 to 7.7 per euro.
"The central bank in fact already hedges the economy from the currency risk," Vujcic said. "There is no doubt we will be able to keep the currency within an agreed band once we enter the ERM-2."
But Croatia still has work to do to strengthen its economy before it can join the euro zone.
"Croatia must continue its efforts on reducing macroeconomic imbalances, like the public debt to GDP ratio, and also reform to remove structural problems in the economy," Vujcic said.
Public debt is expected to fall towards 70 percent of GDP in the next few years from just under 80 percent now.
Vujcic said reforms were needed to remove obstacles that harm the business climate and discourage investors.
"Court procedures are long, the regulatory framework changes too often, and some rules can even be contradictory. There is a mismatch between education and labour market demands, (and the)pension and health systems, unless reformed, could produce fiscal risks in the future," Vujcic said, adding that taxes, especially on labour, are still too high.
He said the central bank expects economic growth of around 3 percent this year and in 2019, but that the pace of expansion would then slow towards 2.5 percent without structural reforms.
"Those reforms are also important to shield Croatia from an increase in financing costs in case there is a significant rise of interest rates on the global markets," Vujcic said.
He said monetary policy would continue to be expansive even though very high liquidity in the banking system has reduced demand for the central bank's weekly and longer-term repo operations.
Croatia had a record local structural liquidity surplus reached of 28.4 billion kuna ($4.75 billion) last month.
"Due to a considerable current and capital account surplus, the liquidity demands will mostly be created by buying euros on the local (foreign exchange) market," Vujcic said.
($1 = 5.9830 kuna)
(Reporting by Igor Ilic; Editing by Catherine Evans)