Bosnia and Herzegovina: Request for Stand-By Arrangement

This report highlights Bosnia and Herzegovina's Request for Stand-By Arrangement (SBA). The authorities have requested a 15-month SBA in the amount of SDR 67.6 million (40 percentof quota) for June 2002–September 2003. Private investment and FDI remain mired in concerns over political risks, the hostile business environment, and infrastructure bottlenecks. Fixed investment outside government,construction, and reconstruction is low—perhaps 10 percent of GDP, and construction is slowing as aid inflowsare curtailed. Significant fiscal consolidation appears to have been achieved in 2001 and fiscal structures have been strengthened.

Abstract

This report highlights Bosnia and Herzegovina's Request for Stand-By Arrangement (SBA). The authorities have requested a 15-month SBA in the amount of SDR 67.6 million (40 percentof quota) for June 2002–September 2003. Private investment and FDI remain mired in concerns over political risks, the hostile business environment, and infrastructure bottlenecks. Fixed investment outside government,construction, and reconstruction is low—perhaps 10 percent of GDP, and construction is slowing as aid inflowsare curtailed. Significant fiscal consolidation appears to have been achieved in 2001 and fiscal structures have been strengthened.

I. Introduction

1. The authorities of the Republic of Bosnia & Herzegovina have requested a 15-month stand-by arrangement (SBA) in the amount of SDR 67.6 million (40 percent of quota) for the period June 2002–September 2003. This request and the accompanying Memorandum of Economic and Financial Policies (MEFP), dated May 31, 2002, appear in Appendix V. Following missions in May, July, and October 2001, discussions for the program were held in Banja Luka and Sarajevo during March 12–28, and May 7–10, 2002.1

2. BiH’s first stand-by arrangement expired shortly after completion, on May 25 2001, of the sixth and seventh reviews. The Board approved the one-year arrangement on May 29, 1998, for SDR 94.42 million, subsequently extending it three times (Appendix I). In this context, inflation remained low, the convertible marka gained wide acceptance, and structural reform continued. After concluding the Article IV consultation, in February 2002, Directors welcomed these gains and supported continued adherence to the currency board. In that light they urged further progress to contain expenditure arrears and on private sector development to support activity and employment.

3. Parliamentary and presidential elections will be held under current complex constitutional arrangements in the fall (Box 1). The victors will secure four-year terms, up from two years hitherto. Ethnic and political tensions have eased recently, as reflected in the broad consensus behind the recent constitutional amendments which remove all the discriminatory elements of the old constitutions and ensure that all ethnic groups are formally represented at all levels of government in both Entities. But nationalist parties retain strong followings, so prospects for the centrist coalitions—the 10-party “Alliance for Change” in the Federation and the informal PDP-SDS coalition in the RS—are unclear. The High Representative, Lord Ashdown, took office in May 2002.

The Dayton Constitutional Arrangements

Bosnia and Herzegovina comprises of two Entities; the Republika Srpska (RS) and the Federation. The RS is highly centralized and predominantly Serb, accounting for 1/3 of the BiH population. The Federation is highly devolved with 10 autonomous ethnically based cantons. It is mainly Bosniac and Croat and accounts for the remaining 2/3 of the population. The Entities have co-dominion over the tiny Brcko district, which abuts both.

The Entities and Brcko enjoy significant autonomy including on key aspects of fiscal policy. The State Government has limited responsibilities, including customs, foreign affairs, and foreign debt service, and it has negligible revenue raising powers.

On behalf of the main powers party to Dayton, the High Representative oversees the political aspects of the Dayton Peace agreement. He enjoys sweeping powers to pass or veto laws, ban political parties, and remove individuals from elected office and the civil service. These powers have been extensively used.

4. Surveillance is clouded by the poor quality of economic data despite years of intensive technical assistance. No demand-side or real GDP estimates are published and underreporting bedevils all real sector data, including, notably, the official nominal GDP estimates. Due to capacity constraints, there are no officially published balance of payments or consolidated general government data—numbers reported here for both are all staff estimates. Revisions to the latter since the most recent staff report are described in Appendix III).

