Business environment for domestic and foreign investors

Mid-term Development Strategy BiH (PRSP) has paid due attention to the promotion of business environment, local and foreign investments and development of entrepreneurship. In order to complete the process of creating the single economic space in BiH (which is still divided by differences in regulations/provisions between entities) it will be necessary to harmonize the provisions regulating the freedom of movement of goods, services, capital and persons with EU laws and regulations. It will also be necessary to establish the legal and institutional framework, which is to guarantee the free competition and protection of consumers and also provide the mutual recognition of technical standards for goods from both entities.

The establishment of a single public procurement system, bringing in the VAT and strengthening the coordination in managing the public infrastructure will additionally promote the business climate. The implementation of already harmonized labor legislation in the entities must ensure the elimination of all forms of discrimination in employment, which is to contribute to larger scale of labor force mobility. The continuation of applying the model of regional development will have a significant role in facilitation of economic development and there must be a defined strategy for this and suitable laws and regulations must be approved for this purpose. In this regard, it is important to strengthen the network of regional development agencies.

The activities of eliminating the administrative obstacles for local and foreign investments will be continued with, especially in the area of business registration. Judicial system reform will provide faster resolution of economic disputes and it will also be necessary to amend the laws on obligations in order to ensure greater protection of creditors. The elimination of unfair competition (smuggling) and more efficient protection of intellectual, industrial and commercial property will be important task for the next mid-term. Inspection services in BiH will be reorganized and rationalized, while the realization of already adopted Action Plan will precede the implementation of reforms for more efficient struggle against corruption.

It is necessary to modernize the system of land, real-estate management and use of it, which will go hand in hand with strengthening of urban planning system.

New structure of economy calls for strengthening of the corporate management system – primarily the strengthening of transparency. Already existing tripartite dialogue with private sector should be further on strengthened too.

Strengthening the competitiveness of BiH enterprises must be the main and long-term goal of reforms and the key fields for urgent operations are: the reduction of taxes, especially pay-roll taxes, reduction in size of informal economy, liberalization of the labor, energy and telecom markets, speeding-up the process of dispute resolution, lowering the cost of entry. Together with aforementioned, further strengthening of the Foreign Investment Promotion Agency’s capacities, applying the foreign investment strategy and creation of the State Commission for Concessions (and suitable commissions at lower levels) should ensure the attraction of more foreign investors in our country. In this light, it is very important to continue with and facilitate the process of privatization.

Public opinion is the key point for success of all these reforms. Maintaining the political stability and avoidance of social disorders is certainly the key for successful implementation of the reforms and that is why the public should be regularly informed and included in the open dialogue on the process of reforms. It is especially important to conduct a campaign, which would promote the understanding of the public about the role and significance of foreign investments. It is also important to work on improving the international image of BiH.

Significance of small and medium enterprises for development of BiH is recognized in the document General Framework of Economic Development Strategy (dated in 1999). It is necessary to adopt the development strategy for easier and faster development of this category of companies, which will be able to utilize the limited investment opportunities in BiH in the best possible way due to their flexibility. It is also necessary to establish legal and institutional framework to support the development of entrepreneurship. Especially is important it initiate the wider affirmation of knowledge on entrepreneurship through inclusion of subjects on entrepreneurships into the curriculums of schools and universities as well as by strengthening the specific education for entrepreneurs and managers. The governments in BiH have recognized the fact that the establishment of Guarantee Fund for Small and Medium enterprises is a significant concrete step that would facilitate access of bank loans to SMEs.

Privatization

Privatization process, and especially the process of privatizing the “strategic enterprises” that was in tardiness during the past years, will be speeded-up. This will be achieved through the strengthening of an institutional framework. The entity agencies for privatization will take the leading part in preparation of the enterprises for privatization. Other problems related to the country-wide corporate restructuring will be improved by resolving of big and growing corporate debt and by reorganizing the system of protection from unemployment in order to ensure adequate social programs of workers that might lose their jobs due to the process of speedingup reforms. Special strategies will be prepared for the regulation and privatization in the sectors of energy, telecommunications, railways, and water management, waste-management as well as in the sector of forestry and in media. Strengthening of transparency of the privatization and responsibility of the state-led managing boards and managements in managing the state enterprises will be also important step forward. In parallel with this it is equally important to establish more efficient institutional framework for bankruptcy procedures and prepare list of companies and action plans for initiating bankruptcies.

Financial sector

It is necessary to strengthen the stability of banking sector by improving the local bank’s capacities for risk management. Equally is important to ensure appliance to the rules for capital adequacy. Further strengthening of stability of the banking sector could be improved by having the Central Bank of BiH to play limited role of the bank of last resort in compliance with the currency board rules. The strengthening of the existing framework for supervision of banks will be continued. The State Agency for Supervision of the Banks will be established in 2005 and it will operate within the Central Bank of BiH. The policy of decreasing the number of the banks will be continued: all banks will have to meet the requirements from the State Deposit Insurance Agency, otherwise the working licenses of banks shall be withdrawn.

The measures will be undertaken in order to improve the term structure of deposits. In the sphere of crediting, there will be further work on reduction of risk in the bank operations, which should lead to further decrease of interest rates and greater corporate lending. There is still a need for harmonization of the bank regulations between the two entities as well as with the regulations of EU. Legal and regulatory framework will be established for the operations of leasing, which provides the additional opportunities for induce of economy.

It is also important to harmonize the inter-entity regulations in insurance sector and implement the activities that would equalize the local insurance sector with the foreign insurance companies. It is necessary to improve regulation of the sector, and stimulate companies to develop new instruments and services.

The strengthening of corporate management and transparency is especially important for the faster development of capital market in BiH. This is to increase the attractiveness of these markets as well as their liquidity. Application of the new instruments, such as the short-term certificates of the Central Bank of BiH will also help the further capital market development. The possibility of uniting the regulatory framework at the state level will be reconsidered in order to stimulate merger of the capital markets with positive effects on increasing their liquidity.

Micro-financial sector has turned out to be very successful in providing the financial services to very small enterprises. Its further development will be stimulated through smaller guarantee funds, especially in agriculture. Important step forward in developing this sector will be to improve the regulatory framework by harmonizing it between two entities.

Labor market

It is necessary to eliminate all forms of discrimination and induce the mobility of labor force in the whole country. System of salaries and collective bargaining agreements should be reformed for the purpose of mitigating of the down wage rigidity of minimal wages, which is to lead to the reduction of gray economy. It is also necessary to strengthen the institutional framework and control over the Employment Offices, especially in the field of financing the employment programs that were quite non-transparent up-to-date. Revision of the use of privileges on the basis of non-employment, such as the right to health insurance, will influence the reduction of gray economy. In order to pave the road for speeding-up reforms it will be necessary to extend the period for utilization of unemployment benefits. It is essential on a long-term basis to reform the education system so that it can meet the needs of the labor market. It is especially important to stimulate the development of vocational education, as one form for re-qualification and additional qualification.

Anti-corruption

Establishment of the suitable bodies within the state and entity ministries of justice will provide better coordination of anti-corruption activities. Further reform of the judicial system and strengthening of the efficiency of the bodies specialized to uncover and suppress the corruption are the key points for the success in this field. The forthcoming public administration reform will also contribute to more successful anti-corruption activities. Strengthening of the system of management and control over public finances and especially the reform of the indirect taxation system (that leads to the bringing in VAT) will additionally reduce the space for corruption and abuses of power. Especial attention will be given to the management of the public enterprises. It will be necessary to promote greater transparency in privatization process as well as in the financing of education and health system. The establishment of single custom administration at BiH level will also influence the reduction of corruption. Money laundry and human trafficking incidents are the specific problems that BiH is facing lately -- special attention will be given to modification of the legal framework and adoption of suitable action plans to improve the coordination among institutions dealing with these matters.

Foreign trade and export promotion

The liberalization of foreign trade will be continued within the framework of obtaining the full membership at the WTO and meeting the criteria for integration into the EU. It will be necessary to enhance the coordination in implementing the state laws on foreign trade between respective ministries at the state and entity level. Moreover, it will be important to strengthen the institutional framework for the purpose of utilizing the unilateral trade preferential agreements approved and given to BiH by the EU and other developed countries. Further simplification of the custom procedures, establishment of the institutional framework for protection of local consumers and strengthening the foreign trade statistics are also priority tasks for the next midterm period. The new Custom Tariff Law will be approved in order to accommodate the needs of the BiH’s economy. Introduction of stricter control of the rules of origins and application of the reciprocities in appalling the foreign trade rules will also be one of the main emphasis for the next period. Important step forward will be signing of the Pan-European Charter on Cumulation. In order to reduce the trade deficit, it is necessary to apply more efficient ways to protect and stimulate the development of local agricultural production.

Increasing the rate of export represents the key challenge in the implementation of the PRSP. Aforementioned measures will directly or indirectly stimulate the increase of export. However, an overall strategy for increase of export will be developed, which will define the productions where BiH posess a competitive advantage, the most favorable markets for goods and services from BiH and institutional framework for export. Current low level of production must be increased and the competitiveness of BiH enterprises strengthened. In the context of increasing of export, it is necessary to facilitate privatization and insure bigger inflow of foreign investments. It is especially important to create the system for support to the exporting enterprises, which will be based on transformation of the existing Agency for investment guarantees BiH into Export-Credit Agency BiH. Reviving of railways and inclusion of the road transporters in international associations should create the conditions for reduction of transport costs.

Public administration reform

In order to implement the reform of public administration system, it is primarily needed to conduct functional reviews of administration at all levels of authorities. The strategy of public administration reform and follow-up action plan will be adopted by the end of 2004. It is necessary to strengthen the administrative capacities of BiH for the requirements of the EU integration process. The current activities in implementation of the State Civil Service Law and the reforms in defense and security sector will be continued.

Statistics

It is of great importance for overall reform process to strengthen the statistic system in BiH. It must function as single system to ensure that all institutions will be provided access to data necessary to plan activities. This process will be based on already adopted law at the state level.

Indicators

To verify whether the set targets are being achieved, an established set of indicators should be followed over the next medium term. With the assistance of UNDP, PRSP was able to incorporate the millennium development goals and indicators, adapted to BiH, into the PRSP monitoring mechanism. To ensure systematic monitoring of the PRSP indicators, additional strengthening of the capacity of statistics bureaus is planned, as well as partnering with NGOs and international institutions. It is important to stress that an undeveloped system of statistics of BiH, and in this context the lack of the data reliability, will represent a particular problem for monitoring and evaluation of the PRSP, and accordingly for the Millennium Development Goals. Some of the indicators with special importance for monitoring of PRSP are: percentage of population below poverty line², unemployment rate, net rate of enrollment in primary school, primary and secondary school enrollment rate, higher education enrollment rate and ect.

The Major Risks and Preconditions for Successful Implementation of the Medium-Term Development Strategy of BIH (PRSP)

The implementation of the BiH Medium-Term Development Strategy (PRSP) will require a greater determination of the governments in preservation of the achieved political consensus on implementation of reforms. The BiH Medium-Term Development Strategy (PRSP) envisages adoption and/or amending of a large number of laws and sub-laws. To complete these tasks within the given timeframe will require increased efficiency in the work of the parliaments at all levels. The process of acceleration of reforms will cause a short-term increase in unemployment, which might threaten social peace. In the near term, preservation of the social peace will depend on the governments’ ability to implement a social program to mitigate negative consequences of increasing unemployment in first year of the implementation of the Strategy.

In view of declining international aid, in the coming period BiH will have to rely on foreign investment as the most important source of financing future development. In this context, in addition to the acceleration of reforms and strengthening of the political stability of the country, the rate of recovery of the world economy and the increase of investment globally will influence successfulness in implementation of the PRSP.

Finally, a major precondition for a successful realization of the BiH Medium-Term Development Strategy (PRSP) is securing of additional assistance in the form of concessional credits and grants. The focus of the international community on other regions, or a failure of the government to convince the international community to continue extending aid to BiH may pose a serious difficulty to the implementation of PRSP goals.

1.1. UNDP Report on Human Development in BiH

In view of the lack of reliable and accurate information and statistical data in BiH already referred to, the activities of UNDP, in collaboration with the BiH authorities and with the assistance of the domestic statistical and research institutions, make a major contribution to filling the information gaps and providing a fuller picture of the situation in our country. UNDP’s activities in this field are formulated as quarterly reports within the Early Warning System, where a number of essential trends from the economic and social sphere are monitored continuously. The second major contribution is the publication of the Human Development Reports that constitute comprehensive research into key areas of society and phenomena that have an impact on the quality and standard of living of the members of society.

