The economy of BiH recovered in 2013, and GDP grew by 1.8 percent. The composition of the national accounts aggregates pointed to a balanced and robust, albeit moderate recovery, driven mainly by an increase in exports by 8.3 percent. As a result, the current account deficit, which is a longtime weakness of the economy, contracted sharply to a level of 5.4 percent of GDP, and public debt went down to 42.5 percent of GDP. These positive developments continued in the first quarter of 2014, and were expected to intensify throughout this year.
While the economy was recovering the authorities continued to make progress with their economic plan. First and foremost, fiscal consolidation was secured, and a responsible budget for 2014 was legislated on time. The fiscal policy implemented in 2014 continued to adhere to the program’s targets, and the end-March 2014 fiscal performance criteria were met in full.
The authorities were able to make progress with their reform agenda. Although progress was sometimes slower than expected, as some of the measures turned out to be tough to implement, resolution and patience led to favorable outcomes and completion of the main structural benchmarks. These include strengthening the cooperation between the different tax authorities, legislation of a new procurement law that is aligned with EU standards, implementation of a new law on budgets in the Federation of BiH, registration of commercial farming activities in Republika Srpska. Most importantly, the legislation of the excises law, which was the stumbling block that prevented the completion of the 6th review on time, is now completed.
Unfortunately, these positive developments have been interrupted by the May floods. The floods have caused loss of life and severe damage, which is yet to be fully assessed. The initial estimates were between 5 and 10 percent of GDP. The latest estimates published after the staff report was distributed, point to a damage of about euro 2 billion, about 15 percent of GDP, larger than quoted in the report. The uncertainty around the damage assessment is compounded by additional uncertainty regarding the pace of recovery, resulting in an exceptionally wide range of economic forecasts for growth, public deficit and current account. International experience shows that the pace of recovery after similar shocks is largely unknown. Thus, the risks are now much higher than before.
Although the extent of the damage is still unclear, it is obvious that it is of a macroeconomic scale. The floods hit infrastructure, production facilities, farms and residential buildings in an area that is geographically larger than one quarter of the country. The result is a temporary sharp contraction of economic activity. Going forward, the blow to the capital stock will negatively affect the supply side, while the negative wealth effect will weigh on demand. Property insurance in BiH is uncommon, and the implication is that many households suffered a major wealth effect. The reconstruction phase will require massive investments, some of which are imported, and hence will lead to a deterioration of the current account balance.
These unfortunate events require a recalibration of the economic targets. Lower economic activity and lower tax collection will lead to an increase in public deficit and debt, which are now expected to be at about 4 percent and 45 percent, respectively. This implies a temporary deviation from the consolidation process, which was on track in 2013 and in early 2014. The authorities are now recalibrating their policies to aim at feasible targets while alleviating immediate needs. Therefore, the authorities are requesting a modification of the fiscal performance criteria for end-June, end-September, and end-December of 2014.
The natural disaster caused an urgent balance of payments need. In order to deal with that, and the higher than expected financing gap, the authorities are requesting an augmentation of 50 percent of quota of the current SBA. The augmentation will allow smoothing of the consolidation process, which has become more painful now, by financing part of the larger financing gap. The augmentation is of the size of a disbursement under the RFI, which would probably be the channel through which the Fund would have assisted BiH if an SBA had not been in place. The Fund’s assistance is expected to be matched by significant help from the international community, which has already taken initial action. This is going to be crucial in the reconstruction phase, which requires substantial public investments.
The augmentation would be allocated between the entities according to an internal agreement. The additional access of SDR 84.55 million will be used to finance the larger deficits of the entities, thus alleviating the impact of the disaster, and finance part of the reconstruction. The allocation of the additional tranche will be 49 percent to the Republika Srpska, and 49 percent to the Federation of BiH, while the Brcko District will receive the remaining 2 percent. This breakdown, which is different from the usual way SBA tranches are handled, reflects the entities’ internal agreement.
The reform agenda for the next months is ambitious. The authorities understand that continued progress on this front is of the essence. Therefore, they plan to keep promoting the following issues during the run-up to the elections: legislation of new corporate income tax laws at the entity level; legislation of a fiscal responsibility law that will define the fiscal targets in Republika Srpska, the establishment of a centralized database of all beneficiaries of social transfers in the Federation BiH, and legislation of new banking laws in both entities.
The authorities continue to be committed to the SBA-supported program. The authorities see the SBA as the cornerstone of their economic policies. The challenges in the coming period are substantial, as the country is approaching the elections and a period of political uncertainty. The authorities will do their utmost to make continuous progress throughout this period. The previous extension of the SBA, which now covers the period of political transition, is instrumental in this regard.
We would like to thank the team, headed by Ron van Rooden, for their excellent report and work. The Fund has reacted swiftly to the unfortunate conditions and has shown both flexibility and creativity.