II. Background

5. Six years after the cessation of hostilities, normalization has yet to be secured. The currency board set up in 1997 has lowered inflation to industrial country levels, but the aid-financed post-conflict boom has lost momentum with output apparently still well below pre-war levels (Table 1, Figure 1). Private investment and FDI remain mired in concerns over political risks, the hostile business environment, and infrastructure bottlenecks. In 2001 refugees continued to return to BiH in significant numbers, swelling unemployment already likely in the low- to mid-20s. With internal resettlement also accelerating, many property rights disputes are coming to a head and personal security remains a concern for returnees, especially in rural areas. International peace-keeping and police forces—with a combined strength of 20,000—remain in place, though their numbers will be cut by a quarter immediately following the fail elections. After aid disbursements of some US$2½ billion since 1997 in addition to security assistance, donors have begun—and will continue—to scale back their military, political, and economic commitments from hitherto exceptional levels.

Table 1.

Bosnia and Herzegovina: Main Economic and Financial Indicators, 1997–2003 1/

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Sources: Data provided by the authorities, and IMF staff estimates.

Data refer to the entire country, unless otherwise indicated.

Starting in 1997 in the Federation, and in 1999 in the RS, GDP is estimated based on 1993 SNA methodology.

Manufacturing, mining and electricity.

Average gross wages in the economy as a whole.

In 2002, first quarter only.

Figure 1.
Figure 1.

Bosnia and Herzegovina: Selected Financial and Economic Indicators

(1997–2001)

Citation: IMF Staff Country Reports 2002, 191; 10.5089/9781451804867.002.A001

Source: Data provided by Bosnian authorities; and IMF staff estimates.1/ excluding arrears.

6. With aid declining, self-sustained growth has yet to take root. In 2001, activity decelerated—with the RS apparently in recession—and labor market and external imbalances remained sizeable. (Figures 1 and 2):

  • Staff estimate that BiH GDP decelerated to around 2½ percent in 2001 as the Federation slowed and the RS recession continued (Text Table 1). Fixed investment outside government, construction, and reconstruction is low—perhaps 10 percent of GDP, and construction is slowing as aid inflows are curtailed. At least 40 percent of GDP is accounted for by the private sector, possibly much more including the gray economy;

  • Official data suggest that some 40 percent of the labor force seek employment (Text Table 2). However, World Bank “informal estimates” put joblessness around 20 percent. Official data suggest job growth in the Federation in recent years against continued (possibly sharp) declines in the RS with nominal wage growth above inflation in both Entities;

  • Estimated BiH export growth in 2001 largely reflects production capacity coming back on stream and renewed exports to Yugoslavia (Text Table 3 and Table 2). Imports also appear to have remained buoyant, partly boosted by remittances from abroad and high oil prices, despite weak domestic demand, reduced reconstruction aid, and a 5 percent depreciation of the CPI-based real effective exchange rate. The current account deficit increased slightly and FDI inflows remained negligible.

Figure 2.
Figure 2.

Bosnia and Herzegovina: Selected Indicators by Entity

(1997–2002)

Citation: IMF Staff Country Reports 2002, 191; 10.5089/9781451804867.002.A001

Source: Data provided by Bosnian authorities; and IMF staff estimates.1/ The GDP series since 1994 has been revised compared to SM 98/96 on the basis of new official data.
Text Table 1

Economic Activity

(Annual growth rate)

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Text Table 2

Labor Market

(Annual average)

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Text Table 3

Balance of Payments

(US$ million)

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Table 2.

Bosnia and Herzegovina: Balance of Payments 1998–2006 1/

(In millions of U.S. dollars; unless otherwise indicated)

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Sources: Data provided by Bosnian authorities: and IMF staff estimates.

Estimates for merchandise trade are based on partner country reporting.

Partner country data (see footnote 1) for non-reconstruction imports are lowered by 5 percent to account for imports of non-residents to BiH and all imports include an S percent conversion from C.I.F. to F.O.B. basis.

Disbursement for budget finance and includes the World Bank and EU loans. The level of EU loans in 2002 is provisional.

Other debt refers to non-convertible currency debt, unallocated debt from Yugoslavia, and other commercial (mainly trade credits), i.e., non-Paris Club and non-London Club debt.

Figures for 2001 and 2002 reflect the effects of the conversion of the peg from the DM to the euro.

The net (negative) figure for 2002 arrears reflects a debt cancellation of the remaining other debt (see fn. 4) plus the State’s assumption of enterprise liabilities to Russia for arrears of payments for natural gas shipments in 1994 and 1995.

Reflects Paris Club debt consolidation and rescheduling on Naples Terms agreed in October 1998.

Reflects London Club debt consolidation agreed in December 1997.

Principal and interest payments due on original maturities, less payments due on rescheduled debt.

Primary current account is current account minus interest payments on foreign debt.