The Human Development Report, published in September 2002, introduced the Index of human development for BiH for the first time. This index is a scale that enables ranking of individual countries by their level of development compared with other countries of the world. It includes the economic dimension, but it is specifically adapted to encompass human dimensions of development that could not be adequately represented by other statistical and research methods and procedures. The human development index takes into account the issues of accessibility of education, health care, social services and information, as crucial for the successful and viable development of any society. Although issues such as human rights, oppression and discrimination of all kinds cannot be easily included in the index itself, they are also subject of analyses. In that regard, the possibility of comparison with other countries of the world (166 countries are included) facilitates the identification of specific weaknesses and provides an incentive and guidelines for improvements.

The Human Development Index (HDI) for BiH is 0.718. The significance and meaning of the HDI becomes clearer when its components are considered: HDI is composed of three sub-indices: GDP per capita, access to education and average lifetime of inhabitants. At the same time, bearing in mind the often incomplete and imprecise statistical data available for our country, we are not in a position to rank ourselves precisely on the HDI scale, and this number should be regarded as preliminary only.

The Human Development Report/Millenium Develpment Goals from June 2003 shed additional light on the poverty issue. This report estimated that 27% of adults in BiH are poor from the standpoint of education, and that 16% suffer from poverty in the health-care sense. From the employment aspect, 22% of work-capable population is poor. Housing conditions are below the poverty threshold for 11% of inhabitants, and 29% live in conditions of «legal poverty» because they live in apartments for which they lack adequate ownership or tenancy rights. In total, this analysis showed that some 72% of adults in BiH are poor from at least one of these aspects.¹⁵

2.1. The Young Generation and Poverty

Children are one of the categories that are most at risk of having a standard of living below the poverty line. Some 56% of the poor live in families with children. The children in RS are particularly vulnerable, since around half of this age group lives in poor families, while in the FBiH this holds for around one-third of all children.¹⁹ Around 13% of children live in families that fall into the category of the poorest, and 29% in households that are on the poverty line. Poverty of families with children is at its most pronounced where none of the family members are employed, and the situation is particularly difficult for displaced households, where the head of household is unemployed.²⁰

Children under 5 years of age are particularly at risk. This threat takes many forms, such as: very low access to preschool education (less than 9% of children attend a preschool education institution), lower access of poor children to secondary education, very low health insurance coverage, especially in rural areas. Surveys conducted among the population also confirm that the absence of health care affects young children of both sexes most seriously, since children are seen as more susceptible to accidents and illness, and as less resistant than adults.²¹ Children without parental care and other children in care (in the care of social welfare institutions) are at even greater risk than children living in poor families, since the social welfare systems are financially too weak to provide appropriate care.

Unemployment is probably the major problem affecting the young generation, equally in urban and rural areas of BiH. When this is combined with housing problems, the lasting economic crisis and political manipulation, young people become depressed and desperate and turn to drugs and alcohol, or make plans to emigrate as the only way to secure a better future.²² According to the available data, 92,000 young people left BiH between January 1996 and March 2001, and surveys show that 62% of the young would emigrate if they had the opportunity.²³ This is probably the most detrimental trend for the long-term revival and viability of economic development of BiH. The fact that there are fewer women among newcomers to the labour market (19 to 29 years of age) is interesting, since this means that a larger number of women than men are leaving the country.²⁴

2.2. Refugees and displaced persons

The data of the Ministry for Human Rights and Refugees of BiH indicate that 283,900 displaced persons reside in BiH (35% from the territory of FBiH and 65% from RS). It is estimated that more than 500,000 BiH refugees live abroad, and some 100,000 have no permanent status, so the possibility of their return should be anticipated. some 248,300 displaced persons live in the RS and around 23.500 in Brčko District.²⁵ 9 According to the data of the Ministry of Refugees and Displaced Persons of BiH and UNHCR, by September 30, 2003, 713,261 refugees and displaced persons returned to the FBiH, while 242,598 went back to their homes in the RS, and 20,951 refugees and displaced persons to Brčko District.²⁶

In all parts of the country, these categories, who are frequently without any stable source of income and not being covered by the existing social welfare systems, are considerably more vulnerable to poverty than the population that was not forced to move. In the case of returnees, the picture varies: in the RS returnees are extremely exposed to the risk of poverty, while in the FBiH that risk is lower.²⁷

Although LSMS failed to provide sufficient data for an in-depth analysis, the severity of the plight of this category is confirmed by the earlier research. Displaced persons constitute around 45% of the extremely poor in the FBiH, while in the RS, the displaced population accounts for only 21% of all those falling into this category. Eight percent of the poorest and 37% of persons on the poverty line live in a joint household with at least one displaced person. By far the most difficult is the situation of displaced persons still living in collective centers.

In the circumstances of radical cut-backs and the imminent cessation of these types of assistance, the displaced are in an especially difficult position, as there is no organized system at the entity and cantonal level that could take over the role of financing the needs of the displaced. The displaced therefore left in a charge on the municipalities which, in most cases, are unable to provide them with even the minimal conditions for survival. Displacement had an impact on the stratification of the labour market: the displaced are in a much more difficult situation, facing greater difficulties in finding a job and often forced to accept jobs that other groups were not interested in. In view of the difficult economic situation as well as continued ethnic tensions, returnees almost never manage to return to their previous jobs. Single mothers in displaced persons or returnee households face particularly serious problems since, in addition to all the other aspects of discrimination, they do not have access to even the basic forms of social welfare provided to other population groups.²⁸

2.3. Classic social welfare cases

There are around 260.000 beneficiaries of social welfare in BiH, i. e. around 7% of the population from each Entity. Additional 125.000 beneficiaries were registered for child care programs (2% of the population in FBiH and 6% in RS)²⁹. The categories of social welfare beneficiaries (in both Entities)³⁰ are children without parental care, educationally neglected children, children whose development is disrupted by their family situation, the disabled and persons with mental and physical developmental problems, persons incapable of working and without any material insurance, elderly persons without any family care, persons with anti-social behaviour as well as persons and families in social need due to special circumstances.³¹

Although 2% of the BiH population is registered as receiving financial benefits as a social welfare right, the reality is that funds are not available for everyone to exercise that right. For instance, only 13% of those registered in the RS are actually receiving welfare payments, and in some municipalities the percentage of those registered that are actually receiving welfare payments is as low as 2–3% while in others it may be over 20%.³² The situation is similar in FBiH, where some cantons offer no form of social assistance.

2.4. The unemployed

According to official statistical data, in December 2002 the official number and rate of unemployment (unemployed registered with employment bureaus) were 435,505, or 41.1% (42.7% in the FBiH and 38.2% in the RS) of active population.³³ Women represented 44,6% of the overall number of unemployed. Approximately one third of the unemployed were demobilized soldiers, while 4% were family members of killed soldiers and military war disabled.³⁴ About 34% of the population (38,6% of the FBiH population and 26,7% of RS population) regard unemployment as the single most serious problem faced by the country. As a result of cuts in military personnel, as already announced, as well as the impact of privatization, jobless numbers are expected to continue to rise.

Subject to certain conditions, the unemployed who previously had jobs have the right participate in the safety net which provides benefits of between 117 and 240 KM, payable for a period of between 6 and 12 months. Insufficiency of funds for this purpose led to only 3,320 people receiving these benefits in 2002,³⁵ and in the first six months of 2003 some 4,700 persons, or 1.6% of the total of those registered with employment bureaus in this entity. Unemployed persons in the FBiH are entitled to health care on condition that they are registered with one of the cantonal employment bureaus. In the RS, during 2002, an average of 1,290 persons per month received unemployment benefits, averaging some 70 KM, and there were some 1,530 on average in the first six months of 2003. Eligibility for unemployment benefits, which are payable over a period of between 3 and 12 months, depending on years of service, is based on a specified number of years of employment during the period preceding the claim.³⁶

The Poverty Assessment Study, drafted by a team of World Bank experts using data collected under the auspices of the Living Standards Measurement Survey (LSMS) and in collaboration with domestic experts, has reached a surprising conclusion in the preliminary phase that poverty is not primarily a consequence of unemployment. This conclusion is based on findings that less than 20% of the poor live in households in which the head of the family is not working, while more than double that number live in families in which the head of the family has a job. About 63% of the poor live in households in which at least somebody is employed. On the other hand, 28% of the unemployed are poor³⁷, while the unemployed represent only about a third of the overall number of the poor.³⁸ An explanation for such a wide incidence of poverty among the employed and among members of their households should be sought in the difficult conditions in which the BH economy functions. Average wage in the FBiH in December 2002 amounted to 513 KM, and in the RS to 356 KM³⁹ (in comparison with the estimated monthly price of the consumer basket, which is 459 KM in the FBiH and 458 KM in the RS).⁴⁰ At the same time, a significant number of businesses are showing very poor trading results and pay low wages, often in arrears by several months.

Bearing in mind that women account for only a third of the employed in BiH, and 44,6% of the officially unemployed are women - one of the solutions to the difficult position of families with working members is to promote a more active role for women on the labour market. However, the current state of the economy means that increasing the number of employed women will be a difficult and long-term process.⁴¹

The Poverty Assessment Study also showed that, although all unemployed persons do not fall into the category of the poor, they are at significantly higher risk of seeing their standard of living falling to below the poverty line than any other category of the population.

2.5. Low Income Pensioners

The LSMS data point out that the elderly, as a group, do not belong to the most vulnerable category, mostly because the level of pensions, especially in the FBiH, is above the poverty line. Only 17% of the poor are of retirement age.⁴² However, the members of that group are mostly concentrated just above that line. Belonging to a higher age group is, however, a common enough characteristic of the poor, and their specific needs and dependence on assistance from other people mean that this group is in exceptionally difficult circumstances. According to the findings of the team in charge of the Poverty Assessment Study, as many as 20% of the poor are either retired or incapable of working. In addition, at least 25% of the poor over the age of 60 are from the category of those who have not acquired the right to a pension.

In comparison with the year 1991, when the ratio of pensioners and employees was 1:3, by the end of the year 1995 the ratio had decreased to 1:1.3, after which it stabilized at about 1:1.4 in the FBiH. The level of pensions in the FBiH (an average pension of 186 KM was disbursed in December 2002) reflects the strength of the post-war recovery. Owing to the tripling of wages, and the 25% increase in the number of people paying insurance, the average pension has tripled by comparison with 1996 levels. By 2001, the average pension in the FBiH had reached 2/3 of average income per capita, which is above the ratio in most countries in transition. However, average pensions are still only around 36% of an average wage in FBiH (513 KM)⁴³ this solid average conceals significant differences in pension levels, so that older women, widows of pensioners, are to a significant extent exposed to the risk of poverty, while a household receiving two pensions can enjoy an income significantly above the FBiH average. In addition, women pensioners are, in general, in a more difficult position than men, given that women’s pensions are lower because, in general, they had lower-paid jobs.⁴⁴

The situation in the RS is significantly more difficult, with each person paying insurance contributions supporting more than one pensioner: a ratio of 1.08:1. As a result, even the very high contributions and transfers from the budget do not make it possible to pay average pensions of more than 30% of average income per capita. The level of pensions in the RS is half of what it is in the FBiH (an average pension in December 2002 as 120.18 KM), i. e. 34% of the average wage of 356 KM).⁴⁵, Despite this,+, the RS pension system can function only with significant transfers from the entity budget.

3.1. Human Rights and Poverty

It must always be stressed that effects and consequences of poverty are multidimensional. This means that negative influence on one dimension of human rights (e. g. the economic aspect) inevitably affects all other rights. It is difficult to claim with certainty that economic growth might by itself lead to poverty reduction and that is why it is of utmost importance to consider poverty from an inter-sectoral perspective.

Existing legal framework in BiH (BiH Constitution, constitutions of entities and cantons, ratified international conventions) provide a high degree of protection of human rights and freedoms. Equal treatment of men and women is guaranteed by law. In addition, BiH ratified a series of international human rights conventions (although it irregularly reported to international monitoring bodies)⁴⁶.

