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Statement by Mr. Snel and Mr. Friedman on Bosnia and Herzegovina, January 31, 2014

Author(s):
International Monetary Fund. European Dept.
Published Date:
February 2014
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Bosnia and Herzegovina continues to make progress with its SBA-supported economic program. 2014 is an election year, and the pressure on policymakers to run looser policies builds up. That notwithstanding, the authorities’ actions continue to be guided by the program’s principles, namely: macroeconomic policies that will secure fiscal consolidation; structural reforms that will enhance growth and employment; and securing financial stability. All quantitative performance criteria for end-September 2013 on the budget balances were met, and program implementation is strong. Thus, the authorities request to conclude the Fifth Review under the 2012 SBA program.

Although economic activity has been picking up recently, the level of nominal GDP in 2013 is still lower than had been envisaged when the program was launched. As the recovery in most European countries is weaker than expected in 2012, growth rates in BiH, which is highly dependent on the European market, also fell behind those on which the SBA was based. Thus, the contraction in economic activity in 2012 was sharper than estimated, and the base effect continues to affect tax revenues today. In addition, the uneven composition of growth results in low tax revenues. The recent recovery is led by exports, which is fundamentally good news. In the short run, however, the drop in private consumption and inflation resulted in indirect tax revenues that are lower in 2013 than in 2011, in nominal terms. The result of the above two factors is a larger than expected financing gap in 2014.

Public debt to GDP fell just below the level of 45 percent, breaking the upward trend of the previous years, in spite of the lower tax revenues. Although the recovery is modest and still fragile, the authorities managed to consolidate the fiscal position. This is a major achievement given the drop in real private consumption in 2013, and the fact that VAT is the largest tax base.

A complete fiscal framework for 2014 is now in place. The most important step that has been completed since the last review is the legislation of the 2014 budgets by the state institutions as well as the entities of BiH, namely the Federation of BiH and Republika Srpska (RS). The entities’ budgets, which were legislated ahead of the fiscal year, continue to secure the necessary process of fiscal consolidation. The budgets are designed so as to reduce the deficit to below 2 percent of GDP, which would result in a further reduction of debt to GDP to a level of just below 43 percent. Consolidation is based mainly on containing spending at its 2013 level in nominal terms, thus reducing the share of government in economic activity.

The entities of BiH have made progress with respect to their structural reform agenda. In the Federation of BiH, a new law on budgets, which will allow tighter control over low levels of government, was adopted as of 2014; the eligibility audits under the newly legislated Privileged Pension Law are continuously implemented; and the parliament adopted a new pension strategy, which will contribute to the pension fund’s sustainability and to employment, once finalized and legislated. In the RS, the rules for classifying agricultural farms into commercial and non-commercial farms were finalized, which will enhance tax collection and improve subsidy targeting.

The state level government has also made significant reforms lately. The indirect Tax Authority has started to publish the list of 100 tax debtors, a step which is expected to improve tax collection; a new procurement law, which is in line with the best practice, was submitted to the parliament and is expected to be adopted in February; fiscal monitoring and reporting on the aggregate state-level has improved.

The authorities continue to take measures to boost financial stability. As NPLs are high and still rising, the authorities continue to make sure that financial stability is maintained. The bank supervisors have started to hire external auditors who will conduct an independent asset quality review. In order to increase confidence, bank-deposit insurance was doubled to equal up to km 50,000 (about euro 25,000).

In order to further shore up the SBA-supported program, which includes ambitious structural reforms, and to address the higher financing gap, the authorities are requesting to extend the current arrangement, which expires in September 2014. As a result of the weaker recovery, the higher financing gap, and given the limited access of BiH’s government to local and international markets, the authorities are asking for an extension of the current arrangement, which is a 2-year 200 percent of quota SBA, by 9 months and 80 percent of quota. The extended arrangement would continue to guide economic policies during the period of the elections and its aftermath - including the transition period and the formation of the next government.

An extension will support additional progress on fiscal consolidation, structural reforms, tax collection and public sector efficiency fronts. The authorities see the SBA as an important contribution to their economic plan. An extension will also help to finance the gap that opens up in the second half of 2014 and to smooth the transition to 2015, a year in which, based on a cautious economic forecast of 2 percent growth, the financing gap will be substantially lower and the public deficit is expected to be lower than 1.5 percent.

The authorities would like to express their gratitude to the IMF team, headed by Mr. van Rooden, for its dedicated work and good advice.

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