7. But in some key policy areas, prospects for growth have clearly improved—the currency board continues to anchor low inflation and international reserves have risen strongly; a significant fiscal consolidation appears to have been achieved in 2001; and fiscal structures have been strengthened:

  • Inflation continued to decline overall, notably in the RS as prices there largely completed their convergence with prices in the Federation (Text Table 4 and Figure 2).

  • Foreign exchange inflows in the context of introduction of the euro have raised reserves by over 3 months of import cover to over five months (Text Table 5 and Table 2). Households exchanged formerly unrecorded holdings of DM notes for KM causing measured monetary aggregates to rise sharply. Reserve money grew particularly sharply because perhaps only one-third of these inflows found their way into banks, reflecting continued depositor reservations with—notably—RS banks. Despite the inflows, growth of bank credit to non-government declined, along with weakening domestic activity.

  • Despite decelerating activity, preliminary data suggests that a major fiscal consolidation was achieved during 2001 and net arrears accumulation was significantly curtailed (Text Table 6 and Tables 4a4i). Tax revenues were unchanged relative to GDP as cuts in Federation sales and wage tax rates were offset by strong customs collections and extension of the tax collection period (with 0.4 percentage points of BiH GDP collected in early January 2002 but booked in 2001). Grants to BiH fell by 2 percentage points of GDP and the spending associated with them fell in parallel. Average pensions were cut by 15 and 50 percent in the Federation and the RS, respectively, and some pensions and invalid benefits arrears were cleared. Nevertheless, even these measures were not quite enough to stop the stock of arrears from increasing—albeit at a much reduced rate compared with 2001—with the RS pension fund, and the Federation Ministry of Defense and cantons accruing new arrears during 2001.

  • Fiscal structures have also been strengthened. Considerable progress was made on arrears (Box 2). Entities’ sales tax structures were harmonized, consolidating progress towards a common economic space. New treasuries and audit offices began operations in the central governments of both Entities. The Entities lowered labor taxes, and a raft of tax administration improvements were prepared and implemented during 2001 and into 2002 with U.S. and EU aid.

Text Table 4

Consumer Prices Index

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Text Table 5

Money, Credit, and Reserves

(12-month growth rates, December)

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Text Table 6

Fiscal Outturn

(Percent of BiH GDP, accruals)

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Table 3.

Bosnia and Herzegovina: Monetary Survey, 1997–2002

(In millions of KM)

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Sources: Central Bank of Bosnia and Herzegovina; and IMF staff estimates.
Table 4a.

Bosnia and Herzegovina: Consolidated General Government, 1998–2003

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Sources: Ministries of Finance; and IMF staff estimates.

Budget outcomes, finalized in the Federation, the Cantons and the RS, still preliminary for the State. Staff estimates for the RS municipalities and the extrabudgetary funds.

Assuming 70 percent of the sales tax revenues in the RS go to the RS budget and the rest to the municipalities.

In IMF projections for 2002 and 2003, privatizations receipts are placed in escrow, implying negative domestic financing.

Does not include war damage claims not frozen foreign currency deposits.

The decrease in 2001 is related to a large debt-relief operation, and the increase in 2002 includes contingent liabilities from state-owned enterprises assumed by the State.

Including privatization receipts and succession monies put on an escrow.

Table 4b.

Bosnia and Herzegovina: Consolidated General Government, 1998–2003

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Sources: Ministries of Finance; and IMF staff estimates.

Budget outcomes, finalized in the Federation, the Cantons and the RS, still preliminary for the State. Staff estimates for the RS municipalities and the extrabudgetary funds.

Assuming 70 percent of the sales tax revenues in the RS go to the RS budget and the rest to the municipalities.

In IMF projections for 2002 and 2003, privatizations receipts are placed in escrow, implying negative domestic financing.

Does not include war damage claims not frozen foreign currency deposits.

The decrease in 2001 is related to a large debt-relief operation, and the increase in 2002 includes contingent liabilities from state-owned enterprises assumed by the State.

Including privatization receipts and succession monies put on an escrow.

Table 4c.

Bosnia and Herzegovina: Consolidated General Government, 1998–2003

(In millions of KM)

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Sources: Ministries of Finance; and IMF staff estimates.

Budget outcomes, finalized in the Federation, the Cantons and the RS, still preliminary for the State. Staff estimates for the RS municipalities and the extrabudgetary funds.

Includes transfers to the cantons and the extrabudgetary funds.

Pension Fund, Health Fund, and Employment Fund. Also includes the Child Fund in the RS.

Includes transfers to the extrabudgetary funds.

Data for 2000 are incomplete. The Brcko District started collecting revenue in March 2000.