In the summer of 2000, a crucial decision of the Constitutional Court determined that changes must be introduced into entity constitutions to protect the rights of constitutional peoples in BiH. Subsequently, constitutional mechanisms were introduced in the entities to balance and safeguard the rights of every constitutional people. This decision ensured equality and proportional representation in political, administrative and judicial institutions.⁴⁷

All areas of social and economic development contain a dimension of human rights and require monitoring and analysis of effects of measures implemented with regard of the individual rights of citizens, as well as rights of different citizen groups, which require a higher degree of protection, such as: children, elderly, women, people in social need, persons with invalidity, families of killed and missing, war victims, displaced persons, and in particular returnees, minorities, refugees, asylum seekers, Roma etc. Social and economic rights of BiH citizens remain constrained because of underdeveloped economy.⁴⁸

According to the reports of the Ombudsmen, the most frequent human rights violation relate to equality before the law, property rights and right to work. The BiH Poverty Assessment demonstrated the strong link between violations of human rights, that are guaranteed by law, and poverty. This link is particularly strong in the case of returnees, as well as of minority populations (Roma).

3.2. Education and Poverty

About 60% of the poor live in households in which the head of the family has primary education only, or not even that The probability of a household falling into the category of poor households is almost tripled if the head of the family has completed primary school level education only.⁴⁹ High-school level education is already a major guarantee of the family’s avoiding falling into poverty. This indicates the importance of the improvement of the educational system for young people, as the basic tool for the long-term eradication of poverty. In the medium term, creating new options for adults with lower educational levels would yield positive results for a large proportion of the poor.

One of the basic findings of the majority of studies relates to the negative correlation between the level of education and poverty. In general, the higher the level of education, of either an individual or a household, the lower the probability that they will become unemployed, and therefore that they will fall into the category of the poor. Even in the 25–35 age group, half of all the poor are persons who have primary education only.⁵⁰ Lower education levels are linked to working in the “gray economy” -more than a half of the employees with primary school level of education work in the informal economy, while for categories with higher levels of education that indicator is under one fourth.⁵¹ Education level is single most significant of all factors affecting the poverty risk.⁵²

3.3. Gender Equality⁵³ and Poverty

Although there is not enough data to enable an analysis of poverty from the aspect of gender, existing studies point out that poverty takes the same toll amongst women and amongst men. Both men and women believe that the causes of poverty are the war, poorly conducted privatization, lack of the skills in demand on the labour market, corruption and the absence of the rule of law. Both groups seek their way out of poverty through improvements of their employment options, resolving their housing problems, adequate access to health and educational services, as well as through mobilization and activation of the society itself. It is interesting to note that all the groups consider that the alienation and poor cultural life are some of the important consequences of poverty.⁵⁴ In the BiH context, the male and female roles were disrupted with the outbreak of the war. Men assumed the role of defenders, protectors with the absolute power and control in public and pollitical life. Women thus lost a role in public life and reverted back to the limits of the home, household and family.⁵⁵

According to the findings of IBHI⁵⁶ researchers, the impact of poverty is different on men and on women: men often fall into a depression over unemployment or inability to support their families, while women are more inventive and ready to accept all kinds of jobs, but are prone to stress and tend to sacrifice their own health. In our new social circumstances, women often take on additional responsibilities for supporting their families, together with their traditional roles of mother and housewife.⁵⁷

Women comprise 44.65% of the overall number of unemployed, which is more evident than their share of overall employment (35%)⁵⁸. or active population (37.4%).⁵⁹ This is the lowest proportion of women in the total active labour force of any country in Southeastern Europe. Low employment rates among women are a problem for two reasons: first, the decline of real wages in comparison with the pre war period indicates that one wage can hardly meet all the demands of a family now; second, the ravages of war and the post war cuts in social benefits for family support have forced families to take on additional domestic responsibilities, without any additional resources.⁶⁰

Women suffer discrimination in employment, in both the private and the public sector, they receive lower wages than men for the same work and they have fewer opportunities for promotion, which has a direct impact on their financial position and makes it harder for them to maintain a satisfactory standard of living. Women are first to be fired during times of restructuring and reform and it is harder for them to find new employment. The available data lead to the conclusion that female-headed households are exposed to significantly higher risks of falling into the category of the poor than male-headed households. A further problem that is a particular barrier to employment for women is the almost virtual non-existence of childcare institutions.⁶¹ For all these reasons, it is not surprising that the data indicate that women in the 19 to 29 age group are less represented in the category of new entrants to the labour market, although it may also indicate that some of the best educated are leaving the country in search of better living conditions.

Even the fact that women have a longer life expectancy contributes to significantly higher exposure of older women to the risk of falling below the poverty line. Women account for 58% of the population over 65. It is very common to find women living alone, without a pension or any other regular income, especially in rural areas.⁶² Even when they have acquired the right to a pension, women pensioners receive lower pensions, having as a rule had lower-paid jobs. Bearing in mind that low education levels and illiteracy are the most frequent among the members of this group, it becomes clear how hard it is for such women to make use even of the options that exist for them to receive assistance.

Poor women are especially stricken by the sense of disempowerment and inability to express their opinions, either in their own surroundings or in relation to the authorities. Single mothers (particularly of childred with special needs), elderly women, wome refugees, Roma women, victims of violence, uneducated and unemployed women, and women in rural areas have special difficulties. Women in returnee households are in by far the worst position of all, due to their minority status and, often, their total isolation from the community to which they have returned. In view of the fact that there are different categories of vulnerable women in BiH, various problemss must be addressed when designing assistance programs. Additional research in the area of gender equality is vital to obtain a clearer picture of the situation on the ground.

At the level of BiH, the issue of gender equality is completely regulated by the Law on Gender Equality in BiH⁶³ This Law regulates, promotes and protects gender equality and guarantees equal possibilities to all citizens, both in the public and private sphere of the society, and prohibits gender-based direct or indirect discrimination. Full gender equality is guaranteed in all segments of society, and particularly in education, economy, labor and employment, social and health care, sports, culture, public life and the media, without regard to marital and family status. However, the focus in the next period must be on the implementation of the Law on Gender Equality in BiH and on integration of gender equality issues into all future strategic documents.

3.4. Elderly People and Poverty

The BiH population is rapidly aging, due to the declining rate in the natural increase of population, increasing life expectancy and emigration of the young. It is estimated that more than 12% of the BiH population is over 65, and for the RS this estimate is 15%. Over 80% of elderly persons are pensioners, about 10% of them receive benefits as war disabled, and about 5% are receiving social assistance.

Bearing in mind that pensions are low and social welfare, which is low and is often in delay, elderly people are one of the potentially most vulnerable groups. Although precise data are not available, some groups, such as elderly women living alone in villages, find it very hard to cope, due to the lack of access to social services, while the isolation of their homes and their own illiteracy often means they have no way of seeking assistance.⁶⁴

3.5. Poverty in Rural and Urban Areas

The consequences of the war have extremely complicated the situation in BiH and the position of its rural population, where the level of poverty is significantly higher. Although BiH has no pronounced potential for the development of agriculture, about half the rural population relies to a large extent on agriculture to survive. Many rural communities have been destroyed and their population displaced, either to third countries or within the country, where they are now largely living in cities. The slow pace of demining means that normal life is still impossible in many parts of the country, and a proportion of arable land cannot be cultivated.

Only about 20% of the poor live in urban communities, and poverty is most present in smaller communities, which frequently suffered the worst damage during the war. The risk of falling into poverty in the RS is significantly higher in non-urban, than in urban areas: 27% to 12%., while in the FBiH this risk is balanced: 16% of the poor live in non-urban, and 15% in urban areas.⁶⁵

Practically all the aspects which influence household living standards are more unfavourable in rural areas. In many parts of the country the basic infrastructure is still lacking. Access to educational and health facilities is more difficult and more expensive, and the quality of those which are accessible is lower. The virtual absence of pre-school institutions is increasingly significant, as they could help children from rural areas to compensate for the limitations which are often the result of growing up in a village. Only 6% of children from rural areas attend such institutions, in comparison with 15% of city-dwelling children.⁶⁶

The lack of a comprehensive agriculture development policy deters people from investing in that activity, while options for other types of employment in rural areas are minimal. All this prevents many displaced persons from leaving their temporary residences in the cities, which creates an additional pressure on the very small number of jobs, increases the cost of housing and gives rise to difficulties in the provision of educational, health care and social services.

3.6. Ethnic and Religious Dimensions of Poverty

UNDP findings⁶⁷ prepared in collaboration with the BH authorities, indicate that there is a correlation between the ethnic structure of certain parts of the country and levels of household income. In Croatmajority areas, 6.9% of households fall into the category of the poor based on income levels, in Bosniac-majority areas the percentage is between 22% and 25%, and in Serb-majority areas it is between 40% and 43%. Expressed differently, there is a growing gap in the economic development and standard of living between the different regions of BiH: Croat-majority areas enjoy the highest living standards, Bosniak-majority areas are in the middle, and RS has the lowest standard of living. Bosniak-majority Sarajevo Canton is the exception to the rule, thanks to its specific position as the capital and the presence of so many government authorities and international organizations

Almost everywhere in BiH minorities are much more vulnerable in regard to their financial status. In comparison with the above figures on the majority populations of the various areas, more than half of ethnic minority households in RS are poor, and in the Croat-majority areas of FBiH, 15.6% of ethnic minority households are poor. In Bosniak-majority areas, about 25% of ethnic minority households fall into the category of the poor, but the data from 2002 do not indicate any great differences between majority and minority ethnic groups.⁶⁸

A minority group that is almost entirely marginalized in BiH is the Roma population. Although it is impossible to ascertain the number of Roma living in BiH today with any degree of certainty (the estimates of Roma organizations range between 17, 000 to close to 80,000⁶⁹) it is almost certain that they represent the largest ethnic minority.⁷⁰ The number of Roma is difficult to ascertain because many of them still live nomadically. Although no in-depth surveys of poverty among Roma have been conducted, all available information indicates that they are one of the most vulnerable groups, living in conditions below even the most minimal for survival and often without the resources to support their families and ensure that their children can receive an education. As a group, Roma have by far the lowest levels of education in the country, their unemployment rate is almost 100%, and more than 90% have no health insurance. Due to their minority status they are marginalized, and their lack of knowledge of the system means that they are effectively deprived of many legal rights, including the right to social assistance.

Of the Roma families polled, 80% have no family members in permanent employment, and the majority mostly survive by doing temporary work or seasonal jobs, as small-scale traders in outdoor markets, or as scrap merchants.⁷¹ Roma encounter discrimination when job-hunting. A further problem is that very few have any formal education and even fewer have professional qualifications of any kind The results of polls conducted among the Roma show them to be poorly integrated into the education system, with 23% illiteracy and low attendance rates at pre-school institutions and primary schools, resulting in their almost total exclusion from high school, vocational and university education.⁷² By way of illustration, a poll by the Roma association “Our Future”, covering 582 Roma children aged 7 to 18 in Sarajevo Canton during the school year 1995/1996 found that only 189, or 33%, attended school regularly.⁷³ As Sarajevo is an urban area in which the majority of children have the opportunity to attend educational institutions, one can assume that the situation in other parts of BiH is even worse. Confirmation for this can be found in a survey on the status of Roma in Tuzla Canton, which covered 189 families and established that only 10 families enrolled their children in schools.⁷⁴

Roma give as reasons for their children’s failure to attend school: poverty, the necessity for children to start working and providing for the family at an early age, lack of confidence in the authorities (including schools), ill-treatment by their peers at school, and their inability to provide an environment conducive to study at home. Another reason often cited is the language issue: 86% of Roma polled give their mother tongue as Roma, which adds to their problems at school, where in the overwhelming majority of cases no special provision is made for pre-school assistance to Roma children.

Roma have long faced difficulties and exclusion from community, but the BiH Law on the Rights of National Minorities from 2002, and establishment of consultative fora, created a mechanism for protection of their rights.⁷⁵

4.1. War destruction

About 250.000 people lost their lives during the war in Bosnia between 1992 and 1995, and more than half the pre-war population of 4.4 million people became internally displaced or refugees abroad. The war caused immense devastation to manufacturing capacity and infrastructure, severed trade connections and put an end to the economic reforms that had just been launched in former Yugoslavia. Direct material war damage is estimated at between 50 and 60 bn. US$, of which about 20 bn. US$ on industrial capacities⁷⁶. Adding to this the loss of GDP from 1992 to date, overall damage amounts to more than 100 bn. US$. Because of the war, from a development country (within the former SFRY) BiH had, in European terms, become a poor country.

4.2. Slow Implementation of Reforms

In the post-war period, issues related to the implementation of the Dayton Accords were the focus of attention of all governments. Implementation of necessary reforms, that would lead to an economic revival, and consequent increase in employment, were delayed. Lack of political consensus on the reform program represented an additional obstacle.⁷⁷

4.3. Unemployment

Unemployment, especially widespread among the younger population, one of the most significant causes of poverty in BiH. The unemployed are not in fact a majority of the poor, because many live in households where one or more persons are employed. Another significant reason is the very strong informal sector (36,2%)⁷⁸. The size of the “grey economy” led the World Bank to conclude that real unemployment rate (based on the very broad ILO definition) could be as low as 16.7%.⁷⁹

4.4. Human Rights Violations

Human rights violations in BiH, particularly in cases of returnee and Roma populations, influence the poverty rate. Ethnic discrimination is expressed in difficulties in achieving return of private property, threats to personal security or obstruction of returns to pre-war places of residence and pre-war jobs, as well as the general impossibility of finding work, particularly in the public sector. Access to education, health-and social services or participation in the labor market are all hampered.

4.5. Inadequate Social Assistance System

In the conditions of insufficient fiscal revenues, the existing social assistance system is incapable of providing for the large numbers of the poor. Discrimination is present in realization of benefits, in that the transfers to military disabled are higher and more regular than to other categories of persons with disabilities. At the same time, discrimination is also regionally-based. Unlke other parts of the country, poor cantons in FBiH and poor RS municipalities are not allocating funds for social assistance, due to the shortage of funds in their budgets. The inadequate organization of social assistance in post-war conditions, together with the decentralized formulation and implementation of social policy, with policy determined on one level (entity) and implemented on another (canton or municipality), makes the adequate provision of assistance much harder. The peripheral municipalities, especially in the RS and Goražde Canton, pose a particular problem, as many were created through a division of pre-war municipalities and most lack even the most basic physical infrastructure, let alone the capacity to organize social assistance and care for the poor within their jurisdiction. Finally, the oversight of the benefits’ approval process is inadequate, which leads to the conclusion that social assistance benefits granted to date need to be reviewed.

Social assistance is an important factor in reducing poverty: the current assistance is equal to some 17% of GDP in BiH. Transfers to households comprise the largest share – around 15% of GDP. One in five inhabitans is a recipient of social assistance in some form. This assistance comprises around 11% of total household spending. For some 13% of the polled, the assistance is the shield from sliding into poverty, because for that group it increases spending by 50% on average. Many households in BiH receive some form of assistance, but less than half of the poor households are covered by these programs. Compared with other countries in the region, social assistance in BiH was unequally distributed between vulneragle groups and has limited effect to reduction of general poverty level in the country.⁸⁰ As previously mentioned, the existing social assistance system favors one group in relation to others, thus the total social transfers are not equally shared between all those in need of such assistance. The issue of financial assistance of both entity governments to war veterans is a particularly complex. Contrary to the public opinion, the analysis of the data collected during the Living Standard Measurement Survey (LSMS) demonstrated that the war disabled and war veterans face considerably lower risk of sliding into poverty in relation to average inhabitant of BiH. This may be explained by higher sensitivity of governments to this category, owing to their ability to exercise far more effective influence on the public opinion in comparison with other categories of the poor. Thus, for instance, transfers to the veteran populations are 13 times higher in FBiH, and 2 times in RS, than allocations for child protection.

Amounting to nearly 4% of GDP, veteran transfers represent a major burden for entity budgets and restrict the capacity for assistance to other vulnerable categories of the population. In addition, in both entities, significant additional financing is channelled to these categories from lower levels of government. It has been recognized that the most severely disabled (over 50% of disability) are not adequately protected, while the assistance is provided for a great number of work-capable disabled.

That the situation of social assistance beneficiaries is not even worse may be explained by other forms of assistance they receive. During the war and post-war period, humanitarian aid was particularly significant, as it often included, in addition to food, clothes and medicines. Humanitarian assistance was shared and through government bodies and through NGOs, and was available to nearly everyone in need. However, this form of assistance has been considerably reduced in recent years and one must expect that in the near future it will no longer have a significant role in meeting the basic needs of the vulnerable categories of the population. On the other hand, other survival strategies are in evidence: many poor rely on assistance of the family and relatives, and many others have access to arable land. Assistance from abroad is also a significant means of supstituting or complementing social protection. Most of this assistance flows outside official financial channels, making it impossible to determine their levels with certainty. The BiH Central Bank estimates that private transfers from abroad in 2001 reached KM 2.1 billion, i. e. equal to 22% of GDP, which is far above the other countries in the region. It is, however, impossible to determine what share of these funds goes to the poor or to those who would be poor without such assistance.⁸¹

4.6. Quality of Education

The quality of education has a direct influence on employment options, and thus on the possibilities for poverty reduction.

4.7. Corruption

Corruption, which is widespread in BiH, affects the poor especially hard, whether it is the matter of visit to a doctor, realization of the right to some form of social assistance, obtaining documents, education, return of property or employment.. Displaced persons, the elderly, the rural population and unemployed are often forced to pay for such services because they lack the channels of communication that would allow them to access these services in any other way.

4.8. Inability to Influence the Institutions of the System

Inability to influence the institutions of the system are both a cause and a consequence of poverty. In most cases the poor lack or are unaware of the channels of communication with the authorities that make the decisions and control the resources affecting their lives, which reduces their chances of breaking out of the “vicious circle” of impoverishment and participating in the formulation of policies and measures adjusted to their needs.

2.1. Problems

Recent economic development has been associated with substantial external and internal imbalances generated by the post-war adjustment and reconstruction of the economy. The massive reconstruction programme required a very high level of imports that has been reflected in the still present extremely large current account deficit, which amounted to around 17% of GDP in 2003. Slow renewal of domestic production affected the exports, which were weak, and which, in 2003, amounted to about 31 percent of total imports. Unemployment rate was also at a very high level.

The reconstruction of the country required a significant public investment program, which, for example, in 2001, represented about 10% of GDP, having fallen from around 15% of GDP in the late 1990s. Levels of public consumption have remained high, at around 23% of GDP in 2003, which affected the growth of tax burdens and fiscal revenues that have grown in line with the Gross Domestic Product (GDP). The continued high level of public consumption to a significant extent reflects the limited progress with economic transformation. In parallel with that, throughout the period, there is a constant trend of extremely high levels of public expenditure. In 2003 they amounted to about 46% of GDP and they by far outreach the average for transition countries.

High levels of imports, public consumption, public investments and public expenditure were, in the most part, possible due to substantial inflows of foreign aid, the spending of a significant number of foreigner residents in BiH and high levels of remittances from BiH citizens living abroad (refugees).

The data on the overall budgetary deficit are still unknown, and it could turn out to be higher than the data shown in this document indicate, due to strong indications that the cantonal and municipal budgets got indebted in the domestic banking sector. According to the IMF³ data cantonal budgetary deficits financed in this manner reached the amount of about 42 mill KM in the year 2002, which is far above planned level.

A particular difficulty is present in the level of the so-called corporate debt, which is, in the most part, the debt of companies in state ownership or companies privatized through certificates (vouchers). In fact, of special concern is the appearance of the so-called “non-payer culture” in relation to wages, contributions, taxes and liabilities to suppliers, creditors etc. Debts of those enterprises grew to such an extent that they pose one of the most severe obstacles for privatization and continuing development of the country.

Activities in the recent period failed to result in achieving total integration of the single economic space in BiH, and the size of the gray economy (36 percent of GDP) creates a magnitude of problems. The transition is posing a set of questions bearing social and cultural consequences, that are already present in BiH, such as, for example, «to pay or not to pay the taxes», «to register or not to register the workers».

3.1. Reform Scenario

The scenario envisages that, in mid term, the real GDP growth rate will increase from 3.5 percent in 2003 to 5 percent in 2004, reaching about 5.5% by 2007. Such growth rates envisaged by the Reform Scenario would enable BiH to regain the pre war levels of GDP by the end of the decade, and accelerate the integration of BiH into EU.

The key risk to realization of the Reform Scenario is the possibility that the necessary pace of reforms proposed by the Mid-term Development Strategy for BiH (PRSP) will not be achieved, which would result in lower rates of economic growth. The impact would be further exacerbated by a sharper than expected fall in external resource inflows, which can be expected to be increasingly linked to the timely implementation of reform measures.

3.2. Scenario in the Case of a Slower Implementation of Reforms (status quo)

Due to the risk that the governments might fail to achieve the necessary pace of implementation of reforms, the PRSP team prepared an alternative mid-term macroeconomic projection which is titled “Scenario in the Case of a Slower Implementation of Reforms”. That scenario is based on the trends in growth and implementation of reforms, which existed between 1996 and 2002 (status quo scenario).

According to this scenario, GDP growth rate in real terms would, in 2004, will fall down to 1.8 percent, after which it would stabilize at the level of 1.9 percent annually (Table 2). In 2006, GDP growth in real terms would be around 10% lower than the one projected within the Reform Scenario. In real terms, public consumption would fall by 8 percent, which would require significant reductions of allocations for social benefits, public service and public investment financing. In case of this scenario, there is a risk that, due to internal and external imbalances, enforced adjustments would take place, which would additionally undermine economic growth and stability. Prospects for building a sustainable economy and reaching the pre war GDP level would be utterly uncertain, international aid would decline drastically, the country would not have credit worthiness to get indebted on the international capital market, and the prospects for entering EU by 2009 would be significantly undermined.

Table 2.

Scenario in the Case of a Slower Implementation of Reforms

Table 2.

Scenario in the Case of a Slower Implementation of Reforms

			2004	2005	2006	2007
			Proj.	Proj.	Proj.	Proj.
Real Sector
	GDP in nominal terms (KM million)kt		11,593	11,924	12,298	12,717
		(percentage change)	3.5%	2.9%	3.1%	3.4%
	GDP in real terms (KM million)		11,185	11,398	11,614	11,835
		(percentage change)	1.8%	1.9%	1.9%	1.9%
	CPI: period average percentage change		1.7%	1.9%	2.0%	2.1%
General Government (% of GDP)
Total balance (KM million)			-321	-341	-353	-347
		Total Revenues and Grants	53.3%	53.0%	52.8%	52.6%
		Total Expenditure	56.0%	55.9%	55.6%	55.3%
		Overall Balance	-2.8%	-2.9%	-2.9%	-2.7%
Total Foreign Assistance (grants and loans in m.US$)			371	381	356	341

View Table

Table 2.

Scenario in the Case of a Slower Implementation of Reforms

			2004	2005	2006	2007
			Proj.	Proj.	Proj.	Proj.
Real Sector
	GDP in nominal terms (KM million)kt		11,593	11,924	12,298	12,717
		(percentage change)	3.5%	2.9%	3.1%	3.4%
	GDP in real terms (KM million)		11,185	11,398	11,614	11,835
		(percentage change)	1.8%	1.9%	1.9%	1.9%
	CPI: period average percentage change		1.7%	1.9%	2.0%	2.1%
General Government (% of GDP)
Total balance (KM million)			-321	-341	-353	-347
		Total Revenues and Grants	53.3%	53.0%	52.8%	52.6%
		Total Expenditure	56.0%	55.9%	55.6%	55.3%
		Overall Balance	-2.8%	-2.9%	-2.9%	-2.7%
Total Foreign Assistance (grants and loans in m.US$)			371	381	356	341

Taking into account the adverse effects of maintaining the status quo and a slower implementation of reforms, BiH does not have any alternative other than to accept the Reform Scenario and accelerate the reforms. Even in the case of the implementation of the Reform Scenario, which requires the implementation of an ambitious reform plan envisaged by the Mid-term Development Strategy of BiH (PRSP), BiH will lose 18 years of development, as the reinstatement of the pre war GDP levels is envisaged in 2009, and not prior to that. The question to ask the governments and the public in BiH is: must we lose even more?

3.3. Important Prerequisites for the Realization of the Reform Scenario

In order for the objectives envisaged by the Reform Scenario (Table 1) to be achieved, it will be necessary to undertake the following priority activities and measures:

3.1. Fiscal Reform: Reform Scenario⁸

Relatively rapid economic growth will permit progress to be made towards fiscal consolidation with the overall general government deficit for 2004–2007 remaining at a low level of about 0,6 percent of GDP (including grants). That should provide scope for funding regular servicing of foreign and domestic debt in line with plans for the reduction of public debt. Total revenues and grants over the period are projected to fall from about 47% of GDP in 2003 to about 431% of GDP in 2007. This is in line with the entity MTEF projections (BFP)⁹.

On the public expenditure side, total expenditure is projected to fall from about 46% of GDP in 2003 to 43% of GDP in 2007, which is also in line with entity MTEF projections (BFP).

Thanks to the favorable structure of external debt it is expected that the servicing of foreign debt will decline from 8.6 percent of overall exports in 2003, to around 4.4 percent by 2007. in view of the importance of capital investments for the development of the country in the conditions of insufficiently developed private sector, in the coming mid term period it shall be important to maintain their scope at the level of about 5 percent of GDP, regardless of the decline of international aid. However, domestically financed public investment will have to be increased, from 2% in 2002 to 2.6% of GDP in 2007, to compensate for a decline in foreign financed investment.

External concessionary credits will continue to provide the primary source of financing of the budget deficit, although total foreign assistance is expected to fall from 8% of GDP in 2002 to 2% of GDP in 2007. Public sector borrowing from domestic sources will continue to be tightly controlled.

3.2. Fiscal Reform: Scenario in Case of a Slower Implementation of Reforms

This scenario illustrates possible consequences of a slowdown in the pace of economic reform leading to lower rates of investment and growth. It assumes that real economic growth from 2004 onwards will only be one third of that in the Reform Scenario and that external aid flows would only be twothirds of expected as donors respond to the slow pace of reform by delaying the release of planned financial aid and reducing new funding commitments. As a result, public expenditure would remain static in real terms. That would lead to significant deterioration in the quality of public services and would make it more difficult to meet the demands for social assistance, which would increase the level of poverty in comparison with the current one.

4.1. Establish a More Efficient System of Public Revenue Collection

Significant progress has already been made in the harmonization of indirect taxes, rationalization of exemption policies and reduction of high rates of labor taxes¹⁰.

The focus of this reform area is put on establishing the BiH Board for Indirect taxation, within which a unified customs administration is going to function on the state level. Another important step is the introduction of value added tax (VAT) on the BiH level, with the fundamental aim of elimination of the existing obstacles to economic development, more efficient collection of direct revenues, prevention of fraud and corruption, reduction of the level of gray economy, and achieving progress towards EU integration and WTO membership.

In the same period, it is necessary to prepare and realize the reform of direct taxation, also with the aim to modernize the system and harmonize it with European practices. In this context, it is important to eliminate all present forms of double taxation, especially in the case of profit tax and income tax. Finally, in parallel with the strengthening of the customs administrations, it shall be necessary to continue with the strengthening of tax administrations.

The establishment of a new system of revenue collection shall contribute to increasing efficiency, as well as to the reduction of the level of gray economy. Introduction of the VAT is an importantly instrument in achieving this goal. However, taking into account that the implementation of the VAT is expected in the final phases of the implementation of the Mid term Development Strategy for BiH (PRSP), positive effects of its introduction could not be taken into account when designing entity Mid Term Expenditure Frameworks (BFPs).

Although the general objective of the BiH Medium Term Development Strategy (PRSP) is to reduce the overall tax burden, especially for the economy, through the reduction of the scope of public spending, it was determined that there is room for increasing certain types of taxes. That primarily refers to the so-called «property taxes» which are under the scope of authority of sub-entity levels of government. However, on those levels, especially municipal ones, there is a practice of enforcing new tax burdens which do not have any foundation in the legislation. This concerns the introduction of various administrative fees. In line with that, it is necessary to ensure the implementation of the legislation and prevent such occurrences.

With the objective of more efficient collection of public revenues based on oil, it is necessary to create preconditions for the transport of oil and oil derivatives by rail and waterways exclusively (Brčko).

4.2. Ensure Adequate Allocation of Public Revenues to Different Levels of Government and Strengthen Coordination Between Them

A further set of issues relates to the assignment of revenues and expenditure responsibilities. As has already been mentioned, BiH is functioning as a highly decentralized system, in which almost all revenues are collected and spent on sub state levels. According to the Constitution of BiH, institutions on the state levels have limited authorities, only, so, due to that, the level of expenditure on the state level is also low. The largest part of public revenue spending happens on entity and cantonal levels. In both FBiH and RS, municipalities play a limited role, directed primarily to urban planning, public utility services, local facilities, culture and limited functions in health and education. As has already been mentioned, municipal expenditure accounts for just 7–8 percent of overall entity spending, and in RS it amounts to 22 percent.

There are substantial regional variations in per capita revenues, especially in FBiH, which was, in the absence of sufficient equalization mechanism, reflected in the quality of public service delivery. For example, in 2001–2002 cantonal per capita revenues averaged KM 521 across all cantons, ranging from KM 299 in Gorazde to KM 1,172 in Sarajevo.

On the other side, entities have adopted policies which had implications on expenditure programs on cantonal and municipal levels, without a thorough consideration of the availability of resources for covering the resulting costs on the sub entity level. That presents a special problem, especially when it comes to legislation in the sector of social protection. When determining tax-sharing mechanisms, insufficient attention was paid to public expenditure needs of sub entity governments. For example, in FBiH, although canton governments have the major responsibility for the delivery of public services, their share of total FBiH revenues¹¹ has fallen from 61% in 1999 to and estimated 49% in 2002. The situation improved due to the change of the point of collection of sales tax, which occurred in the course of 2003¹². However, the cantons are, in general, faced with enormous difficulties in budgetary expenditure planning because of the insufficient level of coordination between the entity and the cantonal level in decision making, which results in the change of revenue and expenditure policies.

The strengthening of state level revenues shall be executed in parallel with the introduction of the VAT, and, until that period, the state budget shall be filled with transfers from entity budgets. A part of the reforms is directed towards the strengthening of public administration (for example. Defense reform, customs reform…) which should not lead to an increase of the overall public spending: the transfer of entity authorities to the state level shall lead to the reduction of their budgets. In 2004 the Brčko District shall initiate regular transfers of a part of its revenues to the state budget.

In the course of the coming period one can expect a further decrease of customs revenues, of up to 20 percent per annum, especially because of the implementation of the free trade agreements with the countries of the region. Taking into account that the customs represent a very important source of revenues for entity budgets (especially in FBiH), and in order for disturbances in entity financing to be avoided, it shall be necessary to compensate for the loss of revenues, primarily through increasing the level of efficiency in the functioning of customs administration, and, in the coming mid term, through the reallocation of revenues on the basis of VAT. An important step in that direction is the reduction of the number of customs offices, customs desks and border crossings for the trade of goods.

The preparation of public administration reform in BiH is ongoing and one of its objectives is to eliminate the overlapping of activities, to increase efficiency and establish coordination between different levels of government. In line with the strengthening of the system of public revenue collection and reforms in the area of public administration, it shall be necessary to ensure adequate allocation of public revenues to different levels of government.

In connection with those issues, it is necessary to:

• Ensure the coordination of activities in relation with the decision making with implications on the change of revenue and expenditure policies. This is especially important in the case of FBiH, where the Ministry of Finance of FBiH has established regular coordination with cantonal ministries of finance, which needs to be strengthened constantly,

• Ensure that the allocation of resources between entity and sub entity levels reflects the distribution of responsibilities connected to public service provision,

• Establish a higher level of solidarity, in order to assist poorer cantons and municipalities.

4.3. Constrain Public Sector Wage bill Spending

At 19.6%¹³ of GDP in BiH, wage bill spending in the public sector is almost three times the level of other Central and Eastern European (CEE) transition countries. One consequence is that spending on current operations and material costs are on a low level, which is threatening the quality of public services.

The high level of wage bill spending in BiH is not, to such a degree, a consequence of the size of public service employment¹⁴, as of the level of public sector wages and salaries, which are significantly higher than in similar transition countries (especially in the case of FBiH and the state level). An equally significant factor is that the levels of public sector wages are different on different levels of government: wages on the state level are up to 40 percent higher than wages in RS public services. Wages in the district of Brčko and City Administration of Mostar are the highest in BiH. In FBiH, wages on public administration are by 35 percent higher than average, and, in RS, by 37 percent, while the difference in the District of Brčko is the most pronounced (67 percent). The disparity in the level of wages in the country additionally affects the differences in the quality of public service provision.

In contrast with the practice present in all developed countries, the level of public sector wages is significantly higher than the level of wages in the real sector of economy, with the exception of the financial sector¹⁵. Polls among the employers (see section on labor market) have ascertained that they have significant difficulties in finding adequate labor force on the market, which is, inter alia, a result of the high level of interest for working in public administration and public enterprises. Nevertheless, there continue to be substantial pressures for additional salary and wage increases in public administration. In the course of the previous year (2002), the Government of FBiH has increased the budget item for wages by about 30 percent in comparison to the year before, while the RS did the same, at the level of about 10 percentage points. The trend of growth in public sector wages continued in 2003 also.

In view of the aforementioned, in the coming mid term period (2004–2007) it is necessary to constrain the allocations for public sector wages. However, taking into account the different wage levels, this measure should not be implemented equally in both entities and the Brčko District. That means that the average budgetary wage increase in FBiH should not be over 2 percent, while in the RS it should not be over 4–5 percent, and any additional wage increase should be compensated for with an adequate decrease of the number of public servants.

Constraining wage allocations shall enable the decrease of overall allocations on that basis as the share of GDP in the coming mid term – in RS, from about 10 percent in 2003 to 7.8 percent in 2006, and in FBiH from about 16 percent in 2003 to 12.3 percent in 2006.

4.4. Reduce Allocations for Defense and law and Order (including Judiciary)

Budgetary spending on defense at 4.5% of GDP¹⁶ (2.7 percent in RS, 5.1 percent in FBiH¹⁷) is over twice the average (1.9% of GDP) for other CEE countries. Substantial off-budgetary expenditure and arrears means that in recent years, the true level of defense expenditure has been significantly higher¹⁸. Spending on defense is also excessively concentrated on personnel (around 80% of budget).

Spending on public order and safety at 4.4% of GDP¹⁹ is over twice the average for other CEE countries and four times the average for EC countries. Expenditure in the sector is driven by high levels employment which are substantially above pre-war levels.

In the defense sector, reforms and demobilization should be continued, in order for the allocations for defense in FBiH to be reduced from 5.1 percent of GDP in 2002 to 2.3 percent in 2006, and, in RS, from 3.8 percent in 2002 to 1.9 percent in 2006. In the course of 2004, alone, both entities are planning to demobilize about 8,000 soldiers, which will lead to additional savings at the level of about 1 percent of GDP.

In the area of law and order, rationalization plan needs to be prepared, in order for the allocations for that purpose in FBiH to be reduced from 4.5 percent of GDP in 2002 to 3.5 percent in 2006, and in RS, from the same level in 2002 to 3.9 percent in 2006.

4.5. Adopt Legal Framework for Public Procurement

The adoption of a legal framework for public procurement shall lead to further strengthening of the single economic space and transparency in public revenue spending. The adoption of this legal framework is a conditions for a faster integration of BiH in the EU and for the membership in the WTO. However, it is important to mention that the new legal framework in this area shall lead to more significant savings in public expenditure.²⁰ Besides the adoption of the legal framework, it shall be necessary to establish adequate public procurement agencies, as well as bodies for auditing public procurement.

BiH needs to gradually harmonize its laws on public procurement with those of the EU. It is also necessary to strengthen the corresponding institutions and judiciary, in order for the public procurement procedure to be implemented according to the regulations.²¹

4.6. Increase the Share of Domestic Public Revenues in the Financing of Current (Operating) Costs

The major part of public revenues is being spent on public administration wage bill. In recent years, allocations for material (operating) costs were below the necessary level, and the majority of those costs were covered from donors’ resources. However, the overall allocations, from both domestic and donor revenues, were not sufficient, which lead to weaknesses in the level of equipment in public administration and the deterioration of government infrastructure. In order for public services to be improved, in the coming mid term (2003–2007) it is necessary to ensure a higher share of public revenues in the financing of current (operating) costs of public administration. Constraining the nominal level of allocations for public administration wage bill shall enable an increase of allocations for that purpose, which should, in 2006 amount to 4 percent in FBiH and to 4.5 percent in RS (of GDP).²²

4.7. Increase the Share of Domestic Public Revenues in the Financing of Public Investments

Since 1996 the international donor community has, mostly through donations, largely financed the public investment program in BiH. For example, in the previous years, domestically financed capital spending has accounted for around 10% of all public investment. The need to move ahead quickly with reconstruction projects has meant that the major share of internationally financed projects have been managed through independently established project implementation units (PIUs) operating outside of the framework of the government budget. This has resulted in a number of problems. It has been difficult for Entity and sub-Entity governments to track credit investments into public investment, which has seriously undermined accountability related to the servicing of those credits. On the other side, decisions on public investment projects have often been taken without adequate harmonization with financial capacities.

Due to the expected decrease of international aid flows, the share of domestically financed public investment will have to increase substantially. By 2006 it is estimated that domestically financed projects will account for two-fifths of all public investment, with externally financed projects largely being financed from concessional credits.

Therefore, in the coming mid term period (2004–2007) it shall be necessary to increase the share of domestic resources in the financing of public investment programs, by 15% per year in comparison with the 2003 allocations.

There is an urgent need to strengthen the planning and management of the public investment program in both entities, and recent establishment of Aid Coordination Units on the state and entity level is a step in that direction. The RS Government has already adopted a Public Investment Program for the coming mid-term, and it is expected that the FBiH Government shall do the same by the end of February of this year.

4.8. Reduce Sectoral Spending to Sustainable Levels

An analysis of expenditure by function suggests that spending levels in Bosnia across a number of major sectors are substantially higher than those in other CEE countries.²³ Consequently, there is considerable scope for the reform of spending programme linked to the overall reduction of public expenditure as a share of GDP.

Spending on education, at 6.4% of GDP, is also higher than average for other transition economies (3.3% of GDP), with spending considerably higher in the FBiH (6.8% of GDP) than in the RS (4.7% of GDP).²⁴ The highly fragmented education system, particularly in the FBiH, results in high unit costs, inequitable provision, and poor outcomes. High levels of spending and inefficiencies show that an increase of spending on education in nominal terms should not be permitted, but, instead, it should be reduced, especially in FBiH. Education sector reform, which is ongoing, shall reduce the spending for this purpose to 5.6 percent of GDP in FBiH and to 4.5 percent of GDP in RS, by 2006.²⁵

Public spending on health is financed primarily from Health Insurance Fund contributions, and, to a lesser extent, by budget interventions. At 6.9% of GDP in FBiH and 6.4% of GDP in RS²⁶, spending levels in the health sector are significantly higher than average allocations for that area in other transition countries (4.4%). It is estimated that the level of allocations on the basis of payments for health services in the private sector accounts for an additional 5% of GDP in both entities. However, health revenues fall significantly short of the financial requirements of the legally stipulated level of health services.

In view of that, the efficiency of health spending needs to be improved, through the rationalization within the sector itself, which implies the improvement of management in public health funds, direction of resources to priority programs of prevention and treatment, and improvement of public procurement procedures. Future spending on health shall depend on the level of inflow of resources into health funds. It is expected that by 2006 spending in this sector shall fall to 6.9 percent of GDP in FBiH and, in RS, from 6.4% in 2002 to 5.9 percent.²⁷

Public spending on social transfers (including allocations on the basis of veterans’ rights, unemployment, pensions and classical forms of social protection) at 18.9% of GDP in FBiH and 14.7% in RS²⁸ is only slightly higher than the average for CEE countries (14.2% of GDP). However, the high percentages of allocation do not show the real picture of the situation, taking into account the relatively generous and extensive veterans’ entitlements. Allocations on that basis account for around one third of total social transfers. On the other side, social welfare services continue to face acute funding problems and an unclear and overlapping division of responsibility between different levels of Government. In the FBiH, the recent Law on Social Services placed considerable additional spending responsibilities on the Cantons without any corresponding adjustment in revenue assignment. There is still a lack of clarity in the assignment of responsibilities and resources with respect to refugees, displaced persons and returnees, especially in FBiH.

Sending on social transfers need to remain in the existing levels. It is expected that spending on this purpose in 2006 shall amount to 17.8 percent of GDP in FBiH and 13.5 in RS.²⁹ Social transfers towards the veterans’ population shall remain at the same level, while other social transfers shall be increased by 4% per annum³⁰, in order to finance poverty reduction oriented programs.

Spending on utilities shall increase at 5% per year, to allow for improved services, especially amongst the poorest areas. Finally, spending on development programs shall be increased by 2.5 % per annum, to allow for a higher level of agricultural support.³¹

The necessary reform measures in each of those sector are identified in the following txt of the PRSP.

4.9. Reorienting Public Expenditure in Compliance with the Priorities of the Mid Term Development Strategy for BiH (PRSP)

The priorities identified in the Mid Term Development Strategy for BiH (PRSP) will have an impact on the nature of future public expenditure, both for investment and for recurrent activities. The instruments for the realization of those priorities will include the entity Mid Term Expenditure Frameworks (BFPs) entity Public Investment Programmes (PIP) and discussions with donors.

The Reform Scenario of the Macroeconomic Framework of the PRSP expects rapid implementation of reforms to generate growth of about 5,5% per year. Under this reform scenario, it is expected that the public revenues in both entities shall grow at the rate of 4.5 percent per year.³² The total level of public investment during the four year period 2004 – 2007 will be about KM 2.3 billion, of which about KM 500m is already programmed for completion of ongoing projects. The allocation of the remaining KM 1.8 billion is ascertained by entity Public Investment Programmes which are an integral part of the PRSP.

The PRSP working groups have done some initial work on estimating the financial implications of the reforms. This work has included consideration of financial implications of the implementation of reforms within conventional investment projects, as well as other ‘one-off’ and recurrent costs. The recommendations of the PRSP are presented in figures 1 and 2 below.

Indicative Share of Public Investment and ‘One-Off’ Expenditure suggested by the PRSP

Citation: IMF Staff Country Reports 2004, 114; 10.5089/9781451804874.002.A001

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Indicative Share of Public Investment and ‘One-Off’ Expenditure suggested by the PRSP

Citation: IMF Staff Country Reports 2004, 114; 10.5089/9781451804874.002.A001

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Indicative Share of Public Investment and ‘One-Off’ Expenditure suggested by the PRSP

Citation: IMF Staff Country Reports 2004, 114; 10.5089/9781451804874.002.A001

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Allocation of Public Resources by Priority

Citation: IMF Staff Country Reports 2004, 114; 10.5089/9781451804874.002.A001

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Allocation of Public Resources by Priority

Citation: IMF Staff Country Reports 2004, 114; 10.5089/9781451804874.002.A001

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Allocation of Public Resources by Priority

Citation: IMF Staff Country Reports 2004, 114; 10.5089/9781451804874.002.A001

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Allocations for the program of public investments and other one-off interventions are presented in Figure 1.

Investment requirements for the financing of the public investment program are substantially higher than the projected growth rate of public revenues, so that it shall be necessary for a part of the public investment program to continue to be financed by donors, but in amounts significantly lower than before.³³ Most reforms will have to be funded from savings in recurrent spending arising from increased efficiency. However, in case the excepted growth rate of 5 % per annum in real terms is ensured, some incremental resources will be available in the coming four years, which will in most part be a result of the decrease of the defense spending, spending on law and order, public administration wages (as a share of GDP), internal savings, including the implementation of new legal regulations in the area of public procurement, and more efficient collection of public revenues. According to the Reform Scenario, it is expected that the total recurrent spending be expected to be KM 87 million higher in 2007 than in 2003, in real terms. It is also expected that defense savings shall provide an further KM 88 million per year by 2007, thus allowing for non-defense spending to be KM 175 million higher in 2007 than 2003, in real terms.

Work on reorienting recurrent expenditure in line with the PRSP is ongoing, and is linked to the MTEF and budget process. Figure 2 presents an early indicative sectoral allocation of incremental recurrent costs. Most education reforms will be funded from savings and all health improvements will be self-funding within the Health Insurance Fund. As a result, it is the reforms in social welfare which dominate incremental recurrent spending. Some increase in agricultural subsidies is also foreseen, in line with recent parliamentary decisions.

Figure 2 represents sectoral recommendations of the PRSP for the allocation of those additional public revenues. The major part of reform in education sector shall be financed from savings, and in the health sector through the increase of efficiency and self-financing of health insurance funds. As a result, the major part of additional public revenues should be used for the financing of reforms in the social protection sector, inter alia for the financing of social implications of accelerated implementation of structural reforms (acceleration of privatization, reform of public administration, restructuring of mines etc.). A certain increase of subsidies in agriculture is also envisaged, in line with the recent decisions of entity parliaments, and it shall also be necessary to ensure a higher share of domestic public revenues in the financing of works in the sectors of transport and water management, which will be most affected by the reduction of donor aid.

Savings executed through the realization of the Reform Scenario in the coming mid term should also be used for the reduction of taxes. In that, priority should be given to the reduction of tax burdens and contributions levied on wages, which would yield multiple results: it would have a stimulating effect on the growth of the private sector, attraction of foreign investments and reduction of the gray economy.

The level of additional public resources available is strongly related to the rate of economic growth envisaged by the Reform Scenario. On the other side, in the Scenario of Slower Implementation of reforms (ie with only 1.9% growth), total revenue envisaged for 2007 are by KM 113 million lower than according to the Reform Scenario. If growth is only 1.9% and defense savings are not realized, then recurrent spending would have to decline by KM 26 million in real terms, to protect the KM 2.3 billion investment levels, the servicing of external debt and the reduction of the level of domestic public debt.

4.10. Improve the System of Public Spending Planning and Management

In 1999 both entities undertook steps directed to the development of the Mid-term Expenditure Framework (MTEF), with the objective of strengthening macro-fiscal planning and improving connections between government policies and resource allocations. In the course of that year, entity governments adopted mid term expenditure frameworks for 2004–2006, which were used as an important document in the preparation of the Mid Term Development Strategy for BiH (PRSP).

It shall be necessary for the entity governments to revise the BFP regularly, in line with the priorities of the PRSP. The MTEF shall present an important element for strengthening the annual budget preparation cycle, through the provision of more reliable and detailed projections of revenues. This issue is extremely important in the case of FBiH, where the cantons are faced with serious difficulties in connection to revenue projections. The FBiH Government, and, especially, the Federation Ministry of Finance should establish a regular practice of holding monthly meetings with cantonal governments and ministries. In that context, activities in connection with the planning and realization of public investment programmes need to be adjusted with the priorities of the PRSP and entity mid term expenditure frameworks.

In line with the recommendation of the EU Feasibility Study, it shall be necessary to adopt budget laws on all levels, in line with the Mid Term Expenditure Frameworks (MTEF), and introduce unified government accounts. It shall also be necessary to undertake steps on recording all payments to public bodies on all levels of government, including payments of grant funds and other modes of international assistance.³⁴

Entity ministries of finance need to strengthen their departments for: macroeconomic analysis and projections, fiscal analysis and analysis of budgetary policies, consolidation and analysis of fiscal data and reporting. On the other side, line ministries will need to strengthen their departments for sector policy analysis and public investment program planning. It can be expected that it will include the establishment of sectoral units for creating strategies, programs and budgets in the most significant line ministries.

4.11. Establish Institutional Framework for Preparing Consolidated Balances on BiH Level

On the state level there is no mechanism for the preparation of consolidated fiscal balances. So far, that was done by the IMF and that is a practice that needs to be terminated. Besides the BiH Ministry of Finance and Treasury, the BiH Indirect tax Administration should be engaged in the preparation of consolidated fiscal balances, and a body (a council) could be formed within that institution, with the task of coordinating fiscal issues on BiH level.

4.12. Introduce Treasury Operations in All Public Institutions

The establishment of treasury functions in 2001 has significantly strengthened budget execution, as it enabled a more efficient control of spending and a better management of cash assets. It will be necessary to establish treasury operations on the sub entity level, which includes both cantons and municipalities³⁵. Additional steps which need to be taken include: the implementation of treasury procedures on the functioning of extra budgetary funds, the improvement of the classification of public expenditure in order for a higher level of consistency and correctness in recording to be ensured.

4.13. Strengthen Transparency and Accountability in Collection and Spending of Public Revenues

In the area of public finance, a significant step ahead has already been achieved through the establishment of external audit offices and through the establishment of treasury procedures. Additional steps which need to be taken include the following: presentation of mid-term expenditure frameworks to entity parliaments, preparation and publishing of reports aimed to the general public, on public revenue spending, further strengthening of audits, involving parliamentary commissions into the control of budgetary execution.

There is a practice of managing significant public revenues and other resources outside of the budget. In both entities, almost 50 percent of public spending happens outside of the budget, mostly through health and social insurance funds. Necessary mechanisms of coordination between different levels of government do not exit, which has lead to overlapping of functions, inconsistencies between the allocation of revenues and expenditure responsibilities, especially on the cantonal and municipal level. Entity ministries of finance must get enabled for the monitoring of extra budgetary funds, which represent a significant element of Government fiscal operations. In FBiH, insufficient analysis of spending on sub-entity levels has contributed to significant imbalances that appeared in the allocation of public sector resources, both between different levels of government, and on individual levels. The elimination of those weaknesses shall require that the entity ministries undertake activities on including the remaining extra budgetary sources of financing into the budget and improving the comprehensiveness and quality of budgetary analysis and monitoring. It shall also require that the ministers of finance make the presentation of budgets of extra budgetary funds to the parliaments, together with annual budgets, as is stipulated by the relevant laws on budgets in each of the entities. It shall be necessary to establish an adequate mechanism for coordination of budget planning issues with the District of Brčko.

In line with that, the Roads Directorate in RS shall be totally included in the Budget in 2004, and, in FBiH, full transparency in view of the usage of resources of the federal Roads Directorate, including the cantonal directorates, shall be ensured.

It shall be of key importance to increase the level of transparency and financial management in the operations of public enterprises.

4.14. Public Debt

Internal public debt in BiH in 2003 amounted to about 67 percent of GDP. In 2002, the total external debt amounted to Km 4,045,862,0133³⁶, which is about 40 percent of GDP. In view of external indebtedness, BiH can be considered a moderately indebted country. However, what makes BiH an over-indebted country is the size of internal debt, which represents one of the most severe threats to macroeconomic stability of the country. According to the Reform Scenario, the total public debt should, by 2007, be reduced to about 49 percent of GDP. In connection with that, entity governments opened an escrow account,³⁷ on which a part of privatization proceeds are deposited, together with the resources from succession, in order to ensure a starting basis for the reduction of the public debt.

The reduction of public debt to the level of 49 percent of GDP is important element for achieving credit worthiness of BiH on the international capital market. That would have a positive effect on the macroeconomic stability, prospects for a faster integration of BiH in the EU, increasing the level of interest of foreign investors and enable a larger scope of credit funds for the development of BiH.

Both entity governments have adopted plans for the reduction of the public debt, in which the following claims were identified as parts of the internal public debt:

• general claims (arrears of budgetary and extra budgetary beneficiaries),

• claims ion the basis of old foreign currency savings,

• claims on the basis of war damages (mobilized and taken over tangible and technical assets and equipment, delivery of materials, produce, goods and services rendered for the demands of military operations, pecuniary assets taken over).

In compliance with the plans for the reduction of public debt, the amount of resources to be used for the repayment of internal debt is limited to the level of 10 percent of GDP. A part of the claims shall be settled in cash, with resources from the escrow account, but the majority shall be settled through the emission of long-term bonds. A significant amount of internal debt needs to be written off.

In order to realize the plans for the reduction of public debt, it is necessary to adopt a legal framework in the first part of 2004.

4.15. External Borrowing Strategy

The macroeconomic framework envisages that BiH may attain external and fiscal sustainability, as well as limited external creditworthiness, by 2007, but this will require a considerably greater effort on structural reforms, along with the continuation of donor support. This requires adoption of a strategy of foreign borrowing.

4.15.1. Analysis of the External Debt of BiH

After the dissolution of former Yugoslavia, and during the wartime period, BiH had considerable arrears to all its creditors.³⁸ Recognition of all obligations accruing to the end of the war was a precondition for the normalization of the membership and continued extension of credits by the International Monetary Fund (IMF) and the World Bank. In the course of the debt-rescheduling process in 1996 – 1997, BiH managed to normalize relations with the majority of creditors and renew its membership in the IMF and the World Bank.³⁹ An agreement was reached with the Paris Club, which led to the reduction of BiH debt by 67%. In December 1998, an agreement was concluded with the London Club to write off 73% of this debt.⁴⁰

At end-2001, the overall indebtedness of BiH, was Km 4,045,862,013 (about 40 percent of GDP), of which KM million 2,613 (64.4%) concerns FBiH, and KM million 1,432 concerns RS (35.4%). The indebtedness of BiH on the basis of old (pre-war) debt, with December 31^st 2002, amounts to KM 2,310,334,262 (57% of overall debt), and the new (post-war) indebtedness amounts to KM 1,732,528,751 (43% of overall debt).⁴¹

The major share of the external debt was incurred with the World Bank (KM 2,173 million): on the basis of pre-war indebtedness, this debt amounts to KM 967 million, and on the basis of post-war indebtedness, KM 1,206 million (see Table in the text below). The write-off and the rescheduling of a significant part of commercial credits on the basis of IDA conditions⁴² have contributed to the favorable situation in connection with the servicing of the external debt. The private sector had limited access to foreign credits, mostly because of the lack of credit worthiness of the country. Excluding the amount for which the repayment is outstanding, the debt of the private sector represents only 0.6% of overall remaining external debt. The currency structure of the external debt is mostly in US$ and EUR.

Through analyzing the structure of post-war indebtedness, one can notice that the majority of credits were spent on budgetary support and financing in the sectors of education, health and social protection (KM 938 million). That is followed by credits for infrastructure investments (KM 493 million), and the credits spent on investments in economic activities, mostly in the private sector, are at the bottom (KM 303 million).⁴³

Table 1.

SUMMARY REVIEW OF THE STRUCTURE OF BIH BORROWING BY CREDITOR AND SHARE OF “OLD” AND “NEW” DEBT IN 1998–2002 PERIOD

Table 1.

SUMMARY REVIEW OF THE STRUCTURE OF BIH BORROWING BY CREDITOR AND SHARE OF “OLD” AND “NEW” DEBT IN 1998–2002 PERIOD

	BALANCE OF DEBT			Amounts in KM
	1998	1999	2000	2001	2002
Old debt - total	1.375.827.701	2.464.536.214	2.496.374.897	2.599.815.973	2.310.334.262
Paris Club	80.342.730	1.071.465.724	1.093.562.388	1.093.669.493	1.038.252.520
London Club	261.919.000	261.919.000	261.919.000	261.919.000	261.919.000
World Bank IBRD	956.811.503	1.035.250.094	1.089.745.567	1.197.609.567	967.255.022
Other	76.754.485	95.901.396	51.147.942	46.617.913	42.907.720
New debt - total	863.835.536	1.271.475.797	1.531.960.515	1.766.064.588	1.735.528.751
European Invest, Bank	0	0	0	7.370.670	20.210.420
World Bank IDA	729.637.014	962.675.512	1.093.900.935	1.252.873.845	1.206.232.151
Saudi Fund For reconstruction and development	29.764.717	34.893.329	42.703.705	47.637.535	47.200.235
IFAD	16.569.656	33.178.008	39.245.806	40.064.806	38.651.223
IMF	56.965.675	141.215.973	220.643.699	245.714.475	260.849.552
European development Bank Council	3.347.200	9.516.602	10.391.991	10.936.149	9.258.267
EBRD	20.520.717	55.365.170	89.407.091	108.214.122	99.671.845
European Commission / Union	0	19.558.300	19.558.300	39.116.600	29.116.600
Other	6.994.557	15.090.903	16.108.988	14.136.596	14.338.458
Balance of debt - old and new debt - together	2.239.663.237	3.736.012.011	4.028.335.412	4.365.880.561	4.045.863.013

View Table

Table 1.

SUMMARY REVIEW OF THE STRUCTURE OF BIH BORROWING BY CREDITOR AND SHARE OF “OLD” AND “NEW” DEBT IN 1998–2002 PERIOD

	BALANCE OF DEBT			Amounts in KM
	1998	1999	2000	2001	2002
Old debt - total	1.375.827.701	2.464.536.214	2.496.374.897	2.599.815.973	2.310.334.262
Paris Club	80.342.730	1.071.465.724	1.093.562.388	1.093.669.493	1.038.252.520
London Club	261.919.000	261.919.000	261.919.000	261.919.000	261.919.000
World Bank IBRD	956.811.503	1.035.250.094	1.089.745.567	1.197.609.567	967.255.022
Other	76.754.485	95.901.396	51.147.942	46.617.913	42.907.720
New debt - total	863.835.536	1.271.475.797	1.531.960.515	1.766.064.588	1.735.528.751
European Invest, Bank	0	0	0	7.370.670	20.210.420
World Bank IDA	729.637.014	962.675.512	1.093.900.935	1.252.873.845	1.206.232.151
Saudi Fund For reconstruction and development	29.764.717	34.893.329	42.703.705	47.637.535	47.200.235
IFAD	16.569.656	33.178.008	39.245.806	40.064.806	38.651.223
IMF	56.965.675	141.215.973	220.643.699	245.714.475	260.849.552
European development Bank Council	3.347.200	9.516.602	10.391.991	10.936.149	9.258.267
EBRD	20.520.717	55.365.170	89.407.091	108.214.122	99.671.845
European Commission / Union	0	19.558.300	19.558.300	39.116.600	29.116.600
Other	6.994.557	15.090.903	16.108.988	14.136.596	14.338.458
Balance of debt - old and new debt - together	2.239.663.237	3.736.012.011	4.028.335.412	4.365.880.561	4.045.863.013

SOURCE: MINISTRY OF FINANCE AND TREASURY OF BIH

^*Water, roads, electricity, waste management, telecommunications

^**Privatization projects, small enterprises, agriculture IGA

^***Social program, PFSAC, IMF, education, health

	STRUCTURE OF NEW DEBT BY SECTOR – PURPOSE				Amounts in KM
	1998	1999	2000	2001	2002
New debt - total	863.835.536	1.271.475.797	1.531.960.515	1.766.064.588	1.735.528.751
Credits for investments in infrastructure*	270.320.213	384.425.126	475.993.330	530.446.973	493.549.822
Credits for investments in economic activities**	132.983.799	187.244.233	242.600.114	261.097.636	303.121.281
Credits for public – budgetary expenditure***	460.531.524	699.806.384	813.427.071	974.519.979	938.857.648

SOURCE: MINISTRY OF FINANCE AND TREASURY OF BIH

^*Water, roads, electricity, waste management, telecommunications

^**Privatization projects, small enterprises, agriculture IGA

^***Social program, PFSAC, IMF, education, health

View Table

	STRUCTURE OF NEW DEBT BY SECTOR – PURPOSE				Amounts in KM
	1998	1999	2000	2001	2002
New debt - total	863.835.536	1.271.475.797	1.531.960.515	1.766.064.588	1.735.528.751
Credits for investments in infrastructure*	270.320.213	384.425.126	475.993.330	530.446.973	493.549.822
Credits for investments in economic activities**	132.983.799	187.244.233	242.600.114	261.097.636	303.121.281
Credits for public – budgetary expenditure***	460.531.524	699.806.384	813.427.071	974.519.979	938.857.648

SOURCE: MINISTRY OF FINANCE AND TREASURY OF BIH

^*Water, roads, electricity, waste management, telecommunications

^**Privatization projects, small enterprises, agriculture IGA

^***Social program, PFSAC, IMF, education, health

1.1. Promote entrepreneurship and more rapid private sector development

Remove administrative barriers for the start up of businesses -- reduce the time period required for the registration of business to 15 days.

1.2. Create conditions for a more efficient privatization process

A more favorable business climate will significantly improve the privatization process.

1.3. Attract more foreign investment

In the time period between 1996 and 2002, BiH attracted about USD 2,1 billion KM (1,1 billion EURO) in foreign investments. It is necessary to attract an additional USD 2 billion in foreign investments during the period from 2003 until the end of 2007 in order to meet the macroeconomic goals outlined in the midterm proposal of the Poverty Reduction Strategy Paper (PRSP).¹

4.1. The strengthening of a single economic space in BiH

The provisions of the BiH Constitution guarantee freedom of movement of persons, goods, services, and capital.⁴ However, despite the success of the past few years, there still exist certain obstacles that make it difficult to conduct business countrywide.

The harmonization of the tax system was achieved largely in the area of indirect taxation. However, in the area of direct taxes, e.g. income tax, one still finds double taxation.

The European Commission project, Single Economic Space⁵, noticed a number of inter-entity problems pertaining to trade, production, carrying out services, and the mobility of the work force. The project focuses on a limited number of activities, including the production and trade of medicines for human consumption, the movement of goods with the CE mark, phyto-sanitary controls in the entities, inspection (Brčko), market barriers in the entity laws, bus transport, free movement of the labor force, and market surveillance. Practices in all of the above areas points to an absence of the constitutionally guaranteed freedom of movement of goods, services, capital, and persons.⁶

The fact that the state level government does not have a larger role in creating and coordinating the economic policy of the country poses a particular problem.

Infrastructure is an area that is quite fragmented, as can be seen in the functioning of the railroads.⁷

The transposition of the EU Acquis Communutaire (the complete legal heritage of the EU), as a part of the stabilization and association process, will help resolve the above problems and integrate the BiH economic space. Added institutional building and technical infrastructure modeled after the internal EU market, will aid in creating a single economic space and movement towards integration into the EU market. This, in turn, will accomplish three important goals – an improved business climate and increased efficiency of the BiH market; better consumer protection; the creation of preconditions for more exports to the EU.

In line with the above, it is necessary to achieve the following priorities:

4.2. Maintaining macroeconomic stability

In the years following the end of the war, BiH succeeded in maintaining macroeconomic stability. This is an important presumption for a better business environment in the upcoming period.

4.3. Eliminating all forms of unfair competition

A significant portion of the BiH economy is still gray (36%). There is smuggling of goods, especially those with higher tariffs. Even though an accurate analysis has never been carried out, the international community, the OHR, and CAFAO in particular, have made public audit information that shows an amount of up to KM 1 billion a year.¹¹ Unfair competition is also a large obstacle to substantial domestic production, and consequent increased employment.

It is important to strengthen the State Boarder Services, establish a customs administration on the state level, simplify customs procedures and reduce the number of custom-houses, adopt procedures that will ensure the import of petroleum and petroleum products by rail only, and increase control over the free custom zones. It is especially important to establish a BiH indirect taxation authority and introduce a value added tax (VAT) before the end of 2006.

4.4. Removing all administrative barriers to domestic and foreign investment and reducing the cost of registering businesses

In 2001, it took an average of 120 day to register a business. According to this year’s research conducted by the World Bank, over the last two years the number of days has dropped¹²; it now takes 59 days¹³ to register a business. Nonetheless, this change does not constitute a satisfactory improvement. However, the entity governments report that the number has fallen down to around 30 days.¹⁴ Regardless of the various data, it takes too long to register a company in BiH. There are several factors that attribute to this, including strict administrative regulations, inadequate administrative apparatus, and the large number of state level institutions involved with registration (12 to be exact). It is therefore necessary to simplify registration procedures and reduce the number to institutions involved in the process to a bare minimum, as in the case of the registration of foreign enterprises.

When comparing registration costs, it is evident that start up costs for companies registering their business in BiH are extremely high, and much higher than in other countries in transition or the OECD countries.¹⁵ Consequently, measures need to be taken to reduce the costs of registering a company in BiH.

In relation to the above, it is paramount to adopt a framework Law on the Registration of Businesses, as well as respective entity laws, and to establish entity business registers and one single date base for BiH.

4.5. Accelerating commercial dispute settlements

Settling commercial disputes in BiH is a lengthy and costly affair. According to World Bank research,¹⁶ the average time period required to settle a commercial dispute in a judicial proceedings takes around 630 days. With the exception of Slovenia and Poland, in BiH this procedure lasts longer than in any of the other countries in transition and twice as long when compared to the OECD average.

At the moment, judicial reform is underway, a part of which is amended criminal and procedural laws. Several activities have been underway in cooperation with USAID, including the formation of 16 commercial divisions as a part of first instance courts in BiH, the appointment of judges, and judicial training in the area of commercial disputes. In addition to the above, there should also be an alternative, out-of-court system for commercial dispute settlement (arbitration).

4.6. Simplifying the tax system in BiH

There is double taxation in BiH, especially in the areas of profit and income taxes. The introduction of a VAT will to a large extent simplify the country’s tax system.

Reform of tax on profit and income tax would lead to their simplification and the abolishment of double taxation. Additional activities should include continuing with the reduction of tax withholding which would automatically stimulate a reduction of the gray economy; adopting a Code of Conduct for tax officials on all levels; and the establishment of an independent appellate body on all levels to decide on appeals of tax administration decisions.

4.7. Strengthening corporate governance¹⁷

Efficient corporative governance is an important prerequisite for the creation of better business environment, which means the proper functioning of the financial market in BiH. Strong corporative governance improves access to capital markets, increases the trust of investors, and strengthens a company’s competitiveness. The main problem with corporate governance in BiH lies with the fact that 60 percent of the economy is still state owned. On the other hand, the privatization model used has led to ownership dispersion, the appearance of PIF, as well as a fragmented and insufficiently liquid capital market. The fact that there is no tradition of corporate governance results in a lack of information on the part of owners regarding their rights and responsibilities, and this presents a particular problem.

In addition to focusing on the ongoing reforms in the area of enterprise legislation, other issues, such as a quicker privatization process, continued activities in strengthening the capital market, and especially its regulatory framework must also be dealt with. An important measure in supporting corporate governance would be if stock companies and public companies were required by law to be quoted on the stock market. This would not only contribute to the development of the capital market, but would also increase their transparency.

4.8. Restructuring of inspections

Due to the multi-layered system of state organization, there is much overlap of authority when it comes to inspections. The system of inspection of private sector activities is massive, the required coordination does not exist, and the inspectors’ discretionary power is too great. There are too many inspections, and this work is not transparent. The governments of the Federation of BiH and the RS have adopted action plans for the reorganization of inspections. These action plans address reforms in three major areas – drafting regulations, the internal organization of entity inspections, and the training of inspectors.

In the upcoming period it will be necessary to adopt a BiH framework Law on Inspections, as well as respective entity laws. Furthermore, a Federation inspectorate and the RS inspectorate must be established. In the Federation of BiH, each canton has its own inspectorate. The aim of the restructuring of the inspectorates is to centralize inspections into several inspectorates in order to increase their efficiency, transparency and to reduce costs.

4.9. Ensuring more efficient protection of creditors and creating greater access to bank loans

As previously stated, there should be a more efficient system for the resolution of commercial disputes. This must be accomplished in the upcoming period. In addition to slow court procedures, another problem is the fact that a proper system for the protection of creditors does not exist. Credit securing is not systemized, nor is there an efficient mechanism for collection, both of which present obstacles to greater availability of loans to the private sector. The collection of collateral in BiH is still quite complicated and must be simplified. It is necessary to adopt a number of new laws and to amend existing ones, so that there is a more efficient mechanism for the protection of creditors in place. In relation to the above, it is necessary to adopt mutually harmonized entity level Law on Obligations and Law of Things in the FBiH and the RS, and the Law on Notaries in the RS. It is particularly important to adopt a state level Law on the Registration of Pledges on Movable Property, as well as entity Laws on the Registration of Pledges on Movables, and to establish a single register of pledges on the BiH level.

The Bankruptcy Law and the Law on Liquidation play a significant role in creating an attractive business environment. Recently, the RS adopted a Bankruptcy Law, which meets the requirements of the contemporary business climate. However, the same cannot be said of the FBiH, which gives an unlimited right to collect back salaries in full. In this way, other creditors are put in an unfavorable position and have no incentive to decide for bankruptcy and restructuring of a company in order to revive it. With such a law, creditors are more likely to liquidate a company. Therefore, the FBiH Bankruptcy Law must be amended.

4.10. Implementing reforms in order to combat corruption more efficiently

According to research done by the World Bank in cooperation with local experts¹⁸, the level of corruption in BiH presents a big obstacle to private sector development. According to this research, “18 percent of costs incurred by companies go to pay bribes” and in the process of doing business, managers spend one tenth of their managing time communicating with government representatives.¹⁹ It is necessary to implement an action plan for combating corruption, which is an integral part of the PRSP.

4.11. Modernizing the system for land and real estate management

There are no harmonized laws regarding ownership and transfer of ownership of all types of real estate. Obtaining zoning permits and building permits is a slow and costly affair. The unresolved issue of restitution poses an added problem. A number of problems have been discovered during privatization regarding the transfer of ownership of real estate, which additionally complicates privatization, making it less efficient, especially in the case of PIF.

What is needed is to strengthen the urban planning system and coordination at all levels to eliminate the Institute for Urban Planning’s monopoly in the process of preparation of infrastructure development of locations, as well as to introduce private sector competition, and to merge the procedures for obtaining zoning permits and building permits. In this context, modern cadastre laws must be adopted in order to integrate land books and the cadastre, a state Law on Restitution must be adopted, and the process of amending existing laws must be accelerated in order to resolve property rights issues related to privatization in a more expedient manner. It is particularly important to introduce a harmonized system for land registration, which would bring about a greater level of trust in exercising one’s property rights.²⁰

4.12. Providing more effective protection of intellectual, industrial, and commercial property

One of the prerequisites of the Stabilization and Association Agreement (SAA) is more effective protection of intellectual, industrial, and commercial property, including protection from counterfeiting and piracy. BiH also needs to sign multilateral European conventions in this area.²¹

4.13. Institutionalize existing activities which would bring about dialogue with the private sector

The influence that the private sector has over the government is quite weak, with a visible tendency of strengthening associations, formed outside of chambers, on the basis of voluntary membership. Still, considering the tradition, it would seem most logical that the chambers, and the Foreign Trade Chamber of BiH in particular, would be the most important partner for the governments at all levels. In the past two years, the so-called Bulldozer Committee has yielded the best results in terms of cooperation between the private sector and the government on the issue of improving the business climate. This is in part due to the fact that this committee has been established by the OHR. Taking into account the results achieved so far, it is paramount to continue with the activities modeled after the Bulldozer Committee. The local authorities must takeover the ownership of this initiative from the OHR. In the same context, it is important to schedule regular work of the economic and social councils in the entities.

5.1. Situation

In the time period between 1996 and 2002, BiH attracted around USD 710 million in foreign investments. In 2002, the inflow of foreign investment grew (USD 240 million) and achieved a 100 percent increase in comparison to the previous year. Nonetheless, the number of investments in BiH is generally low. The total per capita inflow of foreign investment in the postwar period has been around USD 166, far below the average for countries in transition. For the sake of comparison, during the same time period, per capita foreign investment in Croatia was USD 1,321, in Bulgaria USD 480, and in Romania USD 288. The level of foreign investment in Macedonia and Albania is also high three times higher²² It should be noted that in just two years Serbia and Montenegro succeeded in attracting three times as much foreign investment as BiH.

There has been no considerable foreign investment in the real sector in BiH. This presents a particular weakness from the point of view of competitiveness of the local economy, and consequently exports and employment. The structure of foreign investments by sectors is not particularly dispersed. Investment in the exploitation of resources (the steel plant in Zenica and the cement factory in Kakanj) and the finance system (as much as five out of the ten largest investments are in the banking sector) are at the forefront.

In order to meet macroeconomic goals set in the midterm proposal of the Poverty Reduction Strategy Paper (PRSP) by 2007, it will be necessary to attract an additional USD 2 billion in foreign investment. This represents a great challenge, given the situation of the BiH economy, the worldwide investment crisis, and the fact that there is strong competition among countries in the region, which also base their economic development on attracting foreign investment.

The attraction of a greater share of foreign investment remains an important priority of the midterm proposal of the Poverty Reduction Strategy Paper (PRSP), given the many positive effects that these investments create, including increased employment, new management skills, new technologies, new markets, and more exports.

5.2. Priority activities

In order to attract more foreign investment, the above priorities must be achieved, starting with the strengthening of a single economic space and maintaining macroeconomic stability, as well as putting in place all the other elements important in the creation of a business environment more conducive to domestic and foreign investment.

The following text emphasizes the reforms and measures that would affect the increased competitiveness of the BiH economy, an important prerequisite for attracting a larger share of foreign investment, as well as private sector development.

6.1. Situation